D’Pharma has just managed to get breakthrough in developing a new drug for skin
ID: 2615669 • Letter: D
Question
D’Pharma has just managed to get breakthrough in developing a new drug for skin cancer, which it has patented for next 10 years. Due to overwhelming demand and monopoly rights, it has to invest in a new plant to produce the drug in sufficient quantity.
The proposal has the following cost and revenue structure. The required setup in plant and machinery would cost $1.5 million.
The plant and machinery shall be written-off completely during this time using a straight-line method.
The incremental revenue and cost from the project would be $250,000 and $100,000 respectively. Additional working capital required for the project would be $100,000 initially with additional injection of $10,000 each year starting from the beginning of the 6th year. The scrap value of the machinery at the end of the project is estimated to be $100,000. The project has comparable risk.
when we calculated the npv, why in terminal cash flows in the ten year, why NWC is 150000???
Explanation / Answer
When Working Capital is introduced in the projects, it is assumed that the working capital will be released at the end of the life of the project.
In this case, $100,000 Working capital has been introduced in the beginning i.e. at Year 0 and $10,000 is introduced in each of the years from 6 to 10
Therefore, Working capital Released at the end of the tenth year will be
$100,000+$10,000*5 = $150,000
And terminal Cash flows at the end of 10th year will be:
Release of working capital = $150,000
Scrap value of machinery = $100,000
i.e. $250,000 + normal profit earned in each year i.e. $150,000 ($250,000-$100,000)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.