Future economic conditions and consequent actions taken by the Federal Reserve have resulted in higher treasury yields. Suppose that the 3-month T-bill yield (risk-free rate) is now 1.50% (the expected market risk premium is unchanged at 8%).

A pharmaceutical company is evaluating the production of a new vaccine. It will evaluate the project by discounting the expected cash flows using its WACC. The following information is known about the project:

6 months ago, the firm spent $2,000,000 on research, development and testing to confirm the safety and efficacy of the vaccine.

The project requires the purchase of new equipment (in year 0) for $12,000,000. The new equipment has a 6-year lifespan and will be fully depreciated under the straight-line method with zero salvage value.

The project will generate sales of $6,000,000 per year and expenses of $2,000,000 per year for years 1-4 after which the firm will no longer be producing the vaccine.

In year 1, the firm must increase its inventory by $1,500,000. It will maintain this level of inventory until the end of year 4.

The project will require the firm to use a warehouse it owns (until the end of year 4), that it would otherwise be renting out for $240,000 per year.

The equipment purchased for the project will be sold off at the end of year 5 for $3,000,000.

The firms marginal tax rate is 20%.

The firm would like to evaluate the vaccine project on its own as well as compare it to its other projects, which have different lifespans and different capital requirements. The firm believes that the riskiness of the cash flows associated with the vaccine project is similar to the average riskiness of its other projects. Therefore, it will use its WACC to evaluate the project. The firm currently has 62 million shares of common stock with a book value of $5 per share and a current market price of $15 per share. A dividend of $1.00 is expected to be paid next year. Dividends are projected to grow at 4% each year thereafter. The firm's outstanding bonds have a total face value of $200 million, a maturity of 20 years, a 5% annual coupon, and are selling currently for 100% of face value.

The firms CEO is interested in knowing what the annual return of the vaccine project is and has therefore asked you to compute the projects IRR. You are concerned however that the IRR will overstate the projects annual return because it assumes that the projects interim cash flows will be reinvested at the IRR. Instead, you believe that it is more reasonable to assume that the projects interim cash flows are reinvested at the firms cost of capital (WACC). Here is the website used for this: Internal rate of return: A cautionary tale | McKinsey

10. Compute an IRR for the vaccine project that assumes interim cash flows are reinvested at the firms cost of capital (i.e., the modified IRR).