1. Construct the decision tree. What should Merck pay to license the drug?
Based on our decision tree calculations shown below, we believe that the net present value of the investment is $13.98 million. Merck should be willing to pay to Davanrik a licensing fee up to this amount in order to make the endeavor worthwhile. Given that no discount rate was mentioned in the case and given that we also do not know how expenses are prorated, we made the assumption that these values are already expressed in their present value.
Another consideration is that Merck will have the ability to discontinue the research process at any point if a better opportunity arises to utilize its capital.
In addition to the tangible value created by this process, Merck will also stand to benefit in many intangible ways. To be associated with successful drug launches will help build Merck’s cache in the marketplace, enabling it to better attract talent and win future business. In addition, Merck could improve its tacit knowledge while conducting R&D on Davanrik’s drug, potentially resulting in a competitive advantage.
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