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Bio Tech
Bio Tech
Q1.) What is Bio-Tech's strategy? How do the various divisions relate to the firm's overall
strategy?
Bio-Tech's Strategy
Just after the initial public offering in the year the year 1960 Bio Tech Inc. decided to define clear
set of responsibilities for each individual business unit so that their performance can be managed
and evaluated with respect to their market and distribution channels they have been using and in
order to implement this plan Bio Tech Inc formulated a corporate level strategy in order to segregate
the business operations into three individual operating divisions so that the divisions performance
can be evaluated.
However, entire divisions are not being evaluated as per the devised strategy regarding the
evaluation of divisions, because the strategy states the each departments responsibility should be
defined and evaluated in accordance with their respective market they are serving, meanwhile, the
consumer product divisions is being held responsible for the research and development cost which
but in reality as per the statement of consumer product group manager his group only uses sells the
byproducts that are the developed in the course of research and development work done for the
other two divisions and holding consumer product division responsible for the research and
development cost is not an act in accordance with the strategy devised for the divisional
responsibilities.
Q2.) Compute Bio-Tech's weighted average cost of capital.
Weighted average cost of capital (WACC) is a combination of cost of equity and cost of debt and in
order to calculate the combined cost of capital these cost of capitals are combined together in
proportion to the capital invested as per the capital structure of the overall business entity. However
the cost of equity represents the returns required by the shareholders and we have to different
approaches for the calculation of cost of equity the first one is dividend valuation model and the
second one is capital asset pricing model. Capital asset pricing model uses the risk free returns on
treasury bill and average market premium on equity investment in addition to this the beta values
are used for the calculation of cost of equity capital which represent the systematic risk of the
industry, however, data provided in the case is in sufficient for the calculation of cost of capital
through capital asset pricing model, therefore, the cost of equity of Bio Tech Inc. has been
calculated using the dividend valuation model. Dividend valuation model uses the current years
dividend, current price of equity shares and the growth in dividend; therefore, the cost of equity has
been calculated using the dividend valuation as 17.75%. Meanwhile the cost of debt has been
calculated using the interest expenses for the year 1974 and existing debt of $45 million which is
6%, however, for the calculation of weighted average cost of capital interest rate has been calculated
after tax. Finally, the calculation of WACC requires equity and debt value, therefore, value of equity
has been calculated using the average share price of $49 per share (high $57 and low $41) and total
outstanding share of 8,493 million, meanwhile, the value of debt has been taken from the balance
sheet as at year ended December 1974. Therefore, based on the valuation above, weighted average
The LPG division produces and sells the laboratory products and the market for this type of
products is very volatile because of the changing technology being uses in the production of
these medical products. However, since this division has been generating profits as per the last
four years records, meanwhile, the division is operating in a growing market and LPG division is
unable to meet the growing demand for laboratory products, hence, management has decided to
expand the production capacity in order to increase the market share and revenues from
laboratory market. Meanwhile, the management is concerned about the rapidly changing
technology that is used in the production of laboratory products want to evaluate the investment
in LPG division in order to make sure that the investment creates positive results for the division
and get the maximum benefit of developing and investing in the production of laboratory
products. Therefore, the management should invest its first round financing the LPG division
with acquisition of land and investment in machinery and equipment that will generate enough
capacity to meet next two years demand and the remaining investment for the purchase of
equipment and machinery would be done after year two. Investment in equipment in this way
will minimize the risk of losses that could result from the rapidly technology in laboratory
product markets which will make the equipments useful life shorter not because of the physical
wear and tear of equipment but because of the fact that the technology would probably become
obsolete if a latest and improved technology has been developed. Meanwhile, the delaying of
part of the invest would mean that the remaining capital expenditure now would be used in to
purchase a latest technology which would meet the projected targets set in exhibit 5.
Q4.) Evaluate the proposal to sell the CPG division?
