You work as a financial analyst for a firm that provides business consulting services for firms in the pharmaceutical and medical device industries. Por Ortho Specialist Instruments (aka POSI ) has hired you to assist them with the analysis of a new stent design that the firm has developed. Dr. Santhosh Keshvan, the Chief Medical Officer, has been working on the design for five years. Assume that Dr. Keshvan was paid $650,000 last year and that his salary has been going up at 3% annually over this time. POSI bought the research on a stent design from a French firm in 2018 for $4 million. The French design still had several technical problems and was not ready for commercial development. Since that time, Dr. Keshvan's lab has spent $6 million per year in 2019-20 refining the design and working on choosing the best materials for stent construction so that the product will have the longest possible life, provide the best possible support for coronary arteries, and be unobtrusive enough to be used in elective surgery for patients with coronary conditions. Assume that the price paid to the French firm and the other past costs were treated as expenses in the respective periods in which they were incurred. POSI just received a patent on the new design and is ready to evaluate the prospects for commercial development.Dr. Keshvan and CFO Lance Nail have proposed building a new plant to make the stents. The new plant would use state-of-the-art techniques and equipment. It could be built within one year for a cost of $23 million. The cost would be paid half today and a half at the end of this year (or time 1). The land for the new plant will cost $6 million and be paid immediately. The building will be depreciated on the 15-year schedule (see Table 6-3 on p. 176 of RWJ) with the first year of operations in year two and the final year's depreciation in year 17. Assume that POSI will sell

the land in year 18 at a price that simply reflects inflation over the life of the plant. Ignore the residual value of the plant at that time. POSI will need $11 million of equipment in the plant to start production in year two. The equipment will be depreciated on the 5-year schedule (see the table in RWJ). POSI will purchase the equipment at time one to use the equipment in production during the year and claim the first year's depreciation for year two's tax filing (the first year of operations). POSI will need to replace the equipment in year 7. Assume that the cost of the equipment will rise at the expected rate of inflation of 1.2%. Note that in year 7, POSI will claim both the final year's depreciation on the original equipment and the first year's depreciation on the replacement equipment. POSI will also need to replace equipment in year 12 with similar assumptions about the purchase price and depreciation. The fixed costs of operating the new plant are expected to be $5.5 million in the first year of operations, with variable costs of $510 per stent in that year. Assume that both costs will change with inflation. The annual capacity for production for the new plant will be 10,700 units. If you encounter an operating profit before taxes for any year that is negative, assume that POSI has other operations that generate revenues and a positive income for that year from which these expenses or losses can be deducted. Treasurer Dylan Moses advises you to use 8.6% as the project's required return and to assume that you will need to invest in net working capital of 4% of annual revenue for each year of operations. To begin the operations in year two, plan to make an initial investment in working capital of $195,000 in year 1. Assume POSI's marginal tax rate is 21%. Vice President in Marketing Hannah Cho has prepared two forecasts of future sales. The baseline forecast predicts sales of 6,500 units in year two as the new product gets a foothold in the market. Her staff forecasts that sales will increase by 1,900 units in each of the second and third years of production. She predicts that the new device will maintain constant sales from the third through the tenth year of production. Beginning in the eleventh year of production, she expects that sales will drop off at 3% per year as more advanced products begin to capture market share. The initial price of a stent in year two for her baseline forecasts is expected to be $2,100. Stent prices are forecasted to rise at 6% through year six and then at the inflation rate thereafter. The higher rate of price increase during the first five years of operation will be due to the market placing a high valuation on Dr. Keshvan's new design. Cho has also prepared an alternative set of forecasts that involve promoting the new design more at the beginning of the product's life and reducing the price. Marketing costs are part of the variable costs for the product. The combined effect of these changes will be to create a demand for 8,300 units in year 2, 11,000 units in the second year of operations, and 10,400 units per year from the third through the tenth year of production. To achieve the higher sales level, POSI will start with a price of $1,950 in year 2. Prices after that will follow the same growth rates described under the baseline forecast. POSI will also expect to incur an additional $35 per unit of variable costs to boost production and promote the new product. Finally, the alternative forecasts will also require that net working capital increase by one-fifth of 1% (or by 0.20%).

Your task: Build an Excel model to analyze this project. Use the end-of-year convention for all financial information, except for the first purchase of equipment at the start of operations for the new plant. Assume that it occurs at the beginning of the second year (or at time 1). Use an Assumptions worksheet in your Excel document to display the key assumptions and a Model worksheet to build your model of the project. Calculate free cash flow for each year for the project. Calculate payback, net present value, and the internal rate of return (both modified and standard) for the project

Prepare a table summarizing the two scenarios. Include the values of the free cash flow in each year and all other relevant variables as referenced or discussed in your answers to the questions below (i.e., every number discussed in your answers should appear in the table). Submit a Word document with your summary table and your answers to the questions below through Canvas. Make sure that the table looks professional and is easily readable for the average 50-year-old person. Submit your spreadsheet model of the analysis via Canvas. Place the names of group members in the cell A1 in the upper left-hand corner of your Assumptions sheet. Your document should have 3 worksheets one for your model, one for assumptions, and the third for your summary table. Name your document using the first initial and last name of the submitting group member.

Questions: 1. How should the costs of acquiring the rights from the French firm, Dr. Keshvan's salary, and the lab costs for the past 3 years be handled in making a decision on the commercial introduction of the new stent design? Briefly explain your answer.

2. (a) Describe the pattern of free cash flows for the stent project. (b) Describe your decision using payback with a cut-off of 5 years of operations. (c) Describe your decision using NPV.

3. Cho observes the free cash flow pattern and argues that modified IRR should be used to evaluate the project. Moses replies that with this specific pattern of cash flows, the standard IRR will give the correct decision. (a) Calculate both versions of IRR. Does your accept/reject decision for this project depend on which version of IRR you use? To determine who is correct, construct a table in which you compute NPV for discount rates varying between 4% and 17% in increments of 1% (4%, 5%, 6%, etc.). Graph the NPV profile for the project. Do the graph, and your calculations suggest that MIRR is required? Why or why not?