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This report concern with the evaluation of the two production facilities for Salza
Pharmaceuticals. The medicine Cholo 2 that is prime product and yields high revenue for the
company therefore, the evaluation of two options is mentioned in this work, so that high
profitability option can be highlighted for enhancing the wealth of the shareholders.
Alternative A has a utile life span of approximately 9 years on the other hand the alternative B
has a useful span of life of 4 years. NPV and IRR Methodology of Capital Budgeting have been
utilized to ascertain the profit yield by projects. Both the alternatives have positive NPV and the
IRR is also greater than the needed rate of return of the investors. Hence, these two options are
viable for implementation. Capital budgeting tools are actually applied to wipe out the effects of
unequalize lives also for examination of the profitability of the project from different zones.
The break-even factors also calculated to comprehend the price, units or variable cost that will be
feasible for the company. The sensitivities of some significant factors is also assessed just to
identify the importance of these factors and the direct effect that they would place on the NPV of
the project. Lastly, the likelihood of taking the equipment on lease or the purchase has also been
established in 1995. This is one of the top notch manufacturer of cholesterol bursting drug Cholo
It possessing a signed contract for advertisement and marketing for Cholo 2, so as to boost the
sales of the product. Now a days it is already start working on a licensing deal for the gel
offering treatment and rapid relief of arthritis. Other than that the company also producing some
The primary fiscal flow of the company is directly related from the overall sales of Cholo 2.
The report concern with the feasibility of the acquirement of a new production facility, the
available option and net cash flows which are related with them. Since both the products have
unequal lives the options are to be examined in terms of effectiveness and make judgement over
The inclusion or exclusion of the following items in the cash flow is going to discussed here.
Interest Expense of $2 million loan can be included in the incremental cash flow, as the
bank loan would be financed against this project. Hence, it reveals that an expense that
has been incurred for the project and must be included for calculation of the net cash flow
table.
The $95000 incurred last year in rehabilitation of the plant and that would not be
presented in the overall cash flows statement because it is a sunk cost. This cost was not
been incurred for the project so, it will not be added in the cost of project.
The decrement in sale of current products and its associated costs must be included in the
cash flows because the income that will be lost in a result of the project is the opportunity
cost to implement the project and it has to be added in the cash flow analysis.
Overall Present Value is the surplus of existing value of cash inflows overall the cash outflows of
the project. The cash flows for the project life are economical at the needed rate of return to get
NPV of the project. If the NPV of the project is towards positive side then it may be expected to
IRR states about the return that is expected to be generated from the project if the project is
undertaken. For a project to be results given, it is essential that the internal rate of return is higher
Budgeting. They are immensely viable. But if the projects have unequal lives the effectiveness of
Here, the NPV is greater for Option A as it is producing cash flow for greater number of years
and IRR is greater for Option B. Hence, in this Option A is suggested because it is producing
higher value in comparison to Option B. Since, the overall lives of the projects are unequal
Whenever the projects are regarded as unequal lives either Replacement Cost Method or Annual
In Annual NPV Method the viability NPV for every year is made into calculation. It implicit that
sum of NPV that can be generate on an average in a year. In the substitution cost method, the
project with lesser time frame is reassessed by purchasing the asset in the needed financial year
and the flow of cash is determined once again. In this case, option B has a project life of four
years whereas the Option A has a life of nine years Hence, the replacement cost method has to be
In this case, after making adjustment for unequal lives the NPV of option B is greater than the
In the old scenario, the Option A has higher NPV when compared to Option B. The rationale
behind the same was that since the project was for long time frame the in cash flows from the
project for the whole duration is considered in comparison to Option B which had shorter time
frame for cash flows as the project was for short duration. It resulted in higher NPV for the
Option A.
Sensitivity Analysis(Appendix 6)
Sensitivity Analysis actually studies the impact of different variables on the NPV of the project
when they are altered keeping the other variables constant. This methodology helps in assessing
In this case study, it has been observed that four variables raw material, selling price cost and
salvage value of the project varies so as to assess their sensitivity upon the NPV of the project.
The sensitivity has been estimated according to Project A, as the project was available for the
In Sensitivity Analysis the optimistic and pessimistic overview is adopt for understanding the
impact of the variables over the NPV of the project under these two scenarios.
