GSBS6130 Corporate Finance
Individual Assignment
Trimester 1, 2017, Weblearn
Course Coordinator: Dr Md Lutfur Rahman
Weight: 20%
Total Marks: 20
Due time and date: 11:59pm (AEST) on Thursday 6 April 2017
Submission Instructions:
1. Maximum word length: 2500 words, excluding graphs, tables, references and appendices.
2. You need to submit the assignment in pdf, with an assignment cover sheet included, via Turnitin by the due date.
3. In addition, an Excel file with supporting calculations (if any) must be submitted online to Assignment_Supporting Excel File link on BB by the due date. You will need to include your student ID and your name in the Excel file name (for example, cxxxxxxx_FirstName_LastName_assignment).
4. Submission by other means (email/hard copy) or forms (scanned copy) will attract no marks.
Penalties:
1. In the case of late submission without an approved extension of time, a penalty of 10% will apply for each day the assignment item is late.
2. Penalties will also apply if academic misconduct is found (refer to the Course Outline for more information).
Question 1 (10 marks)
Alex, the product development manager for Apex Pharmaceuticals (AP) joined the firm about 7 years ago. With a bachelor’s degree in chemistry and an MBA in Finance from the University of Newcastle, Alex has been fairly successful in his professional career. Prior to working at AP, Alex was responsible for the launching of three highly successful drugs at another mid-sized pharmaceutical company. It did not take long for the head-hunters to find him and shortly thereafter AP made him an offer that was too good to refuse. AP is a fairly large pharmaceutical company that has a number of patented drugs under its belt. With a number of the firm’s patents expiring in the next three years, there has been some pressure to expand its production lines. Alex has been asked to make recommendations for new investment to the Board, specifically regarding a new drug recently developed by AP’s Research Department.
The Vision Research division recently invented a new drug, nicknamed ClearView, for the cure of myopia, which has shown tremendous promise in the preliminary test. The project leader, Catherine, is very confident that this new drug could revolutionise the world of ophthalmology. Upon Alex’s request, she also provides some standard cost estimates if the product is approved and launched early this year.
Development costs: 15 million
Testing costs: 10 million
Initial Marketing costs: 13 million
Initial outlay: 38 million
The new drug is expected to be a block-buster, which will help to increase the company’s market share and the sales are expected to be $13 million in the first year. The sales revenue generated from this product alone is expected to grow at a rate of 15% pa in the first three years and stay in line with inflation thereafter until its patent expires in 10 years.
The product would be manufactured in an unused plant owned by the firm which would otherwise be leased out for $150,000 per year. Required equipment costing $6 million is expected to have a salvage value of $500,000 after 10 years, though it will be fully written off for tax purposes. Fixed costs are estimated to be $2 million per year while variable production costs are expected to be equal to 25% of sales revenue in each case. To get the project underway, additional inventory of $600,000 would be required. The company would also need to increase its accounts payable by $200,000 and its accounts receivable by $300,000. Catherine estimates that the net working capital committed to each production line would be maintained at 20% of its sales each year thereafter.
The weighted average cost of capital is calculated to be 12%. The current inflation of
2% pa is expected to remain stable over the next 15 years, and so is the company’s tax rate of 30%.
You have been asked to advise the manager whether the proposal should be adopted using NPV and IRR analyses.
In addition you need to provide a sensitivity analysis using the numbers above, an analysis which could be scrutinised and questioned by the relevant company committee. The sensitivity analysis should be based on the following scenarios:
Scenarios Sales Fixed Cost (FC)
Pessimistic estimate 30% decrease in sales 30% Increase in FC
Base case $13 million $2 million
Optimistic estimate 30% Increase in sales 30% Decrease in FC
Readings for Question 1
1. GSBS6130 Weeks 3 and 4 Course Notes/Handout/ activities
2. Chapters 5 and 6, Peirson, G., Brown, R., Easton, S., Howard, P. and Pinder,
S. (2015). Business Finance (12 ed.): McGraw-Hill Australia, North Ryde (ISBN: 1743078978)
QUESTION 2: (10 Marks)
You are a research analyst in an investment bank. You need to write a research report on the sensitivity of the stock return to the market return. The following model can be used to estimate the sensitivity of the stock return to the market return:
𝑅𝑖,t = a0 + ß1𝑅𝑚,𝑡 + 𝜀𝑖,𝑡 (1)
Where Ri,t is stock return on the ith institutions; Rm,t is return on the S&P/ASX all Ordinaries Index (^AORD.AX); and 𝜀𝑖,𝑡 is the random error term at day t. You are required to estimate the market model (equation 1) for the following companies:
• National Australian Bank (NAB.AX)
• BHP Billiton Ltd (BHP.AX)
• Woolworths Limited (WOW.AX)
Data sources
• Daily adjusted closing stock prices for companies and the All Ordinaries Index:
http://au.finance.yahoo.com
Estimation period
January 1, 2010–December 31, 2016
Referencing style
American Psychological Association (APA) 6th Edition. You can find helpful examples of APA 6th ed. citation in pp 26-38 of the 2013 NBS Postgraduate Student Manual as well as at http://www.apastyle.org/index.aspx.
Required
Write a research report based on the market model as given in Equation 1 with the following parts:
(a) Introduction (hint: you should discuss why companies are sensitive to the market return)
(b) Methodology (hint: you should discuss the model, sources of data etc.)
(c) Findings (hint: you should discuss the results from the model) (d) Conclusion (hint: you should discuss the implications) (e) References.
Readings for Question 2
1. GSBS6130 Week 8 Course Notes /Handout/ activities
2. Chapter 7, Peirson, G., Brown, R., Easton, S., Howard, P. and Pinder, S.
(2015). Business Finance (12 ed.): McGraw-Hill Australia, North Ryde (ISBN: 1743078978)
Marking Guide
Question 1 (10 marks):
• 1 mark for clearly presenting relevant assumptions
• 1 mark for treatment of depreciation
• 1 mark for treatment of working capital
• 1 mark for treatment of tax
• 1 mark for treatment of opportunity costs
• 1 mark for calculation of NPV and IRR
• 1 mark for -appropriate- treatment of inflation
• 1 mark for reaching valid conclusion based on analysis
• 2 marks for sensitivity analysis and any other risk assessment
Question 2 (10 marks):
• 1 marks for Introduction
• 2 marks for Methodology
• 5 marks for Findings
• 1 mark for Conclusion
• 1 mark for References