Schering Plough: Replacing Claritin

Topics: Net present value, Cash flow, Discounted cash flow Pages: 5 (1134 words) Published: September 27, 2007

Schering Plough is a large pharmaceutical company who is about to lose the patent to its largest revenue generating drug, Claratin. The loss of exclusive rights to this product could decrease Schering Plough's revenue by over 90%.

Schering Plough in hindsight of what will become of their financial position with the expiration of this patent has decided that it must develop a new product which uses Loratadine, the main component of Claratin. The two drugs the company wishes to investigate are Newprox, an asthmatic drug; and Minprox, a nasal congestion spray. Based upon data provided from its financial and marketing department Schering Plough has compiled data for the two products that could replace Claratin as its new "flagship product". The data used for the decision analysis in this report can be found in Appendix A.

Schering Plough must decide which product to invest in and produce. The up front costs are large in drug production due to the strict regulations imposed by the FDA; a decision therefore, must be made with due diligence.

Key Assumption

The assumptions made in this report are the following:
both drugs pass FDA approval
costs incurred prior to FDA approval are not recoverable uncertainty exists for only the sales figures
sales figures could be either less or more than the projected figures (see Appendix A); therefore a triangular probability distribution is used for simulation minimum value and maximum value for triangular distribution are 25% above and below the most likely sales value projected by the company (see Schering Plough-Decision Analysis.xls) each year is treated as independent; there is no correlation between year 1 and 2 and so forth

Decision Analysis

"Decision analysis is a deductive reasoning process that allows a decision maker to choose from a well-defined set of options on the basis of the model-based analysis of all the probable outcomes." A rational decision maker will choose the option that provides the greatest expected value. In decision analysis each outcome is assigned a given probability and value, the Schering Plough case does not provide the probability of all possible outcomes, it does state though that the greatest uncertainty lies in the prediction of the sales figures for the two products under analysis. As a result of this drawback liberty was taken for the values used in the simulation. It should be noted that the values used in the triangular probability distribution are conservative estimates at best, and that other values could have been used.

The greatest expected value is provided by the calculation of the net present value (NPV) of the modeled products. The following figures presented are in $ millions.

Traditional NPV Analysis

A traditional NPV Analysis is the stand-alone discounted cash flows (DCF) analysis. The following are the results of this analysis.

Newprox production NPV

Discount rate16.40%

Newprox sales projections
Sales ($ millions)2603506508001000

Variable costs
Total variable costs540567657702762

Gross Margin-280-217-798238
Capital Investment
R&D Cost

NPV of cash flows($240.38)
Figure 1.0 Newprox NPV Analysis

Minprox production NPV

Revenue (as % Newprox)10.00%
COGS (as % revenue)10.00%
Promotion (as % revenue)20.00%
Discount rate16.40%

Newprox sales projections
Sales ($ millions)26.0035.0065.0080.00100.00125.00231.71687.17

Variable costs
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