Question 6 Score The Aplus pharmaceutical company has completed the scientific w

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Question 6 Score The Aplus pharmaceutical company has completed the scientific work on a new product. The investment needed for development of this completed research into a marketable product is being proposed. The forecasted Revenue, COGS and SG&A are shown below in the beginning items of the following income statement. Income Statement 0 1 2 3 4 Revenue $2,000,000 $8,000,000 $15,000,000 $15,000,000 COGS ($800,000) ($3,200,000) ($6,000,000) ($6,000,000) Gross Margin $1,200,000 $4,800,000 $9,000,000 $9,000,000 SG&A ($300,000) ($300,000) ($300,000) ($400,000) A four year time span is to be used in the evaluation of the proposal with a MARR of 25%. The income tax rate is 20%, and the capital gains tax rate is 15%.    The depreciable investment needed for the development effort will be $6,000,000 in year 0 and should be depreciated using -5-year MARR The total needed working capital in each h of the four years needed for this new product is $2,000,000 in year 0, $2,500,000 in year 1, $2,000,000 in year 2, $1,500,000 in year 3, and $1,000,000 by the end of year 4. The product line is expected to be saleable for $2,000,000 to another pharmaceutical company at the end of the fourth year. (Completed in the fourth year). Complete the Income Statement, prepare a cash flow statement, and evaluate the proposal using the present worth and internal rate of return criteria.   Solution Question 6 Score The Aplus pharmaceutical company has completed the scientific work on a new product. The investment needed for development of this completed research into a marketable product is being proposed. The forecasted Revenue, COGS and SG&A are shown below in the beginning items of the following income statement. Income Statement 0 1 2 3 4 Revenue $2,000,000 $8,000,000 $15,000,000 $15,000,000 COGS ($800,000) ($3,200,000) ($6,000,000) ($6,000,000) Gross Margin $1,200,000 $4,800,000 $9,000,000 $9,000,000 SG&A ($300,000) ($300,000) ($300,000) ($400,000) A four year time span is to be used in the evaluation of the proposal with a MARR of 25%. The income tax rate is 20%, and the capital gains tax rate is 15%.    The depreciable investment needed for the development effort will be $6,000,000 in year 0 and should be depreciated using -5-year MARR The total needed working capital in each h of the four years needed for this new product is $2,000,000 in year 0, $2,500,000 in year 1, $2,000,000 in year 2, $1,500,000 in year 3, and $1,000,000 by the end of year 4. The product line is expected to be saleable for $2,000,000 to another pharmaceutical company at the end of the fourth year. (Completed in the fourth year). Complete the Income Statement, prepare a cash flow statement, and evaluate the proposal using the present worth and internal rate of return criteria.   Solution

Explanation / Answer

1)

Working Notes:

b)

It has been assumed that at the end of the fourth year the working capital will be recovered completely

c)

IRR

IRR is the discounting rate at which NPV is zero.

Using interpolation we get

IRR = 25 % +[ (0-4665407)/(-315102 - 4665407) ] * 25%

IRR = 48.42%

Recommendation:

On the basis of NPV and IRR the project should be accepted.

Income Statement 1 2 3 4 Revenue 2000000 8000000 15000000 15000000 COGS -800000 -3200000 -6000000 -6000000 Gross Margin 1200000 4800000 9000000 9000000 SG&A -300000 -300000 -300000 -400000 Net Income Before Tax 900000 4500000 8700000 8600000 Capital Gain on sale of the product line 963200 Income tax @ 25% on net income before tax -225000 -1125000 -2175000 -2150000 Tax on capital gain @ 15% -144480 Net Income after tax 675000 3375000 6525000 7268720

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