FBL5030: Fundamental of Value Creation in Business- Finance Case Study Assignment

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Finance Case Study Assignment:

Task:

CASE STUDY IN FINANCE – Salza-Pharmaceuticals
Based in Australia Salza-Pharmaceuticals Company was formed in 1995 and is a leading manufacturer of a cholesterol busting drug known as Cholo-2®. The company’s founder Dr Zaide Salzman initially commenced his career with a large German pharmaceutical operator and eventually became CEO of a US listed health company. Dr Salzman moved away from the corporate sector to set up his own research house where he collaborated with researchers from CEU University in Perth Western Australia. After recently securing seed capital from investors

Salza-Pharmaceutical Company intends to list on the Australian Stock Market in 2018. By 2013 Salza- Pharmaceuticals had signed a significant licencing deal with Aspel for the sales and marketing of Cholo-2®. A second licencing deal is in the pipeline with Aztor-Zanca after receipt of EU marketing clearance for a gel offering treatment and rapid relief for arthritis. As this arthritis gel is still in the early stages of commercial development Salza-Pharmaceuticals key cash flow direction is centred on the Cholo-2® drug. The company also produces a number of lines of health supplements and vitamins. By 2015, the company had a sales turnover of over $15 million with profits with excess of $3 million.

The company’s management recognises the licencing deal with Aspel as a potential company maker and as a result wishes to expand its Joondalup primary manufacturing facility. The new drug will cost more, but is superior to the primary competing product produced by its closest competitor. As a recent business school graduate working as a financial analyst at Salza-Pharmaceutical Company, you must analyse the project and present the findings to the company’s executive committee.

Production facilities for the Cholo-2® drug would be set up at the company’s main plant. A new high-tech production line facility will cost $1,225,000 inclusive of shipping and installation charges. This machine will have a useful life of 9 years, and can be depreciated on a straight-line basis. At the end of 9 years, the machine is expected to fetch a salvage value of $175,000. Due to heavy use, the new machine will have to be overhauled at the end of 5 years
of its useful life, at a cost of $250,000. The cost of the overhaul can be further depreciated on a straight-line basis
for the remainder of the machine’s life. Management is being cautious and wary that the new product may not be as well received in the market as initially expected, and are concerned if it is advisable to commit funds to such a large capital expenditure. There is an alternative to buy a used production facility from Korea with a remaining useful life of 4 years for an installed cos of $575,000. The used machinery can also be depreciated on a straight-line basis but the firm expects it will not have any salvage value at the end of its useful life.

If the company goes ahead with this new production, expenditure of raw materials will have to be increased by $125,000 at the start of the first year. The supply contracts include consideration for the impact of inflation on raw
material prices. Prices are expected to rise at a rate of 3% p.a. starting from the end of the first year.

Required:
1. Calculate the appropriate Weighted Average Cost of Capital (WACC) for the company if this project proceeds.
Apply this rate as the project’s required rate of return.

2. Prepare the incremental cash flow tables for Options A and B. Assume revenue and cost estimates from paragraph 7. Include adjustments for inflation in your cash flow forecasts. Discuss if the following items should or should not be included in the incremental cash flow tables.
A. Interest expenses on the $2 million loan;
B. The $95,000 spent last year to rehabilitate the plant; and
C. The reduction in sales of existing products and associated production costs.

3. Using the base-case scenarios, determine the NPVs and IRRs of this project. On the basis of these measures, should the project be undertaken and if so, which option is more beneficial to the firm?

4. Consider the impact of unequal lives for Options A and B. Does this change your recommendation in (3)?

5. Consider the sensitivities of the project’s value against variations to: unit sales, sale price per unit, costs of raw materials, and the salvage value. Advise management which two variables will need to be scrutinised carefully if the project is implemented.

6. Using the base-case scenarios for Options A and B, determine:
A. how low sales volume will have to fall to,
B. how low sales price will have to fall to, and
C. how high variable costs will have to rise to; before the project becomes unfeasible to the company. Discuss how this impacts your recommendation in (4).

7. Without any calculations, the company would also like you to start a preliminary discussion on whether the production line facility should be leased or purchased outright. Your discussion should consider the advantages and disadvantages of adopting an operating or finance lease for the machine. Address how a lease arrangement might change your analyses

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Posted on : February 03rd, 2018
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