Guidelines and Questions for Merck Case The Merck case is included in your course pack. A careful read of the case is critical to get the decision tree, and the various probabilities and cash flows right. Drawing the tree The Merck decision tree has ten total outcomes - 5 successes and 5 failures. The two leftmost branches depict the alternatives of either licensing the drug (Davanrik), or not to license the drug. If Merck decides to pursue license, they go into phase I, which results in a success or failure. Phase I success is followed by phase II where Merck has the opportunity to develop the drug to treat depression alone, weight loss alone, or both, or contemplate phase II failure. Finally, phase II success for the different options leads to phase III, and again there are success or failure related outcomes for each of the alternatives in phase II. The probabilities of various outcomes (success / failure) in each phase should sum to 100%. In each phase, the stated cost already includes fees paid to LAB. For example, cost of Phase I is $30 million (this number includes $5 million paid to LAB). Use Excel to draw the tree and do the necessary calculations. As an example see below the decision tree drawn in EXCEL for the Snow-Fun Ski Resort example we worked on earlier. This tree shows seven outcomes. EXPECTED PROFIT PROFIT $ 45,000 Larger hotel operates the resort $ 45,000 More than 40 inches of snow 40% $120,000 Between 20-40 inches of snow 20% $ 40,000 Run resort without snow maker Less than 20 inches of snow 40% $ (40,000) $40,000 More than 40 inches of snow 40% $ 95,000 Between 20-40 inches of snow 20% $ 43,000 Run resort with snow maker Less than 20 inches of snow 40% $ (9,000) $ 43,000 In the Merck decision tree diagram, adjacent to each outcome, show the overall profit or loss (sum of all costs indurred along the way, subtracted from revenue, if any), overall probability (product of all probabilities), and the probability weighted profit/loss. Consider Phase II failure as an outcome. The overall cost incurred along the way is $70 million ($30 million cost for Phase I, and $40 million cost for Phase II), and the overall probability of this outcome is 42% (60% chance of success for Phase 1, 70% chance of failure for Phase II). The probability weighted loss for the Phase II failure outcome is: $70 * 42% - $29.4. The sum of all of the probabilities from the ten outcomes should equal 100%. The expected value for the entire tree will be the sum of all probability weighted profit or loss. Construct the tree and please answer the questions below: 1. What is the total probability that the drug will fail to reach the market? 2. What is the total probability of failure in Phase III? 3. What is the expected value and standard deviation in launching Davanrik (i.e. what is the expected value for the entire decision tree)? Sensitivity analysis You may (should) wonder: "Where did the various case probabilities, costs, and revenue figures come from? How sensitive is the decision tree outcome to the various assumptions"? You can address the assumptions by answering the following questions: 4. What is the expected value / standard deviation of launching Davanrik if the probability of success in Phase I is 65% (instead of 60% as given in the case)? 5. What is the expected value / standard deviation of launching Davanrik if the probability of success in Phase I is 50% (instead of 60% as given in the case)? 6. What is the expected value/ standard deviation of launching Davanrik if the three present value (PV) numbers given in the final paragraph are higher by 10%? For example, a 10% increase in a PV of 1.2 billion would result in a PV of 1.32 billion. For this analysis assume that Phase I success has a 60% probability. Guidelines and Questions for Merck Case The Merck case is included in your course pack. A careful read of the case is critical to get the decision tree, and the various probabilities and cash flows right. Drawing the tree The Merck decision tree has ten total outcomes - 5 successes and 5 failures. The two leftmost branches depict the alternatives of either licensing the drug (Davanrik), or not to license the drug. If Merck decides to pursue license, they go into phase I, which results in a success or failure. Phase I success is followed by phase II where Merck has the opportunity to develop the drug to treat depression alone, weight loss alone, or both, or contemplate phase II failure. Finally, phase II success for the different options leads to phase III, and again there are success or failure related outcomes for each of the alternatives in phase II. The probabilities of various outcomes (success / failure) in each phase should sum to 100%. In each phase, the stated cost already includes fees paid to LAB. For example, cost of Phase I is $30 million (this number includes $5 million paid to LAB). Use Excel to draw the tree and do the necessary calculations. As an example see below the decision tree drawn in EXCEL for the Snow-Fun Ski Resort example we worked on earlier. This tree shows seven outcomes. EXPECTED PROFIT PROFIT $ 45,000 Larger hotel operates the resort $ 45,000 More than 40 inches of snow 40% $120,000 Between 20-40 inches of snow 20% $ 40,000 Run resort without snow maker Less than 20 inches of snow 40% $ (40,000) $40,000 More than 40 inches of snow 40% $ 95,000 Between 20-40 inches of snow 20% $ 43,000 Run resort with snow maker Less than 20 inches of snow 40% $ (9,000) $ 43,000 In the Merck decision tree diagram, adjacent to each outcome, show the overall profit or loss (sum of all costs indurred along the way, subtracted from revenue, if any), overall probability (product of all probabilities), and the probability weighted profit/loss. Consider Phase II failure as an outcome. The overall cost incurred along the way is $70 million ($30 million cost for Phase I, and $40 million cost for Phase II), and the overall probability of this outcome is 42% (60% chance of success for Phase 1, 70% chance of failure for Phase II). The probability weighted loss for the Phase II failure outcome is: $70 * 42% - $29.4. The sum of all of the probabilities from the ten outcomes should equal 100%. The expected value for the entire tree will be the sum of all probability weighted profit or loss. Construct the tree and please answer the questions below: 1. What is the total probability that the drug will fail to reach the market? 2. What is the total probability of failure in Phase III? 3. What is the expected value and standard deviation in launching Davanrik (i.e. what is the expected value for the entire decision tree)? Sensitivity analysis You may (should) wonder: "Where did the various case probabilities, costs, and revenue figures come from? How sensitive is the decision tree outcome to the various assumptions"? You can address the assumptions by answering the following questions: 4. What is the expected value / standard deviation of launching Davanrik if the probability of success in Phase I is 65% (instead of 60% as given in the case)? 5. What is the expected value / standard deviation of launching Davanrik if the probability of success in Phase I is 50% (instead of 60% as given in the case)? 6. What is the expected value/ standard deviation of launching Davanrik if the three present value (PV) numbers given in the final paragraph are higher by 10%? For example, a 10% increase in a PV of 1.2 billion would result in a PV of 1.32 billion. For this analysis assume that Phase I success has a 60% probability