A pharmaceutical firm is considering undertaking an investment in a new tablet for moderate sore throats. This
Question:
A pharmaceutical firm is considering undertaking an investment in a new tablet for moderate sore throats. This product does not belong to any of the Business lines currently developed by the company. If it is undertaken, this project would represent 40% of the total assets of the company and the majority of the investment would be destined to acquire a patent. The company is currently financed with 70% equity and 30% debt, for which the company pays a Spread of 1%. The long term risk free rate is 5%.
There exist three companies specialised in similar tablets and their data is summarized in the following table:
Firm | Leverage (D/V) | ICR | Rating |
Farmacomp | 30% | 3,2 | A- |
Fimca | 25% | Not available | A |
Müller | 35% | 2,9 | Not available |
- Compute the beta debt of the three comparable companies knowing that the expected market return in the long term is 11%.
- Compute the cost of capital of the new Project knowing that the average beta of the assets of the firms Farmacomp, Fimca and Müller is 1.22 and the expected market return in the long term is 11%.
On the other hand, the finance department has collected the following information:
Rating | ICR | Spread (bp) |
AAA | > 9 | 20 |
AA | 7,5 – 9 | 40 |
A+ | 6 – 7,5 | 60 |
A | 4,5 – 6 | 90 |
A- | 3 – 4,5 | 100 |
BBB | 2 – 3 | 120 |
BB | 1,5 – 2 | 180 |
B+ | 0,75 – 1,5 | 220 |
An Introduction to Statistical Methods and Data Analysis
ISBN: 978-1305269477
7th edition
Authors: R. Lyman Ott, Micheal T. Longnecker