Financial Plan ABC Pharmaceuticals - Essay Example

Financial Plan ABC Pharmaceuticals February 10, 2007 CONTENTS EXECUTIVE SUMMARY 3 SECTION ONE 4 About MPMP 4 Resource Planning for MPMP 4 Budget Allocation for MPMP 5 Funding Options for MPMP 7 SECTION TWO 12 Cash Flow Forecast 12 Profit & Loss and Trading Forecast 14 Projected Capital Expenditure 16 Sensitivity Analysis 16 BIBLIOGRAPHY 18 EXECUTIVE SUMMARY ABC Pharmaceuticals is a leading pharmaceuticals company that applies innovative proprietary technologies to develop new drugs and improved formulations of existing drugs that target current unmet and underserved medical need of its target market. The current product range of ABC comprises severe pain medication market segment. Given its major share in the pharmaceuticals industry and considering the potential for introducing differentiated pain control products, ABC Pharmaceuticals is considering the option to venture into moderate pain control medication market segment. The first section of the report identifies and justifies the funding level required for the Moderate Pain-Control Medication Project (MPMP) whilst at the same time explores potential sources of funds available to fund the project together with the accessibility of each. A comparative analysis substantiates the study and provides the top management with the rationale for the preferred funding option. The second section of the report provides with the financial fundamentals of MPMP such as; cash flow forecast, projected capital expenditure, forecast trading results, additional working capital requirements and sensitivity analysis. SECTION ONE About MPMP Moderate Pain-Control Medication Project, named MPMP, is the upcoming project of ABC Pharmaceuticals. Since its inception in 1997, the company has excelled in severe pain medication market and after several years of presence in the pharmaceuticals industry, the company has acquired a major share in the market segment it serves, not to mention the brand name and excellence in the pharmaceuticals industry's fundamentals. Based on its experience in the market, the company plans to develop differentiated pain control products that provide the flexibility and versatility required to address the limitations of existing prescription pain medications in supervised health care settings. Resource Planning for MPMP MPMP is an extension project. Most of the resources of the existing product line, especially on the soft side such as human resources and technical resources could support the new product line as well. However, certain additional resources would also be required to support the project; encompassing, production plants, human resources such as production labor and specialists in moderate pain control medication, working capital, office supplies etc (see details in section 2). A brief of the resources required are as follows: Human Resources: Production specialists in the area of moderate pain-control medication would be required. In line with the previous experience, three specialists each at the three production locations of the company would suffice. Apart from that, production labor would be required. Based on the sales forecasts, as such three teams, each comprising 10 workers (daily wagers), supervised by a production incharge and headed by the area specialist, would be established. The core human resource function would remain at the head office. Technical Resources: For the first five years of the project, three production plants will be fixed at the current production sites. Each plant will have the capacity to produce approximately 15,000 units a year (including breakdowns, if any). Budget Allocation for MPMP The total estimated cost of the project comes to $ 10,500 million calculated as follows: Cost Estimations for MPMP Expenditure Million Dollars Capital Expenditure: Plant & Machinery 4500 Furniture & Fixtures 1000 Land & Building 3000 Revenue Expenditure (5 years): Wages 350 Salaries of production specialists 700 Electricity and Power 950 TOTAL 10,500 The above schedule shows that the total cost of the project would come to $ 10,500 million. The project cost is a five year estimation, including both the fixed expenditure, capitalized over five years, and the revenue expenses calculated on per annum basis and multiplied by 5 to get the total cost for the period. The ensuing discussion provides rationale for each of the items under the cost schedule. Plant & Machinery: Currently the company has its presence in the three prominent cities of the country. Considering the brand name leverage and the market share in the existing sites, the company should fix production plants in all the three locations, with the production capacity of 5,000 units per annum each. Bids were received from 14 different companies to set up the production plant for ABC's new product line, and after thorough examination, bid from XYZ Technical Company was found to be most competitive. XYZ Company offers the total plant set up (inclusive of training to the production teams) at $ 1500 million each, with the total cost of $4500 million for five years. Apart from that, the set up cost also covers any abnormal breakdowns, which was our prime consideration while evaluating the bid, to avoid any breakdown costs as experienced in the past with the existing product line. Furniture & Fixtures: Furniture and Fixtures expenditure is slightly on the lower side, especially when compared with the yearly replacement cost of the furniture and fixture for the existing set up, that comes to approximately $45 million per annum on average, i.e. $ 225 million for 5 years. The new set up would require around $ 200 million per annum, totaling $1000 million for 5 years. The furniture will be purchased from BB Fixtures, which is comparatively new company in the market, providing better facilities at cheaper rates. Land & Building: The cost of purchasing land and construction of the building including any renovation in five years has been incorporated in the project cost, which comes to $ 3000 million. Given the hike in real estate prices, such costs are on higher side. Funding Options for MPMP The total budget requirement for MPMP is quite substantial, and can be met from the following funding options available in the market: Debt: The first and the most obvious source of funds available to ABC Pharmaceuticals is bank financing. The cost of such financing is around 15 percent (discount rate) if availed at most competitive rates from the market. However, the project cost is quite high and as per the regulations governing the banks, the maximum ABC can avail from this source is $ 2500 million, where the per party limit for the company exhausts, as the company has already availed huge financing from banks and fresh equity injection is required, in order to enhance the financing limit. The above mentioned cost of 15 percent is the explicit cost of debt. As the interest charges are tax deductible, the implicit cost of debt (tax adjusted) would be substantially less than the explicit cost viz. before-tax costs. The marginal rate of tax for the company is 35 percent. Based on this, the implicit cost would be as follows: Implicit cost= explicit costs (1-marginal rate of tax) = 15 (1-0.35) = 15 (0.65) = 9.75 percent Preferred Stocks: Funds available through the preferred stocks option would be limited. The cost of preferred stocks is a function of its stated dividend (Horne 175), therefore based on the last five years' pattern of dividends; the company can raise 10 percent preferred stock at current market price of $ 550 million ($ 500 million-par value). The cost of funds through this source would be: = (10 percent * 500) / 550 = 9 percent approx. Common Stocks: Given the strong share in the market and healthy financial fundamentals, raising funds from public using stock options is an easy option. Using the before tax cost of debt plus risk premium approach, the cost of common stock option would be as follows: = Before tax cost of debt + Risk Premium = 15 + 2 = 17 percent Risk premium of the company, considering the market dynamics, the overall situation of the pharmaceuticals industry and the growth prospects of the company, the risk premium of the company is on lower side at 2 percent. A glance at the respective costs of funds for debt, preferred stocks and equity at 9.75 percent, 9 percent and 17 percent respectively shows that bank financing and preferred stocks are available at cheaper rates. However, funds available through both the sources would be limited. On the face of it, it appears that bank financing should be availed to its maximum extent. Given the current financials of the company as of year ended December 31, 2006, the company can avail a maximum of $ 7500 million from banks in compliance with the applicable regulations, out of which $ 5000 million has already been availed. The