Beta Compounding Pharmaceuticals is about to launch a new specialty drug for arthritis. It has been working on this drug for around 10 years and has spent in excess of $4 million in research and development to date. It will need to spend $400,000 on new equipment for a production facilities upgrade to be able to produce the new drug. The company estimates that an additional $50,000 will be required to train current workers on the new equipment before production can begin. This equipment will be depreciated on a straight line basis over 5 years with no planned salvage value. Beta estimates that it will I have to add about $10,000 in net working capital before production begins. Beta also estimates that it will have to market the new drug at an initial cost of $100,000, with incremental marketing costs of at least $25,000 for the next three years. The company believes that the drug will continue to be sold for a long period of time, at least to the end of patent protection, so does not have a final time horizon for the project. During the first year of operations, Beta expects its total revenues to increase by $200,000. These incremental revenues are expected to grow to $275,000 in year 2, $300,000 in year 3, and level off at $400,000 after that. The company does accept that the new drug will likely result in the loss of sales in one of its current well established arthritis drugs. It thinks this loss could be as high as $100,000 a year, but most likely would be $75,000 per year. The company's incremental operating costs are expected to total $125,000 the first year and increase at a rate of 8% per year until year 5 and remain at that level thereafter. Beta has a marginal tax rate of 30%. Beta has a cost of debt of 12%. Its beta is 2.1. The risk free rate is 5% and the return on the market is 13%. Beta has a current capital structure of 45% debt and 55% equity. What is the base case net present value for the drug?

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Set up the cash flow for this. Calculate the net present value
FINA 340
Long Horizon NPV Problem (terminal value)
Beta Compounding Pharmaceuticals is about to launch a new specialty drug for arthritis. It has been
working on this drug for around 10 years and has spent in excess of $4 million in research and
development to date. It will need to spend $400,000 on new equipment for a production facilities upgrade
to be able to produce the new drug. The company estimates that an additional $50,000 will be required
to train current workers on the new equipment before production can begin.
depreciated on a straight line basis over 5 years with no planned salvage value. Beta estimates that it will
have to add about $10,000 in net working capital before production begins. Beta also estimates that it
will have to market the new drug at an initial cost of $100,000, with incremental marketing costs of at
least $25,000 for the next three years. The company believes that the drug will continue to be sold for a
long period of time, at least to the end of patent protection, so does not have a final time horizon for the
project.
This equipment will be
During the first year of operations, Beta expects its total revenues to increase by $200,000. These
incremental revenues are expected to grow to $275,000 in year 2, $300,000 in year 3, and level off at
$400,000 after that. The company does accept that the new drug will likely result in the loss of sales in
one of its current well established arthritis drugs. It thinks this loss could be as high as $100,000 a year,
but most likely would be $75,000 per year. The company's incremental operating costs are expected to
total $125,000 the first year and increase at a rate of 8% per year until year 5 and remain at that level
thereafter. Beta has a marginal tax rate of 30%.
Beta has a cost of debt of 12%. Its beta is 2.1. The risk free rate is 5% and the return on the market is
13%. Beta has a current capital structure of 45% debt and 55% equity.
What is the base case net present value for the drug?
Transcribed Image Text:FINA 340 Long Horizon NPV Problem (terminal value) Beta Compounding Pharmaceuticals is about to launch a new specialty drug for arthritis. It has been working on this drug for around 10 years and has spent in excess of $4 million in research and development to date. It will need to spend $400,000 on new equipment for a production facilities upgrade to be able to produce the new drug. The company estimates that an additional $50,000 will be required to train current workers on the new equipment before production can begin. depreciated on a straight line basis over 5 years with no planned salvage value. Beta estimates that it will have to add about $10,000 in net working capital before production begins. Beta also estimates that it will have to market the new drug at an initial cost of $100,000, with incremental marketing costs of at least $25,000 for the next three years. The company believes that the drug will continue to be sold for a long period of time, at least to the end of patent protection, so does not have a final time horizon for the project. This equipment will be During the first year of operations, Beta expects its total revenues to increase by $200,000. These incremental revenues are expected to grow to $275,000 in year 2, $300,000 in year 3, and level off at $400,000 after that. The company does accept that the new drug will likely result in the loss of sales in one of its current well established arthritis drugs. It thinks this loss could be as high as $100,000 a year, but most likely would be $75,000 per year. The company's incremental operating costs are expected to total $125,000 the first year and increase at a rate of 8% per year until year 5 and remain at that level thereafter. Beta has a marginal tax rate of 30%. Beta has a cost of debt of 12%. Its beta is 2.1. The risk free rate is 5% and the return on the market is 13%. Beta has a current capital structure of 45% debt and 55% equity. What is the base case net present value for the drug?
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