Question

Overview- Assume you have just earned an MBA and taken a position as an analyst with an investment bank. You are assigned to a team of analysts responsible for monitoring pharmaceutical companies. Your report would be used in formulating buy/sell recommendations on these companies.

Assignment- Select Teva Pharmaceutical Industries, Ltd. and Merck & Co. for comparative purposes. Prepare a three‐year comparative report and financial analysis on the two companies using the most recent financial data from each company's annual financial statements.

Requirements The report must include:

1. Description and background of companies and product lines

2. How they compare:

a) Financially 1. Working capital 2. Current ratio 3. Liquidity 4. Financial leverage 5. R&D Expenditures 6. Profitability 7. Out‐of‐theordinaryevents/transactions 8. Cash flow analysis 9. Return on assets (ROA) 10. Return on equity (ROE)

b) Operationally 1. Number of days in accounts receivable and accounts receivable turnover 2. Number of daysin inventory and inventory turnover 3. R&D percentage ofrevenue 4. Organic growth vs. growth through mergers and acquisitions 5. Off‐balance sheetobligations

3. Recommendations on how the companies could improve ROE

4. Conclusion as to financial strengths and weaknesses of each company

Answer 1

A.. Since in this question the financial statements of both the companies are missing i would answer this question from conceptual point of view.

Part 1. In this part you can give a description of Teva pharceutical campanu and Merk & Co. as follows:

History: write a brief history of both the companies as to how the companies started, what was the idea behind the company setup, what group of consumers the company targest and what was it's original product range.

Research and development: Under this head write about the research and develpment conducted by both the industries on their product range. Since these are pharmaceutical companies, research and development plays a very vital role for such industries because it concerns with the health of people.

Product approval: This is another vital point for such industries as their products require proper testing and approvals before being launched in the market for human consumption. Under this head mention the various tests which the products have gone through and also mentions the approvals gathered from various boards and government for launching of such products.

Global sales:

Under this head write about the sale pattern of both the companies around the world. Write about the presence of the companies in the world market and their product sale pattern in different countries and the response from the consumers. Mention a comparative study of sale patterns of both companies.

Marketing: Under this head write about marketing strategies of both companies and how it affects their sales patterns. Write in details about the marketing strategies and which one works the most. Write a comparative study about marketing strategies both companies, which one is better and why??

Controversy about drug marketing and lobbying: Under this head write about any controversies which the companies have been involved with and also about their strategy to handle the same. Mention about the regulatory issues faced by the company’s for their various products and again the mitigation strategies. Also, write about drug frauds prevalent in the pharmaceutical industry.

Part 2 Under this compare both the industries as asked in the question. I am mentioning here the basic formulas of the questions asked their meaning and the way of comparison:

1. Financially:

1. Working Capital: Working capital is a way for businesses to see if they have the ability to pay off their current liabilities. What are current liabilities? Well, they're a business’ debts that must be paid within one year. Common examples include:

• Accounts payable
• Short-term loans
• Sales taxes payable
• Income taxes payable
• Payroll taxes payable
• Interest payable
• Accrued expenses

These debts are paid using current assets which are usually cash or assets that turn into cash within one year. Current assets include:

• Cash
• Accounts receivable
• Inventory
• Prepaid expenses
• Investments or cash equivalents (i.e., treasury bonds, publicly traded stock, mutual funds, etc.) that can be easily liquidated

The amount of working capital a business has indicates business liquidity. And how liquid you are demonstrates your ability to convert assets into cash to pay liabilities and debts.

So, the Working Capital Formula = Current Assets – Current Liabilities

Interpretation of the above be as higher the working capital the better it is, therefore, the company having higher working capital is considered better.

2. Current Ratio:

The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations. To gauge this ability, the current ratio considers the current total assets of a company (both liquid and illiquid) relative to that company’s current total liabilities. The formula for calculating a company’s current ratio is:

Current Ratio = Current Assets / Current Liabilities

The current ratio is called “current” because, unlike some other liquidity ratios, it incorporates all current assets and liabilities.

• -A ratio under 1 indicates that a company’s liabilities are greater than its assets and suggests that the company in question would be unable to pay off its obligations if they came due at that point. While a current ratio below 1 shows that the company is not in good financial health, it does not necessarily mean that it will go bankrupt. So an ideal ratio of 2:1 is considered perfect. Therefore, in this case the company having a better ratio is considered better.

3. Liquidity: In accounting, the term liquidity is defined as the ability of a company to meet its financial obligations as they come due. The liquidity ratio, then, is a computation that is used to measure a company's ability to pay its short-term debts. It is mainly based on the current ratio mentioned in point no. 2. So we can interpret it as higher the current ratio, the better is the liquidity. So the company having a better current ratio is said to have better liquidity.

