Merck and Lab Pharmaceuticals Case Study

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Business description In 2000 Merck is a successful pharmaceutical company with a handful of drugs developed internally as well as in joint-ventures. Its success however linked to the exclusivity rights of its patents, which makes its investors concerned about the close expiration (2002) of several patents of its blockbusters, which would dry out future revenues. The long-term viability of the company depends thus on the ability to refresh its portfolio of patent-protected drugs in order to counterbalance the loss of sales resulting from the generics. The large financial capacity of Merck & Co enables the company to buy rights to test, manufacture and market compounds which were generated by smaller companies which lack the capital or want…show more content…
Notice that in this scenario the net present value for each testing phase is positive, so if given the possibility Merck will continue the testing until the final results.

Project’s value for LAB From LAB’s point of view, after agreeing upon the contract the company will receive the initial sum, a fixed sum per testing phase and 5% royalty fees expressed as percentage of sales. Since the present values of the future cash flows post phase III exclude already the royalty fees, we have considered them to be 95% of the sales and assumed the future cash flows are sales minus royalty fees, which implies that the value of the royalty fees is (5%*100)/95 multiplied by the value of the future cash flows. Knowing that Merck will proceed with all the testing phases and using the same probabilities as before, after having computed the expected payoffs for LAB and because the company won’t have costs during the testing process, we have reached a NPV of 16.69 mil (see Appendix) + the initial price of the contract for LAB, thus maximum 30.67 (16.69+max 13.98 Merck is willing to pay for the contract).

Change of scenario An increase in the costs for weight loss scenario will impact multiple levels of the decision tree: first the launching of the weight loss Davanrik will be less profitable, which determines a negative NPV of proceeding with the Phase III of the testing if the Phase II concludes that the drug will be effective only for weight loss,
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