Reference no: EM13729376
The risk free rate is 2.75%, measured by a long-term U.S. government bond. The total market return is expected to be between 12% over the foreseeable future. A biotech firm without production experience is considering making a drug in-house and profiting from its own patented drug dealing with gene therapy treating various ailments. The effect on this move will result in a Beta coefficient of 3.0 on the CAPM when finding out its hurdle rate for the project. The company expects to pay 3% for any new debt it receives, and its corporate tax rate is 33.33%.
To move forward, the company will expect to need $500 million in capital now, which they plan to finance through a combination of debt and equity infusions. The company does not plan on giving out dividends, and the company doesn’t plan to retire debt or stock. The company’s current debt-to-equity ratio is 2:3 (that is, 40% debt and 60% equity) and the company plans to keep it that way. The cash flows from this investment are expected to return $0 the first year, and then $77 million per year for the next 2 years, and then $119 million per year for 3 years after that. After that, at the end of the following year, the firm will sell the investment at market value, which is expected to be $50 million at that time, as it is subject to obsolescence and patent expiration.
What is the cost of capital to the firm for this project? (The “hurdle rate”)
What is the NPV of this project?
Should the firm invest?
If the discount rate was 0%, then what would the NPV be?
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