Table showing total revenue and total expenses:
With contract Manufacturing
|
Years
|
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw Material
|
|
|
|
|
|
|
|
|
|
|
|
|
New Product
|
|
$ 4,50,000.00
|
$ 6,00,000.00
|
$ 8,25,000.00
|
$ 9,00,000.00
|
$ 9,18,000.00
|
$ 9,36,360.00
|
$ 9,55,087.20
|
$ 9,74,188.94
|
$ 9,93,672.72
|
$ 10,13,546.18
|
|
Contract Manufacturing
|
|
$ 67,500.00
|
$ 81,000.00
|
$ 1,01,250.00
|
$ 1,21,500.00
|
$ 1,35,000.00
|
$ 1,37,700.00
|
$ 1,40,454.00
|
$ 1,43,263.08
|
$ 1,46,128.34
|
$ 1,49,050.91
|
|
Raw Material cost
|
|
$ 5,17,500.00
|
$ 6,81,000.00
|
$ 9,26,250.00
|
$ 10,21,500.00
|
$ 10,53,000.00
|
$ 10,74,060.00
|
$ 10,95,541.20
|
$ 11,17,452.02
|
$ 11,39,801.06
|
$ 11,62,597.09
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New Product
|
|
$ 15,00,000.00
|
$ 20,00,000.00
|
$ 27,50,000.00
|
$ 30,00,000.00
|
$ 30,60,000.00
|
$ 31,21,200.00
|
$ 31,83,624.00
|
$ 32,47,296.48
|
$ 33,12,242.41
|
$ 33,78,487.26
|
|
Contract Manufacturing
|
|
$ 2,50,000.00
|
$ 3,00,000.00
|
$ 3,75,000.00
|
$ 4,50,000.00
|
$ 5,00,000.00
|
$ 5,10,000.00
|
$ 5,20,200.00
|
$ 5,30,604.00
|
$ 5,41,216.08
|
$ 5,52,040.40
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$ 17,50,000.00
|
$ 23,00,000.00
|
$ 31,25,000.00
|
$ 34,50,000.00
|
$ 35,60,000.00
|
$ 36,31,200.00
|
$ 37,03,824.00
|
$ 37,77,900.48
|
$ 38,53,458.49
|
$ 39,30,527.66
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw Material
|
|
$ 5,17,500.00
|
$ 6,81,000.00
|
$ 9,26,250.00
|
$ 10,21,500.00
|
$ 10,53,000.00
|
$ 10,74,060.00
|
$ 10,95,541.20
|
$ 11,17,452.02
|
$ 11,39,801.06
|
$ 11,62,597.09
|
|
Additional Wages
|
|
$ 1,50,000.00
|
$ 1,53,000.00
|
$ 1,56,060.00
|
$ 1,59,181.20
|
$ 1,62,364.82
|
$ 1,65,612.12
|
$ 1,68,924.36
|
$ 1,72,302.85
|
$ 1,75,748.91
|
$ 1,79,263.89
|
|
Variable Factory Overheads
|
|
$ 3,15,000.00
|
$ 4,14,000.00
|
$ 5,62,500.00
|
$ 6,21,000.00
|
$ 6,40,800.00
|
$ 6,53,616.00
|
$ 6,66,688.32
|
$ 6,80,022.09
|
$ 6,93,622.53
|
$ 7,07,494.98
|
|
Replacement & Maintenance Costs
|
|
|
|
$ 15,000.00
|
$ 30,000.00
|
$ 50,000.00
|
$ 51,000.00
|
$ 52,020.00
|
$ 53,060.40
|
$ 54,121.61
|
$ 55,204.04
|
|
Advertisement Cost
|
|
$ 3,75,000.00
|
$ 3,75,000.00
|
$ 3,00,000.00
|
$ 2,75,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
|
Building Modification Costs
|
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
|
Depreciation
|
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
|
Preliminary Expenses
|
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
|
Interest
|
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Expenses
|
|
$ 9,67,200.00
|
$ 10,69,200.00
|
$ 11,60,760.00
|
$ 12,12,381.20
|
$ 11,30,364.82
|
$ 11,47,428.12
|
$ 11,64,832.68
|
$ 11,82,585.34
|
$ 12,00,693.04
|
$ 12,19,162.90
|
Determination of net cash flows after tax
|
|
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
operating cash flows
|
|
$ 7,82,800.00
|
$ 12,30,800.00
|
$ 19,64,240.00
|
$ 22,37,618.80
|
$ 24,29,635.18
|
$ 24,83,771.88
|
$ 25,38,991.32
|
$ 25,95,315.14
|
$ 26,52,765.45
|
$ 27,11,364.76
|
|
Tax @ 30%
|
|
$ 2,34,840.00
|
$ 3,69,240.00
|
$ 5,89,272.00
