Longstreet Pharmaceutical is considering opening a new Compound Pharmacy in San Antonio. The company’s top Pharmacists estimates that the new pharmacy would be productive for eight years, after which increased regulations and market competition will drive returns too low to continue. As the Chief Financial Officer, you have been asked to perform an analysis of the new pharmacy and present your recommendation on whether the company should open a compound pharmacy.
If the company opens the pharmacy, it will cost million today and a cash outflow of $400,000 in 9 years from now to close the pharmacy and dispose of the pharmaceutical components within federal and state regulations. Longstreet will also need to purchase purchase $1 million worth million worth of equipment now to produce their compound pharmaceuticals. They expect a straight-line depreciation over the 8 years with no salvage value.
Longstreet will have $250,000 in fixed costs every year. They expect to sell at an average price per script of $220 and an average variable cost per script of $85. The company will remain in the 35% tax bracket throughout the life of the project and requires a 12% return. Their expected volume of scripts is as follows:
Year 1 10,000
Year 212,375
Year 314,000
Year 418,750
Year 516,500
Year 615,000
Year 711,235
Year 88,000
Calculate the following:
1. Operating Cash flow per year (hint: don’t forget year 0 and year 9).
2. Contribution Margin per script.
3. NPV of the project. Should Longstreet open the pharmacy? Why or why not (in terms of NPV)?
4. Internal Rate of Return. Should Longstreet open the pharmacy? Why or why not (in terms of IRR)?
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