Fin20014 Evaluation Of Projects For Assessment Answer

Answer:

The expenditure incurred toward Research and Development during primary phase is non depreciable and non –tax deductible. The same is sunk cost of the company.

Bases on the stated assumptions, the quantitative analysis of P-REC & T-REC has been carried on the basis of four capital budgeting tools. The same has been enumerated here-in-below:

• Discounted Payback period: In the said method of capital budgeting, the time value of money is considered and the cash flow earned over the life of the project is discounted to present value. Further, the analysis involves computation of time period in which the initial outlay shall be realised. The benchmark set by the company is 5 years and the said benchmarking is not satisfied for both the projects. 

As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the discounted payback period of the project is 5.25 years and 6.43 years respectively and the same is greater than 5 years. A brief version of the said computation has been outlined here-in-below: 

Sl NO	Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Terminal Value
1	Operating Cash flow before Tax	-2890000	748060	748060	748060	748060	1336060	1336060	1336060	1336060	310000
2	Tax		-224418	-224418	-224418	-224418	-400818	-400818	-400818	-400818	27600
3	Depreciation		306000	306000	306000	306000	306000	306000	306000	306000
4	Net Operating Cash flow	-2890000	829642	829642	829642	829642	1241242	1241242	1241242	1241242	337600
5	Discounting Factor @18%	1	0.847458	0.718184	0.608631	0.515789	0.437109	0.370432	0.313925	0.266038	0.266038164
6	Discounted Cash Flow	-2890000	703086.4	595836	504945.7	427920.1	542558.3	459795.2	389656.9	330217.7	89814.48408
7	Net Present Value	1153831
8	Cumulative	-2890000	-2186914	-1591078	-1086132	-658212	-115653	344141.8	733798.7	1064016	1153830.921
9	Discounted Pay back period							5.251532
10	Discounting Factor @24%	1	0.806452	0.650364	0.524487	0.422974	0.341108	0.275087	0.221844	0.178907	0.178906664
11	Cumulative	-2890000	-2220934	-1681364	-1246228	-895311	-471914	-130464	144898	366964.4	427363.3353
12	Discounted Pay back period								6.473792

On the other hand for T-REC,  it shall be pertinent to note that discounted payback period is beyond 8 years when project is discounted @24% while the same is 7.024 years when discounted @18% (Anon., 2018). A brief computation has been outlined here in-under: 

Computation of Net Present Value for T-REC
Sl NO	Particulars	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Year 7	Year 8	Terminal Value
1	Net cash flow	-2890000	956300	922000	766600	618200	578300	560800	535600	504800	337600
2	Discounting Factor @18%	1	0.847457627	0.718184	0.608631	0.515789	0.437109	0.370432	0.313925	0.266038	0.266038164
3	Discounted Cash Flow	-2890000	810423.7288	662166	466576.4	318860.7	252780.3	207738	168138.2	134296.1	89814.48408
4	Cumulative	-2890000	-2079576.271	-1417410	-950834	-631973	-379193	-171455	-3316.6	130979.5	220793.9465
5	Discounted Payback period									7.024696
6	Discounting Factor @24%	1	0.806451613	0.650364	0.524487	0.422974	0.341108	0.275087	0.221844	0.178907	0.178906664
7	Discounted Cash Flow	-2890000	771209.6774	599635.8	402071.9	261482.3	197262.6	154268.7	118819.8	90312.08	60398.88991
8	Cumulative	-2890000	-2118790.323	-1519155	-1117083	-855600	-658338	-504069	-385249	-294937	-234538.2196
9	Discounted Payback period	Never Paid off

Net Present Value: Net present Value is the most important tool under capital budgeting. In the said tool the discounted cash flow realised over the life of the project is reduced from the initial outlay. If the NPV is positive, the project is viable otherwise not. Further, the higher the value of NPV, the viable the project is. In addition, the rate for discounting the project shall be the project cost of capital.(CFI Education Inc., 2018)The simple formula for Net Present Value has been stated here-in-below: 

Net Present Value = Present value of Inflows – Present Value of Out flows. 

As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the NPV of the project is $ 1,153,831 and $427,363 respectively A brief version of the said computation has been outlined here-in-below:

Year	Cash flows @18%	Cash flows @24%
0	-2890000	-2890000
1	703086	669066
2	595836	539569
3	504946	435137
4	427920	350917
5	542558	423397
6	459795	341449
7	389657	275362
8	420032	282465
Total	1153831	427363

On perusal it can be seen that P-REC has positive net present value under both 18% and 24% discounting rate.

On the other hand for T-REC,  it shall be pertinent to note that Net Present Value is negative when project is discounted @24% and stands at  -$2,34,538/-  while the same is $2,20,794/- when discounted @18%. A brief computation has been outlined here in-under: 

Year	Cash flow @18%	Cash flow @24%
0	-2890000	-2890000
1	810423.7288	771209.6774
2	662166.0442	599635.796
3	466576.427	402071.9345
4	318860.6826	261482.2782
5	252780.2597	197262.6061
6	207738.0072	154268.7264
7	168138.2478	118819.7877
8	224110.5491	150710.9741
Total	220793.9465	-234538.2196

On perusal it can be seen that T-REC has positive net present value under 18% discounting rate and it is not feasible @24% discounting rate 

• Internal Rate of Return:  The third parameter for analysis is Internal Rate of Return, In the said method , the cash flows are discounted ta a rate by which the present value of inflows from the proposed project shall stand equal to initial outlay made in the project. (CFI Education Inc., 2018)The simple formula for the said methodology has been presented here-in-below’: 

Present Value of Cash outflow on the project= Present Value of inflows from the project at a discounting rate which is equal to internal rate of return. 

