Pzix is a drug manufacturer and trades on the NASDAQ. On May 25th its stock pric

Question

Pzix is a drug manufacturer and trades on the NASDAQ. On May 25th its stock price closes the day at $15.00 with 10M shares outstanding. On May 26th the stock price jumps to $16.25 upon announcement of approval of a new drug to fight obesity. Assume that the jump in price and market value of Prix is due the new drug. The change in the value can be thought of as the NPV of this new investment in the drug. What size must the net annual after-tax cash flows be from the new drug to support the change in price, if one assumes that the cash flows will begin this year, and last for 10 years. Prix’s cost of capital is estimated to be 9%.

Explanation / Answer

Number of shares outstanding =10,000,000

Price change in shares =($16.25 -$15.00)

=$1.25

NPV as mentioned in the question = 10,000,000*$1.25

=$12,500,000

NPV= Present value of net cash flows after tax * Present value annuity factor for 10 years @9%

Present value of net cash flows after tax =NPV/Present value annuity factor for 10 years @9%

=$12,500,000/6.41765

=$1947751..12.

Answer is $1947751..12 rouded to $1,947,751

Year Present value factor @9% 1 0.917431193 2 0.841679993 3 0.77218348 4 0.708425211 5 0.649931386 6 0.596267327 7 0.547034245 8 0.50186628 9 0.46042778 10 0.422410807 PVAF 6.417657701

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