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12.2 Year 1 3 4 5 6 7 80 120 160 200 160 80 Cash Flows and NPV 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has been gathered: Floxin is expected to have a product life cycle of seven years and after that it would be withdrawn from the market. The sales from this drug are expected to be as follows: 2 Sales (in million) 120 The capital equipment required for manufacturing Floxin is 120 million and it will be depreciated at the rate of 25 percent per year as per the WDV method for tax purposes. The expected net salvage value after seven years is * 25 million. 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 in relation to the projected sales for the year. At the end of 7 years, working capital is expected to be liquidated at par, barring an estimated loss of 3 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: : 30 percent of sales : 10 percent of sales :* 10 million Raw material cost Variable manufacturing cost Fixed annual operating and maintenance costs Variable selling expenses Overhead allocation (excluding depreciation, maintenance, and interest) : 10 percent of sales : 10 percent of sales The incremental overhead attributable to the overhead are, however, expected to be only 5 percent of sales. 5 The manufacture of Floxin will cut into the sales of an existing product thereby reducing its contribution margin by 10 million per year. The tax rate for the firm is 30 percent. (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 percent