Jacques Rousseau is considering investing in Health Life Ltd., a pharmaceutical company. He read in the paper that this company is doing cancer research and is close to a breakthrough in developing a new drug that will be effective against bone cancer. The author of the article said that this was a good time to buy because, once the breakthrough happens, the share price is going to rise very rapidly. Jacques therefore decided to look at the company’s most recent financial statements.
On the statement of financial position, he saw that the company had a significant amount of cash and short-term investments. It had some assets listed as “buildings and equipment under capital lease,” which he interpreted to mean that the company was leasing its buildings and equipment rather than owning them. When he looked at the statement of income, he saw that there was no revenue. By far the largest expense was for research and development. The company had a loss during the current year, and the company reported a deficit on the statement of financial position. He thought that this made sense, because the company had yet to make its first medical breakthrough. The company had little debt, and its shares were recorded at approximately $35 million. When he looked at the notes, he saw that there were about 7 million shares issued. In fact, 1 million of those shares had been issued during the current year.
Help Jacques with his decision by answering the following questions:
a. Do you think that investing in this company would be risky? Explain.
b. Does the fact that Health Life is holding a large amount of cash and short-term investments mean that management is doing a good job? Explain in detail.
c. Is it possible for Jacques to make a rough estimate of how much longer the cash and short-term investments will last, assuming that the company does not get its breakthrough? What information would help him make this estimate?
d. Based on the number of shares that have been issued and the amount that is recorded in the share capital account, it is obvious that many investors have concluded that this is a good investment. Think carefully about this, and then list three or four advantages and disadvantages of buying shares in Health Life at this time.