Question

Phastor pharmaceuticals, a leading global pharmaceutical company is considering investing in some equipment to produce a localized vaccine named Covid cure to help combat the Covid-19 pandemic. The new equipments capital cost is estimated at $100 million. If its purchase is approved now, the equipment can be bought and production can commence by the end of this year. $50 million has already been spent on research and development work. Estimates of revenues and costs arising from the operation of the new equipment appear as follows:

Year 1 Year 2 Year 3 Year 4 Year 5

Sales price ($/litre) 100 120 120 100 80

Sales volume (million litres) 0.8 1.0 1.2 1.0 0.8

Variable cost ($/litre) 50 50 40 30 40

Fixed cost ($000) 30 30 30 30 30

If the equipment is bought, sales of some existing Covid-19 products will be lost, resulting in a loss of contribution of $15 million a year, over the life of the equipment. The accountant has informed you that the fixed cost includes depreciation of $20 million a year on the new equipment. It also includes an allocation of $10 million for fixed overheads. A separate study has indicated that if the new equipment were bought, additional overheads, excluding depreciation, arising from producing the chemical would be $8 million a year. Production would require additional working capital of $30 million. For the purposes of your initial calculations, ignore taxation.

Required:

Write a publishable research paper to an International Journal using Harvard Referencing style to respond to the questions below:

Deduce the relevant annual cash flows associated with buying the equipment and

(i) Calculate the payback period.

(ii) Calculate the net present value using a discount rate of 8 per cent.