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Exercise 4. Modern Pharma

Modern Pharma is considering manufacturing a new drug called Floxin for 7 years. Sales are expected to range from Rs. 80 million to Rs. 200 million over the 7 years. Capital equipment costs Rs. 120 million and can be sold for Rs. 25 million after 7 years. Working capital is 25% of annual sales and is liquidated at the end of 7 years with an estimated Rs. 4 million loss. Manufacturing Floxin will reduce contribution margin of an existing product by Rs. 10 million per year. The post-tax incremental cash flows and NPV of the project at a 15% cost of capital need to be estimated.

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Soham Sinha
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317 views

Exercise 4. Modern Pharma

Modern Pharma is considering manufacturing a new drug called Floxin for 7 years. Sales are expected to range from Rs. 80 million to Rs. 200 million over the 7 years. Capital equipment costs Rs. 120 million and can be sold for Rs. 25 million after 7 years. Working capital is 25% of annual sales and is liquidated at the end of 7 years with an estimated Rs. 4 million loss. Manufacturing Floxin will reduce contribution margin of an existing product by Rs. 10 million per year. The post-tax incremental cash flows and NPV of the project at a 15% cost of capital need to be estimated.

Uploaded by

Soham Sinha
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Modern Pharma is considering the manufacture of a new drug, Floxin, for which the following

information has been gathered:

- Floxin is expected to have a product life cycle of seven year and after that, it would be
withdrawn from the market. The sales from this drug are expected to be as follows:

Year 1 2 3 4 5 6 7
Sales 80 120 160 200 160 120 80
(INR mm)

- The capital equipment required for manufacturing Floxin is Rs. 120 million, and it will be
depreciated at the rate of 25% per year, as per the WDV method for tax purpose (Assume 0
salvage value for the purpose of depreciation calculation).
- Modern Pharma expects to sell this equipment for Rs. 25 million at the end of the 7th year.
- The working capital requirement for the project is expected to be 25 percent of sales.
Working capital level is adjusted at the beginning of the year is related to the expected sales
for the year. At the end of 7 years, working capital is expected to be liquidated at par,
barring an estimated loss of Rs. 4 million on account of bad debt, which, of course, will be a
tax-deductible expense.
- The accountant of the firm has provided the following estimates for the cost of Floxin:
o Raw material cost : 30% of Sales
o Variable manufacturing cost : 10% of Sales
o Fixed annual operating and maintenance costs : Rs. 10 million
o Variable selling expenses : 10% of Sales
o Overhead allocation (excl. depreciation, maintenance, interest) : 10% of Sales
- The incremental overhead attributable to the overhead are, however, expected to be only 5
percent of sales.
- The manufacture of Floxin will cut into the sales of an existing product, thereby reducing its
contribution margin by Rs. 10 million per year.
- The tax rate for the firm is 30%.

Questions:

(a) Estimate the post-tax incremental cash flows for the project to manufacture Floxin.
(b) What is the NPV of the project, if the cost of capital is 15%.

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