|
$ 6,71,285.64
|
$ 7,28,890.55
|
$ 7,45,131.56
|
$ 7,61,697.40
|
$ 7,78,594.54
|
$ 7,95,829.63
|
$ 8,13,409.43
|
|
Cash flows after tax
|
|
$ 5,47,960.00
|
$ 8,61,560.00
|
$ 13,74,968.00
|
$ 15,66,333.16
|
$ 17,00,744.62
|
$ 17,38,640.32
|
$ 17,77,293.92
|
$ 18,16,720.60
|
$ 18,56,935.81
|
$ 18,97,955.33
|
|
Depreciation
|
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
|
CFAT
|
|
$ 6,34,460.00
|
$ 9,48,060.00
|
$ 14,61,468.00
|
$ 16,52,833.16
|
$ 17,87,244.62
|
$ 18,25,140.32
|
$ 18,63,793.92
|
$ 19,03,220.60
|
$ 19,43,435.81
|
$ 19,84,455.33
|
|
Less Principle Repayment
|
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
|
Less Working Capital
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
|
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
|
Receivables
|
|
$ 1,93,000.00
|
$ 1,96,860.00
|
$ 2,00,797.20
|
$ 2,04,813.14
|
$ 2,08,909.41
|
$ 2,13,087.60
|
$ 2,17,349.35
|
$ 2,21,696.33
|
$ 2,26,130.26
|
$ 2,30,652.87
|
|
Add Salvage Value
|
|
|
|
|
|
|
|
|
|
|
$ 1,29,500.00
|
|
Net Cash Flows
|
$ -10,50,000.00
|
$ 2,36,932.00
|
$ 5,46,672.00
|
$ 10,56,142.80
|
$ 12,43,492.02
|
$ 13,73,807.22
|
$ 14,07,524.72
|
$ 14,41,916.58
|
$ 14,76,996.27
|
$ 15,12,777.55
|
$ 16,78,774.46
|
Determination of Net Present Value
|
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
Net Cash Flows
|
$ -10,50,000.00
|
$ 2,36,932.00
|
$ 5,46,672.00
|
$ 10,56,142.80
|
$ 12,43,492.02
|
$ 13,73,807.22
|
$ 14,07,524.72
|
$ 14,41,916.58
|
$ 14,76,996.27
|
$ 15,12,777.55
|
$ 16,78,784.46
|
|
DCF @ 15%
|
$ 1.00
|
$ 0.87
|
$ 0.76
|
$ 0.66
|
$ 0.57
|
$ 0.50
|
$ 0.43
|
$ 0.38
|
$ 0.33
|
$ 0.28
|
$ 0.25
|
|
|
$ -10,50,000.00
|
$ 2,06,027.83
|
$ 4,13,362.57
|
$ 6,94,431.03
|
$ 7,10,970.60
|
$ 6,83,024.99
|
$ 6,08,511.78
|
$ 5,42,069.85
|
$ 4,82,832.70
|
$ 4,30,025.80
|
$ 4,14,969.84
|
|
NPV
|
$ 41,36,226.98
|
|
|
|
|
|
|
|
|
|
|
Determination of internal rate of return:
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
-1050000
|
236931.1304
|
546671.2439
|
1056142.142
|
1243491.444
|
1373806.719
|
1407524.288
|
1441916.199
|
1476995.94
|
1512777.268
|
1678794.216
|
|
64%
|
|
|
|
|
|
|
|
|
|
|
Determination of payback period
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
-1050000
|
236932
|
546672
|
1056142.8
|
1243492.016
|
1373807.216
|
1407524.721
|
1441916.575
|
1476996.267
|
1512777.552
|
1678784.463
|
|
|
-813068
|
-266396
|
789746.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.33
|
|
|
|
|
|
|
|
|
|
|
Without Contract Manufacturing:
|
|
|
1.00
|
2.00
|
3.00
|
4.00
|
5.00
|
6.00
|
7.00
|
8.00
|
9.00
|
10.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw Material
|
|
|
|
|
|
|
|
|
|
|
|
|
New Product
|
|
$ 4,50,000.00
|
$ 6,00,000.00
|
$ 8,25,000.00
|
$ 9,00,000.00
|
$ 9,18,000.00
|
$ 9,36,360.00
|
$ 9,55,087.20
|
$ 9,74,188.94
|
$ 9,93,672.72
|
$ 10,13,546.18
|
|
Contract Manufacturing
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw Material cost
|
|
$ 4,50,000.00
|
$ 6,00,000.00
|
$ 8,25,000.00
|
$ 9,00,000.00
|
$ 9,18,000.00
|
$ 9,36,360.00
|
$ 9,55,087.20
|
$ 9,74,188.94
|
$ 9,93,672.72
|
$ 10,13,546.18
