Concept explainers
It is January 1 of year 0, and Merck is trying to determine whether to continue development of a new drug. The following information is relevant. You can assume that all cash flows occur at the ends of the respective years.
- Clinical trials (the trials where the drug is tested on humans) are equally likely to be completed in year 1 or 2.
- There is an 80% chance that clinical trials will succeed. If these trials fail, the FDA will not allow the drug to be marketed.
- The cost of clinical trials is assumed to follow a triangular distribution with best case $100 million, most likely case $150 million, and worst case $250 million. Clinical trial costs are incurred at the end of the year clinical trials are completed.
- If clinical trials succeed, the drug will be sold for five years, earning a profit of $6 per unit sold.
- If clinical trials succeed, a plant will be built during the same year trials are completed. The cost of the plant is assumed to follow a triangular distribution with best case $1 billion, most likely case $1.5 billion, and worst case $2.5 billion. The plant cost will be depreciated on a straight-line basis during the five years of sales.
- Sales begin the year after successful clinical trials. Of course, if the clinical trials fail, there are no sales.
- During the first year of sales, Merck believe sales will be between 100 million and 200 million units. Sales of 140 million units are assumed to be three times as likely as sales of 120 million units, and sales of 160 million units are assumed to be twice as likely as sales of 120 million units.
- Merck assumes that for years 2 to 5 that the drug is on the market, the growth rate will be the same each year. The annual growth in sales will be between 5% and 15%. There is a 25% chance that the annual growth will be 7% or less, a 50% chance that it will be 9% or less, and a 75% chance that it will be 12% or less.
- Cash flows are discounted 15% per year, and the tax rate is 40%.
Use simulation to model Merck’s situation. Based on the simulation output, would you recommend that Merck continue developing? Explain your reasoning. What are the three key drivers of the project’s
Want to see the full answer?
Check out a sample textbook solutionChapter 11 Solutions
Practical Management Science
- A project does not necessarily have a unique IRR. (Refer to the previous problem for more information on IRR.) Show that a project with the following cash flows has two IRRs: year 1, 20; year 2, 82; year 3, 60; year 4, 2. (Note: It can be shown that if the cash flow of a project changes sign only once, the project is guaranteed to have a unique IRR.)arrow_forwardYour company is scheduled to receive 2, 000, 000 euros in 1 year. The euro is currently trading at 1.0813, you can borrow in the US for 1 year at 5.5% or invest in the US at 5.2%. You can borrow in euros at 3.6% or invest in euros at 3.3%. If you use a money market hedge on the receivable, how much will you get in US dollars?arrow_forwardWhich of the following statements describes the payment amounts over the life of an ARM? A) Payments will remain constant for the life of the loan. B) Payments may go up or down in relation to the index rate. C) Payments may go up or down in relation to the margin rate. D) Payments may go up or down in relation to the equity in the property.arrow_forward
- What is the main reason lenders pay borrowers' property taxes through a pre-paid escrow account? It prevents a tax lien from being applied to the home. The tax lien would be senior to the mortgage lien. It prevents the borrower from refinancing with another lender because they would lose all of their escrow funds. It allows the lender to earn interest on the pre- paid tax money as itsits in the account. It allows the lender to take advantage of corporate tax deductions.arrow_forwardWe are thinking of filming the Don Harnett story. Weknow that if the film is a flop, we will lose $4 million, andif the film is a success, we will earn $15 million. Beforehand,we believe that there is a 10% chance that the Don Harnettstory will be a hit. Before filming, we have the option ofpaying the noted movie critic Roger Alert $1 million for hisview of the film. In the past, Alert has predicted 60% of allactual hits to be hits and 90% of all actual flops to be flops.We want to maximize our expected profits. Use a decisiontree to determine our best strategy. What is EVSI? What isEVPI?arrow_forwardWhy might a borrower prefer a fully amortizing loan over an adjustable-rate mortgage? О The monthly mortgage payment will remain constant throughout the term of the loan The principal and interest payment varies each month. The payment towards interest increases as the loan is amortized. The interest rate may increase over the term of the loanarrow_forward
- A borrower wants to lower the amount of money they pay in interest over the life of a loan. Which of these tactics is best for decreasing the amount of interest the borrower would pay? making payments small enough to create negative amortization never defaulting on a monthly payment making monthly payments on a non- amortized loan making biweekly payments on an amortized loanarrow_forward2. The Government of Ghana, through the Ministry of Trade and Industries (MOTI) has called for Business Plans from all ‘Year 2020’ Ghanaian graduates of tertiary institutions across the country to access a seed money for setting businesses through Stimulus Package known as the COVID FUND. It is important to note that the Fund Managers require applicants to show proof of how feasible their plans would be. This implies that you are expected to explicitly show how and when the venture would pay back the investment, at what point would the venture break-even as well as the opportunity cost of your venture (e.g., Time Value of Money (TVM) like NPV, BCR & IRR). Fortunately for you, after a semester’s course in Entrepreneurship, you have learnt about how to write a pitching business plan. How would you go about this onerous task?arrow_forwardWhy do lenders need liquidity? so they have the funds to originate more loans so they can put their money in long-term assets to qualify for FHA insurance so loans can be packaged together to create MBSSarrow_forward
- Describe the IFRS treatment of increases in the market value of property, plant, and equipment held during the year. Compare that treatment to the U.S. GAAP requirements.arrow_forwardWith the success of your business, you are ready to establish a storefront. However, you do not have the necessary funds to acquire the building and pay the necessary rent. You are considering borrowing a short-term note from a bank for $130,000. Required part B. Research the lending practices of a local bank. Determine the interest rate charged for a $130,000 loan. What collateral does the bank require to secure the loan? Determine your overall payback amount if you were to repay the loan in less than one year. Choose either a payback with periodic payments or all at the end of the loan term and compare the outcomes. After conducting your research, would you consider borrowing the money? What positive and negative outcomes accompany borrowing the money? Instead of borrowing on a short-term note, you are thinking on borrowing $130,000 and signed a 5-year, note payable with a 12% interest rate. Each annual payment is in the amount of $34,920 and payment is due each Dec. 31. What is…arrow_forwardYour answer is partially correct. An independent contractor for a transportation company needs to determine whether she should upgrade the vehicle she currently owns or trade her vehicle in to lease a new vehicle. If she keeps her vehicle, she will need to invest in immediate upgrades that cost $5,200 and it will cost $1,300 per year to operate at the end of year that follows. She will keep the vehicle for 5 years; at the end of this period, the upgraded vehicle will have a salvage value of $3,800. Alternatively, she could trade in her vehicle to lease a new vehicle. She estimates that her current vehicle has a trade-in value of $9,800 and that there will be $4,100 due at lease signing. She further estimates that it will cost $2,900 per year to lease and operate the vehicle. The independent contractor's MARR is 11%. Compute the EUAC of both the upgrade and lease alternatives using the insider perspective. Click here to access the TVM Factor Table Calculator. 1943.56 EUAC(keep): $…arrow_forward
- Practical Management ScienceOperations ManagementISBN:9781337406659Author:WINSTON, Wayne L.Publisher:Cengage,