After extensive medical and marketing research, Pill, Inc., believes it can pene
ID: 2759443 • Letter: A
Question
After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products. The first is to produce a medication for headache pain. The second is a pill for headache and arthritis pain. Both products would be introduced at a price of $8.50 per package in real terms. The headache-only medication is projected to sell 3 million packages a year, while the headache and arthritis remedy would sell 4.6 million packages a year. Cash costs of production in the first year are expected to be $4.45 per package in real terms for the headache-only brand. Production costs are expected to be $5.00 in real terms for the headache and arthritis pill. All prices and costs are expected to rise at the general inflation rate of 2 percent.
Either product requires further investment. The headache-only pill could be produced using equipment costing $18 million. That equipment would last three years and have no resale value. The machinery required to produce the broader remedy would cost $27 million and last three years. The firm expects that equipment to have a $1 million resale value (in real terms) at the end of Year 3.
Pill, Inc., uses straight-line depreciation. The firm faces a corporate tax rate of 34 percent and believes that the appropriate real discount rate is 6 percent.
Calculate the NPV for the headache pain reliever only. (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)
Calculate the NPV for the headache and arthritis pain reliever. (Enter your answer in dollars, not millions of dollars (e.g. 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places (e.g., 32.16).)
After extensive medical and marketing research, Pill, Inc., believes it can penetrate the pain reliever market. It is considering two alternative products. The first is to produce a medication for headache pain. The second is a pill for headache and arthritis pain. Both products would be introduced at a price of $8.50 per package in real terms. The headache-only medication is projected to sell 3 million packages a year, while the headache and arthritis remedy would sell 4.6 million packages a year. Cash costs of production in the first year are expected to be $4.45 per package in real terms for the headache-only brand. Production costs are expected to be $5.00 in real terms for the headache and arthritis pill. All prices and costs are expected to rise at the general inflation rate of 2 percent.
Explanation / Answer
1. Calculation of the NPV for the headache pain reliever only.
We will solve the question using nominal quantities. The nominal discount rate is (1 + inflation rate) x (1 + real rate)
= (1+0.02)*(1+0.06)=10.8%
Headache only After tax operating income (using nominal prices and costs) is
2.Calculation the NPV for the headache and arthritis pain reliever.
The firm should choose for manufacturing headache and arthritis pain reliever because it has higher NPV.
Year 1 2 3 Total Qty 3,000,000 3,000,000 3,000,000 Price $ 8.50 8.67 8.84 Revenue 25,500,000 26,010,000 26,530,200 Costs/unit$ 4.45 4.54 4.63 Total cost$ 13,350,000 13,617,000 13,889,340 Op.Income 12,150,000 12,393,000 12,640,860 tax 34% 4,131,000 4,213,620 4,297,892 NOPLAT 8,019,000 8,179,380 8,342,968 Depreciation Tax shied (18million/3)*.34 204,000 204,000 204,000 OCF 8,223,000 8,383,380 8,546,968 PVF @ 10.8% 0.9025 0.8146 0.7352 PV 7,421,480 6,828,725 6,283,372 20,533,577 Project cost $ 18,000,000 NPV$ 2,533,577Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.