BFF5956 Corporate Financing Decisions Commonwealth Serum Laboratories Limited (CSL) Assessment Answer

Company Background

Commonwealth Serum Laboratories Limited (CSL): Company Background and Setting

Introduction Commonwealth Serum Laboratories Limited (CSL) is a prominent Australian biotechnology company that specializes in the development, manufacturing, and distribution of biotherapies. With a rich history spanning over a century, CSL has established itself as a global leader in the production of vaccines, plasma products, and pharmaceuticals. This report aims to provide an overview of CSL, including its nature of business, industry context, key divisions, market position, drivers of value, and strategic focus.

1.1 Profile of Commonwealth Serum Laboratories Limited (CSL) CSL, headquartered in Parkville, Victoria, Australia, operates in the biotechnology sector. The company was founded in 1916 as a government-owned organization known as the Commonwealth Serum Laboratories.

1.2 Evaluation of the Biotechnology Industry and Outlook The biotechnology industry is a rapidly growing sector characterized by innovation, research, and development in the field of life sciences.

1.3 CSL's Product Range and Key Divisions CSL's core business involves the production of vaccines, plasma products, and pharmaceuticals. The company's key divisions include CSL Behring and Seqirus.

1.4 Positioning in the Biotechnology Industry CSL's market position is robust, reflecting its impressive financial performance and market share. The company's total assets and revenues have consistently increased over the years, reflecting its strong market presence and successful product offerings. CSL's market capitalization is also substantial, positioning the company among the top players in the global biotechnology industry.

Furthermore, CSL's commitment to research and development, strategic partnerships, and acquisitions has helped consolidate its position in the industry. The company's focus on innovative therapies, high-quality products, and global expansion has enabled it to capture a significant market share in various therapeutic areas.

1.5 Key Drivers of CSL's Value Several factors contribute to CSL's value and success in the biotechnology industry:

a) Research and Development: CSL invests significantly in research and development to develop novel therapies and vaccines. This commitment to innovation and scientific advancements allows the company to stay ahead of competitors and deliver cutting-edge solutions.

b) Global Presence: CSL's extensive global presence enables it to access diverse markets and cater to a wide range of healthcare needs. This global footprint enhances revenue generation and provides opportunities for future growth.
c) Strong Product Portfolio: CSL's diverse portfolio of vaccines, plasma-derived products, and pharmaceuticals contributes significantly to its value.

d) Quality and Safety Standards: CSL adheres to stringent quality and safety standards in its manufacturing processes, ensuring the reliability and efficacy of its products.

1.6 Most Important Strategic Focus of CSL The most important strategic focus of CSL revolves around innovation and growth

a) Research and Development: CSL's robust investment in research and development is evidence of its commitment to innovation.

Capital Structure and Cost of Capital

Sample Data for WACC Calculation:

Cost of Equity: 10%

Cost of Debt: 5%

Market Value of Equity: $100 million

Market Value of Debt: $50 million

Tax Rate: 30%

Unlevered WACC Calculation:

Calculate the proportion of equity and debt in the company's capital structure:

Equity Proportion = Market Value of Equity / (Market Value of Equity + Market Value of Debt)

Debt Proportion = Market Value of Debt / (Market Value of Equity + Market Value of Debt)

Calculate the unlevered WACC using the following formula:

Unlevered WACC = Cost of Equity * Equity Proportion + Cost of Debt * Debt Proportion

Levered WACC Calculation:

Calculate the weighted cost of equity using the following formula:

Weighted Cost of Equity = Cost of Equity * (1 - Tax Rate)

Calculate the proportion of equity and debt in the company's leveraged capital structure:

Leveraged Equity Proportion = Market Value of Equity / (Market Value of Equity + Market Value of Debt)

Leveraged Debt Proportion = Market Value of Debt / (Market Value of Equity + Market Value of Debt)

Calculate the levered WACC using the following formula:

Levered WACC = Weighted Cost of Equity * Leveraged Equity Proportion + Cost of Debt * Leveraged Debt Proportion

Using the provided sample data, you can apply these formulas in an Excel sheet to calculate the unlevered and levered WACC. Simply enter the values in their respective cells and use the formulas mentioned above to obtain the results.

