i have just to answer these 2 questions. the picures on attachment it will help u.

1: Calculate the cost of debt: i) without flotation costs and ii) with flotation costs. Assume a new issue of debt will have a maturity of 20 years and assume coupons are paid semi-annually. Note: Assume the 12.69% yield noted in the case is a year old (not a current) number.

2; How can Ron estimate the firms cost of retained earnings? Compute an average cost of retained earnings using the methodologies you suggest. Should the cost of retained earnings be adjusted for taxes?

had been recently moved into that position, as a result of their las merger. 21 Marginal Cost of Capital and Capital Budgeting The firm had gone through a series of "right sizing" attempts and managerial transformations in recent years. Somehow, Ron had survive it all. Obviously, his smart decisions and sharp foresight had served hin well over the years. Unfortunately, their last merger had taken its toll on the company's stock price. With a number of the firm's patents expiring in the next three years, and most of its products far away from getting fina FDA approval, there was pressure to expand the product line. As result, the last couple of product acquisitions were made rather hastily, a the insistence of the prior CFO, John Ziegler, despite Ron's negative concerns One thing that Ron had consistently warned against was the us Where Do We Draw The Line? of an arbitrary hurdle rate when deciding on new product acquisitions Ron was a fim believer in the use of the weighted average cost of capita (WACC) when evaluating project cash flows. John, on the other hand preferred to use a baseline rate of 13% and would begin negotiations at 1 discount rate of 20%, while this strategy had resulted in a few gooc acquisitions, Ron, was aware that sooner or later it would come back to haunt them. Their last two acquisitions, an anti-inflammatory drug, BruPain and an anti-allergy medication, Immunol, were made using a discoun rate assumption of 14%, Ron was highly skeptical because he felt tha with their 20-year bonds sellingt yield 12.69% at that time, 14% woul be too low to cover the 6% risk premium that analysts had typically required on the firm's equity. "We'll get by with debt financing on thes 2 acquisitions," was John's way of justifying the decision, paying little heed to Ron's concerns. "We have to get some more products in ou portfolio," he remarked. As Ron shuffled through the stack of files on his desk and clicked away on his mouse, his mind kept racing back to what Paul, his boss, had said to him at the last budget meeting. "We can only fund 2 or 3 new projects over the next year," he said, "And up to a maximum capital investment of around $275 million. You've got to be highly selective," he cautioned. "The analysts have been rather critical of our last two product acquisitions and our stock price does not need any further jolts!" After the announcement of NuChem's last merger with Ron Pimenta was the business development manager for NuChem Pharmaceuticals, a fairly large company with manufacturing acilities in 4 countries and sales and research and development centers ll over the world. He had seen the firm go through two major estructurings during his twenty-year career with NuChem and was strumental in making a number of their product acquisition decisions. on reported directly to the Chief Financial Officer, Paul Andrews, who Daychem, John Ziegler took early retirement, and was replaced by Paul Andrews, who had been serving as Daychem's Vice-President of Finance. Unlike John, Paul preferred to be more objective and selectiv when evaluating new product acquisitions. He had heard about John's arbitrary investment decision rule and had made it a point to tell Ron tha he disagreed with it. "I would rather