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Homework answers / question archive / Investment Analysis and Management: BACF/18B/FT Assignment 2 Individual 50 Marks Part 1: Max Drugs Limited is a leader in the bulk drug industry
Investment Analysis and Management: BACF/18B/FT
Assignment 2
Individual
50 Marks
Part 1:
Max Drugs Limited is a leader in the bulk drug industry. It manufactures a range of bulk drugs, technically called APIs (active pharmaceutical ingredients). Max is considering a new bulk drug called MBD-9. You have recently joined Max as a finance officer and you report to Prakash Singh, Vice President (Finance), who coordinates the capital budgeting activity. You have been asked to develop the financials for MBD9. After discussing with marketing, technical, and other personnel, you have gathered the following information. The MBD-9 project has an economic life of 5 years. It would generate a revenue of Rs.50 million in year1 which will rise by Rs.10 million per year for the following two years. Thereafter, revenues will decline by Rs.10 million per year for the remaining two years. Operating costs (costs before depreciation, interest, and taxes) will be 60 percent of revenues. MBD-9 is expected to erode the revenues of an existing bulk drug. Due to this erosion, there will be a loss of Rs.4 million per year by way of contribution margin for 5 years. While there may be some other impacts as well, they may be ignored in the present analysis. MBD-9 will require an outlay of Rs.40 million in plant and machinery right in the beginning. The same will be financed by equity and term loan in equal proportions. The term loan will carry an interest of 8 percent per annum and will be repayable in 4 equal annual instalments, the first instalment falling due at the end of year 1. For tax purposes, the depreciation rate will be 15 percent as per the written down value method. The net salvage value of plant and machinery after 5 years is expected to be Rs.20 million. The net working capital requirement will be 20 percent of revenues. Assume that the investment in net working capital will be made right in the beginning of each year and the same will be fully financed by working capital advance carrying an interest rate of 10 percent per annum. At the end of 5 years the working capital is expected to be liquidated at par. The effective tax rate is 30%
Required:
The current dividend on an equity shares of Max Drugs Limited is Rs.4.00. Assume that Max Drugs Limited dividend will grow at the rate of 18 percent per year for the next 5 years. Thereafter, the growth rate is expected to fall and stabilize at 10 percent. Equity investors require a return of 15 percent from Max Drugs Limited equity shares.
What is the intrinsic value of Max Drugs Limited? (5marks)
Assume now that the growth rate of 18 percent will decline linearly over a period of 4years and then stabilize at 10 percent. If investors require a return of 15 percent:
Max Drugs Limited is considering an investment project which has an estimated life of three years. The cost of the project is Rs 15,000,000 and the possible cash flows are given below:
Year 1 |
Year2 |
Year3 |
|||
Cash Flow in Rs in mln |
Prob |
Cash Flow in Rs in mln |
Prob |
Cash Flow in Rs in mln |
Prob |
7 |
0.3 |
6 |
0.5 |
5 |
0.4 |
8 |
0.5 |
8 |
0.2 |
7 |
0.3 |
9 |
0.2 |
10 |
0.3 |
9 |
0.3 |
Note: Prob = Probability
The cash flows of various years are independent and the risk-free discount rate (post tax) is 12 %.
Required:
Calculate the Expected Net Present Value and the Standard Deviation of the Net
Present Value using the Hillier Model. (5 Marks)
Max Drugs Limited has a Rs.1000 million, 10 percent (coupon rate) bond issue outstanding which has 5 years residual maturity. The bonds were issued 3 years ago at par for Rs.1000 million and Max Drugs Limited incurred floatation costs of Rs.24 million which are being amortised for tax purposes at the rate of Rs.3.0 million per year. If the bonds are called, the unamortised portion of the floatation costs (Rs.15.0 million) can be deducted for tax purposes. Max Drugs Limited tax rate is 35 percent. Max Drugs Limited can call the bonds for Rs.1060 million. Assume that the call premium of Rs.60 million can be treated as a tax-deductible expense.
Max Drugs Limited has been advised by its merchant bankers that due to fall in interest rates the firm can issue Rs.1000 million of new debt at an interest rate of 7 percent and use the proceeds for refunding of old bonds. The new issue will have a maturity of 5 years and involve a floatation cost of Rs. 20 million, which can be amortised in 5 equal annual instalments for tax purposes.
Required:
and how would you dispel them? (5 Marks)