Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

You are hired as a consultant for the following 7 - year BIOTECHNOLOGY project: Initial Capital Spending ( paid at T = 0 ) :

You are hired as a consultant for the following 7-year BIOTECHNOLOGY project:
Initial Capital Spending (paid at T=0): an asset worth $35 mil
The asset will have no book value and will be completely worthless at the end of projects life
Initial investment in Net Working Capital (paid at T=0): $2 million. No additional investment in NWC is expected during the projects life.
For your consulting services, you are guaranteed compensation of $0.5 million to be paid at T=0.
Operating Cash Flows: Consider the following two scenarios:
A) If your client signs long term contracts with suppliers, customers, and employees, the Operating Cash Flows are projected to be $2 in year 1, $2 in year 2, and $15 million per year EVERY year 3 through 7.
B) If your client signs only short-term contracts, the project costs will be substantially higher, and the annual Operating Cash Flows are estimated to be only 85% of the annual values projected under Scenario A. HOWEVER, the short-term contracts will allow your client to walk away from the project EXACTLY TWO YEARS FROM NOW. The client will give up all the future benefits of the project after year 2, but it will get a one-time payment of $22 million.
Your client understands that the project benefits are uncertain, and they can change in the future. In fact, the annualized volatility of changes in the present value of project benefits is 60% per year.
The WACC for the project (either of the two scenarios) should be 15%.
i. What is the NPV of the project under Scenario A? Would you accept it? Why or why not? (1 sentence)
ii. What is the NPV of the project under Scenario B (not considering the opportunity to walk away from the project)? Would you accept the project under Scenario B (without the option to walk away) if Scenario A was not available to you? Why or why not? (1 sentence)
iii. What is the dollar value of the opportunity to walk away from the project under Scenario B?
iv. Ultimately, which scenario if any would you advise your client to undertake Scenario A or Scenario B (WITH the opportunity to walk away)? Provide a number-based answer AND explain in 1-2 sentences.
v. If the Scenario B project with the same characteristics (Costs, PV of benefits; the opportunity to abandon it after 2 years for $22 mil) were to be considered by an ELECTRIC UTILITY company, then the value of the opportunity to walk away from the project would likely be higher/lower/equal to the value you computed in part iii.(Pick the correct choice and explain why in one sentence)
(NO CALCULATION needed for part v. The answer should be centered strictly on finance intuition based on the expected difference between biotechnology and utilities.)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Fixed Income Securities Tools For Todays Markets

Authors: Bruce Tuckman, Angel Serrat

3rd Edition

0470891696, 978-0470891698

More Books

Students also viewed these Finance questions

Question

When is the deadline?

Answered: 1 week ago