No. 1 (9 marks)
As of Dec 01, 2020, Pfizer announced that the Federal Drug Administration has approved its new vaccine, COVID-19 VAC, for the treatment of Corona Virus. Imagine that you were working as a stock analyst for a large investment firm and Pfizer is one of the firms you are actively watching. On Dec 01, 2020, Pfizer’s stock price jumped rapidly, and your supervisor wants you to estimate the size of the cash flows necessary to support the jump in stock price. Therefore, he wants you to estimate the net cash flows the market had anticipated from the sale of the newly developed vaccine. He advises that you treat the value anticipated by the market as the NPV of selling the vaccine, then work backward from the NPV to determine the annual cash flows necessary to generate that value. Your supervisor thinks the best way to capture the value is to take the change in stock price from closing on 30th November 2020 to closing on 1st December 2020. Being a smart worker, you just smiled at your boss, trying to show that you understand this work very well. Being an inexperienced to the job, the only thing you understand is the NPV.
The closing price of Pfizer (based on yahoo finance) was $ 38.31 on 30th November 2020 however, the price increased to $39.41 by the end of 1st December 2020 with overall 56,330,000 Shares outstanding in the market.
The information is useful in calculating the increase in value of Pfizer due to announcement of this good news. Because the change in value represents the “expected” NPV of the project, you will have to find the annual net cash flows that would provide this NPV. For this analysis, you will need to estimate the cost of capital for the project.
Assume that Pfizer’s bonds are trading in the market at the rate of $865.80 each (with the face value of $1000) and a coupon rate of 6% annually and currently, 1,000,000 bonds are actively being traded in the market with the maturity of 10 years. Assume Pfizer is listed in NYSE Stock Exchange and the beta of Pfizer is 0.8 and NYSE market premium is 8%. The U.S treasury securities are being traded at a risk-free rate of 3%. The federal tax rate is 30%.
Assuming that firm only uses debt and equity to finance its projects, compute and use the weighted average cost of capital (3 marks) and the NPV (3 marks) to calculate the constant annual cash flow that provides this NPV. Compute cash flows for a) 5 years b) 10 years, and c) 15-year horizons (3 marks).
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