application of real options valuation to r&d investments in ...

More documents

Recommendations

Info

drug with the potential to treat both depression and obesity. The small pharmaceuticalcompany concern that developed the drug, LAB Pharmaceuticals, lacked theresources to complete the lengthy approval process, manufacture the compound, andmarket the drug. LAB had approached Merck with an offer to license the compound.Under this agreement, Merck would be responsible for the approval of Davanrik, itsmanufacture, and its marketing. The company would pay LAB an initial fee, a royaltyon all sales, and make additional payments as Davanrik completed each stage of theapproval process.4.2 Merck CompanyIn 2000, Merck & Co. Inc. was a global research-driven pharmaceutical company thatdiscovers, develops, manufactures and markets a broad range of human and animalhealth products, directly and through its joint ventures, and provides pharmaceuticalbenefit management services (PBM) through Merck-Medco Managed Care. Since1995, Merck had launched 15 new products including Vioxx for the treatment ofosteoarthritis, Fosamac for the treatment of osteoporosis and Singulair for treatingasthma. The company earned $5.9 billion on 1999 sales of $32.7 billion, about a 20%increased from 1998.A handful of Merck‘s most popular drugs, Vasotec, Mevacor, Prinivil, and Pepcid,generated $5.7 billion in worldwide sales. The patents for these drugs, however,would expire by 2002. Once the patents expired, Merck anticipated that the sales ofthese drugs would decline substantially as generic substitutes became available. Theonly way to counter the loss of sales from drugs going off patent was to develop newdrugs and constantly refresh the company‘s portfolio. The companies develops newcompounds primarily through internal research, but complements this throughinitiatives with biotechnology companies to ensure Merck is on the leading edge ofselect therapeutic categories.Page | 38
4.3 DavanrikLAB Pharmaceuticals originally developed Davanrik to treat depression.Antidepressant drugs work by affecting certain parts of the central nervous system.Various receptors in the human brain, when stimulated or blocked, create or inhibitvarious moods. The serotonin system controls nervousness, depression insomnia,hunger, sexual dysfunction, nausea, and headaches. Through a combination ofchemical compounds, the receptors in this system of cells can be stimulated orblocked to treat a patient with one or more of the given symptoms. Davanrik seemednot only to stimulate the receptor that promotes anti-depression, but also to block thereceptor that causes hunger.At the time of LAB‘s offer, Davanrik was in pre-clinical development, ready to enterthe three-phase clinical approval process required for pharmaceuticals in the UnitedStates.LAB Pharmaceuticals specializes in developing compounds for the treatment ofneurological disorders. While the company was only 5 years old and though it had afew drugs in Phase II and Phase III testing, none had successfully completed the FDAapproval process. In fact, the FDA had recently denied approval of another of LAB‘scompounds that had completed all three phases of clinical testing; LAB‘s stock pricefell by over 30% in response to this decision. As a result, LAB was hesitant to issueadditional equity to finance the testing of Davanrik and was seeking a largerpharmaceutical company to license the drug and provide LAB with somemuch-needed cash. The licensee would design, administer, and fund the clinicaltesting of the compound, its manufacturing and its marketing. The licensor, LAB,would receive an initial payment followed by additional payments as Davanrikcompletes each clinical testing phase. LAB would also receive a royalty on theeventual sales of Davanrik.Page | 39
Page 1 and 2: APPLICATION OF REAL OPTIONS VALUATI
Page 3 and 4: Table of ContentsAbstract .........
Page 5 and 6: List of TablesTable 5.1: Value of O
Page 7 and 8: Chapter One— IntroductionAs one o
Page 9 and 10: Then, in Chapter 4, the case study
Page 11 and 12: and we will have the right to take
Page 13 and 14: project, to get its salvage value,
Page 15 and 16: The option to switch:If assets have
Page 17 and 18: 2.2 Advantages of Real Option Valua
Page 19 and 20: In the case of pharmaceutical R&D,
Page 21 and 22: delayed in time. Undertaking one pr
Page 23 and 24: Figure 2.2: Advantages and disadvan
Page 25 and 26: smallest possible payoff of zero, w
Page 27 and 28: options applications is the binomia
Page 29 and 30: t: years to expirationr: annual ris
Page 31 and 32: Chapter Three— Apply Real options
Page 33 and 34: on Howell et al (2001).3.1.1 Precli
Page 35 and 36: approved.3.2 real options valuation
Page 37 and 38: Figure 3.3: Comparison of a call op
Page 39 and 40: applying the principals of activity
Page 41 and 42: that has occurred in the past. Depe
Page 43: Chapter Four— Case StudyFor this
Page 47 and 48: efficacious for depression only, a
Page 49 and 50: Chapter Five— Case Study Analysis
Page 51 and 52: figure below:Figure 5.3: NPV of Dav
Page 53 and 54: Merck & Co (10%), which gives $2338
Page 55 and 56: approval and other issues. Therefor
Page 57 and 58: of $345m at year 0 (which is $672.3
Page 59 and 60: project turns out to be unprofitabl
Page 61 and 62: these three options, the risk-free
Page 63 and 64: ewrite as, noting all the costs (in
Page 65 and 66: Figure 5.10: Valuation of Option A
Page 67 and 68: Figure 5.12: Valuation of Option A
Page 69 and 70: Figure 5.13 Valuation of Compound r
Page 71 and 72: $ in millionmillion to $113.97 mill
Page 73 and 74: Chapter Six— Limitations and conc
Page 75 and 76: discovery projects, arrives in a di
Page 77 and 78: References1. Amram M & Kulatilaka N
Page 79 and 80: 31/08/2006, available at: http://ho
Page 81 and 82: 46. T rigeorgis L . (1995), ―M et

application of real options valuation to r&d investments in ...

Create successful ePaper yourself

Delete template?

Save as template?