On the basis of above methodology, the discounting rate at which inflow is equal to outflow for P-REC is 28%. The brief overview of the same has been highlighted here-in-under: 

Year	Cash Flows
0	-2890000
1	829642
2	829642
3	829642
4	829642
5	1241242
6	1241242
7	1241242
8	1473242
IRR	28%

IRR of project is greater than 24% and hence feasible. 

While on the other hand, the IRR for T-REC is 21%. The brief overview of the same has been highlighted here-in-under: 

Year	Cash Flows
0	-2890000
1	956300
2	922000
3	766600
4	618200
5	578300
6	560800
7	535600
8	842400
IRR	21%

IRR of project is less than 24% and hence not feasible. 

• Profitability Index:  The last tool used for analysing the proposed investment is Profitability Index under which Present Value of inflow is divided by present value of outflow. If, the result obtained is greater than 1, the project is feasible otherwise the same shall not be considered.(AccountingExplained.com , 2013) 

As far as P-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the PI of the project is 1.399 and 1.148 respectively. 

As far as T-REC is considered, it shall be seen based on the Appendix-1 that when the proposed inflow of cash has been discounted at 18% and 24% the PI of the project is 1.076 and .9188 respectively. 

In the case of T-REC discounting has been carried at two rates i.e. 18% and 24% and accordingly the PI of the project stands at 1.076 and .9188 respectively. 

Accordingly, it shall be concluded that T-REC is not feasible @ 24% discounting rate. 

Qualitative Findings 

While analysing the qualitative factors of the project, it shall be pertinent to note that the same is based on probable impact that factors like management, government etc have on the proposed project. Further, in the present case the analysis has been limited to long term impact of the project and proposed issues that might crop up in case of failure. The same has been highlighted here-in-below: 

• As far as P-REC is considered, the same is in grafted with a major risk that it has not been clinically 100% sound proof and the same is in budding stage. Launching P-REC in the market at such a stage without knowing the probable side impact of such medicine can unleash a range of problems in the company.
• In addition to above, if the problem broke out in the middle of the duration of the project the same shall impact the cash flow detailed in the appendix;
• In case of P-REC also there shall be litigation and dispute if the side impact are developed in consumers and may have huge penalty on the company dangering its continuous existence in the long run;
• Pharmaceutical Sector has been prone to litigation  and strict regulation , thus taking such risk for short term benefit shall not be viable
• As far as T-REC is considered, it is proven and tested and launching the same is safe;
• Goodwill of the company shall be impacted in the long run if the project fails.

Recommendation and Justifications 

On the basis of above, it shall be concluded that though P-REC seems profitable and better than T-REC on quantitative front while the same may not be feasible on the qualitative factor and may tarnish the image of the company in the long run. Accordingly, the same is not feasible and T-REC shall be produced if the cost of capital is less than 21%  

Detail Comparison and Further Recommendation 

Further, a detail comparison of quantitative analysis is described here-in-under:

Sl No	Particular	P-REC	T-REC
1	Discounted Pay Back period @18%	5.251532	7.024696201
2	Discounted Pay Back period @24%	6.473792	Never Paid off
3	Net Present Value @18%	1153831	220793.9465
4	Net Present Value @24%	427363.3	-234538.2196
5	Internal Rate of Return	28%	22%
6	Profitability Index @18%	1.40	1.08
7	Profitability Index @24%	1.15	0.92

The company shall consider long run and shall produce T-REC even though the same is less feasible on monetary as presented above as the same has very less risk compared to P-REC

Conclusion 

Company shall produce T-REC based on reason stated above. Further, the company shall thing of long term vision and carry on research on P-REC to develop it further before launching the same in the market as Pharmaceutical sector is prone to litigation and risk measures.

References:

AccountingExplained.com , 2013. Profitability Index. [Online]  Available at: https://accountingexplained.com/managerial/capital-budgeting/profitability-index [Accessed 2 October 2018].

Anon., 2018. Payback Period & Discounted Payback Period | Formula | Example. [Online]  Available at: https://www.wallstreetmojo.com/payback-period-discounted-payback-period/ [Accessed 1 October 2018].

CFI Education Inc., 2018. Internal Rate of Return (IRR). [Online] Available at: https://corporatefinanceinstitute.com/resources/knowledge/finance/internal-rate-return-irr/
[Accessed 2 October 2018].

CFI Education Inc., 2018. Net Present Value (NPV). [Online]  Available at: https://corporatefinanceinstitute.com/resources/knowledge/valuation/net-present-value-npv/
[Accessed 2 October 2018].