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Decision
Case: Merck & Company:
Evaluating a Drug Licensing
Opportunity
1
Broad
range
human and
animal
health
products
Merc
k
Directly
Through joint ventures
Providing pharmaceutical benefit
management services (PBM)
through Merck-Medco Managed
care
Lab
Davanrik
Initial fee
Responsible for the approval of Davanrik, its
manufacture, and its marketing
Royalty on all sales
Merc
k
Compound Success
Rates by Stage
5,000-10,000
screened
Discovery
(2-10 Years)
250
enter preclinical testing
Preclinical Testing
5
enter clinical testing
Phase I
20-80 healthy volunteers used to
determine safety and dosage
Phase II
100-300 patient volunteers used
to look for efficacy and side effects
Phase III
FDA Review/
Approval
Additional
Post-marketing Testing
0
Years
10
12
14
16
Phase I
Tested on
20-80
healthy
volunteers
Phase II
(clinical testing)
Phase III
100-300
of patient
volunteers
1000-5000 of
patients
Effectiveness
Potential side
effect
Safety and
efficacy
in long-term use
Time
taken
2 years
2 years
3 years
Cost
$30 million
$40 million
Depression: 200
mn
Weight loss: $150
mn
Both: $500 mn
Initial
fee /
Milestone
$5 million
$2.5 million
Depression: 20
mn
7
Weight loss: $10
Probability of Success
Phase I
Chance of
success
Phase II
(clinical testing)
Depression: 10%
Weight loss: 15%
Both: 5%
60%
Phase III
Depression: 85%
Weight loss: 75%
Both: 70%
Depression: 15%
Weight loss: 5%
Both: 10%
Cash Flows
Cost to launch
Commercialization
present value
Depression only
Both
$250 million
$100 million
$400 million
$1.2 billion
$345 million
$2.25 billion
All cash flows are expressed as after-tax present values discounted to time zero, including capital
expenditures
Present value is calculated as the after-tax present value of 10 years worth of cash flows from the
drug discounted back to today
It was believed that after 10 years, the drug had very little value to the company since it would be
off
8
its patent by then (and thus a terminal value of zero was used in the calculations)
Possible
Outcome
Probability
10
Cash Outflow
Commercial
Value
$1200
mn
$345 mn
$2250
mn
$1200
mn
$345 mn
Failure
Probability
0.90%
2.25%
40%
42%
0.30%
Total: 85.45%
Success
Probability
6%
60%
9%
3%
5.10%
6.75%
2.10%
0.45%
0.15%
Total: 92.55%
Total Possible
Probability
5.10%
0.90%
6.75%
2.25%
2.10%
0.45%
0.15%
40%
42%
0.30%
Total: 10%
Cash Flow
Outcome
$680 mn
-$270
mn
$25 mn
-$220
mn
$1280
mn
$380 mn
-325 mn
-$30 mn
-$70 mn
-570 mn
Expected Cash
Flow
5.10%*$680 mn = $34.7
mn
0.90%*-$270 mn = -$2.4
mn
6.75%*$25 mn = $1.7 mn
2.25%*-$220 mn = -$5
mn
2.10%*$1280 mn =
$26.90 mn
0.45%*$380 mn = $1.70
mn
0.15%*-$325 mn = -$0.5
mn
40%*-$30 mn = -$12
mn
42%*-$70 mn = $29.4 mn
0.30%*-370 mn = -$ 1.7
mn
Total: $14 mn
Expected
Milestone
Payment
6%* $20 mn =
$1.2 mn
60% * $2.5 mn
= $1.5 mn
100% * $5mn
= $5mn
9% * $10 mn =
$0.9 mn
3% * $40 mn =
$1.2 mn
Total: $9.8 mn
Expected Royalty
Payment
5.10% * $1263 mn *5% =
$3.22 mn
6.75% * $363 mn * 5% =
$1.23 mn
0.15% * $2368 mn * 5% =
$2.49 mn
2.10% * $1263 * 5% =
$0.28 mn
0.45% * $363 mn * 5% =
$0.03 mn
Total: $7.25 mn
Non risk based techniques assumes that all projects were to be equally risky, acceptance of any project
would not alter the firms overall risk
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