Q1) Draw a decision tree for this problem. Your tree should include probabilities associated with chance nodes and payoffs associated with terminal nodes. : Please refer to the following decision tree. ( “Net cash flow = income PV-launching cost- trial cost”)
Q2) Fold back the tree. Assuming Merck is risk neutral, should it license Davanrik? : Yes, Merck should do, since Merck is expected to earn $13.98M by licensing Davanrik.
Q3) For what range of values of “probability of success of Phase 1” would your answer to Question 2 remain the same? : To keep the decision in Q2 the same, the probability of success of Phase I should be not less than 40.93%. The calculation is as below. Assuming that the probabilities of Phase II and III are the same, the expected value of licensing can be calculated as below. If x is probability of success of Phase I, Expected value = 43.3x -30(1-x) If 43.3x -30(1-x) =0, x = 0.4093. 40.93%
Q4) How would your answer to Question 2 change if the costs of launching Davanrik for weight loss were $225 million instead of $100 million as given in the case? : Merck should license Davanrik, since its expected earning is still positive. (Please refer to the following exhibit 2.)
Q5) How much would Merck be willing to pay to guarantee that Phase I of the FDA approval process is successful? : If Merck can guarantee that the Phase 1 of the FDA approval process is successful, the expected value of licensing increases to $43.3M, while the current expected value is $13.98M, as you can see in Exhibit 1. In this manner, Merck would like to pay up to $29.32M(43.3M-13.98M) to guarantee.