Pelican Pharmacueticals XXXXXXXXXXQ1 2017
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Sydney Graduate School of Management
ACCT7012 Corporate Finance
Q3 2022 Group Assignment
Due in session 9
Please read the Learning Guide regarding the requirements and
submission of the group assignment.
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Personcare Pharmaceuticals Limited
Personcare Pharmaceuticals Ltd (PPL) is an Australian company that manufactures
generic pharmaceutical products for supply to the Australian, New Zealand and Asian
markets. The majority of the business is in Australia but both the other markets are
growing rapidly but from a very low base. The company manufactures commonly
used products that no longer have patent protection and the majority of their business
comes from prescription products supplied under the Pharmaceutical Benefit Scheme
(PBS) in Australia. The company does however conduct some limited research and
development and has in recent years launched two differentiated products. These
products are not listed PBS products but are sold over the counter (OTC) with limited
medical claims. PPL has manufacturing premises that operate under the code of good
manufacturing practice and is licensed to manufacture human pharmaceutical
products for distribution in their three markets. They also undertake contract
manufacturing for other companies. The business is successful and is listed on the
ASX.
John Larson, the CEO of PPL, is very keen on launching a new OTC product for the
treatment of constipation in adults as he believes the product has some unique
features which will expand their business considerably, particularly in older age
groups. The product is based on psyllium husk, a natural fi
e product, well known
in the pharmaceutical industry. The new product is a powder that can be mixed in
water but is unique in that the mixture contains only natural products with no artificial
flavours or colourings. Extensive testing has revealed that the side effects are
considerably less than the products cu
ently on the market. PPL cu
ently markets a
tablet that is based on a similar fi
e but this product does have some side effects
particularly in older people. The launch of this new product will require considerable
capital expenditure as it will require new manufacturing equipment and some
uilding modifications to accommodate the new equipment. The equipment will have
spare capacity as PPL cu
ently produce no other powder products. The matter is
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ecoming urgent as Tom Carter, the Manufacturing Director, has just returned from
India where he has identified a reliable source of psyllium husk and has negotiated an
exclusive deal with an Indian partner. The agreement has yet to be signed but the
Indian partner is anxious that the deal be finalised.
John recently called a meeting to discuss the project. In addition to John and Tom the
meeting was also attended by Jennifer Brown, Research and Quality Assurance
Director, Miguel Sanchez, Sales and Marketing Director and Anna Chen, Financial
Controller. John and Miguel were very keen on the project and saw a great
opportunity to increase sales, both in Australia and New Zealand, and had presented
a sales forecast at the meeting. Tom was concerned that based on the sales figures
presented the new equipment would only be working to about 50% of its capacity and
the cost could not be justified. Jennifer pointed out that the research on the new product
had cost $250,000 and PPL needed to launch the new product to justify this
expenditure. John added that in addition to this research expenditure Tom had been
to Europe to investigate suitable mixing and packing machinery and that this trip had
cost $30,000. His two trips to India had also cost $40,000 and legal expenses another
$12,000. It was important that the project went ahead to recover these expenses. Tom
had identified suitable machinery but was waiting for final quotes. The machinery
was expected to cost approximately $1,000,000. A firm quote of $82,000 had already
een received for the internal building modifications. Anna reminded the meeting
that this level of expenditure would require board approval and that the Board
equired that the NPV and IRR for the project be calculated and an executive summary
of the project be submitted to the Board together with the discounted cash flow
calculations. Anna was concerned that the preliminary sales figures would not justify
the expenditure and would like to see a higher usage of the equipment. Miguel
undertook to investigate the possibility of more contract manufacturing to utilise the
spare capacity. John asked that all the attendees work together over the next two weeks
to assemble all the data needed to obtain approval of this project and stated he believed
this project is vital for the continued growth of the company.
