Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

RECENT ANNUAL REPORTS

As of January 1993, Merck had about 38,000 employees and 91,000 stockholders. Sales by non-U.S. subsidiaries were 47 percent of sales in 1989 and 1990 and 46 percent of sales in 1991. The company’s most important product names include Vasotec and Prinivil (inhibitor agents for high blood pressure and angina), Mevacor and Zocor (cholesterol-lowering agents), Primaxin and Mefoxin (antibiotics), Pepcid (anti-ulcer agent), Recombivax HB (hepatitis B vaccine), and Prilosec (gastrointestinal). Financial data for Merck are presented in Appendix 6A.

Strategic Objectives

The main thrust of Merck’s strategic objectives has been to develop, manufacture, and sell products that reflect progress in science and therapy. Year-to-year objectives include staying among the leaders in the industry in sales growth, earnings per share, and (cash) return on assets. Operationally, Merck pursues these objectives under the assumption that research and development (R&D) is the key to its long-term growth. Indeed, in 1991, the company spent nearly $1 billion on R&D, which was about 10 percent of all U.S. pharmaceutical R&D spending and about 5 percent of all such spending in the world. According to Merck’s 1991 annual report, it planned to increase its R&D spending by about 16 percent in 1992.

Structural Reorganization

Merck realizes that the pharmaceutical industry is becoming increasingly global in research, manufacturing, and marketing. Consistent with that observation, the company ...