Company ABC, a biopharmaceutical company, is considering a project that supplies a new drug. The project requires an investment of $1.5 million in a new production facility. This facility lasts 3 years and is depreciated using a straight line method to the zero residual value over 3 years. At the end of the project's life (year 3), the facility can be sold for 20% of its initial cost. The tax rate for the company is 30%. The product revenues from the project are expected to be $3 million per year. The cost of goods sold is projected to be $800,000 per year. The selling, general and administrative expenses are $300,000 per year. In addition, the drug will reduce the demand and therefore the cash flow obtained from an existing drug by $200,000 each year. In years 1 to 3, the inventory of the project is $500,000, account receivables are 10% of the project revenues, and account payables are 20% of the project's cost of goods sold. Assume that the project requires no cash and the full value of the change in working capital due to the project will be recovered one year after the project ends, i.e., in year 4. The company has a target debt to equity ratio of 1, a cost of equity of 12% and a cost of debt of 8%. a. Calculate: [7 marks] • the cash flow from the operating activity for the project • the cash flow from the working capital for the project • the cash flow from the investment activity for the project • the total cash flow from the project b. What is the payback period of the project? [2 marks] c. What are the advantages and disadvantages of the payback period method compared to the NPV rule? [2 marks] d. What are the shortcomings of the NPV rule? [1 mark] e. Calculate the weighted average cost of capital of company ABC. [2 marks] [2 marks] f. Check that the NPV of the project is $1.936 million. Show your working. g. The CEO of the company suggests that any drug in the same product line as the considered drug may cause a side effect with probability 0.2. If the considered drug causes the side effect, it may lead to lawsuits that are expected to reduce the NPV of the project by $3 million. The company can conduct a test to determine if the drug has a side effect or not. The test costs $0.5 million to conduct. Determine if the company should conduct the test. [4 marks]