HC2091 Business Finance Case Study Sample

HC2091 Business Finance

Assessment Title

Risk Return Relationship, Market Efficiency, Capital Budgeting and Project Evaluation

Instructions

Academic

Integrity

Information

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Purpose of the assessment (with ULO Mapping)

Students are required to form a group of 4 members to study, undertake research, analyze and conduct academic work within the areas of business finance covered in learning materials Topics 1 to 10 inclusive. The penalty will be applied to solo groups.

The assignment examines the main issues, including underlying theories, implementing performance measures, and explaining the firm's financial performance. Your group is strongly advised to reference professional websites, journal articles and textbooks in this assignment (case study). All five Unit Learning Outcomes (ULO 1, 2, 3, 4 and 5) are applicable.

INTRODUCTION

The introduction should briefly explain the purpose of the assignment (not more than 200 words)

PART 1. RESEARCH ON RISK RETURN RELATIONSHIP, MARKET EFFICIENCY AND ASSET PRICING (15 marks)

Biotron Limited, listed on the ASX under trading code BIT, is a biotechnology company engaged in research, development, and commercialisation of drugs targeting viral diseases with unmet medical need. The Company focuses on the progression of the clinical development of the drug, BIT225, an investigational, orally-administered, novel antiviral compound in development by Biotron for treatment of HCV and HIV infections.

The fundamental financial information for BIT ltd is presented in the following Table:

On the 27 September 2018 the market close for the stock at $0.019. The company made an announcement about it clinical trial results about HIV treatment on 28 September, 2018.There were huge movements in the share prices of BIT in either direction surrounding the announcement date. The following table demonstrate those movements:

Required:

Please read the above information carefully and answer the following questions:

(a) Although the company has negative earnings per share, why do you think the company has a value?

(b) In the given time period, the shares of Biotron Limited (BIT) sold at the highest price of $0.445 on the 16/10/2018, which had later declined to $0.115 on the 25/01/2019.

(i) Does fundamental analysis of the company justify such a huge swing in the share price within a short span of time? Why do you think such a huge swing was experienced in the share price of Biotron Limited (BIT) within such a short span of time?

(ii) What does such swings in the share price of Biotron Limited (BIT) tell about risk in investing in shares? What type of risk is this?

(c) What does the movement in the share prices of Biotron Limited tell about the efficient market hypothesis?

PART 2. PROJECT EVALUATION AND SENSITIVITY ANALYSIS (25 marks)

Case Study: Your group is working for the financial department of a famous production company, which is considering a potential project with a new product that is expected to sell for an average price of $25 per Unit. Launching this project will require the company to buy new equipment with a cost of $1,500,000 and zero residual value after four years. The company expects it can sell 250,000 units per year at this price for a period of 4 years with this equipment.

With the equipment, to produce a unit of product, the company needs to spend a variable cost per Unit of $10. Cash fixed costs per year are $250,000. Other information is available below:

Depreciation method: straight line

Corporate Income Tax Rate: 30%

Discount rate: XXX %

(Different discount rates will be assigned to different groups of students for this Part 2

HC2091 Group Assignment. Students need to attend Tutorial Class in Week 9 to get the information and perform the tasks.)

Required:

Do an analysis of the cash flows of the project to determine the sensitivity of the project NPV with the following changes in the value drivers:

Unit sales decrease by 15%

Price per Unit decreases by 15%

A conclusion on which value driver has a more significant impact on the NPV of the project cash flows need to be drawn out.

CONCLUSION

Based on the outcome of two parts, provide a brief conclusion, summarizing what you have done in the assignment (not more than 200 words).

Solution

Introduction

The study aims to make a detailed financial analysis for Biotron Limited, a listed organisation for the Australian stock exchange and getting traded as BIT. The company is engaged in the biotechnology sector and engaged in the research development and commercialisation of the drugs for the viral diseases. The objective of this report is to analyse the significant movement of the company's negative earning sports share and how it is going to impact the valuation of the business along with the changes in the share prices and the consideration of the Efficient market hypothesis. Based on the results, it will be committed by the company is worth investing or not. As per MBA Assignment Expert, Thereafter the project evaluation and sensitivity analysis will be conducted for a famous production company which will invest in a 4-year project. Applying the discounting rate of 12.5%, the estimated amounts and their operating cash flows will be discounted. The sensitivity analysis will also be conducted to analyse the impact of change in sales volume and the sales price over the net present value for the proposed investment.

