Question

1. Firms in the patented pharmaceutical industry earned an average return on net worth of 22 percent in 2006, compared with an average return of 14 percent earned by over 1,400 firms followed by Value Line . Which theory or theories of profit do you think best explain(s) the performance of the drug industry?

2. In the context of the shareholder wealth-maximization model of a firm, what is the 7. In 2012– the text. 8. expected impact of each of the following events on the value of the firm? Explain why. a. New foreign competitors enter the market. b. Strict pollution control requirements are enacted. c. A previously nonunion workforce votes to unionize. d. The rate of inflation increases substantially. e. A major technological breakthrough is achieved by the firm, reducing its costs of production.

3. How would each of the following actions be expected to affect shareholder wealth? a. Southern Company adopts fuel-switching technology at its largest power plants. b. Ford Motor Company pays $2.5 billion for Jaguar. c. General Motors offers large rebates to stimulate sales of its automobiles. d. Rising interest rates cause the required returns of shareholders to increase. e. Import restrictions are placed on the French competitors of Napa wineries. f. There is a sudden drop in the expected future rate of inflation. g. A new, labor-saving machine is purchased by Wonder Bread and results in the layoff of 300 employees.

Answer 1

HOMEWORKLIB POLICY requires to solve first 4 parts. Will try to solve as many as possible in the given time. Thank you.

1. I believe the following theories best explain the profits of pharma companies-

• Risk bearing theory of profit- The theory says the higher the risk, the higher the rewards. The pharma companies take huge risks in inventing a new drug, having trials and the getting FDA approvals.
• Monopoly theory of profit- If a new drug is approved, the pharma company gets a patent over it, which means that it will have an effective monopoly on that segment of the market.
• Innovation theory of profit- This theory says that innovation is what keeps a company ahead. And pharma industry is built on innovation. Pharma companies have to continuously find new drugs because once patents run out on existing drugs, there are no profits to be made.

2a. New competitors will mean increased competition, higher supply and lowered profits. This will result in shareholder value will go down.

2b. Stricter pollution norms will increase the costs of production, resulting in lower profits and hence, lower shareholder value.

2c. When a workforce union gets formed, they demand benefits such as higher pay, better working conditions, better overtime pay, better facilities ets. All of this increases the costs- decreasing profits. This will reduce shareholder value.

2d. Higher inflation means less real value of money. This means purchasing power of consumers goes down- resulting in lesser demand and hence lesser shareholder value.

2e. The technological breakthrough will reduce the firm's cost, increasing its profits. Higher profits will result in more shareholder value.