BIO TECH, INC.

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.

Divisions Relativity to the Strategy

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

cost of capital has been calculated as 16.33%. (Appendix A)

Q3.) Should the LPG division spend $10 million on equipment in 1975 or postpone some of

the expenditure to 1978?

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

performed better than the performance of CPG.

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%

Average Growth of--

Laboratory Product Group
20.86
Sales % 20.99% 20.97% 20.97% 20.95%
20.86
EBIT % 20.99% 20.97% 20.97% 20.95%

Average Growth of--

Consumer Product Group
10.17
Sales % 10.31% 10.04% 10.27% 10.20%
10.17
EBIT % 10.31% 10.04% 10.27% 10.20%
Appendix D - Divisional Sales Revenue FY 1974

Consumer Products Group; 19%

Medical Products Group; 54%

Laboratory Products Group; 27%

Appendix E - Divisional EBIT FY 1974

Consumer Products Group; 13%

Laboratory Products Group; 24%

Medical Products Group; 63%