solution

Ivan Johnson is revici g the investment merits of BioTiab, a fast growing biotechnology company.
BioTlab has developed several drugs, which are. being licensed to major drug companies. BoTLab also has
several drugs in phase lil trials (phase Ill trials are the last testing stage before FDA approval), Johnson
notes that two drugs recently received approval which should provide Bio Tab solid revenue growth and
generate predictable cash flow well into the future. Based on the potential for the two drugs. BioTLab’s
estimated annual cast flow growth rate for the next two years is 25%k, and long-term growth is expected to
12%. Because of Bio Lab’s attractive investment opportunities, the company does not pay a dividend.
Bio Lab’s current weighted average cost of capital is 15% and its stock is currently trading at $50 per share.
Financial information for BioTLab for the most recent 12 months is provided below:

Net working pital excluding cash increased from $7,460,000 to 59,985,000
Book value incr 1 from $81.250.000 to $101.250,000
BiofLab current has no debt
Research faciliti and production equipment were purchased for $8,450,000
BioTLab held non-operating assets in the amount of $875,000
Net income for 2 months was $20,000.000
BioLab has a marginal tax rate of 40%6
Noncash charges for depreciation and restructuring for the 12 months were $1,250,000

BioTLab’& managerne indicated an interest in establishing a dividend and will fund new drug
research by issuing additional debt.
Johnson also reviews competitor to Bio Lab, Groh Group, which has a larger segment operating in a
highly cydical business. The Groh Group has a debt to equity ratio of 1.0 and pays no dividends, in
addition, Groh Group plans to issue bonds in the coming year,
Johnson prefers to use free cash flow analysis to value investments. Which of the following
statements is leastaccurate in describing the advantages of free cash flow valuation models?
(Select 111 pts)

Acquiring Issues imit the usefulness of reported earnings, while free cash flow is adjusted for
these issues

Determining free cash flow is easier than dividends

a company must generate free cashflow to grow the long run