Read the following scenarios and complete the corresponding questions. Please remember to answer in complete and grammatically correct sentences. I am looking for your thought process in the answers to the questions, so be complete in your answers and use the opportunity to clearly demonstrate your newly acquired knowledge.
Scenario 1 (length: 0.5 – 1 page)
A pharmaceutical company has hired you to perform an economic analysis on a currently ongoing project. Experts from the company have estimated the market for the drug and thus the potential revenues for the drug are knows, but the relevant costs are becoming a sticking point for the company’s analysis. The company initially provides you the following information:
- The company has already spent $150,000 on research and development for the drug. The first round of clinical trials has been performed cost $75,000 and the results from the trials were promising.
- The company is considering whether to proceed with the development of the product. If the company continues the project, a second round of trials will be necessary.
- The company estimates that the cost of ingredients for the drug will cost $2 per dose, and 150,000 doses will be needed for the trial.
- The company would also seek patent protection for the drug, which would cost an estimated $25,000 in filing fees.
- When the drug goes into production, a new production line would need to be purchased at a cost of $240,000 and would last ten years, and the cost for the ingredients for the drug would fall to $1 per dose.
- Packaging and distribution would cost $0.50 per dose.
- The company also expects to spend $500,000 per year to advertise and promote the drug.
- The patent protection on the drug would last 17 years, at which time a generic version of this drug could be produced, at which time the company would cease production of this drug.
- Which costs are relevant when deciding whether to proceed with the project?
- Which costs are relevant when deciding how many doses of the drug to produce (assuming the drug makes it to production)?
- Is there any other information for which you would need to ask the company to complete your analysis?
Scenario 2 (length: as needed)
An apple farmer has the following costs:
Bushels Total Cost
- What is the marginal cost per bushel of apples produced?
- If the market price of a bushel of apples is $5.50, and is unaffected by the farmer’s production decision, then the marginal revenue of a bushel of apples is $5.50. In that case, how many bushels of apples should the farmer produce?
- If the government imposes a tax on the sellers that results in the sellers receiving $1 less per bushel sold, what amount of apples should the farmer choose to produce?
Scenario 3 (length: 0.5 page)
A company selling widgets advertises through three types of media: print, television and internet. Recently the company has decided to increase its advertising budget by $100,000. In order to determine where the additional money should be spent, the company increased print advertising for a month by $5,000 and attracted 50 new customers. The following month, the print advertising was decreased back to its original level and television advertising was increased by $20,000 and attracted 175 new customers. In the third month, television advertising was decreased to its original level and internet advertising was increased by $2,500 and attracted 30 new customers.
- Given this data, what can you say about where the $100,000 increase should go?
- How would you check to determine if you made the correct decision?
Scenario 4 (length: as needed)
Suppose a company has a WACC of 10% and is considering a project that initially costs $40,000 and will return $15,000 after the first year, $20,000 after the second year and $10,000 after the third year. There are no additional returns or costs for this project.
- What is the NPV of this project?
- Should the company undertake the project?
- Length: as indicated (Show your calculations where appropriate.)