If the difference among NPV in normal and NPV in sensitivity analysis is adopted it may be seen
that per unit sales and selling price per unit is different every time the NPV largely and they have
Both the variables are depends over each other because of which they are regarded as most
crucial. The unit sales of the product has been calculated to be higher side Hence, a small
percentage of change in the unit result in change of higher number of units of the product that
have drastic influence the flow of cash and the NPV of the project.
Break even refers to the point over which the project will neither be giving losses nor making
profits. Any receipt after this would be known as an income for the project.
Here the break even units, the break even sale price and the break even variable cost have been
Option B as its split even units are junior, split even sale price is lower and split even rate is high.
The underlying principle behind the same is that the predetermined cost assurance for Option A
is lesser as compare to the predetermined cost assurance for Option B which is making it more
realistic. Initially, the fixed expenditure cost is lesser for Option A but after the fourth year an
overhaul cost has to be incurred which outcome in high permanent expenses for Option A from
Due to the above cause, the suggestion in this case is unlike because the parameters of Option A
Discussion on Leases
working Lease refers to the let out that is in use for short term period and the leaseholder has to
pay the lease rental to use the lease invention. After the end of the lease time, the ownership of
the manufactured goods leftovers with the lesser. The major benefit of this kind of lease is that
the lease rentals are comparatively lesser. The main drawback of this kind of lease is that they
usually finish in a very short extent of time and may not get extensive if necessary by the lessor.
Finance Lease refers to the lease that is in use for long period of time. In general, the possession
of the leased items is transfer to the lessor following the ending of the lease. The lease rentals are
intended in such a style that the lease rent over the phase of lease is capable to cover up the price
of the items all along with interest. The benefit of this sort of lease is that the lease is for a larger
period. The shortcoming for this category of lease is that the lease rentals are usually elevated.
In the specified case, if the leases are incorporated as well the proprietor has four option: to
execute Option A, to execute Option B, take the tackle on an in use lease or take the equipment
on a finance lease.
If the appliance is taken on lease, the hazard of procure would stay with the lessor and for a
longer term the lease may be additional classy. On the other hand, if the administration is not
sure of the demand for the item in the upcoming years it is additional feasible to obtain an
operating lease for the item and pay for the possessions in the following years when the demand
for the items is more exactly quantifiable. The tools occupy enormous principal speculation for
the companies. Their worth speedily decrease consequently, the resale worth of these tools
normally not high even if they have been use for less period of time. As a result, if the task turns
out to be unbeneficial and the corporation wants to cease in the case of procure it might have to
acquire losses while in the case of operating lease it can resume the equipment without the
Recommendation
These two options have their own set of advantage and disadvantage Hence; they have to be
examined cautiously before opting any option. In the case of Option A, the useful life of the
equipment is nine years; it needs an overhaul expense in the 5th year and has lower Rate of return
when make comparison to Option B. If the Annual NPV is observed they are also higher for
Option B.
In Option B, the useable life of the machine is 4 years and it has greater rate of return and also
Hence, in overall perception the Option B looking more profitable. On the other hand, the useful
life of the machine is four years only which is a principle constraint. At the end of four years, if
there is no possibility of machine replacement it would become a big problem for the company
because it would immediately affect the business operations. The price of the machine can also
not be estimated in reliable wa. Hence, if the product cost increases in a very high proportion it
This implies that, even though Option B looks more profitable at the moment but it has its own
set of associated risks and opting the option is at the discretion of the company.
Appendices
Sl.
c Interest Rate 7%
Appendix 2
Option A
b Salvage Value
c Overhauling Expense
n Depreciation on Over-hauling
a Initial Investment
Option B
Option A
Computation of NPV
Cash
1 717413 634991
2 776567 608381
3 838137 581180
4 902216 553738
5 808900 439427
6 1053290 506452
7 1125489 478994
8 1200606 452260
9 1440592 480316
NPV 3465740
IRR = 62%
Option B
Computation of NPV
0 -620000 -620000
1 830538 735119
2 892317 699063
3 956578 663309
4 1023415 628124
NPV 2105615
IRR = 108%
Option A
A NPV 3465740
Option B
A NPV 2105615
Option B
Cash Flow for 9 years
Computation of NPV
1 830538 735119
2 892317 699063
3 956578 663309
4 1023415 628124
5 690426 375067
6 1165213 560268
7 1240382 527891
8 1318543 496686
9 1299185 433169
NPV 3848696
Option A
Option B