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<h2 class="hd hd-2 unit-title">Accounting Variables to Cash Flows</h2>
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<p><strong>Important Equations:</strong></p>
<ul>
<li>Cash Flow = EBITDA – Taxes – Capital Expenditures – \(\Delta\)Working Capital</li>
</ul>
<ul>
<li>EBITDA = Operating Revenues – Operating Expenses (without Depreciation)</li>
<li>Taxes = \(\tau\times\)(EBITDA – Depreciation)</li>
<li>Working Capital = Inventory + Accounts Receivable – Accounts Payable</li>
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Accounting Variables to Cash Flows
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ABC Pharmaceuticals is considering a two-year project. The project requires an initial capital expenditure of $100 million (in year 0), which can be depreciated linearly to zero in the next two years. It generates a revenue of $80 million and a cost of $25 million per year (without depreciation) for the next two years (year 1 and 2). The tax rate for ABC Pharmaceuticals is 30%. Assume a discount rate of 6% and negligible changes in working capital. What is the NPV of this project?
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<p style="display:inline">$</p>
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<h2 class="hd hd-2 unit-title">Internal Rate of Return</h2>
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Internal Rate of Return
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What is the project's Internal Rate of Return (IRR)? (Hint: Find the discount rate that makes the project's NPV equal to 0.)
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<h2 class="hd hd-2 unit-title">Working Capital</h2>
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Working Capital
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Consider a pharmacy that spends $3 million on inventory in quarter 1. It sells these goods in quarter 2 for $5 million, but its customers' insurance companies do not pay their bills owed to you until quarter 3. Use this information to calculate the change in working capital each quarter. (Assume a tax rate of 0% and the working capital in quarter 0 is $0.)
<p><p style="display:inline">\(\Delta\text{Working capital in quarter 1}=\)</p><div class="inline" tabindex="-1" aria-label="Question 1" role="group"><div id="inputtype_81798a522e8945f48e9d365c8a603ca8_2_1" class=" capa_inputtype inline textline">
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<p><p style="display:inline">\(\Delta\text{Working capital in quarter 2}=\)</p><div class="inline" tabindex="-1" aria-label="Question 2" role="group"><div id="inputtype_81798a522e8945f48e9d365c8a603ca8_3_1" class=" capa_inputtype inline textline">
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<p><p style="display:inline">\(\Delta\text{Working capital in quarter 3}=\)</p><div class="inline" tabindex="-1" aria-label="Question 3" role="group"><div id="inputtype_81798a522e8945f48e9d365c8a603ca8_4_1" class=" capa_inputtype inline textline">
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<h3 class="hd hd-2">Working Capital </h3>
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Valuing a Company
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<p>ABC Pharmaceuticals is considering acquiring LifeWorks Corporation, which has received FDA approval to sell its new rheumatoid arthritis drug, <i>Relievabrex</i>. LifeWorks also has a number of promising candidate drugs in its pipeline.</p>
<p>LifeWorks is a privately held U.S. company with no stock market price data to rely on. LifeWorks has 2.5 million shares outstanding and debt with a market value of $40 million. LifeWorks wants to estimate its equity value to determine what an attractive offer price from ABC Pharmaceuticals would be. Assume that LifeWorks has a cost of capital of 15% per year and tax rate of 35%.</p>
<p>Suppose that LifeWorks assumes the following projections for its financials (in millions of dollars), for years 1 through 7, and further assumes its long-run growth rate after year 7 will be 3% per year in perpetuity.</p>
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<tr>
<th>Year</th>
<th style="text-align:center">0</th>
<th style="text-align:center">1</th>
<th style="text-align:center">2</th>
<th style="text-align:center">3</th>
<th style="text-align:center">4</th>
<th style="text-align:center">5</th>
<th style="text-align:center">6</th>
<th style="text-align:center">7</th>
</tr>
<tr>
<td>Sales</td>
<td style="text-align:center">100.0</td>
<td style="text-align:center">108.0</td>
<td style="text-align:center">116.6</td>
<td style="text-align:center">126.0</td>
<td style="text-align:center">136.0</td>
<td style="text-align:center">146.9</td>
<td style="text-align:center">158.7</td>
<td style="text-align:center">171.4</td>
</tr>
<tr>
<td>Cost of goods sold</td>
<td style="text-align:center">70.0</td>
<td style="text-align:center">75.6</td>
<td style="text-align:center">81.6</td>
<td style="text-align:center">88.2</td>
<td style="text-align:center">95.2</td>
<td style="text-align:center">102.9</td>
<td style="text-align:center">111.1</td>
<td style="text-align:center">120.0</td>
</tr>
<tr>
<td>Depreciation</td>
<td style="text-align:center">3.2</td>
<td style="text-align:center">10.0</td>
<td style="text-align:center">10.8</td>
<td style="text-align:center">11.2</td>
<td style="text-align:center">12.0</td>
<td style="text-align:center">12.4</td>
<td style="text-align:center">12.9</td>
<td style="text-align:center">13.2</td>
</tr>
<tr>
<td>Capex</td>
<td style="text-align:center">12.0</td>
<td style="text-align:center">15.1</td>
<td style="text-align:center">16.3</td>
<td style="text-align:center">17.5</td>
<td style="text-align:center">15.5</td>
<td style="text-align:center">16.2</td>
<td style="text-align:center">16.8</td>
<td style="text-align:center">16.3</td>
</tr>
<tr>
<td>Working capital</td>
<td style="text-align:center">16.0</td>
<td style="text-align:center">17.3</td>
<td style="text-align:center">18.7</td>
<td style="text-align:center">20.2</td>
<td style="text-align:center">21.8</td>
<td style="text-align:center">23.5</td>
<td style="text-align:center">25.4</td>
<td style="text-align:center">27.4</td>
</tr>
</table>
<p>Under these assumptions, what is the value per share of LifeWorks? (Assume it is the start of year 1, and all cash flows occur at the end of the year.)</p>
<p>
<p style="display:inline">$</p>
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<p style="display:inline">per share</p>
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