that you estimate the firm Marginal Cost of Capital using market value weights and flotation costs 112662 he had said to Ron during one of their earlier discussions. "It has worked really well for us at Daychem," he said with pride. Y11 "I totally agree," Ron had replied, "I have been trying to convince John for years, but he would not buy it," he said shrugging his shoulders 412662 At Paul's request, Ron had set up a project team and had asked them to come up with some proposals for acquisitions. "Use a 10-year forecast," he recommended, "and figure out what the residual value will 412662 be after 10 years. After careful analysis, the project team had come up with 4 recommendations: an ophthalmology product, an anti-viral drug, an anti- cancer medication, and an antibiotic. The detailed projections and other relevant information are shown in Tables 1-7 below. All 4 products had 41266 fairly good projections and looked profitable over the 10-year horizon. 41266 but having been burned the last two times, Ron couldn't help wondering, where do we draw, the line?" 055 0 2 Table 1 Anti-Viral Product Year O Year 1 Year 2 Year 3 Year 4 Year 5 Year Year 7 Year 8 Year 9 Ye Figure in 000's) Total Sales 7.200 12,000 14,400 14,400 14,40 14,400 14400 14 Total COGS 31 7 1,404 1, 1,404 1,404 1 12,996 12,996 12,996 12 ross Profit 219 6,444 10 otal Operating Expense EBIT Taxes Net Income 1,00 1,115 7312| 5,520 6,624 6,624 6,624| 6,624 6,624 (1,0001 (896) (868)( 5.280| 6,372| 6.372 6,372 6,37 6372 (380) (341)| (330) 2.00 2.421| 2.421| 2.421| 2.421| 2.421| 2: 620 (556)(538 3,274 3,951 3.951 3.9513,951 3.951 43 1,212 2,004 2,395 2.395 2,39 orking Capital Investment Net Cash Flow Residual Value Total Cash Flow (17,000 (620(556(538) 3274 3.951 3.951 3,951 3,951 3,951 (17000) ( 556) (538 3274 3951 3951 3951 3,951 3951 35 Table 2 Anti-Cancer Product Year4 Year Year0 Year 1 Year, Year 3 -Year, YearT -Year-Year Year 11 gure in 000's) tal Sales tal COGs oss Profit tal Operating Expense 250 7,20012 219 6,44410 (896) 14,40 16,80 19.20 1920 19,200 19 3756 1 12 15,162| 17.32 1732 1732 1732 ,000 1,115 7312 ,50 6,624 7,728 8,83 (1,000) (868) 5,2801 637 2,421 2,82 8.496 8 xes (38%) t Income orking Capital Investment t Cash Flow esidual Value (380) (341) (330 2, (620) (556) (538 3,274 3,951 4 2,794 3,19 3,19 3,1 3,1 210 4 43 ,212 2,004 (14,000 (620(599 (17072482 3,560 4210 14,000) (620-599, (1,707 2.482 3,560 4,2101 4868 5268 526. 47,748 otal cash flows Table 4 Antiblotic Product 000's) d States Sales GS ofit erating Expense s0 60 4,800 4 55.00 50,00 47300 45.1 42 .125 42.88 61 3,430 32 40,72 4,4 4,400 000 3,800 ,661 4,789 3 4201 4,348 4,500 ,858 41.211 51 14,424 17.947 17 278,2 320036,857 333 33,242 5%) 14,58 13,7201202.117 11.36 21,11 841 30,5 30,15 27.074 25,480 23 Capital Investment h Flow l Value 7,880 94588 119,000) 3146 27,575 31,7 0,947 27,862 25.87 ash flows Table 5 NuChem Pharmaceuticals Income Statement 416,497 243,98 Total revenues Total cost of revenues 172.516 Gross profit Total operating expenses 9866 ncome (loss) from operations (1,693 nterest expense nterest and other income, net ncome (loss) before income taxes Provision (benefit) for income taxes Net Income 98.87 34,605 30 Focus NuChem Pharmaceuticals Balance Sheet ash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Other current assets Total Current Assets 182,382 Accounts payable 13,761 94,557 Accrued liabilities 56,951 Deferred revenue 78,894 Deferred income taxes 4,283 Short-term debt 35,058 13,277 2,447 5,581 263 70,387 5,666Current maturities of long-term obligations 432,733 Total Current Liabilities Property and equipment, net 11,605 Long-term debt 125,000 125,000 bonds outstanding,12% coupon, -20-year original maturity) Deferred income taxes Goodwill 21,474 Common stock, $0.001 par value, 18 Intangible assets, net Other assets 13,978 60,000,000 shares authorized; 6,278 (17,782,000 shares outstanding) Additional paid-in capital 173,968 116,695 290,681 Retained Earnings Total shareholder's equity 486,068 486,068 Total liabilities and shareholders' equity Total Assets had been recently moved into that position, as a result of their las merger. 