Orchid Biotech Company is evaluating several different development projects for experimental drugs. Although the cash flows are difficult to forecast, the company has come up with the following estimates of the initial capital requirements and NPVs for the projects. Given a wide variety of staffing needs, the company has also estimated the number of research scientists required for each development project (all cost values are given in millions of dollars). Project Number Initial Capital Number of Research Scientists NPV I $10 2 $10.1 II 15 3 19.0 III 15 4 22.0 IV 20 3 25.0 V 30 12 60.2 a. Suppose that Orchid has a total capital budget of $60 million. Calculate the profitability index for each project. How should Orchid prioritize these projects? b. Suppose that Orchid currently has 12 research scientists and does not anticipate being able to hire more in the near future. How should Orchid prioritize these projects?

OneClass: Orchid Biotech Company is evaluating several different development projects for experimenta...

1) Due to a number of lawsuits related to toxic wastes, a major chemical company has recently experienced a market revaluation. The firm has bonds outstanding that were issued 10 years ago at their par value of $1,000. These bonds have 15 years to maturity and a coupon rate of 8 percent, with interest paid semiannually. The required return on these bonds has increased to 16 percent. What is the current value of one of these bonds?

2)A bond with a $1,000 face value and a 9 percent annual coupon pays interest annually. The bond matures in 12 years.

a)Determine the value of the bond to a friend of yours with a required rate of return of 11%.

b)A zero coupon bond with similar risk is selling for $300. The bond has a face value of $1,000 and matures in 12 years. Your friend asks you which bond she should invest in, the zero coupon bond or the bond in part (a). Which bond do you recommend, and why? Assume the market price of the bond in part (a) is $720.

3)If you are willing to pay $1,077 for a 15-year $1,000 par value bond that pays 9 percent interest semi-annually, what is your expected rate of return?

4)If the expected growth rate for dividends is zero, then the value of common stock will be equal to the current dividend.

a) true

b)false

5)Diana Ltd. paid a $4.50 per share dividend yesterday. The dividend is expected to grow at 9 percent per year for the foreseeable future. Diana Ltd. has a beta of 1.4, a standard deviation of returns of 28 percent, and a required return of 16%. What is the value of a share of Diana Ltd. common stock?

6)You purchased one share of Googling Enterprises common stock for $40 today. If the stock pays a dividend of $6.50 in one year, and sells for $50 at that time, what will the dividend yield, growth rate, and total rate of return be for the year?

7)Two projects are mutually exclusive if the accept/reject decision for one project has no impact on the accept/reject decision for the other project.

a)true

b)false

8)Rent-to-Own Equipment Co. is considering a new inventory system that will cost $450,000. The system is expected to generate positive cash flows over the next four years in the amounts of $250,000 in year one, $125,000 in year two, $110,000 in year three, and $80,000 in year four. Rent-to-Own's required rate of return is 10%. What is the internal rate of return of this project?

A)10.07%

b)11.89%

c)12.26%

d)12.69%

9)

Consider two mutually exclusive projects X and Y with identical initial outlays of $500,000 and useful lives of 5 years. Project X is expected to produce an after-tax cash flow of $150,000 each year. Project Y is expected to generate a single after-tax net cash flow of $1,015,000 in year 5. The discount rate is 15 percent.

a)Calculate the net present value for each project.

b)Calculate the IRR for each project.

c)What decision should you make regarding these projects?

10)

If a firmâs tax rate increases then its weighted average cost of capital increases also.

a)True

b)False

Introduction:

You are the senior financial analyst for Fosbeck Generic Drug Co (Fosbeck). The firm manufactures and sells generic over-the-counter drugs in plants located throughout the country. You have been asked to generate some answers to questions emanating from the Board of Directors. These questions can be grouped into two broad categories â what projects to choose for the near future and how to finance these projects.

