Ali Amar

(09122)
Mon/Wed 1st Slot
Advanced Managerial Accounting
Sir Mohsin Patel
Summary of Merck and co Case Study

This case study is about a research-driven pharmaceutical company Merck

and Co which constantly develops and markets human and animal health
products. Merck and co is one of the largest pharma companies in the world
with revenues of $32.7 billion. The main problem for Merck is that some of its
top products like Vasotec, Mevacor, Prinivil, and Pepcid will have
expired patents in 2002. This will lead to a substantial decline in their sales
as more companies start to produce these drugs. The only way to cover the
lost sales is to develop new drugs and constantly refresh the companys
portfolio. Most of Mercks products are developed through internal research
but Davanrik a medicine from LAB pharma has caught Merck attention.
LAB pharma initially developed Davanrik to treat depression but further
testing revealed that it could also be used to treat obesity. LAB pharma had
approached Merck to sell the licensing rights for Davanrik because they
lacked the resources necessary for the completion of a lengthy process by
the FDA. Merck would pay LAB an initial fee, a royalty on all sales, and make
additional payments as Davanrik completed each stage of the approval
process. At the time of the offer from LAB the drug was in the pre-clinical
development, ready to enter the three phase clinical approval process
required for pharmaceuticals in the United States. In phase 1 the drug is
given to a small number of people in order to test its safety. In phase 2 a
larger number of people are tested in order to test the effectiveness the
drug. In phase 3 a large number of people are tested for safety and
effectiveness.
Potential Cash Flows from Davanrik
All the phases will take a combined time of 7 years after which
Merck will get a patent for 10 years.
Phase 1: In phase one the drug would be administered to 20-80 healthy
individuals to test if the drug is safe enough to continue to efficacy stages. It
would take 2 years to complete and cost $30 million including $5 million paid
to LAB. There is a 60% chance of success in this phase.

Phase 2: In phase 2 the drug would be given to 100 300 patient volunteers
to determine its effectiveness in treating depression and/or obesity. The
Merck team estimated a 10% probability that Phase II would show that the
drug would be effective for depression only, a 15% probability for weight loss
only, and a 5% probability that it would be efficacious for both depression
and weight loss at the same time. It would take 2 years to complete and
would cost $40 million, including a $2.5 paid to LAB.

Phase 3: In this phase Davanrik would be administered to 1000-5000 people

to determine safety and efficacy in long term use. This phase would take 3
years to complete. The costs incurred in phase 3 depend on the result from
phase 2. If Davanrik was effective for only depression in phase 2 Phase 3 t
would cost $200 million including a $20 million payment to LAB, and will
have an 85% chance of success. If it were effective for weight loss only, it
would cost $150 million including a $10 million LAB payment, and have a
75% chance of success. If it was effective for both the diseases it would cost
$500 million, including a $40 million licensing payment to LAB, and had a
70% chance of successful outcome. There is a 15% chance of a successful
outcome for depression only, and a 5% chance of a successful outcome for
weight loss only. The probability of complete failure of the dual indications or
either separate indication is 10%.
The company has estimated that if the drug passed all three stages it would
generate substantial revenues. If the drug was only approved for depression
it would cost $250 million to launch and will have a value of $1.2 billion. If
the drug is only approves for obesity it would cost $100 million to launch,
and would have a PV of $345 million. If the drug is successful in treating both
the diseases it would cost $400 million to launch and have a PV of $2.25
billion.
In multi stage cases like these a decision tree would be most suitable more
good decision making.