21 Marginal Cost of Capital and Capital Budgeting The firm had gone through a series of "right sizing" attempts and managerial transformations in recent years. Somehow, Ron had survive it all. Obviously, his smart decisions and sharp foresight had served hin well over the years. Unfortunately, their last merger had taken its toll on the company's stock price. With a number of the firm's patents expiring in the next three years, and most of its products far away from getting fina FDA approval, there was pressure to expand the product line. As result, the last couple of product acquisitions were made rather hastily, a the insistence of the prior CFO, John Ziegler, despite Ron's negative concerns One thing that Ron had consistently warned against was the us Where Do We Draw The Line? of an arbitrary hurdle rate when deciding on new product acquisitions Ron was a fim believer in the use of the weighted average cost of capita (WACC) when evaluating project cash flows. John, on the other hand preferred to use a baseline rate of 13% and would begin negotiations at 1 discount rate of 20%, while this strategy had resulted in a few gooc acquisitions, Ron, was aware that sooner or later it would come back to haunt them. Their last two acquisitions, an anti-inflammatory drug, BruPain and an anti-allergy medication, Immunol, were made using a discoun rate assumption of 14%, Ron was highly skeptical because he felt tha with their 20-year bonds sellingt yield 12.69% at that time, 14% woul be too low to cover the 6% risk premium that analysts had typically required on the firm's equity. "We'll get by with debt financing on thes 2 acquisitions," was John's way of justifying the decision, paying little heed to Ron's concerns. "We have to get some more products in ou portfolio," he remarked. As Ron shuffled through the stack of files on his desk and clicked away on his mouse, his mind kept racing back to what Paul, his boss, had said to him at the last budget meeting. "We can only fund 2 or 3 new projects over the next year," he said, "And up to a maximum capital investment of around $275 million. You've got to be highly selective," he cautioned. "The analysts have been rather critical of our last two product acquisitions and our stock price does not need any further jolts!" After the announcement of NuChem's last merger with Ron Pimenta was the business development manager for NuChem Pharmaceuticals, a fairly large company with manufacturing acilities in 4 countries and sales and research and development centers ll over the world. He had seen the firm go through two major estructurings during his twenty-year career with NuChem and was strumental in making a number of their product acquisition decisions. on reported directly to the Chief Financial Officer, Paul Andrews, who Daychem, John Ziegler took early retirement, and was replaced by Paul Andrews, who had been serving as Daychem's Vice-President of Finance. Unlike John, Paul preferred to be more objective and selectiv when evaluating new product acquisitions. He had heard about John's arbitrary investment decision rule and had made it a point to tell Ron tha he disagreed with it. "I would rather that you estimate the firm Marginal Cost of Capital using market value weights and flotation costs 112662 he had said to Ron during one of their earlier discussions. "It has worked really well for us at Daychem," he said with pride. Y11 "I totally agree," Ron had replied, "I have been trying to convince