Certainly! Here's an example of how you can calculate the unlevered and levered WACC using the sample data provided:

Sample Data: Cost of Equity: 10% Cost of Debt: 5% Market Value of Equity: $100 million Market Value of Debt: $50 million Tax Rate: 30%

Now, let's calculate the unlevered WACC:

Calculate the proportion of equity and debt in the capital structure: Equity Proportion = Market Value of Equity / (Market Value of Equity + Market Value of Debt) Debt Proportion = Market Value of Debt / (Market Value of Equity + Market Value of Debt)

Equity Proportion = $100 million / ($100 million + $50 million) = 0.6667 (rounded to four decimal places) Debt Proportion = $50 million / ($100 million + $50 million) = 0.3333 (rounded to four decimal places)

Calculate the unlevered WACC: Unlevered WACC = Cost of Equity * Equity Proportion + Cost of Debt * Debt Proportion

Unlevered WACC = 10% * 0.6667 + 5% * 0.3333 = 6.6667% + 1.6665% = 8.3332% (rounded to four decimal places)

Therefore, the unlevered WACC based on the sample data is approximately 8.3332%.

Next, let's calculate the levered WACC:

Calculate the weighted cost of equity: Weighted Cost of Equity = Cost of Equity * (1 - Tax Rate)

Weighted Cost of Equity = 10% * (1 - 0.30) = 10% * 0.70 = 7% (rounded to two decimal places)

Calculate the proportion of equity and debt in the leveraged capital structure: Leveraged Equity Proportion = Market Value of Equity / (Market Value of Equity + Market Value of Debt) Leveraged Debt Proportion = Market Value of Debt / (Market Value of Equity + Market Value of Debt)

Leveraged Equity Proportion = $100 million / ($100 million + $50 million) = 0.6667 (rounded to four decimal places) Leveraged Debt Proportion = $50 million / ($100 million + $50 million) = 0.3333 (rounded to four decimal places)

Calculate the levered WACC: Levered WACC = Weighted Cost of Equity * Leveraged Equity Proportion + Cost of Debt * Leveraged Debt Proportion

Levered WACC = 7% * 0.6667 + 5% * 0.3333 = 4.6669% + 1.6665% = 6.3334% (rounded to four decimal places)Therefore, the levered WACC based on the sample data is approximately 6.3334%.

Capital Budgeting & Real Options

To evaluate the project using the WACC, Adjusted Present Value (APV), and Flow-to-Equity methods, we need to calculate the appropriate costs of capital first based on the debt-to-value ratio computed in question 2.1.

Given: Initial Investment (CAPEX): $500 million Depreciation Period: 10 years (straight-line basis) Salvage Value: $100 million EBITDA in Year 1: $120 million EBITDA growth: 5% for the first 2 years, 2% for the remaining 7 years Net Operating Working Capital (NOWC): $50 million (initial investment only) Tax Rate: 30% Debt-to-Value Ratio: 30%

1. WACC Method: a. Calculate the WACC using the previously computed unlevered and levered WACC: Unlevered WACC: 8.3332% Levered WACC: 6.3334%

2. Calculate the present value of the cash flows using the WACC: Year 1-10: Calculate the after-tax operating cash flows (EBITDA - Depreciation - Tax) and discount them using the WACC. Year 10: Add the salvage value after-tax proceeds (Salvage Value - Tax) and discount it using the WACC.
3. Compute the Net Present Value (NPV) by subtracting the initial investment: NPV_WACC = Sum of discounted cash flows - Initial Investment

4. Adjusted Present Value (APV) Method: a. Calculate the present value of the tax shield: Year 1-10: Calculate the tax shield as (Depreciation * Tax Rate) and discount it using the unlevered WACC.

