group 3 - merck

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2013

Merck and Company: Evaluating a Dru

Licensing Opportunit

Subject: Quantitative Techniques III

Professor: Prof. Bhavin J. Shah

Group No: 3

Date: 6th

March, 2013

IIM Indore PGP Mumbai

Batch of 2014

Prepared By:Ankur Sinha (03)

Arvind Kumar (05)

Gunreet Kaur Thind (11)

Karri Kartik (14)

Pradyoth C John (23)

Sandeep Sayal (28)

Abhijeet Panwar (35)



QT-3 Assignment Merck and Co

Table of Contents

1. INTRODUCTION........................................................................................................3

1.1 Situation Analysis………………………………………………………………………………………………………3

1.2 Objective……………………………………………………………………………..……………………………………3

1.3 Problem Statement………………………………………………………………..…………………………………3

2. ANALYSIS ...................................................................................................................4

2.1 Alternate course of action .............................................................................................4

2.2 Decision Tree ..................................................................................................................5

2.3 Should Merck bid for the license? .................................................................................6

2.4 Expected value of licensing arrangement to LAB ..........................................................6

2.5 Sensitivity analysis…………………………………………………………………….8

3. REFERENCES……………………………………………………….........................9




1. INTRODUCTION

1.1 SITUATION ANALYSIS – RELEVANT CASE FACTS

Merck is a global research driven pharmaceutical company that discovers, develops,

manufactures and markets a broad range of human and animal health products.

Merck earns most revenue from a handful of patented drugs. The company continuously

refreshes its product portfolio by developing new drugs directly or through joint

ventures. This is very important for the company to sustain high growth year after year.

LAB Pharmaceuticals has developed a drug, Davanrik, to treat both depression and

obesity.

LAB had previously tried to get approval for one of its compounds but was unsuccessful.

So it had decided to partner with an established Pharmaceutical company to conduct

clinical trials.

The licensing agreement would require Merck to conduct the clinical trials, market the

drug. Lab would earn via licensing fees - royalty on sales and milestone based payments.

After the approval, the patent protection will last for about 10 years.

1.2 OBJECTIVE

Rich Kender, Vice President of Financial Evaluation & Analysis at Merck, was working withhis team to decide whether Merck should license Davanrik.

1.3 PROBLEM STATEMENT

Should Merck license the Davanrik? If yes, what should be the licensing fee? How sensitive is

this decision on future cash flows associated with various costs?




2. ANALYSIS

2.1 Alternate course of Action

License the drug

Do not license the drug




2.2 Decision Tree1

Launch Revenue

0.85 680

Phase 3 success -250 680 1200 680

1

-200 680

0.1Depression(Phase II) -270

0 -270

-40 537.5

0.15

Phase 3 fail

-270

-200 -270

1

Launch Revenue

0.75 25

Phase III success -100 25 345 25

1

-150 25

0.15 Don't launch

Weight loss -220

0 -220

-40 -36.25

0.25

Phase III fail

-220

-150 -220

1

Launch Revenue

0.7 1280

Dual(Phase III success) -400 1280 2250 1280

1

0.6 -500 1280

Phase I Success Don’t launch

-570

-30 43.3 0 -570

1

Launch Revenue

0.15 380

Depression(Phase III succes -250 380 1200 380

1

-500 380

0.05 Don’t launch

Dual -570

0 -570

-40 879.75

1

Launch Revenue

0.05 -325

License Weight loss(Phase III succe -100 -325 345 -325

1

0 13.98 -500 -325

Don’t launch

-570

0 -570

0.1

Phase III fail

-570

-500 -570

1 0.7

13.98 Fail

-70

-40 -70

0.4

Phase I fail

-30

-30 -30

Don’t License

0

0 0




Since the EMV of the decision tree is positive, Merck should license Davanrik.

From consolidated income statement, we could calculate the retained earnings as a

percentage of income before taxes.

Retained earnings as a percentage of PBT =

This should be maintained for this deal as well. Hence the most Merck could pay as

licensing fee is = 37.84% of $ 13.98 million = $ 5.29 Million

2.3 Should Merck bid to license Davanrik?

As the expected monetary value for licensing the drug is positive ($ 13.98 million), Merck

should license Davanrik.

