Question 18 Pharmos Incorporated is a Pharmaceutical Company which is considering investing in a new production line of portable electrocardiogram (ECG) machines for its clients who suffer from cardio vascular diseases. The company has to invest in equipment which cost $2,500,000 and falls within a MARCS depreciation of 5-years, and is expected to have a scrape value of $200,000 at the end of the project. Other than the equipment, the company needs to increase its cash and cash equivalents by $100,000, increase the level of inventory by $30,000, increase accounts receivable by $250,000 and increase account payable by $50,000 at the beginning of the project. Pharmos Incorporated expect the project to have a life of five years. The company would have to pay for transportation and installation of the equipment which has an invoice price of $450,000. The company has already invested $75,000 in Research and Development and therefore expects a positive impact on the demand for the new product line. Expected annual sales for the ECG machines in the first three years are $1,200,000 and $850,000 in the following two years. The variable costs of production are projected to be $267,000 per year in years one to three and $375,000 in years four and five. Fixed overhead is $180,000 per year over the life of the project.The introduction of the new line of portable ECG machines will cause a net decrease of $50,000 in profit contribution after taxes, due to a decrease in sales of the other lines of tester machines produced by the company. By investing in the new product line Pharmos Incorporated would have to use a packaging machine which the company already has and will be sold at the end of the project for $350,000 after-tax in the equipment market. The company’s financial analyst has advised Pharmos Incorporated to use the weighted average cost of capital as the appropriate discount rate to evaluate the project. The following information about the company’s sources of financing is provided below: The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. Pharmos Incorporated has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue.The company’s preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding.There are 300,000 shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95. Other relevant information about the company follows: The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds from 2010 to 2019. Pharmos Incorporated has a marginal tax rate of 25 percent.As a recent graduate of the UWIOC, The General Manager of the company has hired you to work alongside the Financial Controller of the company to help determine whether the company should invest in the new product line. He has provided you with the following questions to guide you in your assessment of the project and to present your findings to the Company.The initial outlay of the project. Cost of Asset2,500,000Transportation & Installation450,000Increase in cash & cash equity100,000Inventory 30,000Accounts Receivable250,000Accounts Payable50,000[Total initial investment3,280,000 The annual after-tax operating cash flow for year 1-5 Year 12345Depreciation20%32%19%12%12%D/Amount0.2(2.5mil – 450k)944,000560,500354,400354,000Sales1,200,0001,200,0001,200,000850,000850,000Less: Opcosts 267,000267,000267,000375,000375,000Con =933,000933,000933,000475,000475,000Less: Fixed180,000180,000180,000180,000180,000Less:dep590,000944,000560,500354,000354,000PBT =163,000-191,000192,500-59,000-59,000Tax (25%)40,750-4700048,125-14,750-14,750PAT122,250-143,250144,375-44,250-44,250+ dep590,000944,000560,500354,000354,000Operating CF712,250800,750704,875309,750309,750Determine the terminal year non-operating cash flow in year 5 Cost of Machine2,950,000Less Depreciation2,802,500Written down value147,500Sales Price200,000Profit/Loss52,500Tax13,125Non – Operating Cash Flow 186,875From the information provided:Determine the Net Present Value of the project and advice the company whether to invest in the new line of productDetermine the estimated Internal Rate of Return of the project.Should the project be accepted based on the IRR?

Net present value is the present value of all the future cash flows. Higher the NPV more the better…

Answered: Determine the Net Present Value of the…

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Chapter1: Investments: Background And Issues

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Question 18

Pharmos Incorporated is a Pharmaceutical Company which is considering investing in a new production line of portable electrocardiogram (ECG) machines for its clients who suffer from cardio vascular diseases. The company has to invest in equipment which cost $2,500,000 and falls within a MARCS depreciation of 5-years, and is expected to have a scrape value of $200,000 at the end of the project. Other than the equipment, the company needs to increase its cash and cash equivalents by $100,000, increase the level of inventory by $30,000, increase accounts receivable by $250,000 and increase account payable by $50,000 at the beginning of the project. Pharmos Incorporated expect the project to have a life of five years. The company would have to pay for transportation and installation of the equipment which has an invoice price of $450,000.