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
New Product
|
|
$ 15,00,000.00
|
$ 20,00,000.00
|
$ 27,50,000.00
|
$ 30,00,000.00
|
$ 30,60,000.00
|
$ 31,21,200.00
|
$ 31,83,624.00
|
$ 32,47,296.48
|
$ 33,12,242.41
|
$ 33,78,487.26
|
|
Contract Manufacturing
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenue
|
|
$ 15,00,000.00
|
$ 20,00,000.00
|
$ 27,50,000.00
|
$ 30,00,000.00
|
$ 30,60,000.00
|
$ 31,21,200.00
|
$ 31,83,624.00
|
$ 32,47,296.48
|
$ 33,12,242.41
|
$ 33,78,487.26
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Raw Material
|
|
$ 4,50,000.00
|
$ 6,00,000.00
|
$ 8,25,000.00
|
$ 9,00,000.00
|
$ 9,18,000.00
|
$ 9,36,360.00
|
$ 9,55,087.20
|
$ 9,74,188.94
|
$ 9,93,672.72
|
$ 10,13,546.18
|
|
Additional Wages
|
|
$ 1,50,000.00
|
$ 1,53,000.00
|
$ 1,56,060.00
|
$ 1,59,181.20
|
$ 1,62,364.82
|
$ 1,65,612.12
|
$ 1,68,924.36
|
$ 1,72,302.85
|
$ 1,75,748.91
|
$ 1,79,263.89
|
|
Variable Factory Overheads
|
|
$ 2,70,000.00
|
$ 3,60,000.00
|
$ 4,95,000.00
|
$ 5,40,000.00
|
$ 5,50,800.00
|
$ 5,61,816.00
|
$ 5,73,052.32
|
$ 5,84,513.37
|
$ 5,96,203.63
|
$ 6,08,127.71
|
|
Replacement & Maintenance Costs
|
|
|
|
$ 15,000.00
|
$ 30,000.00
|
$ 50,000.00
|
$ 51,000.00
|
$ 52,020.00
|
$ 53,060.40
|
$ 54,121.61
|
$ 55,204.04
|
|
Advertisement Cost
|
|
$ 3,75,000.00
|
$ 3,75,000.00
|
$ 3,00,000.00
|
$ 2,75,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
|
Building Modification Costs
|
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
$ 7,500.00
|
|
Depreciation
|
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
|
Preliminary Expenses
|
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
$ 33,200.00
|
|
Interest
|
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
$ 37,500.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Expenses
|
|
$ 9,22,200.00
|
$ 10,15,200.00
|
$ 10,93,260.00
|
$ 11,31,381.20
|
$ 10,40,364.82
|
$ 10,55,628.12
|
$ 10,71,196.68
|
$ 10,87,076.62
|
$ 11,03,274.15
|
$ 11,19,795.63
|
Determination of Net Present Value
|
|
|
1.00
|
2.00
|
3.00
|
4.00
|
5.00
|
6.00
|
7.00
|
8.00
|
9.00
|
10.00
|
|
operating cash flows
|
|
$ 5,77,800.00
|
$ 9,84,800.00
|
$ 16,56,740.00
|
$ 18,68,618.80
|
$ 20,19,635.18
|
$ 20,65,571.88
|
$ 21,12,427.32
|
$ 21,60,219.86
|
$ 22,08,968.26
|
$ 22,58,691.63
|
|
Tax @ 30%
|
|
$ 1,73,340.00
|
$ 2,95,440.00
|
$ 4,97,022.00
|
$ 5,60,585.64
|
$ 6,05,890.55
|
$ 6,19,671.56
|
$ 6,33,728.20
|
$ 6,48,065.96
|
$ 6,62,690.48
|
$ 6,77,607.49
|
|
Cash flows after tax
|
|
$ 4,04,460.00
|
$ 6,89,360.00
|
$ 11,59,718.00
|
$ 13,08,033.16
|
$ 14,13,744.62
|
$ 14,45,900.32
|
$ 14,78,699.12
|
$ 15,12,153.90
|
$ 15,46,277.78
|
$ 15,81,084.14
|
|
Depreciation
|
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
$ 86,500.00
|
|
CFAT
|
|
$ 4,90,960.00
|
$ 7,75,860.00
|
$ 12,46,218.00
|
$ 13,94,533.16
|
$ 15,00,244.62
|
$ 15,32,400.32
|
$ 15,65,199.12
|
$ 15,98,653.90
|
$ 16,32,777.78
|
$ 16,67,584.14
|
|
Less Principle Repayment
|
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
$ 54,528.00
|
|
Less Working Capital:
|
|
|
|
|
|
|
|
|
|
|
|
|
Inventory
|
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