Deliverable:

Please present your recommendations in a report written for your supervisor, the firm Controller. Clearly show your analysis and communicate your conclusions and recommendations. Support your report by calculations in the Excel spreadsheets. In your report, explain the results of each portion of your analysis (represented by the tabs on the Excel template). Submit all the completed Excel worksheets with the completed responses to the questions posed to support your report and recommendation.

Steps to Completion:

Individual Project Analysis

Your first task is to analyze the companyâs three projects and provide your recommendations about their implementation.

Automation project

One of Fosbeckâs plants is trying to decide whether to automate its drug manufacturing by purchasing a fully automated bioreactor machine complex.

The proposed machine costs $400 M and it will have a five year anticipated life and will be depreciated by using the 3-year MACRS depreciation method toward a zero salvage value. (MACRS depreciation rates are: Year 1: 33%, Year 2: 45%, Year 3: 15% and Year 4: 7%) However, the plant will be able to sell the machine in the after-market for 25% of its original costs at the end of year 5. The firm estimates that the installation of the bioreactor will bring annual costs savings of $50 M from reduced labor costs, $10 M per year from reduced waste disposal costs, and $80 M per year from the sales byproduct of bioreactor process net of selling expenses. Fosbeck requires a 12% of return from its investment and has a 35% marginal tax rate.

Decision Criteria â NPV and IRR

Calculate the NPV and IRR for the project.

The manager of the plant raised some concerns about the revenues from the byproduct sale. He projects that the price of the byproduct in year 1 could be 10% to 50% less than what was projected. However, the savings from reduced labor costs and reduced waste disposal costs would remain same. He presented the following probability distribution on the projected reclaimed plastic sales:

Remain same as projected 40%

Decrease by 10% 30%

Decrease by 30% 20%

Decrease by 50% 10%

Estimate the NPV and IRR for each of these scenarios. Estimate the expected NPV.

Break-even Analysis

At what volume of byproduct sales would Fosbeck have a break-even NPV=0?

Fosbuvir Project

The company considers development of a new drug to treat Hepatitis C, code-named the Fosbuvir Project. Fosbeck has already spent $420 M on preliminary research for drug development and it will need another $600 M on development this year (tax deductible) and $2 B in CapEx next year (these cash outlays are not part of the cash flows that you have estimated earlier, because this project is not approved yet). Capital expenditures will be depreciated over 10 years using straight line depreciation.

The patent for the drug is pending and the company expects to receive an FDA approval and start selling the drug in two years. Its expected revenues in the first year of sales are $1 B ($10 B revenue with a 10% probability) with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 7 years. Even if Fosbuvir gets approved by FDA, each year there is a 5 % probability of the patent becoming obsolete due to a new drug entering the market, in which case the revenues will drop to zero. After that the drug will lose the patent protection and its manufacturing is expected to stop. The CoGS are estimated to be 15% of revenues and SG&A expenses are $2 B a year if the drug is produced and zero otherwise.

NPV and IRR

Please estimate the NPV and IRR of the Fosbuvir Project, using the companyâs WACC of 12%.

Real Option Scenario Analysis

Expected revenues and expenses take into account the uncertainty of getting the patent and FDA approval. The company estimates the probability of getting the approval in two years is 10% (i.e., if the company gets the approval the revenue is $10 B, if it does not, the revenue is zero). Even if Fosbuvir gets approved by FDA, each year there is a 5 % probability of the patent becoming obsolete due to a new drug entering the market, in which case the revenues will drop to zero.

Therefore, your next task is to evaluate these two scenarios for the Fosbuvir Project (see the template) based on probability of FDA approval in two years and patent obsolescence in each subsequent year.

One of your colleagues pointed out that instead of starting construction before the FDA approval, the company can invest only $0.8 B next year (depreciated over 10 years) and delay the remaining $1.2 B investment (depreciated over 8 years) for two years until the drug gets approved. Only if the drug gets approved will Fosbeck proceed with the second stage investment, which will take place in three years. The sales will commence in four years at the level of $10 B (with a probability of 10%) with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 5 years â due to delay the company will lose two years of revenues. The probability of patent obsolescence remains the same as before â 5% each year.