Probability Failure

Phase I 0.4

Phase II 0.42

Phase III Depression 0.009

Weight Loss 0.0225

Dual 0.003

0.85

Money at stake Expected value $ Million

Phase I 12

Phase II 46.8

Phase III 71.8

3.375

1.5

Total 135.475

From the table above, we could see that expected value for failure is $ 135 million. Also,

since the payments are to be made on basis of milestones, Merck would have the advantage

of pulling out on later stages if progress is not made. The chances of failure reduce

dramatically once the drug passes Phase II testing. So Merck will risk losing $ 70 million only.

Once the drug passes Phase II, the chances of success are very high and it would only

require additional investment of $ 65 million.

2.4 What is the expected value of licensing arrangement to LAB? (5% royalty

assumed)

The cash flows of LAB are :1. $ 5 million initial licensing fee in Phase I ( irrespective of success of Phase 1)




2. $ 2.5 million in Phase II (Probability of occurrence 0.6)

3. Phase III

a. $ 20 million if the drug cures only depression (Probability of occurrence 0.1)

b. $ 10 million for weight loss only (Probability of occurrence 0.15)

c. $ 40 million if drug cures both depression and weight loss (Probability ofoccurrence 0.05)

What LAB expects

Cash flows

( $ millions)

Initialization 5 Formula

Phase I 1.5 .6*.25

Phase II Depression 1.2 .6*.1.*20

Weight

Loss 0.9 .6*.15*.10

Dual 1.2 .6*.05*.40

Total 9.8

Expected royalty to LAB

Gross cash

flows ($

millions) Royalty % Probability Expected

Depression independent 1200 5% 5.1 3.1

Weight Loss 345 5% 6.75 1.2

Depression – dual 1200 5% 0.45 0.3

Weight Loss – dual 245 5% 0.15 0.1

Dual only 2200 5% 2.1 2.4

Total 6.9




2.5 How would your analysis change if the cost of launching Davanrik for

weight loss were $ 225 million instead of $ 100 million?

Decision tree for the new scenario is:1

Launch Revenue

0.85 680Phase 3 success -250 680 1200 680

1

-200 680

0.1

Depression(Phase II) -270

0 -270

-40 537.5

0.15

Phase 3 fail

-270

-200 -270

1

Launch Revenue

0.75 -100

Phase III success -225 -100 345 -100

1

-150 -100

0.15 Don't launch

Weight loss -220

0 -220

-40 -130

0.25

Phase III fail

-220

-150 -220

1

Launch Revenue

0.7 1280

Dual(Phase III success) -400 1280 2250 1280

1

0.6 -500 1280

Phase I Success Don’t launch

-570

-30 28.925 0 -570

1

Launch Revenue

0.15 380

Depression(Phase III succe -250 380 1200 380

1

-500 380

0.05 Don’t launch

Dual -570

0 -570

-40 873.5

1

Launch Revenue

0.05 -450

License Weight loss(Phase III succe -225 -450 345 -450

1

0 5.355 -500 -450

Don’t launch

-570

0 -570

0.1

Phase III fail

-570

-500 -570

1 0.7

5.355 Fail

-70

-40 -70

0.4

Phase I fail

-30

-30 -30

Don’t License

0

0 0




From the tree, we could see that launching weight loss when the launching fee is $ 225

million would lead to losses. However, net EMV of the decision tree is still positive. Hence

Merck should still license the drug.

Case (i) If Merck finds out the Davanrik can cure only weight loss after Phase II, it should notproceed any further. Since the loss incurred ($ 70 million) will be less than the loss ($ 100

million) if the product is launched.

Case (ii) If Phase II indicates dual efficacy and Phase III results in efficacy for only weight loss,

then Merck should go still launch the product as it will result in lower losses ($ 450 million)

than abandoning the product ($ 540 million)

3. LIST OF REFERENCES

Richard S.Ruback , “ Merck & Company: Evaluating a Drug Licensing Opportunity .”

Harvard Business School Case 9-201-023 25 March, 2003.

group 3 - merck

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