Salza-Pharmaceuticals

Based in Australia Salza-Pharmaceuticals Company was formed in 1995 and is a leading manufacturer of a cholesterol busting drug known as Cholo-2®. The company’s founder Dr Zaide Salzman initially commenced his career with a large German pharmaceutical operator and eventually became CEO of a US listed health company. Dr Salzman moved away from the corporate sector to set up his own research house where he collaborated with researchers from CEU University in Perth Western Australia. After recently securing seed capital from investors Salza-Pharmaceutical Company intends to list on the Australian Stock Market in 2018.  By 2013 SalzaPharmaceuticals had signed a significant licencing deal with Aspel for the sales and marketing of Cholo-2®. A second licencing deal is in the pipeline with Aztor-Zanca after receipt of EU marketing clearance for a gel offering treatment and rapid relief for arthritis. As this arthritis gel is still in the early stages of commercial development Salza-Pharmaceuticals key cash flow direction is centred on the Cholo-2® drug. The company also produces a number of lines of health supplements and vitamins. By 2015, the company had a sales turnover of over $15 million with profits with excess of $3 million.   The company’s management recognises the licencing deal with Aspel as a potential company maker and as a result wishes to expand its Joondalup primary manufacturing facility. The new drug will cost more, but is superior to the primary competing product produced by its closest competitor. As a recent business school graduate working as a financial analyst at Salza-Pharmaceutical Company, you must analyse the project and present the findings to the company’s executive committee.   Production facilities for the Cholo-2®  drug would be set up at the company’s main plant. A new high-tech production line facility will cost $1,225,000 inclusive of shipping and installation charges. This machine will have a useful life of 9 years, and can be depreciated on a straight-line basis. At the end of 9 years, the machine is expected to fetch a salvage value of $175,000. Due to heavy use, the new machine will have to be overhauled at the end of 5 years of its useful life, at a cost of $250,000. The cost of the overhaul can be further depreciated on a straight-line basis for the remainder of the machine’s life.   Management is being cautious and wary that the new product may not be as well received in the market as initially expected, and are concerned if it is advisable to commit funds to such a large capital expenditure. There is an alternative to buy a used production facility from Korea with a remaining useful life of 4 years for an installed cost of $575,000. The used machinery can also be depreciated on a straight-line basis but the firm expects it will not have any salvage value at the end of its useful life.   If the company goes ahead with this new production, expenditure of raw materials will have to be increased by $125,000 at the start of the first year. The supply contracts include consideration for the impact of inflation on raw material prices. Prices are expected to rise at a rate of 3% p.a. starting from the end of the first year.   Salza-Pharmaceuticals will utilise an unused section of its production plant for this project. The space has been unused for several years and consequently has suffered some deterioration. As part of a routine facility improvement program, the company spent $95,000 to rehabilitate that section of the plant last year. The company’s accountant, Mr Malcolm Smith believes this outlay which has already been paid for and expensed for tax purposes, should be charged toward the cholesterol drug project. He contends that if the rehabilitation had not taken place, the firm would have to spend the funds anyway to make the site suitable for the new project.   The company expects to sell 680,000 units of Cholo-2® each year at a price of $5.70 per unit. The new production will incur an additional $150,000 per annum in fixed costs. Variable costs are expected to be $2.50 per unit. The company will also set aside $45,000 at the start of each year for additional advertising and marketing expenses for this new product line. While examining the sales figures, you note a short memo from the company’s sales manager expressing concern that sales of Cholo-2® will cannibalise existing sales of other products which potentially complement Cholo-2®. Specifically, the sales manager estimates that the company can expect a reduction of $1.1 million in sales per year of their existing fish-oil capsule range of health drugs which they

FBL 5030 Fundamentals of Value Creation in Business          Assignment 2 – Finance Page 4

 

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