$ 1,50,000.00
|
|
Receivables
|
|
$ 1,93,000.00
|
$ 1,96,860.00
|
$ 2,00,797.20
|
$ 2,04,813.14
|
$ 2,08,909.41
|
$ 2,13,087.60
|
$ 2,17,349.35
|
$ 2,21,696.33
|
$ 2,26,130.26
|
$ 2,30,652.87
|
|
Add Salvage Value
|
|
|
|
|
|
|
|
|
|
|
$ 1,29,500.00
|
|
Net Cash Flows
|
$ -10,50,000.00
|
$ 93,432.00
|
$ 3,74,472.00
|
$ 8,40,892.80
|
$ 9,85,192.02
|
$ 10,86,807.22
|
$ 11,14,784.72
|
$ 11,43,321.78
|
$ 11,72,429.57
|
$ 12,02,119.52
|
$ 13,61,903.27
|
Determination of NPV
|
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
Net Cash Flows
|
$ -10,50,000.00
|
$ 93,432.00
|
$ 3,74,472.00
|
$ 8,40,892.80
|
$ 9,85,192.02
|
$ 10,86,807.22
|
$ 11,14,784.72
|
$ 11,43,321.78
|
$ 11,72,429.57
|
$ 12,02,119.52
|
$ 13,61,913.27
|
|
DCF @ 15%
|
$ 1.00
|
$ 0.87
|
$ 0.76
|
$ 0.66
|
$ 0.57
|
$ 0.50
|
$ 0.43
|
$ 0.38
|
$ 0.33
|
$ 0.28
|
$ 0.25
|
|
|
$ -10,50,000.00
|
$ 81,245.22
|
$ 2,83,154.63
|
$ 5,52,900.67
|
$ 5,63,286.73
|
$ 5,40,335.26
|
$ 4,81,952.20
|
$ 4,29,817.00
|
$ 3,83,269.31
|
$ 3,41,717.39
|
$ 3,36,644.13
|
|
NPV
|
$ 29,44,322.55
|
|
|
|
|
|
|
|
|
|
|
Determination of IRR
|
IRR
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
Net Cash Flows
|
-1050000
|
93431.13043
|
374471.2439
|
840892.1425
|
985191.4442
|
1086806.719
|
1114784.288
|
1143321.399
|
1172429.244
|
1202119.238
|
1361923.025
|
|
|
51%
|
|
|
|
|
|
|
|
|
|
|
Determination of payback period
|
|
0
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
9
|
10
|
|
Payback
|
-1050000
|
93432
|
374472
|
840892.8
|
985192.016
|
1086807.216
|
1114784.721
|
1143321.775
|
1172429.571
|
1202119.522
|
1361913.272
|
|
Cumulative Cash Flows
|
|
-956568
|
-582096
|
258796.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Payback Period (years)
|
4.249239558
|
|
|
|
|
|
|
|
|
|
|
Question 2
Executive summary:
In this report the investment proposal of Pelican Pharmaceuticals Ltd has been critically analysed using various techniques of capital budgeting. The company in the present case is evaluating to invest in the new equipment for the purpose of manufacturing of a new medical powder that treats constipation. By applying the capital budgeting techniques, it is found that the investment proposal for the manufacturing of a new product is financially viable. The net present value of the project is $ 4136225, which is positive enough. Also the payback period of 2.33 years is significantly lower than the overall useful life of the project and hence the project could be considered as profitable.
To evaluate any investment decision, various capital budgeting techniques must be applied to the proposed project. Capital budgeting decisions are the decisions that involve significant capital investment in the project. These investment decisions are to be critically evaluated because of involvement of huge amount of funds in the project and therefore they are generally irreversible in the short term. In the present case, the useful life of the project is 10 years and which is quite a long period of time. The company is assessing the decision to start the manufacturing of a substitute product of the medical tablets