Problem -
Dr. Joanna Dziendobry (Jo) and Dr. Benoit Hero (Ben) are both medical doctors having graduated from the University of Lausanne. They have developed over the past years a liquid which, when added to test tubes performs a faster ultraviolet photosynthetic chain reaction of certain proteins. For the common investor who has no clue of medicine, just know that their invention is a total killer; everybody will want it. Presently, they plan to bring this methodology to the market. Their value proposition is to produce and sell this liquid. AU amounts below are in CHF. Cash left in bank is not remunerated. Please, round all numbers (no decimals) unless you have percentages.
The following describes the parameters of their project.
- They rent office space in Bussigny with a constant annual cost of 50'000.
- There is an initial cost of 3mio to purchase a robot that manufactures the liquid. This machine is depreciated linearly over 10 years. A second such machine needs to be bought after 5 years to face increased demand. The office has been chosen sufficiently large so that several additional machines can be installed.
- At the time the company gets created, there is a single payment of 500'000 to the University of Lausanne where the research was made. This amount may be amortized linearly over 10 years.
- They have to purchase IT components for 300'000 to run the robot. These computers are depreciated linearly over 5 years. The computers are expected to work for 5 years. Then they will have to be replaced. Because of technical progress, even though inflation raises the general price level the cost is assumed to be the same.
- The company will also purchase a car for 80'000 depreciated linearly over 5 years. This car will operate easily for more than 10 years.
- In addition to Jo and Ben there are three technicians who operate the robot. These operators will also do some research which justifies a relatively high wage. The annual starting wage is 120'000 for each of the two founders and 100'000 for each of the operators. Wages increase every year by 2% and this for everybody.
- General and Administrative Expenditures (CAE) and marketing are expected to cost in year one 40'000. Those costs are also expected to increase at a rate of 4%.
- The first year will not generate sales, only costs. In year 2, the company expects to sell for 500'000. In year 3 for 2mio, in year 4 for 3mio and in year 5 for 3.5mio. At this stage it is assumed that the market grows for 10% per year.
- Ben and Jo are able to obtain a 10 year long credit for 3mio at 7% annual interest. This credit is annuitized. Ben and Jo are bringing 500'000 in equity capital. A venture capitalist has pledged 2.5mio if the project sounds reasonable.
- Inflation rate is expected to be 1% over the coming years.
- The required return on equity for such a startup is 30%. The corporate tax rate is 35%. Taxes are paid only on positive EBT. Taxes have to be paid immediately for the cash flows and not lagged. There is no possibility to report losses in the future nor defer taxes.'
- We assume that working capital amounts to 5% of sales and will be required only when the firm sells something.
For the initial computations you are asked to present an excel sheet up to 10 years. After 10 years you will have to make an assumption about permanent growth and discount with Cordon-Shapiro.
Question 1: Determine the Earnings Statement for this company. What is the Net Income over the next 10 years?
Question 2: Determine the initial cash flows as well as the operating cash flows.
Question 3: What is the WACC of this project?
Question 4: Estimate the cash flows beyond year 10.2 Estimate the present value of these cash flows. This would be the value if the business gets sold some time after year 10. Hint: Cordon-Shapiro may be useful to evaluate this termination value.
Question 5: What is the NPV of this project? What would be the value of the NPV if you had forgotten the cash flows after period 10?
Question 6: What is the MR of this project? Determine the Payback time?
Question 7: Establish the Liquidity Statement of this company for the first 10 years.
Question 8: Your Business Angel wants to recover her money after 10 years.
a. What is the resell value of the company right after the cash flows of year 10 have been paid out?
b. Jo and Ben on one side and the venture capitalist on the other will share the remaining liquidity according to their relative shareholdings. What are the weights of both parties (founders versus VC)? How much do they get?
Question 9: Perform a sensitivity analysis of the project to determine if it should be undertaken or not. To do so provide an optimistic scenario which you can obtain by assuming Sales that are either 25% higher or 25% lower than the given ones. Discuss.