Question - 1: 

Capital Budgeting: Single Project - Accept/Reject Decision

( Renata Ltd)

Renata Limited (formerly Pfizer Limited) is one of the leading and fastest growing pharmaceutical and animal health product companies in Bangladesh. The company started its operations in 1972 as Pfizer (Bangladesh) Limited. In 1993, Pfizer transferred the ownership of its Bangladesh operations to local shareholders and the name of the company was changed to Renata Limited. The core businesses of Renata Limited are human pharmaceuticals and animal health products. In Bangladesh it is the 4th largest pharmaceutical company and the market leader in animal health products. In addition, Renata products are exported to Afghanistan, Belize, Cambodia, Ethiopia, Guyana, Honduras, Hong Kong, Kenya, Malaysia, Myanmar, Nepal, Philippines, Sri Lanka, Thailand, United Kingdom, and Vietnam. The Company is listed on the Dhaka Stock Exchange with market capitalization of approximately Taka 87 billion.

Renata Ltd is examining the economic feasibility of developing a new medicine. The initial cash investment in Year 1 is $500 million. Further cash investment in Year 2 would be $200 million.

There is only a 50 percent chance that the medicine will be developed and will be successful.

If that happens, Renata Ltd must spend another $100 million in Year 3, but its income from the project in Year 3 will be $500 million, excluding the third-year investment of $100 million. In Years 4, 5, and 6, the company will earn $400 million a year if the medicine is successful. At the end of Year 6, it intends to sell all rights to the medicine for $600 million. If the medicine is unsuccessful, none of Renata Ltd.'s investments can be salvaged. Assume that the market return is 12 percent, the risk-free rate is 2 percent, and the beta risk of the project is 2.30. All cash flows occur at the end of each year.

a)Calculate and write down the annual cash flows that occur from years 1 to 6 in proper order.

b)Calculate the cost of capital (cost of equity) for the project.

c)Calculate the NPV for the Project. Should the project be accepted based on NPV?

d)Calculate the IRR for the project. What is the interpretation of this number in this case?

e) When will conflicts occur between IRR, NPV and payback period? If a conflict occurs, then based on which parameter would you accept or reject the project? Explain your hypothesis.

Question - 2: 

The information regarding the expected rate of return for the coming period of Stock A is given below. On the basis of the information calculate:

Probability Stock A 0.11 0.09 0.30 0.27 0.23

Rate of Return Stock A -15% -11% 9% 14% 25%

a)The rate of return

b)The Standard Deviation

Now suppose Prime Bank is investing Tk 10,000 million for upgrading its banking infrastructure. The present value of the future cash flows on an after-tax basis is estimated to be Tk 13,500 million. The bank currently has 113 Crore 22 Lakh 83 Thousand shares outstanding with a current market price of Tk 17 per share. The cost of capital is estimated to be 9%. Given this information, and provided that the project is independent of other expectations about the company's other prospects.

c)What should be the effect of the project on the value of the company and what will be the resultant stock price?