5. Calculate the present value of the cash flows excluding the tax shield: Year 1-10: Calculate the after-tax operating cash flows (EBITDA - Depreciation - Tax) and discount them using the unlevered WACC. Year 10: Add the salvage value after-tax proceeds (Salvage Value - Tax) and discount it using the unlevered WACC.
6. Compute the Net Present Value (NPV) by summing the present value of the tax shield and the present value of the cash flows excluding the tax shield and subtracting the initial investment: NPV_APV = Present Value of Tax Shield + Present Value of Cash Flows - Initial Investment

7. Flow-to-Equity Method: a. Calculate the present value of the cash flows to equity holders: Year 1-10: Calculate the after-tax cash flows to equity holders (EBITDA - Tax) and discount them using the levered WACC. Year 10: Add the salvage value after-tax proceeds (Salvage Value - Tax) and discount it using the levered WACC.

8. Compute the Net Present Value (NPV) by subtracting the initial investment: NPV_FTE = Present Value of Cash Flows to Equity - Initial Investment

To calculate the present value of the cash flows to equity using the equity discount rate calculated in question 2.1, we will use the Flow-to-Equity (FTE) method.

Given: Equity Discount Rate: 10% EBITDA in Year 1: $120 million EBITDA growth: 5% for the first 2 years, 2% for the remaining 7 years Tax Rate: 30% Salvage Value: $100 million (fully taxable)

Now, let's calculate the present value of the cash flows to equity:

1. Calculate the after-tax cash flows to equity holders for each year: Year 1: EBITDA - Tax = $120 million - (30% * $120 million) = $84 million

For the growth years (Year 2-3): Year 2: $84 million * (1 + 5%) = $88.2 million Year 3: $88.2 million * (1 + 5%) = $92.61 million

For the remaining years (Year 4-10): Year 4: $92.61 million * (1 + 2%) = $94.41 million Year 5: $94.41 million * (1 + 2%) = $96.29 million Year 6: $96.29 million * (1 + 2%) = $98.24 million Year 7: $98.24 million * (1 + 2%) = $100.26 million Year 8: $100.26 million * (1 + 2%) = $102.37 million Year 9: $102.37 million * (1 + 2%) = $104.56 million Year 10: ($102.37 million + Salvage Value - Tax) * (1 + 2%) = ($102.37 million + $100 million - (30% * $100 million)) * (1 + 2%) = $199.77 million

2. Discount the cash flows to equity using the equity discount rate: Year 1: $84 million / (1 + 10%)^1 = $76.36 million

For the growth years (Year 2-3): Year 2: $88.2 million / (1 + 10%)^2 = $72.60 million Year 3: $92.61 million / (1 + 10%)^3 = $69.08 million

For the remaining years (Year 4-10): Year 4: $94.41 million / (1 + 10%)^4 = $61.71 million Year 5: $96.29 million / (1 + 10%)^5 = $59.13 million Year 6: $98.24 million / (1 + 10%)^6 = $56.68 million Year 7: $100.26 million / (1 + 10%)^7 = $54.36 million Year 8: $102.37 million / (1 + 10%)^8 = $52.17 million Year 9: $104.56 million / (1 + 10%)^9 = $50.09 million Year 10: $199.77 million / (1 + 10%)^10 = $95.42 million

Compute the present value of the cash flows to equity by summing the discounted cash flows:

Present Value of Cash Flows to Equity = Sum of Discounted Cash Flows

Present Value of Cash Flows to Equity = $76.36 million + $72.60 million + $69.08 million + $61.71 million + $59.13 million + $56.68 million + $54.36 million + $52.17 million + $50.09 million + $95.42 million

Present Value of Cash Flows to Equity = $707.80 million

Therefore, the present value of the cash flows to equity, using the equity discount rate calculated in question 2.1, is approximately $707.80 million.

3.2.1. If the company decided to postpone the plant establishment despite its positive NPV, real option analysis could have supported this decision by highlighting the flexibility and additional value associated with the project.

In this case, postponing the plant establishment could provide the company with the following real options:

2. Option to Wait for More Favorable Conditions: By postponing the project, the company can wait for more favorable market conditions, technological advancements, or changes in the regulatory environment.
3. Option to Expand or Scale Up: Delaying the project gives the company the option to evaluate market demand and success before deciding to expand or scale up the plant.
4. Option to Abandon: Postponing the project provides the company with the option to abandon it entirely if market conditions or business circumstances change.

Real options analysis would consider the value associated with these options and factor them into the decision-making process.

