...Opportunity Statement of the problem- Merck must determine whether or not to bid to license Davanrik My recommendation is that Merck must definitely make a competitive bid for Davanrik. The total expected value from the deal based numbers given in the Merck article is a healthy $14million so keeping a 20% incentive, Merck should bid no more than $11million for Davanrik as the initial licensing fee. Looking at the background of Merck, it is clear that it is a successful company with good cash flow and investable assets. Not only can Merck afford to take risk but also given the fact that several of its key patents are expiring in 2002, Merck must replenish its patented product portfolio otherwise Merck risks loosing its profit margins in future. Since the pharmaceutical business is based on high-risk high-reward model, Merck should be aggressive in getting new products on the market. Although Merck could be developing its own new products, Davanrik presents an interesting opportunity since the parent company LAB pharmaceuticals is eager to license the drug in light of its recent FDA rejection. Looking for a much needed cash influx, LAB might be willing to strike a bargain. To evaluate the risks/rewards of the deal we construct a decision tree for Merck. The structure of tree presents a clearer picture of the possible risks and rewards during the comprehensive FDA approval process. Looking at this decision tree in phase 3, perhaps Merck can reduce its risk by pursuing only...
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...Questions for the Merck Case Create a decision tree for Merck. The 2 leftmost branches would identify the alternatives related to licensing Davarink (specifically license versus not to license). Next, 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 different options leads to phase III, and there are success or failure related outcomes for each of the alternatives in phase II (i.e. developing the drug to treat depression, weight loss, or both). HINTS: Within each phase, remember that the probabilities of various outcomes (including failure, which is not always mentioned as an option) should add up 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). A careful read of the case is critical to get the tree, various probabilities and the cash flows right. Please be sure to include your decision tree along with your answer to the questions below. 1) What is the expected value in launching Davarink as an antidepressant only? 2) What is the expected value in launching Davarink to treat only weight loss? 3) What is the expected value in launching Davarink for possibility of separate...
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...February 3, 2015 Mr. Kender, Merck and Company has been presented with a very interesting opportunity from LAB Pharmaceuticals. After having analyzed the current opportunity that Merck and Company is being presented with we have come up with the following recommendations on how best for you and your company to proceed with this proposal to purchase LAB Pharmaceuticals new drug, Davanrik. We feel that purchasing the rights to Davanrik is a great opportunity for Merck and Company to expand its product portfolio, customer base and future revenues. That being said, there are risks associated with taking on the costly and lengthy FDA approval processes that goes along with it. After having performed our analysis, based in part by the use of the attached decision tree, we have concluded that the maximum that Merck and Company should be willing to offer LAB Pharmaceuticals for the rights to Davanrik is $13.68 million. Also, in order to be more confident in the financial outlook for this plan we also elected to perform a sensitivity analysis. The analysis was run based on a worse case scenario and assumed an increase of launch costs from $100 million to $225 million for the weight loss compound in the third phase of the launch. If Merck and Company was to experience these added costs we would expect to see value of $10.76 million. Within the attached report you will find our detailed analysis, which has led us to the above conclusion. The report also outlines the...
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...Problem Definition Should Rich Kender recommend licensing Davanrik, making Merck & Company responsible for its manufacture and its marketing? In order to provide Rich Kender with a good and thorough analysis and recommendation on the Davanrik licensing project, we need to answer the following guidance questions: I. How has Merck been able to achieve substantial returns to capital given the large costs and lengthy time to develop drugs? II. How much should they pay? III. What is the expected value of the licensing arrangement to LAB? IV. How would our analysis change if the costs of launching Davanrik for weight loss were $225 million instead of $100 million? In our analysis we will build a decision tree that shows the cash flows and probabilities at all stages of the FDA approval process. We will assume a royalty fee of 5% on the cash flows that Merck receives from Davanrik after successful launch. Analysis Merck is in the business of developing compounds for pharmaceutical compounds. The required research and development efforts preceding the launch of a successful blockbuster drug is extensive and lengthy process and is therefore a very expensive one. Nevertheless, Merck has proven perfectly capable to achieve high returns on capital. This is a result of numerous factors. First of all, Merck has been able to generate tremendous amounts of sales. Since 1995, Merck has launched 15 new products, resulting in 1999 sales of $32.7 billion, which includes $15.2 billion...
