question archive You are hired as a consultant for a client considering the following 4-year BIOTECH project X: Initial Capital Spending (paid at T=0): an asset worth $50 mil The asset will have no book value and will be completely worthless at the end of project's life Initial investment in Net Working Capital (paid at T=0): $4 million
You are hired as a consultant for a client considering the following 4-year BIOTECH project X: Initial Capital Spending (paid at T=0): an asset worth $50 mil The asset will have no book value and will be completely worthless at the end of project's life Initial investment in Net Working Capital (paid at T=0): $4 million
Subject:AccountingPrice: Bought3
You are hired as a consultant for a client considering the following 4-year BIOTECH project X:
Initial Capital Spending (paid at T=0): an asset worth $50 mil
The asset will have no book value and will be completely worthless at the end of project's life
Initial investment in Net Working Capital (paid at T=0): $4 million. NWC levels are supposed to increase by $0.5 mil per year.
The project will generate Operating Cash Flows OCF=$15 mil per year, for every year from Year 1 to Year 4.
The cost of capital for the project is 15%.
A) What is the NPV of such a project? Should your client accept it? Why or why not?
B) Assume, in addition, that the client will have the option to follow the initial above-described biotech project with another follow-up project Y with the following characteristics:
Initial Capital Spending (paid at T=4): an asset worth $100 mil
The asset will have no book value and will be completely worthless at the end of project's life
Initial investment in Net Working Capital (paid at T=4): $8 million. NWC levels are supposed to increase by $1 mil per year.
The project will generate Operating Cash Flows OCF=$30 mil per year, for every year from Year 5 to Year 8.
The cost of capital for the project is 15%.
i) Would you recommend your client to pursue both the initial (X) and the follow-up (Y) projects if the client had to commit to the projects right now (at T=0)?
ii) Assume, instead, that the client has until T=4 to decide whether to develop the follow-up project Y. The costs of the follow-up project (to be paid at T=4) should be taken as fixed. However, the cumulative present value of all follow-up project benefits (to be paid from T=5 to T=8) evolves as a "stock price" with σ = 70% per year. In this case, would you recommend your client to develop the initial biotech project X?
C) If a follow-up project Y with the same total Free Cash Flows you estimated in part B were to be considered by an ELECTRIC UTILITY, then the value of the follow-up project (the execution of which does not have to be decided until T=4) would likely be higher / lower / equal to the value you computed in part B.
