Dr. Müller is a bio-technical engineer and an expert in genetic therapy. Spendin

Question

Dr. Müller is a bio-technical engineer and an expert in genetic therapy. Spending several years with a research institute, Dr. Müller thinks about founding his own company. His goal is the completion, patent grant and commercialization of two projects. Both projects have some common features: they require initial capital expenditures, and they should be accomplished in one year without any costs at the end of the project. Project A: Production and commercialization of a new, genetically modified substance for the treatment of asthma. -Completion of project A requires capital expenditures of EUR 4.0m (laboratory equipment, wages for scientists etc.). -According to Dr. Müller, future sales revenues from project A are uncertain. More specifically, Dr. Müller argues that there are three states of the world (A.1, A.2 and A.3), one of which will materialize. The corresponding sales revenues X in t=1 are reported in the following table State of the worldj A.1 A.2 A.3 Pl 0.25 0.50 0.25 EUR 3.9m EUR 4.3m EUR 5.1m Proiect B: Production of a virus-based targeting-system -Completion of project B also requires capital expenditures of 4.0m -th respect to future sales revenues from project B, Dr. Müller argues that there are only two possible states of the world (B.1 and B.2). Corresponding sales revenues X in t 1 are reported in the following table

Explanation / Answer

Answer 1)

Project A have higher net worth than project B , Project A is worth to be realized.

Answer 3)

In case of loan for the project the detail answers are :

a) it is clear that the project B have higher comparetive risk , as NPV b < NPVa

Risk premium =  NPVa -NPV b / Cash inflow = 0.2/4 = 0.05 = 5%

b) Problems in risk premium

C ) the creditors may be part of project as shareholder to get more control on the project and investment .Such activity may incurred additional cost and risk .

( information is not sufficient to calculate exact cost , as rate of interest missing for laon)

Project A Project B Cash out flow (million) (€ 4) Interest rate 7% Cash out flow (million) (€ 4) Interest rate 7% Cash Inflow Cash Inflow State P Inflow( X-millions) PX State P Inflow( X-millions) PX A.1 0.25 € 3.90 € 0.98 B.1 0.7 € 1.90 € 1.33 A.2 0.5 € 4.30 € 2.15 B.2 0.3 € 9.50 € 2.85 A.3 0.25 € 5.10 € 1.28 € 4.40 € 4.18 NPV € 0.11 NPV (€ 0.09)

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