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...Should Merck license the compound? Merck would be responsible for 1) the approval of Davanrik 2) the manufacture of Danavrik 3) marketing of Danavrik Merck would pay LAB for 1) initial fee 2) royalty on all sales 3) make additional pymts as Danavrik completed each stage of approval process (3 Phases) Additional facts: approval process should take 7 years patent will cover 17 years (7 of approval process nad 10 yr period of exclusivity beginning in yr 7) 1 Assumptions: All Cash flows are expressed as after tax present values discounted to time zero, including capital expenditures At any point "failure," investment decision is to stop funding Assuming Standard deviation of 0.5 Using T= 7 years in Black-Scholes Valuation 2 Decision Tree See worksheet "Decision Tree" 3 Detailed description of Real Option Technique "First, using a decision tree, I came up with a simple expected value of $13,980,000 based on the costs to complete each phase, the probabilities of completing each phase, and the costs and probabilities associated with failure at each step in the approval process. The expected value of successful completion with Depression only was $36,390,000, for weight only $1,200,000 and for both $26,880,000. The expected value of failure (including failure at any phase) was ($59,490,000). Next, I calculated the Valuations of each successful outcome using the decision tree analysis and the spectrum of outcomes with an asymetric distribution of rewards....
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...Questions for the Merck Case Create a decision tree for Merck. The 2 leftmost branches would identify the alternatives related to licensing Davarink (specifically license versus not to license). Next, 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 different options leads to phase III, and there are success or failure related outcomes for each of the alternatives in phase II (i.e. developing the drug to treat depression, weight loss, or both). HINTS: Within each phase, remember that the probabilities of various outcomes (including failure, which is not always mentioned as an option) should add up 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). A careful read of the case is critical to get the tree, various probabilities and the cash flows right. Please be sure to include your decision tree along with your answer to the questions below. 1) What is the expected value in launching Davarink as an antidepressant only? 2) What is the expected value in launching Davarink to treat only weight loss? 3) What is the expected value in launching Davarink for possibility of separate...
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...The Application of Decision Trees by Companies and its Advantages and Disadvantages Management science uses different ways of approach to solve management problems. Management science which is also referred to as decision analysis is part of a core of business. Decision analysis is a method used in the business firm to help managers resolve uncertainties in making investment decisions. It helps them make choices, take risks, and gain information that is needed. The decision tree can be simple or complex. It shows a combination of choice with different possible events. The usage of decision trees has helped various companies to determine the best alternative, which yields the greatest monetary gain. An example of a decision tree applied in real life is by the Oglethorpe Power Corporation (OPC). It was used in deciding whether to invest in a major transmission system. Firstly, three groups were established. The first group consists of a senior management team which helps review ideas, recommendations and make a decision based on the approach. Then, we have the analytical team which is responsible for conducting the analysis and analyse the ideas and recommendations given. The last group consists of the OPC experts who helps solve specific topics which have been brought up during the analysing process. The first step in decision analysis was identifying the problems that may arise accurately which were conducted by the analytic team. Major decisions, uncertainties, flaws...
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...consistent , supported by compelling strategic and financial arguments. I highlight in red specific suggestions for how to incorporate outputs from this framework into a recommendation. 1. Define the problem – Objectives & constraints 2. Enumerate the decision factors – Alternatives & uncertainties (e.g., pros & cons) 3. Consider relevant information – Quantitative analysis and SWOT 4. Identify the best alternative. – Decision analysis 5. Develop plan for implementing the chosen alternative. – Marketing mix details & examples 6. Evaluate the decision and the decision process. – Re-evaluate the objective(s) & consider assumptions that make the 2nd-best alternative better than the chosen alternative 1. Define the problem. As you read through the case the first time, identify and highlight the decision-makers’ objective(s) and the constraints that make achieving the objective(s) difficult. The objectives may be broadly defined at this stage (e.g., increase revenues or profits). The constraints likely involve a disadvantage with respect to resources or capabilities or the presence of an external threat. 2. Enumerate the decision factors. Because you are new to case analysis, the alternatives will usually be well-defined in this class. That isn’t always the case! You should identify the uncertainties that make the attractiveness of each alternative ambiguous. You should also clearly identify the...