John for years, but he would not buy it," he said shrugging his shoulders 412662 At Paul's request, Ron had set up a project team and had asked them to come up with some proposals for acquisitions. "Use a 10-year forecast," he recommended, "and figure out what the residual value will 412662 be after 10 years. After careful analysis, the project team had come up with 4 recommendations: an ophthalmology product, an anti-viral drug, an anti- cancer medication, and an antibiotic. The detailed projections and other relevant information are shown in Tables 1-7 below. All 4 products had 41266 fairly good projections and looked profitable over the 10-year horizon. 41266 but having been burned the last two times, Ron couldn't help wondering, where do we draw, the line?" 055 0 2 Table 1 Anti-Viral Product Year O Year 1 Year 2 Year 3 Year 4 Year 5 Year Year 7 Year 8 Year 9 Ye Figure in 000's) Total Sales 7.200 12,000 14,400 14,400 14,40 14,400 14400 14 Total COGS 31 7 1,404 1, 1,404 1,404 1 12,996 12,996 12,996 12 ross Profit 219 6,444 10 otal Operating Expense EBIT Taxes Net Income 1,00 1,115 7312| 5,520 6,624 6,624 6,624| 6,624 6,624 (1,0001 (896) (868)( 5.280| 6,372| 6.372 6,372 6,37 6372 (380) (341)| (330) 2.00 2.421| 2.421| 2.421| 2.421| 2.421| 2: 620 (556)(538 3,274 3,951 3.951 3.9513,951 3.951 43 1,212 2,004 2,395 2.395 2,39 orking Capital Investment Net Cash Flow Residual Value Total Cash Flow (17,000 (620(556(538) 3274 3.951 3.951 3,951 3,951 3,951 (17000) ( 556) (538 3274 3951 3951 3951 3,951 3951 35 Table 2 Anti-Cancer Product Year4 Year Year0 Year 1 Year, Year 3 -Year, YearT -Year-Year Year 11 gure in 000's) tal Sales tal COGs oss Profit tal Operating Expense 250 7,20012 219 6,44410 (896) 14,40 16,80 19.20 1920 19,200 19 3756 1 12 15,162| 17.32 1732 1732 1732 ,000 1,115 7312 ,50 6,624 7,728 8,83 (1,000) (868) 5,2801 637 2,421 2,82 8.496 8 xes (38%) t Income orking Capital Investment t Cash Flow esidual Value (380) (341) (330 2, (620) (556) (538 3,274 3,951 4 2,794 3,19 3,19 3,1 3,1 210 4 43 ,212 2,004 (14,000 (620(599 (17072482 3,560 4210 14,000) (620-599, (1,707 2.482 3,560 4,2101 4868 5268 526. 47,748 otal cash flows Table 4 Antiblotic Product 000's) d States Sales GS ofit erating Expense s0 60 4,800 4 55.00 50,00 47300 45.1 42 .125 42.88 61 3,430 32 40,72 4,4 4,400 000 3,800 ,661 4,789 3 4201 4,348 4,500 ,858 41.211 51 14,424 17.947 17 278,2 320036,857 333 33,242 5%) 14,58 13,7201202.117 11.36 21,11 841 30,5 30,15 27.074 25,480 23 Capital Investment h Flow l Value 7,880 94588 119,000) 3146 27,575 31,7 0,947 27,862 25.87 ash flows Table 5 NuChem Pharmaceuticals Income Statement 416,497 243,98 Total revenues Total cost of revenues 172.516 Gross profit Total operating expenses 9866 ncome (loss) from operations (1,693 nterest expense nterest and other income, net ncome (loss) before income taxes Provision (benefit) for income taxes Net Income 98.87 34,605 30 Focus NuChem Pharmaceuticals Balance Sheet ash and cash equivalents Short-term investments Accounts receivable, net Inventories Deferred income taxes Other current assets Total Current Assets 182,382 Accounts payable 13,761 94,557 Accrued liabilities 56,951 Deferred revenue 78,894 Deferred income taxes 4,283 Short-term debt 35,058 13,277 2,447 5,581 263 70,387 5,666Current maturities of long-term obligations 432,733 Total Current Liabilities Property and equipment, net 11,605 Long-term debt 125,000 125,000 bonds outstanding,12% coupon, -20-year original maturity) Deferred income taxes Goodwill 21,474 Common stock, $0.001 par value, 18 Intangible assets, net Other assets 13,978 60,000,000 shares authorized; 6,278 (17,782,000 shares outstanding) Additional paid-in capital 173,968 116,695 290,681 Retained Earnings Total shareholder's equity 486,068 486,068 Total liabilities and shareholders' equity Total Assets