Business Analysis and Valuation (MBA G593/ECON F355/BITS F493)

Mid Term Examination (Solution Copy)

Q1.
Ans: Adjustments for Dec.31, 2001
Liabilities &
($billions) Assets Equity
Balance Sheet
Accounts Receivable –3.35
Inventory +1.00
Deferred Taxes +.82 or –.82
Common Shareholders’ Equity –1.53

Income Statement
Sales –3.35

Cost of Sales –1.00

Tax Expense –.82

Net Income –1.53

Q2.
Ans: Porter Analysis of Pharmaceutical Industry
Drivers Intensity Justification
Rivalry Medium Firms compete fiercely to develop and patent drugs. However, once a
drug is patented, a firm has a monopoly for that drug, dramatically
reducing competition. Competitors can only enter the same market by
developing a drug that does not infringe on the patent.
Threat of New Entrants Low Economies of scale and first mover advantages are very high for the
industry. In addition, drug firms’ sales forces have established
relationships with doctors, which act as a further deterrent for a new
entrant. This distribution advantage is changing as managed-care firms
have begun negotiating directly with drug companies on behalf of the
doctors in their network.
Threat of Substitute Products Low New drugs are protected by patents giving manufacturers a monopoly to
invent around the patent or to wait until the patent expires. Once the
patent expires, a company will reduce prices as other manufacturers enter
the market. The threat of substitute products, however, is likely to
increase as biotech products enter the market.
Bargaining Power of Buyers Low Historically, doctors have had little buying power. However, managed-
powerful recently, and have begun negotiating substantial discounts for
drug purchases.
Bargaining Power of Suppliers Low The chemical ingredients for drugs can be obtained from a variety of
chemical suppliers.

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Q3.
Ans:
Base Year Financial Forecasts
0 1 2 3 4 5
Revenues 3500.00 3850.00 4235.00 4658.50 5217.52 5843.62
EBIT 450.00 495.00 544.50 598.95 670.82 751.32
Dep 150.00 165.00 181.50 199.65 223.61 250.44
Capex 300.00 330.00 363.00 399.30 447.22 500.88
Net WC 400.00 440.00 484.00 532.40 596.29 667.84
Investment in WC 40.00 44.00 48.40 63.89 71.55
NOPAT (EBIT * (1-t) 297.00 326.70 359.37 402.49 450.79
FCFF (NOPAT + Dep-Capex-Change in WC) 92.00 101.20 111.32 115.00 128.80
WACC Debt Equity Terminal Value
Weights 0.40 0.60 1476
Cost 7.20 18.80
WACC 14.16
Discount Factor 0.88 0.77 0.67 0.59 0.52
PV of Cash Flow 80.59 77.65 74.82 67.71 66.43
PV of Terminal Value 761.44
Enterprise Value of the Firm 1128.63