Capital Budgeting Exam Solution

Capital Budgeting - 5711 Semester 1 2008 Page 4 of 10 Last year Biogen paid a consultant $420,000 to examine its transportation options The

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Unformatted text preview: 5711' Semester 1, 2008 Page 4 of 10 Last year, Biogen paid a consultant $420,000 to examine its transportation options. The consultants report was giVen to the board at the end of the year. - Biogen pays tax at a rate of 30%. I Biogen finances all of its projects using 50% debt and 50% equity. -' o' All figures are. Stated in nominal terms I ' ' ' I Additionai information: ' ' - NTN shares are currently selling at $2.00 in the market. Market consensus is ' that they are fairly priced. o NTN is expected to pay a dividend per share of $0.30 next year and dividends ' are expected to grow at 3% pa forever". ' . . -. __ .. _ _ . NTN-finances ail of its projects using 60%_debt and 40% equity. - The Commonwealth Bends currently yield a nominal return 6% pa. - o .The market portfolio is expected to generate a nominal return of 12% pa. 0 Biogen uses two forms of debt financing; half of their debt financing comes _ _ ' from corporate debentures with a yield of 4% above the Commonwealth Bond rate and the other half comes from a bill=facility with a yield of 8% pa. . Both companies operate in a classical tax system. Part a) ‘ ' (5 marks) Using the information given in the question, prove that the beta of NTN Ltd is 2.0 - (Wig). . Re'=/€er/9/KM~-Ee)' '-- 3 : (106+ 2(0.iz-o.oc) r f — 0:34-03 :$2 (1 0 marks) harehoiders Part b) ii iii Given'the risk of the transportation project, what return should Biogen s expect to receive? Justify your answer. 6 Z ' ' Karaog+ Lé [(9.12 —o.og-) Hi5“ 50:8' flL: 0-3//+}> . .21— (1)5: Partc) S.Lé _- - (5 marks) valuating this What is the appropriate discount rate that Biogen should use- in a project? Justify your answer. Part e) (10 marks) What are the potential risks that Biogen faces with this project? Should the company proceed with the project? Explain. _ V6.9 low" risks; _- germ/19 Fail/f )n 74% _ ‘r‘dwmfioa/ v4 425 _ I «— c‘/cf 0/ f}? buy-‘vaéss No part of this examination paper 13 to be removed firom th 5711 ' Semester 1, 2008 Page 3 of 10 Question 2 There are 5 parts to this question (Total of 50 marks) Biogen Ltd is a biogenetic pharmaceutical company based in Sydney- Recent expansion has meant that the company is now selling its products throughout the Asia-Pacific region. Until now the company has relied upon NTN Transport Ltd to__ transport its products to their customers, however, the recent expansion has meant that NTN's resources are stretched to the limit and supply schedules have suffered as a resuit. Therefore, thedirectors of Biogen are considering establishing their own transportation division to ensure regulardeliveries to their customers. This new division would eliminate the need to use NTN Transport’s services. The new division is then expected to meet Biogen’s transport needs in perpetuity. I a Mr Richard Head, the CFO of Biogen, has begun looking into the viability of this project. Because thisproject is significantly different from the firm’s existing projects Mr'Head'does not” believe that Biogen represents a good proxy for the risk of the project. lnsteadhe feels that NTN'woul'd serVe as a better proxy. I To assist in evaluating the project Mr Head has compiled the following information. about the transportation division proposal: 0 The new transportation division would save the company the transportation costs that fees would have been paid to NTN. This year these fees would . have amounted to $1,600,000. r Biogen would need to immediately purchase 10 new trucks at a cost of. $250,000 each. The trucks are considered depreciable assets. - Biogen would also need to immediately spend $3,000,000 on upgrading its existing facilities. These costs cannot be depreciated. ' o .The new transportation division would incur operating expenses of $850,000.- this year. Ail cost savings and expenses are forecast to grow in line with inflation. each ‘- ’ year. Inflation is forecast to be 4% pa for the foreseeable future. a The Australian Tax Office (ATO) has ruled that the new trucks can be. depreciated for tax purposes at a rate of 30% pa. 0 Establishing the new division would result in an early termination of the' centract that Biogen has with NTN. This may incur an immediate after tax penalty of $5,000,000. Biogen believes however that there is a 50% chance- that it will be able to convince NTN to waive the penalty. No part of this examination paper is to be removed fi'om the examination. room -. ...
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This note was uploaded on 03/09/2012 for the course FINC corporate taught by Professor Kim during the Three '11 term at University of Sydney.

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Capital Budgeting - 5711 Semester 1 2008 Page 4 of 10 Last year Biogen paid a consultant $420,000 to examine its transportation options The

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