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1) Modern Pharma is considering the manufacture of new drug, Floxin, for which the following information has been gathered. Floxin is expected to have
1) Modern Pharma is considering the manufacture of new drug, Floxin, for which the following information has been gathered. Floxin is expected to have a product life cycle of seven years and after that it would be withdrawn from the market.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 (Rs in Million) 80 120 160 200 160 120 80 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 purposes. The expected net salvage value after seven years is Rs. 25 Million. The working capital requirement for the project is expected to be 25% of sales. Working capital level is adjusted at the beginning of the year in relation to the adjusted sales for the year. At the end of seven 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: Raw material cost Variable manufacturing cost Fixed annual operating & maintenance costs Variable selling expenses Overhead allocation excluding depreciation, maintenance and interest 30% of sales 10% of sales Rs. 10 Million 10% of sales 10% 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% 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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