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Advanced Corporate Finance Problem Set

Autor:   •  March 20, 2018  •  949 Words (4 Pages)  •  158 Views

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4. Consider an offshore oil property with an estimated oil reserve of 50 million barrels of oil; the present value of the fixed development cost is $12 per barrel, and the development lag is two years. The firm has the right to exploit this reserve for the next 20 years, and the marginal value per barrel of oil is $12 per barrel currently (price per barrel – marginal cost of extraction per barrel). Once developed, the net production each year will be 5% of the oil in the reserve. The riskless rate is 8%, and the variance in oil prices is 0.03 per year. What is the value of this property?

5. A pharmaceutical firm’s research and development program recently generated a promising idea for a new pharmaceutical product, and successful Phase II clinical trials of the drug have just been completed. One year of Phase III clinical trials is now required. Capital outlays are required to begin the trials, and a much larger expenditure will be required as mass production is initiated. The present value of the expected cash inflows from the mass production is estimated to be $13.13 million, with a volatility of estimate, σ = 110%. Mass production requires the construction of a new plant with an estimated cost today of $10 million (or $12 million if undertaken one year from now, due to inflation and other cost increases). Clinical trials require an up-front investment of $4million. The risk-free rate of return is 8%.

(i) Suppose the firm has to make a commitment today whether or not to go ahead with the mass-production of the drug subsequent to the phase III clinical trials. Should it make such a commitment?

(ii) Assume now that no such commitment to mass production is required, and that the firm needs to decide now only whether or not it wants to go ahead with the phase III clinical trials. Should it decide to go ahead with these clinical trials?

Note: You can assume throughout that the project risk is such that a risk-adjusted discounting rate of 20% is appropriate when discounting all project-related cash flows.


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