Two weeks later the management team met to discuss the data assembled for the
project. Tom stated that he had received a firm quote of $1,110,000 for the new
equipment. Tom and Miguel then presented the sales and cost data which is attached
as Appendix 1. The forecast covered both the sales of the new product and sales of
additional powder products manufactured for other companies (contract sales). The
forecasts were only for five years because it was expected that sales and costs would
only increase in line with the general rate of inflation in subsequent years. It was also
agreed that the product would reach the end of its life somewhere between eight and
ten years time. This was confirmed by Jennifer Brown who believed PPL would have
developed a new product in that time. It was agreed that the life of the project should
e considered as 10 years.
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Anna then detailed other increases in factory cost that she and Tom had identified.
There would be an increase in factory wages. The operation of the machine was
essentially an unskilled job but would require an increase in the number of employees.
The additional cost in wages for the first year was $202,000. There was expected to
e no further increases in the number of employees but wage rates were expected to
increase by 3% per year over the ten year life of the project. Anna said there would
e a significant increase in variable factory overheads such as power, water,
consumables etc, and she and Tom had completed an analysis and felt that these
expenses varied directly with sales and for forecasting purposes would use 20% of
oth the new product sales and contract sales as the estimate of this cost. Both she and
Tom felt that this was accurate enough for the cost projections. Tom added that there
was one other major cost that could not be ignored. In the first two years the new
equipment would be covered by wa
anty for major part replacement but that after
this an allowance should be included for spare parts replacement. Tom had estimated
a cost of $18,000 in year three, $32,000 in year four and $48,000 in year five. After
that the maintenance cost would only increase by the 3% per annum being forecast for
general price increases. Tom had also stated that inventory levels would increase by
$182,000 mainly due to the psyllium husk and finished goods. He was confident
however that, after the initial increase prior to the launch of the new product,
inventory levels would not increase by any more than the $182,000 over the life of the
project as the logistics manager was maintaining tight control over inventory levels.
Miguel then tabled the advertising budget. Miguel stated that a significant amount
would be needed in the first two years to ensure that the message regarding the
elimination of side effects reached its target audience. He estimated $390,000 would
e spent in years one and two. The advertising costs would then fall to $300,000 in
year three and $250,000 in year four. From year 5 the advertising costs would be kept
to a maximum of $160,000 per year with reductions in volume offsetting any
increases in price.
Anna then tabled some concerns that she had with the project. Her first concern was
with the building modifications. The accountants had stated that as the building
modifications did not substantially improve the building or increase the life of the
uilding the tax office had given written advice that the modifications could be
claimed as a tax deduction at the time the expense was incu
ed. As the amount was
significant, for accounting purposes, she would allocate the expense to the profit and
loss account over the life of the project. Similarly the tax office would allow the
depreciation of the new equipment to be claimed over a 15-year life but for
accounting purposes the equipment will be depreciated over the life of the project.
The depreciation for accounting purposes will also take into account the expected
sale value at the end of the project which is expected to be $210,000. The company’s
accountants had also stated that all the preliminary expenditure, totalling $332,000 on
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esearch, overseas trips and legal expenses could be written off to the profit and loss
statement over the life of the project. They had also confirmed that the tax deduction
for these preliminary expenses is claimed in the year the expense is paid. Anna was
also concerned regarding the increase in working capital arising out of the increase
in the level of receivables. PPL allow all customers sixty days to pay their monthly
accounts and this will lead to an increase in receivables of approximately $193,000
in the first year alone. A schedule of the expected increase in receivables balance is
attached as appendix 1.
Anna’s major concern however was the inclusion of the contract sales in the analysis.
It had taken a long time to build up the cu
ent contract manufacturing business and
this business was very variable. Powder mixing was a new area of manufacture and
there were many other competitors in this area. She felt the equipment should be
justified by the new product only. She also felt that the new product sales could be
optimistic by as much as 5%. Miguel and John disagreed with this and had a different
opinion and believed that the sales could be as much as 10% higher.
Anna also provided the following additional information:
1. The company is a profitable company and pays tax at the corporate tax rate of 30%.
2. The company uses straight-line method to depreciate its assets.
3. PPL’s Board have stated that the