Dr. Müller is a bio-technical engineer and an expert in genetic therapy. Spendin

Question

Dr. Müller is a bio-technical engineer and an expert in genetic therapy. Spending several years with a research institute, Dr. Müller thinks about founding his own company. His goal is the completion, patent grant and commercialization of two projects. Both projects have some common features: they require initial capital expenditures, and they should be accomplished in one year without any costs at the end of the project. Project A: Production and commercialization of a new, genetically modified substance for the treatment of asthma. -Completion of project A requires capital expenditures of EUR 4.0m (laboratory equipment, wages for scientists etc.). -According to Dr. Müller, future sales revenues from project A are uncertain. More specifically, Dr. Müller argues that there are three states of the world (A.1, A.2 and A.3), one of which will materialize. The corresponding sales revenues X in t=1 are reported in the following table State of the worldj A.1 A.2 A.3 Pl 0.25 0.50 0.25 EUR 3.9m EUR 4.3m EUR 5.1m Proiect B: Production of a virus-based targeting-system -Completion of project B also requires capital expenditures of 4.0m -th respect to future sales revenues from project B, Dr. Müller argues that there are only two possible states of the world (B.1 and B.2). Corresponding sales revenues X in t 1 are reported in the following table

Explanation / Answer

Sol: 1) For Project A :

As risk free rate is 7%, we will consider it as discount rate and time , t = 1

Hence Net gain/Loss = 4.4/1.07 - 4 = 4.112-4 = 0.112million

Project B

Net Gain/ Loss = 4.180/1.07 - 4 = 3.9065-4 = -0.0935 million

Project A is worth to be realized

2) a) Interest to be served on 3.6 million at 7% = 7%* 3.6 = 0.252 million

Net amount to be paid at the end of project = 4.40 - 3.6-0.252 = 0.8-0.252 = 0.548 million

Yes , bank should be ready to give the loan.

b) In case if he not invested, and thinking to pursue Project B, the amount to be paid to bank = 3.852

Net profit = 4.180-3.852 = 0.3280 < 400000.

Hence, still the project is not profitable.

c) When he is using the Equity finance only the loss of the project = 0.0935 million

when it is debt finance, loss = 0.328 - 0.4 = 0.072 million. So, less in case if leverage the project.

State of World prob, p X, revenues X*p A1 0.25 3.9 0.975 A2 0.5 4.3 2.150 A3 0.25 5.1 1.275 Total Revenues 4.400

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