other recommended source is common stock, equity injection of $ 6500 million would improve the equity position of the bank and the limit of bank financing would increase accordingly from $ 7500 million to $ 9000 million, leaving $ 4000 million of funds yet to be availed through the banks. The rest of the project cost will be covered by funds raised through common stocks. Based on these observations, the company has to raise funds through both common stock and bank financing. However, both options have their specific requirements that have to be complied with. In case of bank financing, access to credit has been easy for the company in the last couple of years based on the strong financial results; however, further enhancement in credit is linked with the ability of the company to raise capital in order to comply with the applicable debt-equity ratios. As regards raising funds through common stocks, the company is already registered with the stock market and the current share value is fairly above the par. Launching a new issue would be well received in the market, especially when the stock market in general is optimistic and doing above average for the pharmaceuticals. The weighted average cost of the funds for MPMP would be as follows: Weighted Average Cost of Funds Funding Option Invested Capital ($ in Million) Percentage Annual Cost Proportion of financing Weighted Cost Dollars Annual Cost Debt 4,000 9.75 38% 3.71 390 Common Stock 6,500 17 62% 10.54 1105 TOTAL 10,500 100% 14.25 1495 The debt option though appears to be cheaper than the equity option, however, due to certain regulations applicable to the banks, the maximum additional funds ABC can avail from banks is $ 4,000 million. This amount is based on the assumption that the fresh equity of $ 6,500 million will be injected, strengthening the overall equity base of the company, enabling it to acquire bank financing thereagainst as well. The procedure for acquiring funds through both the facilities, however, is demanding. In this regard, preliminary work has already been done. The NTN bank has conducted the feasibility analysis of MPMP, and considering the viability of the project, is willing to sponsor us with $ 4,000 million. As soon as the board approves the current budget plan, we will start filing our documentation to get the loan sanctioned for the acquisition of land. As regards the common stock option, the company is already registered with the Central Depository. For this specific issue, the exchange member will specify to the Central Depository our bank account, in which the securities subscribers will remit their payments. Any additional documentation requirements of the Central Depository will be met accordingly. Considering the quantum of the financing required for the project and the peculiarities of the two funding options, on average it will take a quarter year. However, documentation requirements are quite exhaustive and might take longer than this. Moreover, much is based on the ability of the company to attract funds through common stock option. In case the issue is under subscribed, it will affect the funding from the banks and the total budget as well. In order to address this issue, however, as a last option the company can resort to issuing right shares converting its existing un-appropriated profits into equity. SECTION TWO Cash Flow Forecast Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec TOTAL INCOME CASH/CHEQUES RECEIVED Cash Sales (inc. VAT) 5000 7000 10000 12000 12000 15000 20000 25000 25000 25000 25000 25000 206000 Credit Sales (Inc. Vat) 5000 7000 10000 12000 12000 15000 20000 25000 25000 25000 25000 25000 206000 Capital and/or loans introduced 10500 0 0 0 0 0 0 0 0 0 0 0 10500000 Other Income 0 0 0 0 0 0 0 0 0 0 0 0 0 TOTAL 20500 14000 20000 24000 24000 30000 40000 50000 50000 50000 50000 50000 10912000 EXPENDITURE (inc. VAT where appropriate) Materials 1000 3500 5000 6000 6000 7500 10000 12500 12500 12500 12500 12500 101500 Wages 50 50 50 50 50 50 50 50 50 50 50 50 600 Staff Salaries 100 100 100 100 100 100 100 100 100 100 100 100 1200 Rent and rates 150 150 150 150 150 150 150 150 150 150 150 150 1800 Gas/ Electricity 10 10 10 10 10 10 10 10 10 10 10 10 120 Insurances 50 50 50 50 50 50 50 50 50 50 50 50 600 Postage & Stationery 10 10 10 10 10 10 10 10 10 10 10 10 120 Repairs & Maintenance 20 20 20 20 20 20 20 20 20 20 20 20 240 Traveling & Motor Expenses 30 30 30 30 30 30 30 30 30 