Beta Compounding Pharmaceuticals is about to launch a new specialty drug for arthritis. It has been working on this drug for around 10 years and has spent in excess of $4 million in research and development to date. It will need to spend $400,000 on new equipment for a production facilities upgrade to be able to produce the new drug. The company estimates that an additional $50,000 will be required to train current workers on the new equipment before production can begin. This equipment will be depreciated on a straight line basis over 5 years with no planned salvage value. Beta estimates that it will I have to add about $10,000 in net working capital before production begins. Beta also estimates that it will have to market the new drug at an initial cost of $100,000, with incremental marketing costs of at least $25,000 for the next three years. The company believes that the drug will continue to be sold for a long period of time, at least to the end of patent protection, so does not have a final time horizon for the project. During the first year of operations, Beta expects its total revenues to increase by $200,000. These incremental revenues are expected to grow to $275,000 in year 2, $300,000 in year 3, and level off at $400,000 after that. The company does accept that the new drug will likely result in the loss of sales in one of its current well established arthritis drugs. It thinks this loss could be as high as $100,000 a year, but most likely would be $75,000 per year. The company's incremental operating costs are expected to total $125,000 the first year and increase at a rate of 8% per year until year 5 and remain at that level thereafter. Beta has a marginal tax rate of 30%. Beta has a cost of debt of 12%. Its beta is 2.1. The risk free rate is 5% and the return on the market is 13%. Beta has a current capital structure of 45% debt and 55% equity. What is the base case net present value for the drug?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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