Question

Over the semester we have learned that one of the three pillars of our economy is capital expenditures (CAPEX) by private and public businesses. On an annual basis companies allocate a certain amount of their free cash to develop projects that will facilitate company growth and earnings, which will, in turn, improve stock prices and shareholder value. Inside this process is the selection of projects that will be selected among many different available projects. Those companies that make the best choices are the ones that will successfully grow. Those that do not will join the garbage heap of companies that fail. You have that choice as the CFO of Almost Done (AD) Enterprises. Below are the specifics about a project that has been presented. Questions concerning this project follow the specifics of the project.

AD, a pharmaceutical company, has developed a new drug that will supposedly cure COVID-19 and provide immunity to the general population. The results are so promising that the company will purchase land for $1M to build a manufacturing center that will produce this drug in sufficient quantities. This facility will cost $185 million to build. The project will take 10 years and will initially require $535 million in net working capital. Also, the company will spend $5 million on R&D and $4 million in marketing the drug to the general population. The drug will sell for $1,500 in the first five years. Anticipating improved efficiency the drug will sell for $1,250 in years 6 through 9 and $1,000 in year 10. Variable costs will be $400 per unit. Annual fixed costs will be 11% of that year’s total revenue.

Marketing has projected annual sales as follows:

Project Year. Annual Unit Sales

1 15,000

2. 25,000

3. 100,000

4. 100,000

5. 100,000

6. 225,000

7. 225,000

8. 225,000

9. 225,000

10. 500,000

Salvage value for the land and the manufacturing facility are expected to be zero at the end of 10 years. AD plans to use straight-line depreciation on purchased assets.

AD has a capital structure that includes 53,000 5.8% bonds outstanding, 20 years to maturity, selling for 97% of par; the bonds have a $1,000 par value each and make semiannual payments. Also, AD has $1,500,000 common shares outstanding, selling for $97 per share and has a beta of 1.15. In addition, 100,000 shares of 9.5 percent preferred stock outstanding with a par value of $100 has also been issued. Presently, the preferred stock sells for $85.

The expected return of the market is 10.8% and the rate on a T-Bill is 3.8%. AD has a tax rate of 21%.

1. Develop a proforma cash flow statement showing the annual cash flows for this project. (55 points)
2. What is the required rate of return? (15 points)

1. Calculate the NPV for this project. (10 points)

1. Calculate the IRR for this project. (10 points)

1. Calculate the payback period for this project. (5 points)

1. What is your recommendation for this project? Why? (5 points)

Turn in work using an excel spreadsheet. Show your work for partial credit where applicable.

Answer 1