that are already manufactured by it (Kahraman, 2001). For such proposal it has to undertake research activities that will involve heavy cost. Along with the researching cost it will have to incur the cost of tripping to India to make the deal final for the raw material. All these costs are clubbed together and deferred over the useful life of the project as these cost are going to provide advantage over the entire life of the project. The increase in the level of inventory and receivables will increase the working capital requirement of the company. Also, the depreciation is the non-cash item for which the tax benefit can be availed and hence it is deducted from the profits before tax. Tax benefit of the interest element involved in the instalment amount of loan repayment schedule will also be obtained as it is a revenue expense.
Net present value of a project is the net total of present values of all the cash inflows and outflows associated with the project. The present values are calculated by applying the discounting rates to the net cash flows after tax (Brijlal, 2008). NPV of the project indicates the return generating capacity of the project after recovering all the project related costs. In the present case the normal rate of return on all the investments is given as 15%. This rate has been used as the discounting rate and the net cash flows after tax are calculated at the discounting factors of 15%. The new equipment will also be sold at the end of useful life of the project and hence the salvage value (net of tax) must be added to the net cash flows generated from the project. The net present value in the present case is $ 4136227 which shows that the proposal of manufacturing of new medical item i.e. powdered medicine is profitable as it has the capability to generate cash inflows that not only covers the cash outflows but also it generates considerable returns for the investors of the project (Dufey & Srinivasulu, 1983).
Further, the internal rate of return is the rate at which the net present value of the company remains zero which means the point at which company has covered all its project’s cash outflows with the cash inflows. If the IRR of the project is higher than the nominal rate of return of the investments then the project is considered as profitable (Graham & Harvey, 2002). In the present case, the nominal rate of return is quite lower than the project’s IRR and hence the proposed project is profitable.
Payback period is the period in which the project recovers all its initial costs and starts generating returns for the investors (Drake, 2006). If the payback period of the project is considerably lower than the overall life of the project then the project is considered as profitable. In the present case, the payback period of the project is 2.33 years whereas the overall life of the project is 10 years. Therefore it can be said that the new project will recover all its cash outflows within 3 years and will start generating the returns thereafter. Hence, the project is profitable from the point of view of payback period also.
