Biopharma is a pharmaceutical company. Biopharma’s annual stock returns have a C
ID: 2773952 • Letter: B
Question
Biopharma is a pharmaceutical company. Biopharma’s annual stock returns have a CAPM beta of 1.25 (i.e. =1.25). The market portfolio’s return is 13%, and the riskfree rate is 5%. a. What is the required expected return for Biopharma according to the CAPM? b. The firm has the opportunity to develop a new drug. This project requires initial outlay of $400,000 and will bring expected revenue of $100,000 in each of the next 6 years. The riskiness of this project is the same as the overall riskiness of Biopharma. Should the management team of Biopharma approve the project or not and why?
Explanation / Answer
a) Expected return =Rf + Beta(market return -Rf)
= 5 + 1.25 (13- 5)
= 5 + 1.25 * 8
= 5 + 10
= 15%
b)Initial outlay = 400,000
Present value of cash inflows(Revenue) = Revenue * PVAF@15% ,6
= 100,000 * 3.78448
= 378,448.27
NPV (net present value ) =Present value -Initial outlay
= 378,448.27 - 400,000
= $ - 21,551.73
sice the NPV is negative ,biopharma shall not approve the project.
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