Question $2$

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:

$6$ months ago, the firm spent $$10,000,000$ on research, development and testing in

order to confirm the safety and efficacy of the vaccine.

The project requires the purchase of new equipment $($in year $0)$ for $$12,300,000.$ 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 $$15,000,000$ per year and expenses of $$6,250,000$ 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 $$3,750,000.$ It will maintain this level of

inventory until the end of year $4.$

In year $1,$ the firm anticipates an increase in accounts receivable equal to $15\%$ of sales and

an increase in accounts payable equal to $10\%$ of expenses. Accounts receivable and payable

are expected to remain at this level 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 $$1,750,000$ per year.

The equipment purchased for the project will be sold at the end of year $5$ for

$$1,500,000.$

The firm's marginal tax rate is $26\%.$

a$)$ Compute the incremental free cash flows associated with the project for years $0-5.$

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 $60$ million shares of common

stock with a book value of $$5\mathrm{.}50$ per share and a current market price of $$33\mathrm{.}75$ per share. A dividend of

$$3\mathrm{.}25$ is expected to be paid next year. Dividends are projected to grow at $6\mathrm{.}00\%$ each year thereafter. The

firm's outstanding bonds have a total face value of $$950$ million, a maturity of $30$ years, a $6\mathrm{.}0\%$ annual

coupon, and are selling currently for $85\%$ of face value.

b$)$ Compute the firm's WACC

c$)$ Compute the NPV of the vaccine project.