From the above analysis done through the various applications of capital budgeting techniques, it is observed that the project is quite profitable from all the view points and hence it must be undertaken. Further, as the proposed project would not affect the current sales done in the local market off Australia therefore the additional sales of new product will generate additional profitability to the company. Hence the project must be undertaken.
The NPV of the project without undertaking contract manufacturing is $ 29,44,322.55 which is quite lesser than the NPV of project with contract manufacturing. Also the IRR has reduced to 51% which is lesser than the IRR of project with contract manufacturing. Further, the payback period is also 4.34 years in case of project without contract manufacturing. Hence it is clear that contract manufacturing must be undertaken as it will give higher positive results.
Question 3
In the present case, the manufacturing of proposed medical power requires investment in new equipment that is expected to be utilised at 50% of its normal capacity. Therefore, if contract manufacturing is not undertaken, then the remaining capacity of 50% will be left idle. The un-utilised capacity will not enable the company to generate desired returns and hence it must be utilised for the contracted sales so that the overall cost of the project is recovered from the additional contracted sales. As all the members of project management team i.e. Anna, Freddy and Miguel have different predictability of future sales and hence it is difficult to adopt one belief for the sales forecasts so to determine the profitability of the project. Further, the contract manufacturing business has taken a long time to set up and still the variability of the project is quite higher, it is difficult to estimate sales revenue and cost related to this business.
Question 4
Other factors that must be taken into account by the firm before launching the new product in the market that treats the constipation:
The competitive forces:
Pelican Pharmaceuticals Ltd must take into consideration the availability of competition in the pharmaceutical industry. It must identify whether the proposed medicine powder is manufactured by the other firms of the industry or not. The company must consider the pricing policy to be kept for the new medicine. If the product already exists in the market, what is the price set by the competitors of the company?
Demand of the medicine
If such product is already being traded in the market, what is the demand of such product and how consumers see it. Since the proposed medical powder is the substitute of a tablet that already exists in the market, the company must consider whether the consumers will accept the new product and what the changes they expect are in the proposed powder.
Side effects of the powder:
The company must ascertain that whether the side effects of the medical powder are severely injurious to the health or not.
Legality:
The company must take into account the regulatory requirements that are required to be complied to undertake such importation of raw material. It must hold the import eligibility certificate to bring the raw material in Australia. It must also be checked the legality of the consumption of raw material in the Australian country. The company must ensure that it holds the certificate which entitles it to deal in the said raw material.
Fluctuation in foreign exchange rate:
As the raw material that is to be used in the proposed medical powder is to be imported from a dealer in India, so the manufacturing company must consider the trend of the fluctuation in the foreign exchange rates in relation to Indian and Australian currency (Brigham & Houston, 2012). If the exchange rates between these two countries are highly fluctuating, then the company must consider the impact of such fluctuation on the prices of the raw material that is to be imported for the manufacturing of powder.
Economic and political relations with Indian Country:
The company must also assess the Australia’s economic and political relations with the Indian Government. If both the countries are having smooth political relations, then it will not be difficult for the company to import such raw material from India. It must also check the availability of import license which is required for the said importation.
There may be few factors other than those discussed above which must be looked into before starting the manufacturing of the new medical powder.
References:
Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management. Cengage Learning.
Brijlal, P. (2008). The use of capital budgeting techniques in businesses: A perspective from the Western Cape.
Drake, P. P. Capital budgeting techniques. Online (datum poslední revize: 29.6. 2006): www. fau. edu/~ ppeter/fin3403/module6/capbudtech. pdf.
Dufey, G., & Srinivasulu, S. L. (1983). The case for corporate management of foreign exchange risk. Financial Management, 54-62.
Graham, J., & Harvey, C. (2002). How do CFOs make capital budgeting and capital structure decisions?. Journal of applied corporate finance, 15(1), 8-23.
Kahraman, C. (2001). Capital budgeting techniques using discounted fuzzy cash flows. In Soft Computing for Risk Evaluation and Management (pp. 375-396). Physica, Heidelberg.
Ross, S. A., Westerfield, R., & Jaffe, J. F. (1990). Corporate finance (Vol. 2). Homewood: Irwin.