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...gains are attainable without investing more time and money in the products. Given The Decision tree chart attachment shows the predicted gains from each decision alternative described above. Gains depend on how the market reacts to the action taken by the company. The probability of each market reaction is shown on the decision tree. Task: Develop a response to the attached decision tree chart in which you: a) Calculate the expected value for each of the four decision branches. The company can either develop a new product rapidly or thoroughly and the returns from each decision are as follows; The total expected value as a result of each decision is found by multiplying each of the probabilities for each market condition by the corresponding expected value and summing them up (Mind Tools, 2013). Develop thoroughly: (0.4×500,000) + (0.4×25,000) + (0.2×1,000) = $ 210,200 Develop rapidly: (0.1×500,000) + (0.2×25,000) + (0.7×1,000) = $ 55,700 On the decision on consolidating the existing product, the company can either strengthen products or reap from the existing products without investing, each of which has the following expected returns; Strengthen Products: (0.3×200,000) + (0.4×10,000) + (0.3×3,000) = $ 64,900 Reap without investing: (0.6×10,000) + (0.4×1,000) = $ 6,400 b) Determine the decision alternative that has the most favorable total expected value. The decision to develop new products...
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...8m per month of lateness, and the indirect cost of lateness is the cost of lost reputation. As an example, if the project is two months late and the cost of lost reputation is estimated to be $2m, then S is $3.6m. Let: SW Only = software only; HW Now = expand hardware now; Delay HW = delay hardware decision; OT = project finished on time; Late = project finished late; FP = favorable software progress in the first five months; NP = learning nothing new in the first five months; and UP = unfavorable software progress in the first five months. Consider the decision tree shown in Figure 1 where the nodes have been numbered for easy reference. The decision choices at the initial decision node (D1) are: SW Only, Delay HW, and HW Now. Do we need to consider all three decision options at D1? Note that there is no explicit cost to delaying the hardware expansion decision. So you will be right to argue that the SW Only decision is dominated by the Delay HW decision, and thus can be disregarded. Nevertheless, I shall, if only for pedagogical reasons, keep the SW Only option alive. You might also argue that in reality delaying the hardware decision may impede the software progress (Parkinson’s Law: Work expands to fill the available time.) and thus may very well have some costs. Note that in the present problem the objective is to minimize expected cost. In the prose below, I am going to omit the $ sign. At C1, the expected cost is 3 + 0.2S. ...
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...Quantitative Values Project: Homeowner Master Bathroom Remodel To incorporate quantitative values of expected value and probability into the risk management plan for my master bathroom remodel project will be a challenge. The homeowner is taking on the task of trying to do much of the remodel work himself. Hence the risk is related to human failure. Since the homeowner does not have extensive experience in some of the remodeling tasks, there is no history that can be used to calculate failure rates so that probabilities can be determined. The use of a Human Error Probabilities (HEP) model will be needed to determine the probabilities of the remodel tasks that are most at risk. The tasks that have been identified most at risk are the plumbing, electrical and window installation. I will use the Delphi approach to develop HEP estimates for the most at risk tasks. The first step is to select a panel consisting of four subject matter experts (SME), a risk analysis and a group facilitator. Two of the four SMEs will have professional experience in bathroom remodeling and the other two will be homeowners that have taken on bathroom remodel projects but do not necessarily do it for a living. This is to help minimize biasing the data since the analysis is going to be used to determine whether the homeowner does the work himself or contracts it out. After the facilitator introduces each member of the panel and introductions have been made, the risk analysis will present one of the remodel...
