When the tax is half the base case rate the IRR for the investment is 37% but when there is no tax paid the IRR has a small increase to 39%. This shows that the investment is sensitive to tax though the level of sensitivity is not that high as the change in IRR is relatively small compared, 2%, compared to the huge change in tax, about 50%.
If the capital equipment used in the research was changed every 5 years at a $6.6 million cost and the equipment depreciated at 20% for year until it was replaced the IRR would lower as there would be an increase in the costs to be incurred by the investor during the project. This means that the project would be more favorable to an investor if the capital equipment was not replaced at all or if this was done it was not regularly: for example after every 13 years as was the case in question one.
When the R&D cost is increased by 25% for the first three years of the investment, the IRR is 33%. However, when the R&D costs are extended by $ 3.5 million for an extra year the IRR is at 34%. This shows that it is better for an investor when the R&D costs are extended by an extra year rather than when they are increased by 25% for the first three years because a higher IRR means greater returns on investment for the investor.
If the investor was to license the research project to a Pharmaceutical Company after they have completed all R&D costs and then receive a payment of $ 50 million after completion of the R&D, plus a 50% royalty on sales once they begin, and have no further costs the IRR would be 40%. This is when the investor pays a 36% tax on their income.
A license agreement under the conditions given in question 5 would not be attractive to a large pharmaceutical company as it would favor the investor more than the company. This is because the investor would have no more costs and they can concentrate on other investments as the pharmaceutical company ensures that this investment is profitable.
The original investment plan where the investor does not take the license option given in question 5 is sensitive to capital, production, patent, distribution, and marketing costs. This is because the IRR rises when the costs are removed and shifted to the Pharmaceutical Company. Also, the original investment plan is sensitive to these costs since when the costs are increased by replacing the capital equipment every five years the IRR decreased to 31% from 34%. This shows that an investor interested in this project should be keen on reducing the marketing, capital, distribution, patent, and production costs as these expenses have a direct impact on the returns the investor will get from their investment.
The project is attractive to an investor as it has a relatively high IRR of about 30% which is a good assurance to the investor that they will get their investment back plus a profit of about 30%. The attractiveness of this project can be seen in two forms here: one, the investor is assured that they won’t incur losses as the IRR is well above 0%; and two, the investor will get a high IRR.
The NPV for all spreadsheets is 0. The RRR is set by the investor and hence cannot be calculated in this instance. Again, it is not required in any of the questions and hence it was not calculated.