What is the NPV of this two-stage investment?

Is the option to delay the project valuable? Explain.

Pharmaset, Inc. Acquisition

The reason of the low probability of FDA approval for Fosbuvir is that another company, Pharmaset, Inc., is working on a similar drug, called FosbuvirP, and is very close to getting FDA approval and a patent. If Pharmaset gets a patent, Fosbeckâs own application will be denied. Therefore, instead of developing Fosbuvir internally, Fosbeck can acquire Pharmaset. Pharmaset already has manufacturing facilities in place and FosbuvirP is its only product. The book value of the companyâs fixed assets is $3 B, which will be depreciated using the straight-line depreciation over the next 10 years. Pharmaset expects to receive the FDA approval and patent by the end of this year with sales starting next year. Its next year revenues are expected to be $4 B ($10 B revenue with a 40% probability) with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 7 years. After that the drug will lose the patent protection and its manufacturing is expected to stop. The CoGS are expected to be 15% of revenues and SG&A expenses are $3.5 B a year if the drug is produced and zero otherwise. In other words, in case of FDA approval Pharmasetâs revenues and costs will be similar to Fosbeckâs, but SG&A expenses will be higher. If Fosbeck were to acquire Pharmaset, it would be able to bring SG&A costs down to Fosbeckâs level. The probability of FDA approval is 40% and the probability of patent obsolescence remains the same as before â 5% each year.

Mergers and Acquisitions. Target (Pharmaset) Valuation

Pharmasetâs management would be open to the sale in the valuation range of $ 20 to 24 Billion. Please estimate Pharmasetâs value to Fosbeck, if it gets acquired.

Recommendations

Upon reviewing Fosbeckâs choices, what project(s) would you recommend?

Venture Capital Financing

Finally, to further reduce its risk Fosbeck considers to keep acquired Pharmaset as a separate company. In this case Fosbeck will eventually shift its R&D to Pharmaset, which will continue as a viable business even after the initial patent expires. Therefore, we can ignore the probability of a patent becoming obsolete. However, if FDA approval is not received this year, Pharmaset will go bankrupt, in which case its assets will be sold at residual book value.

A venture capital (VC) firm Menlo Ventures is willing to provide financing of up to $5 B in acquisition of Pharmaset.

If the VC agrees to invest in Pharmaset, it plans to exit after eight years at which time it expects that the companyâs value would be eight times its year 8 EBIT.

Menlo Ventures offers three different ways of structuring the financing:

Straight common stock where the VC will not receive any dividend for the first four years and will receive 20% of NOPAT as a dividend for the remaining four years. The tax rate for Pharmaset is 38%. In addition, the VC will receive a 20% ownership of the companyâs equity at the end of eight years.

Redeemable convertible debt with 10% coupon rate (interest is tax-deductible). The debt will be converted for 15% ownership of the equity of Pharmaset at the end of eight years. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets' book value, whichever number is lower.

Redeemable preferred stock with 7.5% dividend plus warrants for 15% of the equity for an exercise price of $150 M. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets' book value, whichever number is lower.

Which financing method should be selected by Fosbeck? Explain your answer.

Frequently Asked Questions/Helpful Hints:

Is it enough to submit Excel file?

No! The deliverable outcome is your written report to the CFO. You use Excel to support your recommendations

Is there a minimum or maximum size of the report?

Although there is no formal minimum size of the report, it has to address all issues raised and provide your analysis and supporting evidence. To complete the thorough analysis required for this assignment you will probably need 3-4 pages. It is also a good idea to add a one-page executive summary to your report.

Similarly, there is no maximum limit for the report, but please avoid adding superfluous information to your report.

How do I explain whether the option to delay the project valuable?

Analyze the costs and benefits of making the capital investment in two steps and delaying the projectâs positive cash flows by two years and shortening the revenue stream.

