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Question - Vaccine Research Limited (VRL) is a biotechnology firm that invests heavily in research and development for vaccines.
(i) Currently, VRL re-invests all of its cash flows to help fund new R&D. Investors expect VRL to produce net cash inflows of $120 million annually for the next 2 years. In the 3rd to the 5th year, cash flows are expected to grow by 15% annually. Beyond the 5th year, cash flows are expected to grow at a constant rate of 2.5% forever. If investors require a 12% rate of return, what is the current value of VRL? (Assume all cashflows occur at the end of the year.)
(ii) VRL announces that it has just discovered a new vaccine, Coronacure, to treat Covid-19. The firm has already spent $120 million developing Coronacure and will have to spend an additional $95 million immediately to prepare the vaccine for sale. Coronoacure is expected to generate cashflows of $140 million for 3 years, with the first cash inflow in one year. What is the new market value of VRL after the announcement?
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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