4. Financial Leverage: The term leverage, in the field of business, refers to the use of different financial instruments or borrowed capital in order to increase the firm’s potential ROI or return on investment. When given a generalized and more technical definition, financial leverage is the extent up to which a firm utilizes the available financial securities, such as equity and debt. It indicates the extent of reliance of a firm’s business over the available debt in the firm’s business operations.The formula of financial leverage with regards to a company’s capital structure can be written as follows:

                                  Financial leverage Formula = Total Debt / Shareholder’s Equity

                                Please note that Total Debt = Short Term Debt + Long Term Debt.

             Interpretation-The higher the value of leverage, the more that particular firm uses its issued debt. A large value for leverage means a much higher interest rate, resulting in higher interest expenses. And this can negatively affect the firm’s bottom line and earnings per share. But at the same time, the leverage value should not go down too low, as the firms issuing too much equity is considered less secure because the amount of risk in equity markets is too high.

So in a way, leverage is also an effective way to understand and analyze financial risks faced by an organization in its business. Therefore, whichever company has a better leverage is considered bad as compared to other.

5. Research and development expenditures: Research and development (R&D) describes activity or expense associated with the research and development of a company's goods or services. R&D expenses are a type of operating expense and can be deducted as such on a business tax return. This type of expense is incurred in the process of finding and creating new products or services. Therefore, the higher research and development, the better it is.

6. Profitability: Profitability is ability of a company to use its resources to generate revenues in excess of its expenses. In other words, this is a company’s capability of generating profits from its operations. The two key aspects of profitability are revenues and expenses. Revenues are the business income. This is the amount of money earned from customers by selling products or providing services. Generating income isn’t free, however. Businesses must use their resources in order to produce these products and provide these services. Resources, like cash, are used to pay for expenses like employee payroll, rent, utilities, and other necessities in the production process. Profitability looks at the relationship between the revenues and expenses to see how well a company is performing and the future potential growth a company might have.

Interpretation- the company having the higher net profits is said to be more profitable hence, mention a comparative analysis of both the companies.

7.Out of the ordinary events: An event or transaction is deemed extraordinary if it is both unusual and infrequent. An unusual event must be highly abnormal and unrelated to the typical operating activities of a company, and it should be reasonably expected not to recur going forward. It was common for some businesses to not have this line item presented for years. Besides segregating the effect of extraordinary items on the income statement, companies were required to estimate income taxes from these items and disclose their earnings-per-share (EPS) impact. So in this case out of the ordinary events can be separately mentioned and the company having lesser out of the ordinary events are preferred more.

8.Cash Flow Analysis: Cash Flow Analysis is a technique used by investors and businesses to determine the value of overall companies as well as the individual branches of large companies by looking at how much excess cash they produce. They typically use the Statement of Cash Flows, a document that shows the actual cash that came in and out of the business during a certain period from investing activities, financing activities, and operational activities, as well as a few other reports. In this you have to prepare the individual reports accordingly.

9.Return on Assets: Return on Assets (ROA) is a type of return on investment (ROI) that measures the profitability of a business in relation to its total assets. This ratio indicates how well a company is performing by comparing the profit it’s generating to the capital it’s invested in assets. The higher the return, the more productive and efficient management is in utilizing economic resources.

The ROA formula is:

ROA = Net Income / Average Assets

Where, Net Income is net earnings or net income during the year.

Average assets is opening assets plus closing assets divided by 2

Interpretation- Under this ratio the company having the higher ratio is considered better as it’s earning much more per unit of assets deployed.

10.Return on equity: Return on equity (ROE) is the amount of net income returned as a percentage of shareholders' equity. Return on equity measures a corporation's profitability by revealing how much profit a company generates with the money shareholders have invested.

ROE is expressed as a percentage and calculated as:

Return on Equity = Net Income/Shareholder's Equity

Net income is for the full fiscal year before dividends paid to common stockholders but after dividends to preferred stock and shareholders equity does not include preference shares.

Interpretation: The company having the higher ROE shows that it is earning much more for its investor to per unit of their investment and hence is considered better.

Part 3- Ways to improve Return on Investment:

Increase Revenues

One way to increase your return on investments is to generate more sales and revenues or raise your prices. If you can increase sales and revenues without increasing your costs, or only increase your costs enough to still provide a net gain in profits, you’ve improved your return. If you can raise your prices without decreasing your sales enough to erode profits, you’ve improved your return. Using your calculation of your current return, look at ways to improve your sales and revenues in ways that provide you with a greater profit than your current business practices.

Reduce Costs

Another way to improve your return is to reduce your expenses. You won’t have to increase your sales or raise your prices to improve the return on your investment this way. Divide your expenses into overhead and production costs to help you better find expense-reduction opportunities. Overhead costs are non-production expenses such as rent, insurance and phones. Production costs are the expenses you incur to make one unit of your product, such as materials and labor.

Re-Evaluate Your Expectations

Every investment you make doesn’t have to provide a dollar benefit; however, your investments should provide some identifiable benefit. If you run a marketing campaign, in addition to sales increases, track the new customers you gain increased traffic to your website and increased awareness of your business in the marketplace. Re-evaluating your expectations can help you spot intangible benefits to pursue that will eventually help increase your profits.