Are preferred dividends tax deductible?

No, unlike coupon payments, preferred dividends are not tax deductible.

How do I decide which financing option is better?

One approach would be to see which option is less costly from Fosbeckâs management point of view.

brownkangaroo143

You are the senior financial analyst for Fosbeck Generic Drug Co (Fosbeck). The firm manufactures and sells generic over-the-counter drugs in plants located throughout the country. You have been asked to generate some answers to questions emanating from the Board of Directors. These questions can be grouped into two broad categories â what projects to choose for the near future and how to finance these projects.

Deliverable:

Please present your recommendations in a report written for your supervisor, the firm Controller. Clearly show your analysis and communicate your conclusions and recommendations. Support your report by calculations in the Excel spreadsheets. In your report, explain the results of each portion of your analysis (represented by the tabs on the Excel template). Submit all the completed Excel worksheets with the completed responses to the questions posed to support your report and recommendation.

Steps to Completion:

Individual Project Analysis

Your first task is to analyze the companyâs three projects and provide your recommendations about their implementation.

Automation project

One of Fosbeckâs plants is trying to decide whether to automate its drug manufacturing by purchasing a fully automated bioreactor machine complex.

The proposed machine costs $400 M and it will have a five year anticipated life and will be depreciated by using the 3-year MACRS depreciation method toward a zero salvage value. (MACRS depreciation rates are: Year 1: 33%, Year 2: 45%, Year 3: 15% and Year 4: 7%) However, the plant will be able to sell the machine in the after-market for 25% of its original costs at the end of year 5. The firm estimates that the installation of the bioreactor will bring annual costs savings of $50 M from reduced labor costs, $10 M per year from reduced waste disposal costs, and $80 M per year from the sales byproduct of bioreactor process net of selling expenses. Fosbeck requires a 12% of return from its investment and has a 38% marginal tax rate.

Decision Criteria â NPV and IRR

Calculate the NPV and IRR for the project.

The manager of the plant raised some concerns about the revenues from the byproduct sale. He projects that the price of the byproduct in year 1 could be 10% to 50% less than what was projected. However, the savings from reduced labor costs and reduced waste disposal costs would remain same. He presented the following probability distribution on the projected reclaimed plastic sales:

Remain same as projected 40%

Decrease by 10% 30%

Decrease by 30% 20%

Decrease by 50% 10%

Estimate the NPV and IRR for each of these scenarios. Estimate the expected NPV.

Break-even Analysis

At what volume of byproduct sales would Fosbeck have a break-even NPV=0?

Fosbuvir Project

The company considers development of a new drug to treat Hepatitis C, code-named the Fosbuvir Project. Fosbeck has already spent $420 M on preliminary research for drug development and it will need another $600 M on development this year (tax deductible) and $2 B in CapEx next year (these cash outlays are not part of the cash flows that you have estimated earlier, because this project is not approved yet). Capital expenditures will be depreciated over 10 years using straight line depreciation.

The patent for the drug is pending and the company expects to receive an FDA approval and start selling the drug in two years. Its expected revenues in the first year of sales are $1 B with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 7 years. After that the drug will lose the patent protection and its manufacturing is expected to stop. The CoGS are estimated to be 20% of revenues and SG&A expenses are $2 B a year if the drug is produced and zero otherwise.

NPV and IRR

Please estimate the NPV and IRR of the Fosbuvir Project, using the companyâs WACC of 12%.

Crystal Ball

Expected revenues and expenses take into account the uncertainty of getting the patent and FDA approval. The company estimates the probability of getting the approval in two years is 10% (i.e., if the company gets the approval the revenue is $10 B, if it does not, the revenue is zero). Even if Fosbuvir gets approved by FDA, each year there is a 5 % probability of the patent becoming obsolete due to a new drug entering the market, in which case the revenues will drop to zero.

