Description: You work as a financial analyst for a firm that provides business consulting services for firms in the pharmaceutical and medical device industries. Greensboro Medical Devices (aka GreensMed) has hired you to assist them with analysis of a new stent design that the firm has developed. Dr. Rajiv Chadha, the Chief Medical Officer, has been working on the design for 5 years. Assume that Dr. Chadha was paid $1,000,000 last year and that his salary will go up at 4% annually in future, regardless any decision on capital budgeting. GreensMed bought the research on a stent design from a French firm in 2012 for $5 million. The French design still had several technical problems and was not ready for commercial development. Since that time, Dr. Chadhas lab has spent $3 million dollars per year in 2013-15 refining the design and working to choose the best materials for stent construction so that the product will have the longest possible life, provide the best possible support for coronary arteries, and be unobtrusive enough to be used in elective surgery for patients with coronary conditions. The firm just received a patent on the new design and is ready to evaluate the prospects for commercial development. Assume that one more round of tests are needed before the product is introduced, and that the tests will cost $3 million today and $3 million after one year. Assume that the firm will treat the cost of these tests as part of its R&D budget and that the costs will be expensed in financial and tax reports that will be filed tomorrow.

Dr. Chadha and CFO Miriam Schwartz have proposed building a new plant to make the stents. The new plant would use state of the art techniques and equipment. It could be built within one year for a cost of $30 million. The cost would be paid 1/2 today (year 0) and 1/2 at the end of year 1. The land for the new plant will cost $5 million and be paid immediately. The plant will start operation in year 2 and will end in year 17. Straight-line depreciation will be used for the building over the 16-year life (year 2 to year 17). Assume that GreensMed will sell the land in year 18 at a price that simply reflects inflation over the life of the plant. The residual value of the plant will be zero at that time.

GreensMed will need $4 million of equipment in the plant to start production in year 2. Straight-line depreciation will be used for the equipment over a 4-year period (year 2 to year 5). GreensMed will purchase the equipment at year 1 so that it can used the equipment in production during year 2 and will claim the first years depreciation for year 2s tax filing. GreensMed will need to replace the equipment in year 5, year 9, and year 13, and the replacement will be used over a 4-year period (year 6-9, year 10-13, and year 14-17). Assume that the cost of the equipment will rise at the expected rate of inflation of 3%. Straight-line depreciation will be used again for the replacement equipment over year 10 to year 17.

The fixed costs of operating the new plant are expected to be $6 million in the first year of operations with variable costs of $500 per stent in that year. Assume that both costs will change with inflation. The annual capacity for production for the new plant will be 10,500 units.

Treasurer Marcus Bryant advises you to use 9% as the projects required return and to assume that you will need to invest in net working capital of 5% of annual revenue for each year of operations. To begin the operations in year 2, plan to make an initial investment in working capital of $200,000 in year 1. The marginal corporate tax rate for GreensMed is 35%.

Vice President in Marketing Melanie Li has prepared to forecasts of future sales. The baseline forecast predicts sales of 6,000 units in year 2 as the new product gets a foothold in the market. Her staff forecasts that sales will increase by 3,000 units in the second and will further increase by 1,000 units in third year of production. She predicts that the new device will maintain constant sales from the 3^rd through the 8^th year of production. Beginning in the 9^th year of production, she expects that sales will drop off at 5% per year as more advanced products begin to capture market share. The initial price of a stent in year 2 for her baseline forecasts is expected to be $2,000. Stent prices are forecasted to rise at 5% through year 8 and then at the inflation rate thereafter. The higher rate of price increase during the first 7 years of operation will be due to the market placing a high valuation of Dr. Chadhas new design.

Questions

1. How should the costs of acquiring the rights from the French firm, Dr. Chadhas salary, the lab costs for the past 3 years, and the cost of the remaining testing affect the incremental cash flow of this project?

2. Calculate the incremental free cash flow for each year for the project.

3. Calculate payback, IRR and NPV of the project. Should this project be accepted?

4. Calculate a break-even (NPV = 0) value for the unit price of a stent and for the variable cost per unit. Calculate the % difference ((BE value originally expected value)/ originally expected value). Based on your break-even analysis, which variable is your project NPV more sensitive to?