BioCom, Inc.: Part $1$

BioCom was founded in $1993,$ when several scientists

and engineers at a large fiber$-$optic$-$cable company

began to see that optical fiber for the telecommuni$-$

cations industry was becoming a cheap commodity.

They decided to start their own firm, which would

specialize in cutting$-$edge applications for research in

the life sciences and medical instruments. BioCom

is now one of the leading firms in its niche field.

BioCom's management attributes the firm's success to

its ability to stay one step ahead of the market's fast$-$

changing technological needs. Almost as important is

BioCom's ability to select high$-$value$-$added projects

and avoid commercial disasters.

This mini$-$case is available

in MyFinanceLab.

Over lunch, BioCom's director of research and devel$-$

opment $($R&D$)$ mentioned to the CFO that one of his best

young scientists had recently left the company because his

line manager had rejected his project. Although not a pat$-$

tern, R&D had experienced similar losses in the past. The

two executives discussed the problem and agreed that if the

$R$&$D$ people understood the selection process better, they

might come up with more commercially viable projects and

understand the project's financial implications. The CFO

has asked his assistant, Jane Donato, to prepare a retreat for

the R&D department to explain the company's project se$-$

lection procedures. Jane is encouraged by the thought that

this group will have no trouble in following the math!b$.$ Comment on the advantages and shortcomings of

this method.

Compute the net present value $($NPV$)$ for each proj$-$

ect. BioCom uses a discount rate of $9\%$ for projects

of average risk.

a$.$ Explain the rationale behind the NPV method.

b$.$ State and explain the decision rule for the NPV

method.

c$.$ Explain how the company would use the NPV

method to rank mutually exclusive projects.

d$.$ Comment on the advantages and shortcomings

of this method.

e$.$ Without performing any calculations, explain

what happens to the NPV if the company adjusts

the discount rate upward for projects of higher

risk or downward for projects of lower risk.

Compute the internal rate of return $($IRR$)$ for each

project.

a$.$ Explain the rationale behind the IRR method.

b$.$ State and explain the decision rule for the IRR

method. Assume a hurdle rate of $9\%.$

c$.$ Explain how the company would use the IRR

method to rank mutually exclusive projects.

d$.$ Comment on the advantages and shortcomings

of this method.

Compute the modified internal rate of return

$($MIRR$)$ for each project.

a$.$ Explain the rationale behind the MIRR

method.

b$.$ State and explain the decision rule for the MIRR

method. Assume a hurdle rate of $9\%.$

c$.$ Explain how the company would use the MIRR

method to rank mutually exclusive projects.

d$.$ Explain how this method corrects for some of the

problems inherent in the IRR method.

Explain to the R&D staff why BioCom uses the

NPV method as its primary project selection

criterion.

Challenge question. Construct NPV profiles for

both projects using discount rates of $1\%$ through

$15\%$ at intervals of one percentage point. At approxi$-$

mately what discount rate does the nano test tube

project become superior to the microsurgery kit

project? You are better off solving this problem using

an electronic spreadsheet.