GSBS6130 Corporate Finance

QUESTION

GSBS6130 Corporate
Finance
Individual Assignment
Trimester 3, 2015,
Weblearn

Weight: 20%
Total Marks: 20
Due time and date: 11pm (AEST) on
Friday 13 November, 2015
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Submission Instructions:
1.
Maximum word length: 2500 words, excluding
graphs, tables, references and appendices.
2.
You need to submit the assignment in pdf, with
an assignment cover sheet included, via Turnitin
by the due date.
3.
Supporting calculations in an Excel file should
be submitted to Assignment_Supporting
Excel File. You will need to include your student ID and your name in the
Excel file name.
4.
Submission by other means (email/hard copy) or
forms (scanned copy) will attract no marks.

Penalties:
1.
A penalty of 10% will apply for every day
late.
2.
Penalties will also apply if academic misconduct
is found (refer to the Course Outline for more information).

Question 1 (10 marks)
Michael, the product development manager for Apex
Pharmaceuticals (AP) joined the firm about 7 years ago. With a bachelor’s
degree in chemistry and an MBA in Finance from the University of Newcastle,
Michael has been fairly successful in his professional career. Prior to working
at AP, Michael was responsible for the launching of three highly successful
drugs at another mid-sized pharmaceutical company. It did not take long for the
head-hunters to find him and shortly thereafter AP made him an offer that was
too good to refuse. AP is a fairly large pharmaceutical company that has a number
of patented drugs under its belt. With a number of the firm’s patents expiring
in the next three years, there has been some pressure to expand its production
lines. Michael has been asked to make recommendations for new investment to the
Board, specifically regarding a new drug recently developed by AP’s Research
Department.

The Vision Research division recently invented a new drug,
nicknamed ClearView, for the cure of myopia, which has shown tremendous promise
in the preliminary test. The project leader, Catherine, is very confident that
this new drug could revolutionise the world of ophthalmology. Upon Michael’s
request, she also provides some standard cost estimates if the product is
approved and launched early this year.

Development costs:

17 million

Testing
costs:

10 million

Initial Marketing
costs:

12 million

Initial
outlay:

39 million

The new drug is expected to be a block-buster, which will
help to increase the company’s market share and the sales are expected to be
$15 million in the first year. The sales revenue generated from this product
alone is expected to grow at a rate of 10% pa in the first three years and stay
in line with inflation thereafter until its patent expires in 10 years.

The product would be manufactured in an unused plant owned
by the firm which would otherwise be leased out for $100,000 per year. Required
equipment costing $5 million is expected to have a salvage value of $300,000
after 10 years, though it will be fully written off for tax purposes. Fixed
costs are estimated to be $1.50 million per year while variable production
costs are expected to be equal to 25% of sales revenue in each case. To get the
project underway, additional inventory of $500,000 would be required. The
company would also need to increase its accounts payable by $100,000 and its
accounts receivable by $200,000. Catherine estimates that the net working
capital committed to each production line would be maintained at 20% of its
sales each year thereafter.

The weighted average cost of capital is calculated to be
14%. The current inflation of 1.5% pa is expected to remain stable over the
next 15 years, and so is the company’s tax rate of 30%.

You have been asked to advise the manager whether the
proposal should be adopted using NPV and IRR analyses.

In addition you need to provide a sensitivity analysis using
the numbers above, an analysis which could be scrutinised and questioned by the
relevant company committee. The sensitivity analysis should be based on the
following scenarios:

Scenarios

Sales

Fixed
Cost (FC)

Pessimistic estimate

20% decrease in sales

20% Increase in FC

Base case

$15 million

$1.50 million

Optimistic estimate

20% Increase in sales

20% Decrease in FC

Readings for Question 1
1. GSBS6130
Weeks 3 and 4 Lecture Notes/Handout/ activities
2. Chapters
5 and 6, Peirson, G., Brown, R., Easton, S., Howard, P. and Pinder,
S. (2015). Business Finance (12 ed.):
McGraw-Hill Australia, North Ryde
(ISBN: 1743078978)

QUESTION 2: (10 Marks)
You are a research analyst in an investment bank. You need
to write a research report on the sensitivity of the stock return to the market
return. The following model can be used to estimate the sensitivity of the
stock return to the market return:

????????,????= ????0+
????1????????,????+ ????????,????
(1)

Where ????????,????is
stock return on the ith institution; ????????,????is
return on the S&P/ASX All Ordinaries Index; and ????????,????is the random
error term at day t. You are required to estimate the market model (Eq.1)[1]
for the following companies:
•
Commonwealth Bank of Australia (CBA.AX)
•
Rio Tinto Ltd (RIO.AX)
•
Insurance Australia Group Ltd (IAG.AX)

Data sources
? Daily adjusted closing stock
prices for companies and the All Ordinaries Index:
.finance.yahoo.com/”>http://au.finance.yahoo.com.finance.yahoo.com/”>

Estimation period
January 1, 2010–June 30, 2015

Referencing style
American Psychological
Association (APA) 6th Edition. You can find helpful examples of APA
6th ed. citation in pp 26-38 of the 2013 NBS Postgraduate Student
Manual as well as at .apastyle.org/index.aspx”>http://www.apastyle.org/index.aspx.apastyle.org/index.aspx”>.

Required
Write a research report based on the market model as given
in Equation 1 with the following parts:
(a)
Introduction (hint: you should discuss why
companies are sensitive to the market return)
(b)
Methodology (hint: you should discuss the model,
sources of data etc.)
(c)
Findings (hint: you should discuss the results
from the model) (d) Conclusion
(hint: you should discuss the implications)
(e) References.

Readings for Question 2
1.
GSBS6130 Week 8 Lecture Notes/Handout/
activities
2.
Chapter 7, Peirson, G., Brown, R., Easton, S.,
Howard, P. and Pinder, S.
(2015). Business Finance (12 ed.):
McGraw-Hill Australia, North Ryde (ISBN:
1743078978)

Marking Guide

Question 1 (10
marks):

•
1 mark for clearly presenting relevant
assumptions
•
1 mark for treatment of depreciation
•
1 mark for treatment of working capital
•
1 mark for treatment of tax
•
1 mark for treatment of opportunity costs
•
1 mark for calculation of NPV and IRR
•
1 mark for “appropriate” treatment of
inflation
•
1 mark for reaching valid conclusion based on
analysis
•
2 marks for sensitivity analysis and any other
risk assessment

Question 2 (10
marks):

•
1 marks for Introduction
•
2 marks for Methodology
•
5 marks for Findings
•
1 mark for Conclusion
•
1 mark for References

[1]
Market model is described in Equation 7.14 on p.195 of the textbook.

ANSWER:

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