ABC Ltd is engaged in the manufacture of pharmaceuticals. The company was established in 2009 and has registered a steady growth in sales since then. Presently, the company manufactures 16 products and has an annual turnover of $2200 million. The company is considering the manufacture of a new antibiotic preparation, Cowin, for which the following information has been gathered.

1. Cowin is expected to have a product life cycle of five years and thereafter it would be withdrawn from the market. The sales from this preparation are expected to be as follows:

Year Sales (in million $)

1 100

2 150

3 200

4 150

5 100

1. The capital equipment required for manufacturing Cowin is $ 100 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 5 years is $ 20 million.
2. The working capital requirement for the project is expected to be 20 % of sales. At the end of 5 years, working capital is expected to be liquidated at par, barring an estimated loss of $ 5 million on account of bad debt. The bad debt loss will be a tax-deductible expense.
3. The accountant of the firm has provided the following cost estimates for Cowin:

Raw material cost : 30 % of sales

Variable labor cost : 20 % of sales

Fixed annual operating and maintenance cost : $ 5 million

Overhead allocation (excluding depreciation,

Maintenance and interest ) : 10 % of sales

While the project is charged on an overhead allocation, it is not likely to have any effect on overhead expenses as such.

1. The manufacturer of Cowin would also require some of the common facilities of the firm. The use of these facilities would call for a reduction in the production of other pharmaceutical preparations of the firm. This would entail a reduction of $ 15 million in contribution margin per year.
2. The tax rate applicable to the firm is 40 %.

Q1 Make a cash flow statement for the period of the project.

Q2 Calculate the Pay Back period, NPV @ 15%, and IRR of the project.

Q3. Highlight some of the shortcomings of IRR, and how can they be overcome.