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...Decision Trees Using TreePlan 16 16.1 TREEPLAN OVERVIEW TreePlan is a decision tree add-in for Microsoft Excel 97–2007 for Windows and Macintosh. TreePlan helps you build a decision tree diagram in an Excel worksheet using dialog boxes. Decision trees are useful for analyzing sequential decision problems under uncertainty. Your decision tree model may include various controllable alternatives (e.g., whether to introduce a new product, whether to bid on a new project) and uncontrollable uncertainties (e.g., possible demand for a product, whether you're awarded a contract), arranged in chronological order. TreePlan automatically includes formulas for summing cash flows to obtain outcome values and for calculating rollback values for determining the optimal strategy. To use TreePlan, you (1) open a new worksheet, (2) choose Tools | Decision Tree from Excel's menu, (3) select a node to change the structure of your decision tree, (4) enter branch names, cash flows, and probabilities, and (5) determine the optimal strategy from TreePlan's results. All of TreePlan’s functionality, including its built-in help, is a part of the TreePlan XLA file. There is no separate setup file or help file. When you use TreePlan on a Windows computer, it does not create any Windows Registry entries (although Excel may use such entries to keep track of its add-ins). 16.2 BUILDING A DECISION TREE IN TREEPLAN You can start TreePlan either by choosing Tools | Decision Tree from the menu bar (Excel...
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...Executive Summary Oceanview is considering a property bid of $5 million, which would require them to submit a deposit of 10% of the bid amount. Should the bid be rejected, the deposit will be refunded. However, should Oceanview win the bid, they must still consider the approval of zoning change to built the condominium. If the zoning is approved, the building can start. If not, the 10% deposit will be forfeited. From the flow summarized above, we can see that the green light to carry on building is dependent on the approval of the zone change, highlighting the need for Oceanview to determine the probability of winning the bid as well as the zoning change approval. The timeline given below reflects Oceanview window of opportunity for it to conduct its market research before submitting its bid. This market research is key to Oceanview outcome to build the condominium since it would provide information as to whether the zoning would be approved. Recommendation Oceanview should consider the dynamic environment and invisible cost that might be incurred on top of the information provided by the market research. Firstly, in today’s volatile and post recession environment, Oceanview must evaluate if a luxury condominium would sell well. With pay cuts and retrenchment, many would opt for a more conservative option of owing a HBD instead on spending lavishly on a condominium. Moreover, the soaring real estate prices would deter many, hence resulting in the Oceanview’s revenue outlook...
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...indicates the client's baseline condition and treatment goals. It is also a memorandum concerning whether these goals were accomplished (Hartsell, 2008). When faced with a request for records, I would employ a systematic decision-making approach verses a heuristic approach. The systematic approach I would use would both investigate the ethical issues and the resolve the dilemma. I would have a seven-step process. I would define carefully the issues and parties involved, scan the ethics codes and identify all relevant clauses. Also check other applicable professional guidelines (for example, the Specialty Guide for Forensic Psychology) and any pertinent legislation, consulting with colleagues is also often appropriate, evaluate the rights, responsibilities and welfare of all affected parties, generate as many alternative decisions as possible, evaluate carefully the likely outcome of each decision, choose what, in my professional judgment, is the best decision, implement it, and inform relevant parties, and lastly, take responsibility for the consequences of the decision. I feel this is the best approach because it covers all of the bases for providing information to a third party and potentially breaking confidentiality. The best and the worst part about the decision tree presented in the journal article was that it specifically was geared towards a legal demand by the court for the records/test data and was not general enough to use for any request. It gives a great guide for a request...
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...1 PROBABILISTIC APPROACHES: SCENARIO ANALYSIS, DECISION TREES AND SIMULATIONS In the last chapter, we examined ways in which we can adjust the value of a risky asset for its risk. Notwithstanding their popularity, all of the approaches share a common theme. The riskiness of an asset is encapsulated in one number – a higher discount rate, lower cash flows or a discount to the value – and the computation almost always requires us to make assumptions (often unrealistic) about the nature of risk. In this chapter, we consider a different and potentially more informative way of assessing and presenting the risk in an investment. Rather than compute an expected value for an asset that that tries to reflect the different possible outcomes, we could provide information on what the value of the asset will be under each outcome or at least a subset of outcomes. We will begin this section by looking at the simplest version which is an analysis of an asset’s value under three scenarios – a best case, most likely case and worse case – and then extend the discussion to look at scenario analysis more generally. We will move on to examine the use of decision trees, a more complete approach to dealing with discrete risk. We will close the chapter by evaluating Monte Carlo simulations, the most complete approach of assessing risk across the spectrum. Scenario Analysis The expected cash flows that we use to value risky assets can be estimated in one or two ways. They can represent a probability-weighted...
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