30 30 30 360 Telephone 25 25 25 25 25 25 25 25 25 25 25 25 300 Professional Fees 0 0 300 0 0 300 0 0 300 0 0 300 1200 Advertising & Promotions 50 50 50 50 50 50 50 50 50 50 50 50 600 Miscellaneous Expenses 50 50 50 50 50 50 50 50 50 50 50 50 600 Loan Interest 3250 3250 3250 3250 3250 3250 3250 3250 3250 3250 3250 3250 39000 Capital Expenditure 8500 0 0 0 0 0 0 0 0 0 0 0 8500 Sundry Payments 0 0 0 0 0 0 0 0 0 0 0 0 0 TOTAL 13295 7295 9095 9795 9795 11595 13795 16295 16595 16295 16295 16595 156740 0 Income less expenditure 7205 6705 10905 14205 14205 18405 26205 33705 33405 33705 33705 33405 10755260 Opening balance - bank 0 7205 13910 24815 39020 53225 71630 97835 131540 164945 198650 232355 Closing balance - bank 7205 13910 24815 39020 53225 71630 97835 131540 164945 198650 232355 265760 10755260 Profit & Loss and Trading Forecast Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec TOTAL Sales Income 8000 10000 10000 11000 14000 14000 16000 16000 16000 16000 16000 16000 163000 Less VAT 1400 1750 1750 1925 2450 2450 2800 2800 2800 2800 2800 2800 28525 Sales (net of VAT) 6600 8250 8250 9075 11550 11550 13200 13200 13200 13200 13200 13200 134475 Materials 1825 3764 3764 4140 5270 5270 6023 6023 6023 6023 6023 6023 60168 Less Vat 825 1702 1702 1872 2382 2382 2723 2723 2723 2723 2723 2723 10529 Materials (net of VAT) 1000 2063 2063 2269 2888 2888 3300 3300 3300 3300 3300 3300 49639 Less Direct Wages (Inluding NI) 50 50 50 50 50 50 50 50 50 50 50 50 600 GROSS PROFIT 5550 6138 6138 6756 8613 8613 9850 9850 9850 9850 9850 9850 84236 DEDUCT Directors Income Staff Salaries 100 100 100 100 100 100 100 100 100 100 100 100 1200 Rent & Rates 150 150 150 150 150 150 150 150 150 150 150 150 1800 Gas & Electricity 10 10 10 10 10 10 10 10 10 10 10 10 120 Insurances 50 50 50 50 50 50 50 50 50 50 50 50 600 Postage & Stationery 10 10 10 10 10 10 10 10 10 10 10 10 120 Repairs & Maintenance 20 20 20 20 20 20 20 20 20 20 20 20 240 Traveling & Motor Expenses 30 30 30 30 30 30 30 30 30 30 30 30 360 Telephone 25 25 25 25 25 25 25 25 25 25 25 25 300 Professional Fees 0 0 300 0 0 300 0 0 300 0 0 300 1200 Advertising & Promotions 50 50 50 50 50 50 50 50 50 50 50 50 600 Miscellaneous Expenses 50 50 50 50 50 50 50 50 50 50 50 50 600 Depreciation 45 45 45 45 45 45 45 45 45 45 45 45 540 TOTALEXPENSES 540 540 840 540 540 840 540 540 840 540 540 840 7680 TOTAL EXPENSES less VAT 69 69 122 69 69 122 69 69 122 69 69 122 1040 TOTAL EXPENSES (net of VAT) 471 471 718 471 471 718 471 471 718 471 471 718 6641 Net Profit (loss) Before Interest and Tax 5079 5667 5419 6285 8142 7894 9379 9379 9132 9379 9379 9132 77596 Loan Interest 417 417 417 417 417 417 417 417 417 417 417 417 5004 Net Profit (Loss) Before Tax 4662 5250 5002 5868 7725 7477 8962 8962 8715 8962 8962 8715 72592 Projected Capital Expenditure Following is a projection of estimated capital expenditure for the new project. Capital Expenditure Amount ($ million) Period and Depreciation Plant & Machinery 4500 20 years to be depreciated @5% per annum ($ 200 million) with a salvage value of $500 million; using Straight Line Method of depreciation Furniture & Fixtures 1000 5 years to be depreciated @20% per annum ($ 200 million) with no salvage value; using Straight Line Method of depreciation Land & Building 3000 20 years to be depreciated @5% per annum ($ 125 million) with a salvage value of $500 million; using Straight Line Method of depreciation Sensitivity Analysis The proposed financial plan is sensitive to risk factors like changes in interest rate, variations in projected statements and forecasts, variances in sales and expenses, raw material availability and price. It has been estimated that a change of 1% in interest rates will result in a financial impact of $ 40 million, since the total debt taken from the bank is $ 4,000 million. The company should take appropriate steps to hedge against the losses that may arise due to interest rate changes. Similarly, a change in raw material price may impact the bottom line of the company. Raw materials are calculated as 25% of the selling price of the product. Hence, an increase of 10% in materials' prices may lead to a decline in gross profits by 2.5%. This situation can be controlled by keeping materials' inventory in adequate quantity, to guard against any adverse movements in prices of raw materials. BIBLIOGRAPHY Horne, V. Principles of Financial Management. 10th Edition. Prentice Hall Publishers, 2000. Read More