Q. India Pharma is engaged in manufacturing of pharmaceuticals.

The company is considering launching a new

antibiotic for which the following information has been gathered.
1. The new antibiotic is expected to have a product life cycle of five years and year-wise sales are projected as
follows:
Rs. million Year 1 Year 2 Year 3 Year 4
Sales revenue 100 150 200 150

2.  Capital investment for acquiring new equipment is estimated to be Rs. 100 million and it will be depreciated @
25% per year following Written Down Value (WDV) method for tax purpose. The expected salvage value of the
equipment after five years is Rs. 20 million.

3. Working capital requirement is estimated to be 20% of the sales revenue. It is further assumed that working
capital investment will be required at the beginning of the year. For example, working capital requirement for the
first year is Rs. 20 million (20% of Rs. 100 million) and this will be deployed at the beginning of the first year, i.e. at
the end of Year 0. At the end of five year, working capital will be recovered at par value.

4. The accountant of the company has provided the following estimates of cost of production:
Items Estimates
Raw material cost 30% of sales revenue
Variable labour costs 20% of sales revenue
Fixed annual operation & maintenaRs. 5 million
Incremental overhead cost Nil
5.  The company will use some common facilities for manufacture of the new antibiotic. The use of these common
facilities will reduce production of other products and thereby result in loss of contribution margin of Rs. 15 million
per year.
6. Effective tax rate of the company is 30%.
7. The company’s minimum required rate of return for launching any new product is 15%.
You are required to estimate cash flows of the new product and then evaluate financial viability of the investment
using NPV. Present your calculations using the format given in the next page.
ng launching a new

s are projected as

Year 5
100

will be depreciated @
alvage value of the

umed that working

al requirement for the
of the first year, i.e. at

n:

use of these common

margin of Rs. 15 million

ility of the investment

Operational Cash Flows
Rs. million Year 1 Year 2 Year 3
Sales revenue 100 150 200
Raw materials cost 30% of sales 30 45 60
Variable labour cost 20% of sales 20 30 40
Fixed O&M costs 5 5 5
Depreciation 25 19 14
Loss of contribution 15 15 15
Profit before tax 5 36.25 65.94
Tax 30% 1.5 10.88 19.78
Profit after tax 3.5 25.38 46.16
Operational CF 28.5 44.13 60.22
Calculation of depreciation (WDV)
Rs. million Year 1 Year 2 Year 3
Opening value 100 75 56.25
Depreciation for the year 25% 25 18.75 14.06
WDV 75 56.25 42.19
Calculation of working capital
Rs. million Year 0 Year 1 Year 2 Year 3
Sales revenue 100 150 200
Working capital 20 30 40 30
Inc. working capital 20 10 10 -10
Calculation of NPV
Rs. million Year 0 Year 1 Year 2 Year 3
Capital cost -100

Inc. working capital(- for out flow +for inflow) -20 -10 -10 10

Free cash flows 18.5 34.1 70.2

Salvage value of equipment
Recovery of Working Capital
Net cash flows -120.00 18.50 34.13 70.22
PV @ 15% 1 0.870 0.756 0.658
DCF -120.00 16.09 25.80 46.17
NPV @ 15% 29.11
IRR 23%
NPV @ 15% ₹ 29.11 =NPV(15%,C30:G30)+B30
QUESTIONS THAT COULD BE ASKED IRR
NPV
PAYBACK
SHOULD THE COMPANY CONTINUE WITH THE PROJEXT

PPP Toolkit (pppinindia.gov.in)

Year 4 Year 5
150 100 Free Flow Cash Flow =
45 30
30 20
5 5
11 8
15 15
44.45 22.09
13.34 6.63
31.12 15.46
41.66 23.37 (Dep added as it is a non-cash expense)

Year 4 Year 5
42.19 31.64
10.55 7.91
31.64 23.73

Year 4 Year 5
150 100
20 0
-10 -20

Year 4 Year 5

10

51.7 23.4
20
20
51.66 63.4
0.572 0.497
29.54 31.51
HE PROJEXT
PAT (Profit After Tax) + Depreciation - Increase of Working Capital + Decrease of Working Capital - Capital Expend
rking Capital - Capital Expenditure- Capex Expenditure (IF ANY) +Sales Proceeds (Gains/Scrap Value)
cost of capital 15%
Rs million 0 1 2 3
CF -200 100 100 100
Pv factor 1 0.8695652 0.7561437 0.6575162
DCF -200 86.956522 75.614367 65.751623
npv ₹ 28.32
Npv 28.32
since npv is greater than 0 the project is financially viable
IRR 23.38%
since irr>cost of capital, the project is financially viable

IRR of project cashflow indicates the maximum rate of interest at the project can pay to the supplier of capital witho
if the irr is <23.38 it’s a gain and if it’s a >23.38% losss
benefit cost ratio/profitability ratio
initail nvestment 200
Pv of cash flows ₹ 228.32 npv 0 bcr 1
npv ₹ 28.32 npv >0 bcr > 1
bcr 1.14
if bcr >1 project is financially viable
npv abs value but bcr is
 if thr is early recovery of cashflow its more good bcz (as we get more npv) of time value of money

the supplier of capital without any gain or loss.