Financial Management

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Financial Management

Executive Summary

In 2000, Merck & Co., Inc., a global research-driven pharmaceutical company, was facing a threat that patents of their most popular drugs would expire in two years. Following by the patents expiration, companys sales and profits would decline dramatically since generic substitutes would take place. The only way to recover the loss caused by patents expiration was to develop new drugs and refresh the companys portfolio.

Table of Contents

Should Merck bid to license Davanrik? How much should they pay?4

Davanrik Expected Value4

What is the expected value of the licensing arrangement to LAB? Assume a 5% royalty fee on any cash flows that Merck receives from Davanrik after a successful launch6

The Problem6


How would your analysis change if the costs of launching Davanrik for weight loss were $225 million instead of $100 million as given in the case?11

What other issues should Merck consider in taking this decision?12

How has Merck been able to achieve substantial returns on capital given the large costs and lengthy time to develop a drug?13

Drug Development13


Financial management

Should Merck bid to license Davanrik? How much should they pay?

Davanrik Expected Value

The bidding decision should be based on the evaluation of expected value from Davanriks potential testing outcomes. As Mercks financial evaluation team, we analyzed this offer through decision tree analysis, and estimated the expected value from each possible outcome and the expected payments to the LAB. We concluded the expected value of licensing Davanrik is around $13.69 million, which included the expected payments to the LAB of $16.68 million.

LAB Pharmaceuticals, who specializes in developing compounds for treatment of neurological disorders, offered Merck to license a new developing drug, Davanrik, which had functions to treat depression, obesity or both. At the time of the offer, Davanrik was in pre-clinical development, which would need to pass the three-phase clinical tests approved by the FDA. Testing would last seven years, which would appear to be high failure and costly. Under the licensing agreement, Merck would be responsible for the approval of Davanrik from the FDA, its manufacturing, and its marketing. As return, Merck would pay LAB an initial fee, a loyalty on all sales, and make additional payments as Davanrik completed each stage of the approval process.

First, we created a decision tree to analyze success or failure possibilities for potential outcomes for each phase. Possibilities of success and failure, and cash flows in each stage were listed below. We conclude that there were five successful outcomes: depression only, weight-loss only, dual, depression from dual trial and weight-loss from dual trial. Accordingly there were five failures: failure at phase I, failure at phase II, failure at phase III at depression test, failure at phase III at weight-loss test and failure at phase III at dual test. In total, there were ten possible outcomes with different success and failure rates.


Phase III Launch Loyalty PV NPV

Phase II

Success - 85% -250 -3.06 1200 676.94

Depression - 10%

-200 Failure - 15%

Success - 75% -100 -1.16 345 23.84

Weight Loss - 15%

-150 Failure - 25%

Phase I

Success - 60% ...
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