Part 1

Part A:

Negative earning for share

In the given case scenario based on the data provided for 2018, the earnings per share for Biotron Limited Was negative at $-0.4; therefore, the price-to-earnings ratio for the business will be negative because in the price-to-earnings ratio, the share prices of the company are getting compared with the earnings per share. The negative earnings are the result of the recent year losses that the company recorded in 2018, which will include a lot of factors into consideration. That the company’s operation expenses or The Adjustment for any expenses during the particular financial year might have consumed the profits that the businesses able to generate after selling the product into the market. Therefore, the earnings and the price-to-earnings ratio are getting negative; however, the company's valuation depends upon many factors. Even if the company is making a negative return in a particular financial year, does not make an impact over the long-term vision and the strategic position of the business and the company will have a value. However, it can be said with confidence that because of the negative Performance or negative results, the company will significantly decrease their valuation. Based on the information provided, it is identified that as of 27th September 2018, the market value of the share was $0.019, there for the company has a value for which the investors in the company will be required to pay the price.

Part B:

I) The fundamental analysis and the impact of the share price swing within a short period of time

The fundamental analysis and the share price movement are two different things even though they are interrelated with each other. It will not make sense that if the company's fundamentally strong will have a positive impact over the short-term period. However, it is generally observed that in the long-term period, a company with good fundamental and efficient business processes and financial stability is expected to provide good value growth for the investor. The reason behind the decrease in the share prices for a particular company will depend upon a lot of facts like the change in government regulations regarding the production of any drug or whether the company has received or rejected any pending patent or similar intangible assets which will be beneficial for the company’s long-term vision and growth will impact the investor decision-making capacity (Zaremba et al 2020, p35(5)). The primary reason behind the changes in the share prices of any company on a short-term period is backed by the Efficient market theorem, which is that the shareholders of a company or the overall market will react on their own depending on the information that they have gathered from various sources which will include the news publication, government publications and the companies’ responses as well.

The reason behind the Huge Swing in share prices of Biotron Limited:

There might be multiple reasons why the biotechnology companies' fare prices might have an impact. Some of the common reasons which can be identified for the business is presented as follows.

Rejection or Approval of any products trial run or patent:
As the company is engaged in the research and development of various medicine, the company is expected to conduct Various trials and apply for a patent for the products for that they can secure the same for their future use without getting the competition. The primary result identified behind the decrease in the share prices of the company is that the company published the clinical trial results about the HIV treatment on 28 September, and they are after a significant increment is recorded for the company share prices, which was $0.019 on 27 September 2018 and increased to $0.041Which is indicating a growth of 115.8% in just one day they are after the share prices of the company have increased by 204.9% by 3rd of October 2018. Hence the announcement of the company signifies that the trial runs and their results are positive, and there is a huge, expected earning possibility for the future based on the Efficient market hypothesis for which the investors are ready to make more payments for acquiring the share because of the earning probability (Bagato, Gioia & Mandelli, 2022, p15(1)).

II) Risk of investing in the share, and the type of risk

Based on the information provided, it is clearly identified that there is a significant price movement recorded for Biotron Limited within a small period which provides a chosen capital appreciation opportunity for the investor. In the given case scenario, the beta value of the shares is identified at 0.91, which indicates that the systematic risk of investing in the share is very low because the company share prices are expected to move in the same direction as the changes in the overall index or the share market (YEE, 2019, p18(2)). However, the short period of share Prices swing justifies that there is some short-term volatility available for the investors because of the information asymmetry, which will be beneficial for the long-term growth and opportunity for the business as well as the investor. In the given case scenario, depending on the announcement by the company regarding the trial for HIV drug, the investors have predicted that the company will get approval for the same and the efficiency of the product to cure or protect people from HIV. Hence there is a probable earnings opportunity for the business in future for which the investors are ready to make higher payments to grab the opportunity. As most of the shareholders are observing or following that trend, the share prices of the company are increasing and providing a short-term swing providing a growth opportunity.
Short-term risks related to the investment