According to Montgomery, the CPG division is not performing well because revenues of this
division are not growing in line with the growth in other two divisions whose sales revenues are
growing each year by greater percentage in relation to the growth rate of CPG division, whereas,
according to the general manager of CPG division this is not a reasonable basis for the evaluation
of his divisions performance because he says that the market for consumer medical products is
not growing as fast as the market for laboratory and other medical products but still his division
has managed to get the reasonable growth of stable market which means that his division has
performed well during the past four years. Furthermore, the he also claims that since his division
does not use the research and development activates directly instead he uses the byproduct which
become developed by the process of developing other medical products for the rest of two
divisions and the research and development activities are principally carried for laboratory and
medical, therefore, allocating the research and development cost to CPG division would not be
reasonable allocation and this has decreased the profitability of this division.
Meanwhile, the performance of CPG division can be measured in accordance with the EBIT
generated by each division in relation to the capital expenditure being made on each division,
therefore, evaluation of each divisions performance has been made and it reveals that CPG
division has generated EBIT as percentage of capital expenditure made in that year. However, the
EBIT as percentage of sales is lower in case of LPG division which means that PCG division has
In addition to this, the performance of CPG division over the last four years and the concerns of
CPG division manager, reveals that the allocation of research and development work has been
charged to CPG division meanwhile, the manager of CPG division states that he does not uses
the research and development activities directly, instead his division uses the by product which
was discovered as a result of primary research for the other two divisions, therefore, the
allocation of research and development cost should have been reversed which will increase the
profits of CPG division and its comparison with other divisions would also get improve and in
order to demonstrate the results and impact of reversion of allocation of fixed research and
development cost has been produced in Appendix of the excel sheet. Additionally, the CPG
division operates in a stable market where revenues can certainly be project and do not much
deviate over the years which makes sure the profitability of division more probable, where as the
other divisions who are operating in more dynamic market makes the profits more volatile which
represents the high risk of those divisions, meanwhile, the volatility of the market in other
division exposes their equipments to become obsolete in short time period in the event of new
technological improvement whereas the CPG division has no such risks so this is an additional
point which will makes the division more stable investment than the other divisions.
However, the CPG division generates lower growth in sales and EBIT, but since it sells the by
product which gets discovered during the product development for the principle divisions and in
case if this division is divested then that by product will not be marketed and sold, hence, that
product will be thrown to the basket and no revenue will be gained through the development of
that by product. Furthermore, the divestment of this division would lead the loss of $13 million
on book value in case of available offer of $25 million; meanwhile, it has to bear the divestment
cost of this division. Therefore, based on the evaluation of different aspects related to the
division CPG of Bio Tech Inc. Mr. Montgomery is recommended not divest the division.
APPENDIX
Appendix A WACC
Cost of Equity
Dividend Valuation Model
Current year dividend 0.47
Average current share price 49
Average growth rate 17%
Cost of Equity 17.75%
Cost of Debt 6%
Tax Rate 48%
Cost of Debt after tax 3%
Capital Structure
Average share price 49
Outstanding share (000) 8492
Equity Value 416,108
Liability 45,000
Total Capital Employed 461,108
WACC 16.33%
Appendix B - CPG Division 1971 1972 1973 1974 (est.)
Medical Products Group
Sales 92.70 102.10 122.30 148.50
EBIT 15.50 17.10 21.30 24.00
Less R&D Exp. Of CPG (1.10) (1.18) (1.31) (1.41)
Net EBIT 14.40 15.92 19.99 22.59
EBIT as Percentage of Sales 16% 16% 16% 15%
Laboratory Products Group
Sales 39.80 46.60 57.30 73.30
EBIT 4.60 5.80 8.10 9.00
Less R&D Exp. Of CPG (0.47) (0.54) (0.61) (0.69)
Net EBIT 4.13 5.26 7.49 8.31
EBIT as Percentage of Sales 10% 11% 13% 11%
Consumer Products Group
Sales 40.30 44.00 49.20 53.60
EBIT 3.90 4.40 5.10 5.10
Add Back R&D Exp. 1.58 1.72 1.93 2.10
Net EBIT 5.48 6.12 7.03 7.20
EBIT as Percentage of Sales 14% 14% 14% 13%
Appendix C Years 1976 1977 1978 1979 Average
Average Growth of--
Medical Product Group
18.75
Sales % 18.80% 18.80% 18.80% 18.79%
18.75
EBIT % 18.80% 18.80% 18.80% 18.79%