BioMask Genetics is a biotechnology firm with only one patent to its name. The after tax operating earnings in the current year is $100 million and the firm has no reinvestment needs. The patent will expire in 3 years and the firm will have a 15% growth rate in earnings during that period. After year 3, operating earnings are expected to remain constant forever. The firm’s management is considering an advertising plan designed to build up the brand name of its patented product. The advertising campaign will cost $50 million (pre-tax) a year over the next 3 years; the firm’s tax rate is 40%. The firm believes this campaign will allow it to maintain a 15% growth rate for 10 years, as the brand name compensates for the loss of the patent protection. After year 10, the operating earnings are expected to remain constant forever. The firm has a cost of capital of 10%.
a. Estimate the value of the firm, assuming it does not embark on the advertising campaign.
b. Estimate the value of the firm, with the advertising campaign.
c. Assume there is no guarantee the growth rate will last 10 years as a result of the campaign. What would the probability of success need to be for the campaign to be financially viable?
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