Market risk

In the given case scenario, the risk which is impacting the decision-making process and the recent behind the short-term price movement for Biotron Limited is because of the market risk. The market risk hair refers to the overall volatility and the fluctuation of the stock market depending on the macroeconomic factors and the information available for the investor regarding the economic conditions, market sentiment and others which will impact the share prices in a short period of time. The sudden market Downtown or unexpected event will impact the significant Movement in share prices, which will increase the risk of investment (Bagato, Gioia & Mandelli, 2022, p6(2)).

Event risk

The event risk refers to any event, such as the regulatory changes, the announcement of the company regarding the earnings are their product, information regarding the merger and acquisition and the change in economic substance and the geo-political scenario that is going to impact significantly over the decision-making process for the businesses (Ilyk, 2019, p5(3)). Recently during COVID-19, it has been identified that the major stock exchange and almost all stocks Recorded a significant downfall in their prices in mid of March 2020 due to the government imposing lockdowns to minimise the spread of COVID-19. The reason behind the decrease in the share prices for all the stocks across different stock exchange is that the earning potential for the businesses is going to be impacted; therefore, the shareholders of the company is getting impacted because of the event. For Biotron Limited, the recent sudden price increment is because of the announcement by the company on their clinical trial for the HIV drug, which moved is a favourable position. Hence the reason behind the decrease in the share prices of the business is due to positive results announced by the company.

Even though the event risk for Biotron Limited is favourable but it is making concern over the investors for a long period of time because any adverse results will impact the share prices of the business even though the systematic risk indicator is that the beta value of the business is very low at 0.91. Therefore, the overall volatility of the stock is not expected to move in a huge direction against the share prices of the overall index movement.
Appendix 1

Part C:

The Efficient market hypothesis indicates that the financial markets are efficient, and the stock prices will reflect all the available information considering the technical and financial analysis along with any probable changes in the regulation, announcements made by the company and others (Kelikume, Olaniyi & Iyohab, 2020, p41(1)). There is different form of Efficient market hypothesis in different stock exchange, such as weak Efficient market hypothesis, medium Efficient market hypothesis and highly Efficient market hypothesis. For the Australian stock exchange, because of the regulations made by ASX and government regulatory bodies, the strong, efficient market hypothesis is available.

Based on the share prices movement for Biotron Limited, the recent behind the sudden increase in the share prices is because of the efficient market hypothesis, which is providing more than the average return for this stock getting credit on ASX depending upon the available information and the adjustment of the share prices based upon the information impacting the perception for many shareholders.

They are for the favourable announcement made by the biotechnology company will suggest that this positive news is going to impact the share prices in a positive manner is that the share prices are expected to be increased by a good proposition impacting the return possibility of the shareholders as well as creating income volatility in performance. Therefore, the implement in the share prices Biotron Limited in accordance with EMH is suggesting that the share prices of the company is getting adjusted with a larger section’s perception towards the brand and the possibility to generate income over the future.

Part 2

Cash flow:

In the given case scenario, to calculate the cash flow from the project, at first, all the expenses, including the depreciation getting charged with the income statement (projected income and expenses) to calculate the tax liability. After deducting the text from the profit before taxes, the depreciation is required to be adjusted with the cash flow because the company has already spent on the depreciation expenses at the time of making the initial investment, and the objective of detecting it separately to minimise the tax obligation. The depreciation tax shield available on the investment will minimise the tax liability and improve the cash flow.

Net present value analysis

The Net present value Is an important tool for making investment-related decisions because it will evaluate and prioritise the investor required rate of return from the investment and consider the value of money over time, which is an essential component for making the investment (Perera et al 2020, p15(2)). The primary reason behind the inclusion of net present value and discounting the cash flow because the investors are forgoing the opportunity to earn interest income over their interested capital; therefore, order to select, the company is required to make Discounting of the forecasted cash flow. Now if the present value of the future income probability after discounting is more than the future value of all the investment of the initial investment at present value, then the project can be selected for the investment purpose.

