Question

In order to receive credit for this assignment, you must: . build a spreadsheet that accurately estimates the cash flows of this project (using both assumptions provided and judgment about how to implement them) . use your spreadsheet to evaluate this project (as directed by the assignment) and determine whether it will create value for the firm; produce a written recommendation explain whether you think the company should accept or reject this project, and why! Case Study: New Product Decision Medical Device Company Iradimed Corporation (IRMD) is a niche supplier of radiation-shielded medical devices that can be used near MRI machines Until recently, its only product has been a radiation-shielded IV pump; this has beern moderately successful, but the company wants to expand its product suite and believes that it has designed a radiation-shielded MRI monitor that can disrupt the market and take share from the leading supplier. It has good reason to believe this: the company's founder, Roger Susi, designed the technology that it's planning to disrupt. His former company, Invivo Research, commercialized the market's leading MRI monitor in the 1990's before it was purchased by Philips (PHX), and the product he originally designed continues to hold over 90% market share today. Iradimed has designed a new monitor that offers significant advantages over the models that Philips is currently selling, and expects to be able to offer it at a lower price. At present, the market for MRI monitors is roughly 1,300 devices per year. Market research suggests that this market is growing at approximately 5% per year, and is likely to continue to do so for at least the next decade. Iradimed plans to sell its new monitors for $60,000 each and believes that it will be able to sell 100 monitors in the first year at that price point. They expect those sales to grow substantially over the next 5 years, and believe that they will have market share of 50% by the end of year 5. The company expects to book its first sales 1 year from now as long as regulatory approvals come through as expected. Produet devel 86ft-tht faf, and the company expects to incur another $12m in costs this year as it prepares for mass production. Iradimed has designed a new monitor that offers significant advantages over the models that Philips is currently selling, and expects to be able to offer it at a lower price. At present, the market for MRI monitors is roughly 1,300 devices per year. Market research suggests that this market is growing at approximately 5% per year, and is likely to continue to do so for at least the next decade. Iradimed plans to sell its new monitors for $60,000 each and believes that it will be able to sell 100 monitors in the first year at that price point. They expect those sales to grow substantially over the next 5 years, and believe that they will have market share of 50% by the end of year 5. The company expects to book its first sales 1 year from now as long as regulatory approvals come through as expected. Produet devel 86ft-tht faf, and the company expects to incur another $12m in costs this year as it prepares for mass production. It will also need to invest S0.5m in inventory before it begins production, and expects net working capital to be approximately 20% of revenues in the future The variable cost of goods sold is expected to be $12,000 per unit AND the company expects to pay its sales force 20% of the revenues that they generate. They do NOT expect to incur any additional depreciation (as the machinery required to produce this product is already in place), and do NOT expect to generate any additional fixed costs. The company's average tax rate is expected to be 21%. The sales life of this product is expected to be 12 years, although there is a risk that it might be considerably shorter if Philips comes out with a competing model. Build a model for this project using the assumptions given, and calculate the NPV IRR, and payback period for this investment. What discount rate should you use to evaluate this investment, and does the investment seem worth pursuing based on these numbers? The company would also like to know what its IRRwill be if it can reinvest the cash from this project at a 5% rate or return; calculate a Modified IRR for this project and comment on whether it changes your assessment. Management would also like you to stress test a few assumptions: 1. What if the company only succeeds in taking 25% market share? 2. What if Philips undercuts their pricing, and they can only sell the monitors for S40,000 each? 3. What if regulatory approval is delayed by 2 years? (This is not unrealistic; they've had problems with FDA delays in the past.) 4. What if the sales life of the product is only 8 vears? (This could very plausibly happen if Philips comes out with a redesign.) They would also like to know the sensitivity of your NPV calculation to this product's expected market share, and the lowest level of market share at which this product will meet management's required return. What is your recommendation? Explairn whether you think the company should APPROVE or REJECT this project, and why! Write up vour analysis: begin with a clear and concise recommendation on whether management should pursue this project, and explain how you arrived at that conclusion This document is intended to help management make a decision, so make sure you enough detail to allow management to follow your logic include Your write-up should be No more than 3 pages plus at most 2 pages of supporting figures, and vou must turn in vour Excel file with your assignment.

