Merck & Company Opportunity .

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INTRODUCTION

-Evaluating

Drug

Licensing

Merck & Company : Evaluating the Licensing Opportunity Various recently-born biotech companies sell their technologies in either finished or early stage to bigger companies in need of financing capital to preceed business, while those bigger companies acquire technologies to scout for promising profitable business. This sort of process needs numbers of decision makings and agreements from both parties on the valuation methods is crucial here. The valuation method being used has to hold objective validity and generality. For the managers to make accurate forecast of future profitability in managing companies, quantified decision making process is needed. Here we are dealing about whether Merck should give financial support to the R&D project of Davanrik offered by LAB, and about the process of valuation and the final decision. First we are to make brief of LABs business proposal and practice detailed valuation functions to decide if the proposal is profitable or not. And finally we will make a decision based on the valuation process in perspective of Rich Kender, Vice President of Financial Evaluation & Analysis of Merck. Brief introduction of Merck and its agenda regarding Davanrik project As a world-class pharmaceutical company concentrated on R&Ds, Merck is performing various researches and developments upon medical supplies for human and animals. Merck is providing Pharmaceutical Benefit Management (i.e. PBM) through a company called Merck-Medco Managed Care. Apparently it is a giant pharmaceutical company with more than 15 blockbuster medical supplies, revenue of $3270 million and net profit of $590 million, ever since 1995. One constraint of Merck is that most of its profit is over-concentrated on the major top 4 items, and in order to diversification of profits Merck is facing a pressure to launch a new business item or take another complementary strategy through biotech and internal R&D. LAB Pharmaceuticals has already finished developing Davanrik, an antidepressant. Even though it carries substantial medical/economical

feasibility for being effective on both hypochondria and obesity, LAB cannot afford the capital to proceed clinical demonstrations ahead the actual sale to acquire licensing. This is the reason why LAB offered Merck of technical affiliation. At the following step, we are to evaluate the profitability of Davanrik based on the expected length of time and expense, chances of success that LAB has suggested. 1. Expectaion of costs and chances of success for each phase Phase I 1. Take 2years 2. Cost $30millin, including an initial $5millin fee to LAB 3. 60% chance of success Phase II[1] 1. Take 2years 2. The efficacy test -10% probability for depression only -15% probability for weight loss only -5% probability for both depression and weight loss 3. Cost $40million, including a $2.5million licensing milestone payment to LAB Phase III 1. Take 3years 2. The Costs and probabilities of success - For only depression : cost $200million including a $20million payment to LAB(85% chance of success - For only weight loss : cost $150million including a $10million LAB payment(75% chance of success

- For both depression and weight loss : cost $500million including $40million licensing payement to LAB(70% chanceof success) And 15% chance of a successful outcome for depression only 5% chance of a successful outcome for weight loss 10% chance of failure 2. Cost of launches and Potential profits[2] 1. For only depression : cost $250million to launch and PV of $1.2billion 2. For only weight loss : cost $100million to launch and PV of $345million 3. For both depression and weight loss : cost $400million and PV of $2.25billon 3. Decision Tree & Calculation [pic] 1. Cash Flow : 1200-250-200-40-30=$680mil Expected Value:680x0.051=$34.68mil (0.051=0.6x0.1x0.85) 2. Cash Flow : 0-200-40-30=-270 Expected Value:-270x0.009=-$2.43mil (0.009=0.6x0.1x0.15) 3. Cash Flow : 345-100-150-40-30=25mil Expected Value:25x0.0675=1.6875mil (0.0675=0.75x0.15x0.6) 4. Cash Flow : 0-150-40-30=-220mil Expected Value:-220x0.0225=-4.95mil (0.0225=0.25x0.15x0.6)

5. Cash Flow : 2250-400-500-40-30=1280mil Expected Value:1280x0.021=26.88mil (0.021=0.7x0.05x0.6) 6. Cash Flow : 1200-250-500-40-30=380mil Expected Value:380x0.0045=1.71mil (0.0045=0.15x0.05x0.6) 7. Cash Flow : 345-100-500-40-30=-325mil Expected Value:-325x0.0015=-0.4875mil (0.0015=0.05x0.05x0.6) 8. Cash Flow : 0-500-40-30=-570mil Expected Value:-570x0.003=-1.71mil (0.003=0.1x0.05x0.6) 9. Cash Flow : 0-40-30=-70mil Expected Value:-70x0.42=-29.4mil (0.42=0.7x0.6) 10. Cash Flow : 0-30=-30 Expected Value:-30x0.4=-12 If we plus all of Expected Values from And it will good for Merck. CONCLUSION The method we have mainly used here to evaluate the forecasted future performance of the project is Net Present Value (NPV). The NPV is the sum of the present values of all the expected incremental cash flows if a project is undertaken. The discount rate used is the firms cost of capital, adjusted for the risk level of the project. For a normal project, with an initial cash outflow followed by a series of expected after-tax cash to , we can get +$13.98million.

inflows, the NPV is the present value of the expected inflows minus the initial cost of the project. A project with a positive NPV is expected to increase shareholder wealth, a negative NPV project is expected to decrease shareholder wealth, and a zero NPV project has no expected effect on shareholder wealth. A key advantage of NPV is that it is a direct measure of the expected increase in the value of the firm. NPV is the theoretically best method. Its main weakness is that it does not include any consideration of the size of the project. Regarding the evaluation we presented above in the body part: The fact that the expected value of $13.98million is greater than 0 shows this project is likely to increase profit and shareholders value. So we suggest Merck to accept LABs offer as the expected value from Davanrik Project is positive. Merck & Company Evaluating a Drug Licensing Opportunity INTRODUCTION Merck & Company : Evaluating the Licensing Opportunity Brief introduction of Merck and its agenda regarding Davanrik project 1. Expectaion of costs and chances of success for each phase 2. Cost of launches and Potential profits 3. Decision Tree & Calculation CONCLUSION ----------------------[1] All cash flows are expressed ad after-tax present values discount to time zero, including papital expenditures. [2] This PV was calculated as the after-tax present value of 10years worth of cash flows from the drug discounted back to today(a terminal value of zero was used in the calculation)