The company has already invested $75,000 in Research and Development and therefore expects a positive impact on the demand for the new product line. Expected annual sales for the ECG machines in the first three years are $1,200,000 and $850,000 in the following two years. The variable costs of production are projected to be $267,000 per year in years one to three and $375,000 in years four and five. Fixed overhead is $180,000 per year over the life of the project.

The introduction of the new line of portable ECG machines will cause a net decrease of $50,000 in profit contribution after taxes, due to a decrease in sales of the other lines of tester machines produced by the company. By investing in the new product line Pharmos Incorporated would have to use a packaging machine which the company already has and will be sold at the end of the project for $350,000 after-tax in the equipment market.

The company’s financial analyst has advised Pharmos Incorporated to use the weighted average cost of capital as the appropriate discount rate to evaluate the project. The following information about the company’s sources of financing is provided below:

The company will contract a new loan in the sum of $2,000,000 that is secured by machinery and the loan has an interest rate of 6 percent. Pharmos Incorporated has also issued 4,000 new bond issues with an 8 percent coupon, paid semi-annually and matures in 10 years. The bonds were sold at par, and incurred floatation cost of 2 percent per issue.
The company’s preferred stock pays an annual dividend of 4.5 percent and is currently selling for $60, and there are 100,000 shares outstanding.
There are 300,000 shares of common stock outstanding, and they are currently selling for $21 each. The beta on these shares is 0.95.

Other relevant information about the company follows:

The 20-year Treasury Bond rate is currently 4.5 percent and you have estimated market-risk premium to be 6.75 percent using the returns on stocks and Treasury bonds from 2010 to 2019. Pharmos Incorporated has a marginal tax rate of 25 percent.

As a recent graduate of the UWIOC, The General Manager of the company has hired you to work alongside the Financial Controller of the company to help determine whether the company should invest in the new product line. He has provided you with the following questions to guide you in your assessment of the project and to present your findings to the Company.

The initial outlay of the project.

Cost of Asset	2,500,000
Transportation & Installation	450,000
Increase in cash & cash equity	100,000
Inventory	30,000
Accounts Receivable	250,000
Accounts Payable	50,000[
Total initial investment	3,280,000

The annual after-tax operating cash flow for year 1-5

Year	1	2	3	4	5
Depreciation	20%	32%	19%	12%	12%
D/Amount	0.2(2.5mil – 450k)	944,000	560,500	354,400	354,000
Sales	1,200,000	1,200,000	1,200,000	850,000	850,000
Less: Opcosts	267,000	267,000	267,000	375,000	375,000
Con =	933,000	933,000	933,000	475,000	475,000
Less: Fixed	180,000	180,000	180,000	180,000	180,000
Less:dep	590,000	944,000	560,500	354,000	354,000
PBT =	163,000	-191,000	192,500	-59,000	-59,000
Tax (25%)	40,750	-47000	48,125	-14,750	-14,750
PAT	122,250	-143,250	144,375	-44,250	-44,250
+ dep	590,000	944,000	560,500	354,000	354,000
Operating CF	712,250	800,750	704,875	309,750	309,750

Determine the terminal year non-operating cash flow in year 5

Cost of Machine	2,950,000
Less Depreciation	2,802,500
Written down value	147,500
Sales Price	200,000
Profit/Loss	52,500
Tax	13,125
Non – Operating Cash Flow	186,875

From the information provided:

Determine the Net Present Value of the project and advice the company whether to invest in the new line of product
Determine the estimated Internal Rate of Return of the project.
Should the project be accepted based on the IRR?

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Determine the Net Present Value of the project and advice the company whether to invest in the new line of product Determine the estimated Internal Rate of Return of the project. Should the project be accepted based on the IRR?