Answer 1

Line Items	Notes/Comments	Inputs
Variable Cost/Unit		12,000
Salary/Commission	% of revenue	20%
Tax rate		21%
Fixed Cost		-
Depreciation		-
Accumulated R&D Cost	5mn USD	5
Current Year R&D	For next year in $mn	12
Inventory	Mn USD	1
Sales Price/Unit	USD	60,000
Net WC	% of revenue	20%

Line Items	Notes/Comments	0	1	2	3	4	5	6	7	8	9	10	11	12
Market Size by Units	Devices/year	1,300	1,365	1,433	1,505	1,580	1,659	1,742	1,829	1,921	2,017	2,017	2,017	2,017
Growth in market Size	5% per year for next 10 years		5%	5%	5%	5%	5%	5%	5%	5%	5%	0%	0%	0%
Market Share	Assumes linear rampup in market share from 100 units in year 1 (=100/1365=7%) to 50% in year 5		7%	14%	28%	43%	50%	50%	50%	50%	50%	50%	50%	50%
Sales Volume	Sales start in 1 year from now		100	204	428	674	830	871	915	960	1,008	1,008	1,008	1,008
Unit Price	$		60,000	60,000	60,000	60,000	60,000	60,000	60,000	60,000	60,000	60,000	60,000	60,000
Sales $	mn $		6	12	26	40	50	52	55	58	60	60	60	60
Variable Cost/Unit	$		12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000	12,000
Variable Cost	mn $		1.2	2.4	5.1	8.1	10.0	10.5	11.0	11.5	12.1	12.1	12.1	12.1
Salary	% of Revenue		20%	20%	20%	20%	20%	20%	20%	20%	20%	20%	20%	20%
Salary Expense	mn $		1.2	2.4	5.1	8.1	10.0	10.5	11.0	11.5	12.1	12.1	12.1	12.1
Pre Tax Profit			3.6	7.3	15.4	24.3	29.9	31.4	32.9	34.6	36.3	36.3	36.3	36.3
Tax	21%		0.8	1.5	3.2	5.1	6.3	6.6	6.9	7.3	7.6	7.6	7.6	7.6
Post Tax Profit			2.8	5.8	12.2	19.2	23.6	24.8	26.0	27.3	28.7	28.7	28.7	28.7
R&D Expense	mn $ (accumulated + This year)	17.0	-	-	-	-	-	-	-	-	-	-	-	-
Inventory	Inventory	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5	0.5
Other Net WC	20% of revenue		1.2	2.4	5.1	8.1	10.0	10.5	11.0	11.5	12.1	12.1	12.1	12.1
Net WC Change	Working Capital is released at the end of project	0.5	1.2	1.7	3.9	4.7	5.8	5.2	6.3	5.7	6.9	5.7	6.9	5.7	(12.6)
Overall Free Cash Flow	=Post tax Profit - R&D Expense - Working Capital Required	(17.5)	1.6	4.1	8.3	14.5	17.8	19.6	19.7	21.6	21.8	22.9	21.8	22.9	12.6
IRR	47%	Using excel formula for IRR
NPV at 9% WACC	107.27	Sum<==	1.51	3.41	6.40	10.25	11.60	11.67	10.80	10.83	10.04	9.69	8.45	8.15	4.48

WACC - Assumed to be 9% as no information on cost of capital available. Else, ideal discount rate depends on weighted average cost of capital (Debt & equity)

Payack Period

3-4 Years

Company can generate enough Free Cash flow (discounted) before end of 4th year to cover for its initial investments

Based on above data and assumptions, the project makes financial sense for any cost of capital below IRR and above the hurdle rate i.e. minimum expected returns

Scenario 1 - 25% market Share

This will impact IRR and will cut it short to 28% and NPV will also go down to half

Scenario 2 - Sales price per unit at 40,000

This will again impact cash flows, IRR will go down to 29% and NPV to 56 mn$

Scenario 3 - if regulatory approval is delayed by 2 years, cash flows will be pushed away by 2 years each. This will again pull down IRR and NPV for the project

Scenario 4 - Sales life of 8 years - This implies the cash flows after 8th year will not be available and will reduce the IRR and NPV accordingly

Sensitivity of NPV to Market Share and Discount Rate - At a given Discount rate, NPV is highly sensitivity to market share and depends on the level of shift i.e from below we can see that sensitivity to 10% change in market share from 50% to 60% is 21% while sensitivity of this change in market share is 54% for change from 20% to 30% market Share.

		Discount rate
	107.27	9%
Market Share	10%	19
	20%	41
	30%	63
	40%	85
	50%	107
	60%	129
	70%	151
	80%	173
	90%	195