mera merck

7/25/2019 Mera Merck

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Background Knowledge

Net Present Value - present value of future cash flows, discounted at appropriate interest rate, minus the presentvalue of the cost of investment. An investment is worth making if NPV is positive, otherwise it should berejected.

NPV = - cost PV

!ecision "ree # it breaks comple$ business into components b% setting out ke% decisions as a series of &%es orno' decision forks and subse(uent random outcomes as additional forks with probabilities.

!ecision tree anal%sis - )idel% used techni(ue to determine value of investments under uncertaint%

*ain steps+

#!etermine possible states of nature

#!etermine probabilit% of reaching each state

#!etermine NPV for each end state

$pected NPVpa%off for each outcome is the NPV multiplied b% the probabilit% of that fork.

$pected NPV of e$periment is e$pected NPV for the decision forks times the probabilities of the e$perimentaloutcomes

hoose the highest e$pected NPV branch at &decision forks'

Case Brief

"he case talks about *erck / o., 0nc., which was a global-research driven compan% and is tr%ing to

bid for a license to develop a drug from another compan%. 1ince 2334, the compan% has launched 24 new

products and the earning of the compan% are 54.3 billion on 2333 sales of 567.8 billion, about a 79: increase

from 233;.


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a patent on the product, which is estimated to have a remaining life, including all possible e$tensions, of 28

%ears. "herefore, the product would have a 29-%ear period of e$clusivit%, beginning in 8 %ears.

Problems Identified

0n the given case the compan% must decide on a plan of action based on a number of possibilities. 0n order to

come to a decision to license !avanrik or not *erck must carefull% anal%Ee the various possibilities in the

project. 1ince at each step a decision has to be made and there is a probabilit% of following a particular path, a

decision tree can be used to help solve the problem. "he tree would give a clear picture of the various options

available at each step and b% calculating the NPV at each decision stage starting from the last and moving to the

first we can estimate whether *erck should license !avanrik or not.

Detailed Analysis

Q1.Fow has *erck been able to achieve substantial returns to capital given the large and length% time to

develop drugsG

Solution

As can be seen from the case facts, a handful of *erckBs popular drugs, namel%, Vasotec, *evacor,

Prinivil, and Pepcid generated 54.8 billion in worldwide sales. "his was primaril% due to the patents on these

drugs.


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H7. uild a decision tree that shows the cash flows and probabilities at all stages of the approval process.

H6. 1hould *erck bid to license !avanrikG Fow much should the% pa%G

1olution+

$pected NPV of the project is calculated b% taking product of the estimated NPV of a particular case and its

corresponding probabilit% of occurrence. As the e$pected NPV of this project is found to be 5 26.3; millionwhich is positive, the project should be accepted. *erck should bid to license !avanrik.

"he pa%ment to @A should be done in such a manner that it should not e$ceed the e$pected NPV. 0n case

*erck agrees to pa% @A the amount e(ual to e$pected NPV, the% will not make an% profit on this project.

"herefore, total pa%ments to @A should be kept below 526.3; million mark. "he e$act amount should be

finaliEed as per the polic% of the organiEation and in accordance with the return that *erck want from this

project.

HI. )hat is the e$pected value of the licensing arrangement to @AG Assume a 4: ro%alt% fee for an% cash

flows that *erck receives from !evanrik after a successful launch.

1olution+

$pected value of the licensing arrangement to @A will be the total of e$pected value of licensing

fee and e$pected value of the ro%alt% received b% sales of drug if the D!A approval is granted.

Ye

sPhase I:

Cost = $30 mn

Failure (0.4)

NPV = -$30

mn

Liense

!

No

"uess

(0.#)Phase II

Cost = $40

mn

e%ression &nl'

(0.)

&esit' &nl'

(0.*)

+oth (0.0*)

Failure (0.,)

NPV= -$,0n

"uess (0.*)

NPV = $#0

mn

Failure (0.*)

NPV = -$/,0

mn"uess

(0.,*)

NPV = $/*

mn

Failure (0./*)

NPV = -$//0

mn"uess (0.,)

NPV = $/0 mn

Phase III

Cost = $/00

mn

e%ression &nl'

(0.*)

NPV = $30 mn

&esit' &nl'

(0.0*)

NPV = - $3/*mn

None (0.0)

NPV = -$*,0 mn

Phase III

Cost = $*0mn

Phase III

Cost = $*00

mn


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$pected values of licensing fee and ro%alt% can be calculated b% multipl%ing amount of licensing fee

and ro%alt% with its corresponding probabilit%.

"he following values were found+

@icensing Dee?= 5 J.93 million

>o%alt%?=5 J.;84 million

"herefore,

@icensing Arrangement? = @icensing Dee? >o%alt%?

= 5 27.3J4 million

H4. Fow would %our anal%sis change if the cost of launching !avanrik for weight loss were 5774 million

instead of 5299 million as given in the caseG

1olution+

"o anal%Ee the affect of this change we will have to calculate the e$pected NPV of the project again.

!ue to increase in cost of launching the NPV of success for obesit% treatment will reduce to -5299 million from

initial value of 574 million. 1imilarl%, the NPV of launching of this drug after failure of Phase 000 for both uses

will go further negative to -5I49 million from the initial value e(ual to -5674 million. "hese changes will reduce

the $pected NPV of the complete project from 526.3; million to 54.644 million.

!ecommendations

According to the anal%sis performed above we would recommend *erck / o. to bid for the !avanrik drug

because the Net Present Value NPV? is positive. "he onl% concern is the riskiness of the project. "he new drug

has to pass the three phase test procedure before it is launched and commercialiEed. ut there are onl% 9.6

probabilities that the drug would cross Phase 00 of the testing process and hence has a ver% high probabilit% of

failing in Phase 00 onl%. )e believe that *erck and o. should not pa% the licensing fee to @A pharmaceuticals

until the drug is successfull% tested and launched.


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