And the hits just keep on comin'.

Last week, the Department of Justice (DOJ) launched a formal investigation into Merck's (NYSE:MRK) practices surrounding the development and ultimate withdrawal of its Vioxx painkiller. Concurrently, the Securities and Exchange Commission (SEC) announced that it is conducting an informal investigation into Merck's shareholder disclosure practices in relation to the drug.

This, ladies and gentlemen, is pretty much the definition of headline risk. I've gotta tell ya, the whole thing just makes you wanna have a Coke (NYSE:KO) and a smile and be done with it -- or at least a Pepsi (NYSE:PEP). We just need a vacation from bad news, and what better way to shake off the funk than downing some brown carbonated liquid? But I digress.

A drop in the pond
In truth, this news is at most a modest addition to the drug company's overall Vioxx burden, as the major risk facing the company continues to be the consumer product litigation resulting from Vioxx-related health problems.

The size of any penalties that could be levied by the DOJ or the SEC would likely be insignificant compared to the payouts associated with the individual cases. That point is further demonstrated by the fact that Merck carries about $190 million in liability insurance that could be applied toward any penalties levied by the SEC.

The DOJ and SEC investigations were no big surprise considering the large number of personal lawsuits that have been filed against the company. This is a fairly common occurrence given the situation, and the agencies were probably compelled to move that much quicker because the FDA has taken such a serious beating over this one.

I imagine government officials wouldn't be too disappointed if there turned out to be some evidence that Merck withheld material information from the FDA; that would result in some of the scrutiny being lifted from the agency (i.e., the fact that they were misled by a big bad pharmaceutical company would come across more favorably than if they had just missed something).

Again, however, the real risk to the company remains the individual product suits, and, therefore, the most material part of these new government cases is their potential to negatively affect the individual ones. All it would really take is a statement from the DOJ claiming Merck acted inappropriately in relation to Vioxx, and all individual suits would be bolstered.

That said, I continue to believe that the consumer cases will be much more difficult for plaintiffs to prove than most analysts and members of the media have speculated. Of course, my beliefs have not stopped the shares from plummeting every time material news is announced. As such, the stock remains appropriate only for those with a stout heart and a long-term focus.

Doom and gloom
Despite the seriousness of the situation, when you truly look at the proposed figures provided by the company and the FDA, I simply don't see any real justification for these $13 billion-$20 billion cost estimates being tossed around by some industry followers. Certainly it's possible for payouts to reach this level, but I think it's unlikely.

Consider these factors: As of Oct. 31, Merck said it was facing about 375 lawsuits from roughly 1,000 plaintiff groups filed by consumers claiming Vioxx-related injury. Though the majority of cases have been filed in the U.S., suits have also been filed in Brazil, Canada, and Israel. In addition, Merck said it has been named in state consumer fraud and fair-business-practice cases.

Merck has stated that one or more of those cases may go to trial in the first half of 2005 but has given no further details as to the anticipated time frame for resolving these cases. In all likelihood, Merck will be dealing with such suits for several years to come.

But again, I do not see judgments at the levels indicated above. Out of the 20 million patients that have taken Vioxx, the FDA released a study estimating that Vioxx could have caused approximately 28,000 negative cardiac events. Now, let's assume that the real number is closer to 35,000. Let's also assume -- despite a plausible estimation that Merck could win about 85% of these cases -- that Merck loses 85% of them.

Next, let's assume that the company is forced to pay out twice the $150,000 case average (or a total of $300,000 per case) to resolve each of the losses. Even in that highly unlikely instance, the company's total payout comes to just $8.9 billion.

But let's take it a step further and assume an additional $1.5 billion in legal expenses and another $2 billion to dismiss, settle, or otherwise resolve all of the frivolous lawsuits that are bound to be filed by those seeking a quick buck from the legal system. That still brings us to a total of less than $12 billion.

Can they swallow the pill?
So, let's get down to what you must be thinking at this point: "Could the company handle such a payout?" For starters, Merck carries nearly $650 million in product liability insurance, and though that's not going to get us there, every little bit helps. In addition, Merck currently has about $13 billion in cash and short-term investments on the balance sheet.

With these new numbers in place and the additional time to revise my models for the company, I'm comfortable saying that Merck could afford to pay out as much as $25 billion over the long term and still live to tell about it. The firm could certainly digest a $12 billion payment.

In fact, I estimate that Merck could afford to pay out nearly $4 billion next year, plus $2.6 billion per year for the next five years and still maintain its current dividend. That would cover a total of $17 billion in payments.

It's all about the defense
Again, I believe injury in these cases is going to be much more difficult to prove than most assume. Comparisons to situations experienced by Dow Corning and Wyeth (NYSE:WYE) are inappropriate at best. We're not talking about a rare disease here, such as the asbestos-related mesothelioma involved in cases that were battled by such firms as RPM International (NYSE:RPM) and Dow Chemical (NYSE:DOW).

Unfortunately, heart attacks are extremely common events, and the risk factors are extensive. It's virtually impossible to point to one particular factor as the cause of a heart attack in all but the healthiest of patients. Some of the most common reasons cited are smoking, diet, lack of exercise, and family predisposition, and those are all factors that could limit the degree of Merck's responsibility in each and every one of these cases.

In addition, though the level of cardiac events doubled in those patients who had taken Vioxx for more than 18 months (i.e., 15 per thousand versus 7.5 per thousand), the mortality rate largely remained the same for both groups -- meaning there were no additional fatal heart attacks for those who had taken Vioxx. This may seem a modest difference, but it can be a very meaningful difference in the eyes of a jury when evaluating actual damages. This factor helps to mitigate the "crying widow" scenario that some have used to justify huge potential payouts.

The Foolish bottom line
All of this is not to say that the company doesn't have a tough row to hoe -- it does. We'll have to watch announcements such as these very closely, as every bit of additional negative news strengthens the cases against the company and moves the potential payout closer to the maximum figures suggested above.

Please understand that Merck remains appropriate for only those investors with a high tolerance for risk and a long-term time horizon. After all, just because I think there could be significant long-term value in the shares doesn't mean we won't wake up one morning in the short term to find them trading at $19 a stub. Anything is possible at this point.

Finally, if you're committed to holding this stock for the long term, this is probably not a situation that you're going to want to watch day in and day out. Doing so could lead not only to ulcers but also to a negative cardiac event. We don't want that.

If you're looking for consistent, ongoing updates on Merck's future, consider a no-obligation free trial to Motley Fool Income Investor, the Fool's dividend-stock newsletter.

Fool on!

Mathew Emmert thinks all pills are bad for you, except for the ones that are good for you. In addition to being a world-class yodeler, he's the chief analyst of Motley Fool Income Investor . He owns shares of RPM International. The Fool has an ironclad disclosure policy.