Original case

Based on the original case scenario, if the company can 250000 every year for the next 4 years at a price of $25, then the company can make a net present value for the investment opportunity will be $6201950.

Decrease in the unit sales

In the given case scenario, it is identified that there is a probability that the sales units for the proposed investment can be decreased by 15%. In that case, the net present value of the investment opportunity will be $5018480. Therefore, the reduction in the sales unit is going to impact the net present value and the profitability of the proposed investment (Jagannathan & Kumar, 2022, p211(2)).

Decrease in sales price by 15%

If there is any event where the sales prices for the company can be impacted by 15%, then in such case, the company is eligible to make or generate a net present value of $4229500. Therefore, the company is getting a significant impact because of the change in share prices on their profitability aspect.

Result of sensitivity

As per the two different sensitivity analyses for the investment opportunity, it is identified that the production company will get a significant impact because of the changes in share prices as compared to the impact recorded because of the decrease in sales. Hence the company should make proper management so that they are sales prices should not be decreased by giving a competitive advantage for the product.

Refer to appendix 2

Conclusion

As per the overall Investment analysis, it is identified that the share price movement recorded by Biotron Limited is in favour of the investment purpose because the share prices have recorded significant growth. However, it is to be noted that the increment in the share prices is because of the Efficient market hypothesis, where the investors have reacted positively and focused that the company will increase their performance which will help them in maximising their capital appreciation. Therefore, they are willing to pay higher prices as compared to the prices they are currently paying, impacting the short-term price swing for the company. Regarding the investment opportunity analysis, it is identified that the depreciation and the tax Shield available on the depreciation is going to play a significant role in the decision-making process because it will impact the Profit ability. The sensitivity analysis suggests that the project is investible even after the recording of a 15% decrease in the sales volume or sales price because of the positive net present value. However, the company will get the maximum impact on their profitability aspect because of categories in the sales price.

Reference:

A Zaremba, R Kizys, DY Aharon, E Demir (2020), Infected markets: Novel coronavirus, government interventions, and stock return volatility around the globe, Finance Research Letters, 35, p.101597. https://www.sciencedirect.com/science/article/pii/S1544612320306310

ATD Perera, VM Nik, D Chen, JL Scartezzini, T Hong (2020), Quantifying the impacts of climate change and extreme climate events on energy systems. Nature Energy, 5(2), 150-159. https://escholarship.org/content/qt8sh5q16v/qt8sh5q16v.pdf

I Kelikume, E Olaniyi, FA Iyohab (2020), Efficient market hypothesis in the presence of market imperfections: Evidence from selected stock markets in Africa. International Journal of Management, Economics and Social Sciences (IJMESS), 9(1), 37-57. https://www.econstor.eu/bitstream/10419/215925/1/full-3.pdf

L Bagato, A Gioia, E Mandelli (2021), The Volaxivity Index Explained: A Reflexivity-Volatility Based Risk Assessment Tool. https://www.researchgate.net/profile/Luca-
Bagato/publication/358280402_The_Volaxivity_Index_Explained_A_Reflexivity-Volatility_Based_Risk_Assessment_Tool/links/61faba6f4393577abe087ddf/The-Volaxivity-Index-Explained-A-Reflexivity-Volatility-Based-Risk-Assessment-Tool.pdf

L YEE (2019), IMPACT OF CLIMATE CHANGE ON THE STOCK MARKET PERFORMANCE OF PLANTATION FIRMS IN MALAYSIA. https://etd.uum.edu.my/9052/2/s821959_01.pdf
UK Jagannathan, KS Kumar (2022), Application for Stochastic Net Present Value (NPV) Estimation and Sensitivity Analysis. https://ieomsociety.org/proceedings/2022india/83.pdf

Y Ilyk (2019), Do M&A create value? The case of European personal luxury good industry. http://tesi.luiss.it/26088/1/695701_ILYK_YAROSLAV.pdf