(a) Kean, CFA is valuing Amviola, a large pharma company with significant research and development (R&D)...
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(a) Kean, CFA is valuing Amviola, a large pharma company with significant research and development (R&D) expenses. To do so she believes that she must adjust for (i.e. capitalize) Amvolia's historical R&D which she believes have an amortizable life of 8 years. Kean has collected the following selected year end 2022 information (in $ millions) and historical R&D (in $ millions) for Amviola: EBIT(1-t) Taxes Book value of equity Book value of debt Capital expenditure (Capex) Depreciation Net working capital 16.227 5,125 127,555 46,375 15,650 10,188 6,597 Note: Amviola's net working capital balance was 5,845 in 2021. Year R&D 2022 28,275 2021 26,676 2020 26,163 2019 25,299 2018 23,835 2017 22,332 2016 19,161 2015 18.475 2014 16,689 Amviola's pre-tax cost of debt is its 4.0%, beta is 1.15 and the marginal tax rate is 35.0%. The risk-free rate and market risk premium are expected to be 2.5% and 6.0%, respectively. (i) Calculate the adjustment to return on equity (ROE) and return on invested capital (ROIC) that results from the reclassification of Amviola's R&D expenses. Comment on your answer. State any assumptions. (10 marks) (ii) Estimate the adjusted firm value of Amviola using the stable growth free cash flow (FCF) model. State any assumptions. (15 marks) (a) Kean, CFA is valuing Amviola, a large pharma company with significant research and development (R&D) expenses. To do so she believes that she must adjust for (i.e. capitalize) Amvolia's historical R&D which she believes have an amortizable life of 8 years. Kean has collected the following selected year end 2022 information (in $ millions) and historical R&D (in $ millions) for Amviola: EBIT(1-t) Taxes Book value of equity Book value of debt Capital expenditure (Capex) Depreciation Net working capital 16.227 5,125 127,555 46,375 15,650 10,188 6,597 Note: Amviola's net working capital balance was 5,845 in 2021. Year R&D 2022 28,275 2021 26,676 2020 26,163 2019 25,299 2018 23,835 2017 22,332 2016 19,161 2015 18.475 2014 16,689 Amviola's pre-tax cost of debt is its 4.0%, beta is 1.15 and the marginal tax rate is 35.0%. The risk-free rate and market risk premium are expected to be 2.5% and 6.0%, respectively. (i) Calculate the adjustment to return on equity (ROE) and return on invested capital (ROIC) that results from the reclassification of Amviola's R&D expenses. Comment on your answer. State any assumptions. (10 marks) (ii) Estimate the adjusted firm value of Amviola using the stable growth free cash flow (FCF) model. State any assumptions. (15 marks)
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