Drug Planning At Mps Pharmaceuticals Essay
This report, describing capacity planning for Sequacor at MPS Pharmaceuticals, should be read in conjunction with the attached model. The objective of this report is to recommend the optimal capacity for the drug. In order to do that, a model has been built, which projects cash flows over the period of 20 years and calculates key metrics which are supposed to help decision making as regards the optimal capacity for Sequacor.
The model area shaded in green contains assumptions which are given in the case. The output area shaded in yellow contains key metrics, such as NPV, IRR, total sales, net cash receipts over the period, total units produced. The second page of the model projects cash flows over the 20 years period, calculated on the basis of assumptions given. It should be noted that all NPV is calculated by discounting all cash flows to year 1, as outflows and inflows of cash start from that year.
Changes in the maximum capacity leads to variation in all the key metrics provided. The question is what key metric should be maximized. It could be argued that NPV is in the best position to serve this purpose as opposed to other indicators. While net cash receipts generated by the product appears to be relevant, it does not differentiate between the time of cash receipts, giving the same value to £ 100 received in year 1 and in year 20. In contrast to this, NPV takes into account time value of money, therefore the discount rate applicable in the case is very important.
Now therefore, having calculated NPV under certain assumptions, the model can be applied to identify which production capacity would maximize NPV. In order to do that ‘what-if’ analysis is applied by calculating NPV for a range of production capacity which is taken from 10 000 to 30 000.
It is easy to see, that at the level of 23 000 unit the NPV is at its maximum of £ 329 250, which is the recommended level of capacity, under the assumptions given.
As mentioned before, the discount rate which is the cost of capital for the company is important for the model. E.g. if discount rate is changed to 5%, then optimum level would be 27 000 units. And increase of the rate to 15% would decrease the optimum capacity to 20 000 units. It can be explained by the effect of discount rate on the present value of future cash flows. The higher the rate the less present value is attached to the same amount of cash receivable in future. Therefore the model would seek to minimize current investment leading to less capacity.
As the model looks 20 years into the future, it is very sensitive to the assumptions, especially growth factors and sales as they have multiplication effect. Given the high uncertainty of future developments over such a long period, the required production capacity may change considerably, should some assumptions not come true in reality. E.g. if demand growth in the years 5-6 would be 10% instead of 15% as given, the optimal capacity level would be only 18 000 units. Therefore, additional analysis and different scenarios testing with different demand levels and growth rates could be advisable before taking decision.