Winery Case for Statistics

Topics: Decision theory, Decision tree, Probability theory Pages: 2 (302 words) Published: March 7, 2011
Winery Case for Statistics


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.)

[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.

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