Therefore, your next task is to evaluate the Fosbuvir Project using Crystal Ball simulation (see the template) based on probability of FDA approval in two years and patent obsolescence in each subsequent year. Alternatively you are welcome to use Random Data generator in Data Analysis Pack.

What is the probability of a positive NPV?

Please discuss the riskiness of the project.

Real Option

One of your colleagues pointed out that instead of starting construction before the FDA approval, the company can invest only $0.8 B next year (depreciated over 10 years) and delay the remaining $1.2 B investment (depreciated over 8 years) for two years until the drug gets approved. Only if the drug gets approved will Fosbeck proceed with the second stage investment, which will take place in three years. The sales will commence in four years at the level of $10 B with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 5 years â due to delay the company will lose two years of revenues. The probability of patent obsolescence remains the same as before â 5% each year.

What is the NPV of this two-stage investment?

Is the option to delay the project valuable? Explain.

Pharmaset, Inc. Acquisition

The reason of the low probability of FDA approval for Fosbuvir is that another company, Pharmaset, Inc., is working on a similar drug, called FosbuvirP, and is very close to getting FDA approval and a patent. If Pharmaset gets a patent, Fosbeckâs own application will be denied. Therefore, instead of developing Fosbuvir internally, Fosbeck can acquire Pharmaset. Pharmaset already has manufacturing facilities in place and FosbuvirP is its only product. The book value of the companyâs fixed assets is $3 B, which will be depreciated using the straight-line depreciation over the next 10 years. Pharmaset expects to receive the FDA approval and patent by the end of this year with sales starting next year. Its next year revenues are expected to be $4 B with subsequent annual growth of 50% over the next three years, after which the sales will be stable for another 7 years. After that the drug will lose the patent protection and its manufacturing is expected to stop. The CoGS are expected to be 20% of revenues and SG&A expenses are $3.5 B a year if the drug is produced and zero otherwise. In other words, in case of FDA approval Pharmasetâs revenues and costs will be similar to Fosbeckâs, but SG&A expenses will be higher. If Fosbeck were to acquire Pharmaset, it would be able to bring SG&A costs down to Fosbeckâs level. The probability of FDA approval is 40% and the probability of patent obsolescence remains the same as before â 5% each year.

Mergers and Acquisitions. Target (Pharmaset) Valuation

Pharmasetâs management would be open to the sale in the valuation range of $ 20 to 24 Billion. Please estimate Pharmasetâs value to Fosbeck, if it gets acquired.

Recommendations

Upon reviewing Fosbeckâs choices, what project(s) would you recommend?

Venture Capital Financing

Finally, to further reduce its risk Fosbeck considers to keep acquired Pharmaset as a separate company. In this case Fosbeck will eventually shift its R&D to Pharmaset, which will continue as a viable business even after the initial patent expires. Therefore, we can ignore the probability of a patent becoming obsolete. However, if FDA approval is not received this year, Pharmaset will go bankrupt, in which case its assets will be sold at residual book value.

A venture capital (VC) firm Menlo Ventures is willing to provide financing of up to $5 B in acquisition of Pharmaset.

If the VC agrees to invest in Pharmaset, it plans to exit after eight years at which time it expects that the companyâs value would be eight times its year 8 EBIT.

Menlo Ventures offers three different ways of structuring the financing:

Straight common stock where the VC will not receive any dividend for the first four years and will receive 20% of NOPAT as a dividend for the remaining four years. The tax rate for Pharmaset is 38%. In addition, the VC will receive a 20% ownership of the companyâs equity at the end of eight years.

Redeemable convertible debt with 10% coupon rate (interest is tax-deductible). The debt will be converted for 15% ownership of the equity of Pharmaset at the end of eight years. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets' book value, whichever number is lower.

Redeemable preferred stock with 7.5% dividend plus warrants for 15% of the equity for an exercise price of $150 M. In the case of bankruptcy the debt will be immediately redeemed at its face value or at the residual assets' book value, whichever number is lower.

NOTE: Please provide email address for excel file. Thank you

tealwildebeest936

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