3.2.2. If the company decided to proceed with the plant establishment despite its negative NPV, real option analysis could have supported this decision by identifying strategic advantages and potential upside beyond the traditional NPV analysis.

Real option analysis in this scenario could highlight the following factors:

1. Strategic Value: The plant establishment may provide the company with strategic advantages such as capturing market share, establishing a competitive position, or gaining a first-mover advantage.
2. Learning and Adaptation: By proceeding with the project, the company can gain valuable knowledge and experience that can be applied to future endeavors.
3. Future Growth Opportunities: The plant establishment, even with a negative NPV, may create future growth opportunities.

When evaluating the project and calculating the NPV, several assumptions were made. These assumptions are necessary to estimate the cash flows and determine the financial viability of the project. The following assumptions were made:

1. Initial Investment: The project requires an initial investment of $500 million to build and fit out the facility in Melbourne.
2. Project Life: The project has a planned life of 10 years, indicating that it will operate for this duration.
3. Depreciation: The facility will be depreciated on a straight-line basis over 10 years for tax purposes. This assumption implies an equal annual depreciation expense throughout the project's life.
4. Salvage Value: After 10 years, the facility will have a salvage value of $100 million. This salvage value represents the estimated value of the facility at the end of its useful life.
5. EBITDA Growth: The EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is projected to grow by 5% per year for the first two years and by 2% per year for the remaining seven years.
6. Net Operating Working Capital: The project requires an initial investment of $50 million in net operating working capital at the start. However, it assumes that no additional net operating working capital will be required throughout the project's life.
7. Corporate Tax Rate: The corporate tax rate is assumed to be 30% for calculating the tax impact on earnings.
8. Debt-to-Value Ratio: The company is assumed to maintain the same debt-to-value ratio as computed in question 2.1, indicating a consistent capital structure for the project.

These assumptions serve as a basis for estimating the cash flows, determining the tax impact, and evaluating the financial viability of the project. It's important to note that these assumptions are simplifications and may not capture all potential variables and uncertainties. The actual project outcomes may vary based on real-world factors and market conditions.

References:

Commonwealth Serum Laboratories: 1916–1986. (1986, December). Medical Journal of Australia, 145(11–12), 643–643. https://doi.org/10.5694/j.1326-5377.1986.tb139521.x

Nantell, T. J., Copeland, T., Koller, T., & Murrin, J. (1991, March). Valuation: Measuring and Managing the Value of Companies. The Journal of Finance, 46(1), 459. https://doi.org/10.2307/2328707

Henry, S. C. (1997, February). Book review: Real Options: Managerial Flexibilty and Strategy in Resource Allocation, by Trigeorgis, L., Cambridge, MA: The MIT Press, 1996, 427pp, $45.00. Managerial and Decision Economics, 18(1), 66–68. http://dx.doi.org/10.1002/(sici)1099-1468(199702)18:13.0.co;2-h

Maldoom, D., Dixit, A. K., & Pindyck, R. S. (1996, May). Investment Under Uncertainty. The Economic Journal, 106(436), 725. https://doi.org/10.2307/2235588

Tsekrekos, A. E., Shackleton, M. B., & Wojakowski, R. (2010, February 19). Evaluating Natural Resource Investments under Different Model Dynamics: Managerial Insights. European Financial Management, 18(4), 543–575. https://doi.org/10.1111/j.1468-036x.2010.00544.x

Mohamed, M., Saber, S., Assem, A., & Gomaa., S. (2017, July 31). EFFECTS OF NOVEL ANTIOXIDANTS COMPOSITE ON OXIDATIVE STABILITY OFREFINED, BLEACHED, AND DEODORIZED PALM OLEIN DURING REPEATED DEEP FRYING OF POTATO CHIPS AND SENSORY QUALITY OF FINAL FRIED FOOD. International Journal of Advanced Research, 5(7), 1791–1796. https://doi.org/10.21474/ijar01/4901

CSL Behring-Prof. Heimburger Award: CSL Behring Funds Global Grants for the Next Generation of Coagulation Researchers. (2008, June). Seminars in Thrombosis and Hemostasis, 34(04), 413–413. https://doi.org/10.1055/s-0028-1089334

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