Course Title: Strategic Finance

MBA 2 EVENING

Date: January 7th, 2014

Lecture In charge: Sir Usman Kemal

Portfolio Risk in making the investment decisions at Global Pharmaceuticals

Submitted By: Qasim Farooq - 1335145 Amir Arshad - 1135153

Introduction:
The decision of investing in any organization is weighting up the risk and evaluation of the rewards of different options. It can possible that the alternative which provides the maximum profit is also the riskiest alternative while least risky alternative provide the smaller rewards. The executive therefore make decisions by weighting up the risk in order to provide the best rewards to the stakeholders of the organizations that include shareholders and customers. The starting point is the main objective and overall aim of the company which then converted into strategy by creating a balanced portfolio made up of various investments. This case study is about the creating the balanced portfolio at Global Pharmaceuticals by examining the process involved in weighting up the risks. This case study is about what type of decisions are required in order to decided where to spend and how much investment is require that will be suitable for the Global Pharmaceuticals. The one of the most important part of pharmaceutical industry is the ethics, making decisions that provide no harm to the environment and that are morally correct. The best investing decision is the one that provide the balance between social, legal and environmental considerations. Ethical decisions are very important in making the investment decisions. Global Pharmaceuticals principles set out the fundamental values and ethical principles within which the Company operates. Global Pharmaceuticals will operate in the territories where the Company can operate according to its business principles. Global Pharmaceuticals will only invest or bid only if it is operating within the ethical guidelines and values.

Global Pharmaceuticals:
The pharmaceuticals industry is one of the important industries in Pakistan where organizations are operating in private sector as well as in a public sector but mostly in private sector and competition is very tight in the industry which also involves some multinationals. Global pharmaceutical was established 18 years ago and since then it is one of the most important organization in the Pharma industry of Pakistan. The management team is very dedicated and consists of high qualified professionals who just not deliver the expected requirement but also always try to provide the benefits that customer desire. It consists of all type of products that range from injectable to tablets, ointments and fluid etc. the company consist of the distribution level that is spread national wide and almost targeting 95% population of Pakistan. Due to the environmental issues, demand for the medicines is estimated to grow at an increasing rate in the coming years, as more germs and bacteria causing the diseases because of the environmental issues that increasing the growth in demand.

Field Development:
The pharmaceuticals business consists of lot of different characteristics that proved to be important in decision making as far as investment is concerned. As it is large industry and capital intensive, most of the investment decisions involved large amount of money that could be in million. These investments are not short term and it can take few years of time between the start of the any major project and rewards in the share of profit from that project that can take more than two to three years from the first investment on that project to its first revenue. Pharmaceutical industry work under the rules and regulations of Ministry of Health and it provide all the guidelines from the expansion of the plant to other development or investment decisions. The organizations require the permission of the government in order to expand its plant or to increase the range of its medicines. Companies have to apply for the permission and after granting the permission only then it can start its operations. Drug inspectors also visit the plant in order to see whether it fulfils all the requirement of the government. In order to launch the new medical section like injections or tablets, organizations need to seek the permission first from the Ministry of Health and then they can invest on the project. There are also government allocated quotas of raw materials of the products that are sensitive and came under the regulations of international laws and narcotics, for that all the pharmaceuticals companies apply through proper procedures and after studying the entire propositions and proposals, the government committee decide the various amount of raw materials allocated to various organizations according to the capacity of that organization and its customers demand. Global Pharmaceuticals makes important decisions as to whether or not to invest in the new medical sections or field or to invest in the distribution network and how much of the investment is required. Global Pharmaceutical decided to invest in new sections of medicines that as psychotropic and narcotics related but there are some uncertainties involved in these projects as narcotics raw materials came under the regulations of the government and companies have to apply for the certain amount of raw material in order to make the products.

The Major Risks:

The major risks in any pharmaceutical project that are analysed by the experts can be: Pharmacists and chemists evaluate the risks around production, innovation, quality assurance. Engineers examine how good facilities are or whether its design or structure is according to the requirement and also evaluate the costs, production rates. Government impose Drug Inspectors who access the security, health and environmental risks.
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Accountants and marketing teams analyse the market demand and price according to the government and partner terms.

Investment Appraisal:
For the investment appraisal, one of the important techniques that is used is discounted cash flow. It is the approach with the help of which organizations the value the future returns on their investment by accessing what values these returns have got in the present time. It also concentrates on the cost of funds that is invested in a project by considering the timing of cash flows. As it can be supposed that one million rupees organizations have in the present time is got more worth as compare to the value of these one million rupees in the future which is due to: The real value of money may be lowered due to the inflation. There is also the risk and circumstances that could occur which prevent organizations to receive the amount of money that they were expecting.

With the usage of discounted cash flow method, the company is allowed to undertake a capital allocation process while appraising investments. It involves the ranking of the projects by the company and then selects those projects that are more valuable and provide best value to the company. The sufficient funds are not available to undertake the projects so it cannot be financed but it incurs the opportunity cost of those projects. The value of the investment that is invested by the company in any projects is the present value that is NPV and it provide the estimated investment figure that company expected to generate. So, it is important to forecast the economical cash flows and discount them. Global Pharmaceuticals uses a discount rate technique that provide the estimated return its investors are expecting for investing they made in an activity that is non-risk free. The NPV calculations are very handy and it can provide the calculations to the company about all the project and then company can decide that is the most suitable project. However, there is also a chance that people stay healthy and demand for medicines decreased or raw material is cheaper than today or change of policies of the government like ban of different raw materials like narcotics products; this risk must therefore be reflected in the valuation. This can be done by placing the probabilities to the unsuccessful outcomes and successful outcomes. Expected Monetary Value (EMV) is the sum of these risked values. The decision tree can be used for the EMV calculation. The company can choose a best alternative course of action with the help of decision trees when facing some uncertainty. Global Pharmaceutical decided to invest in new sections of medicines that as psychotropic and narcotics related but there are some uncertainties involved in these projects as narcotics raw materials came under the regulations of the government and companies have to apply for the certain amount of raw material in order to make the products.
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The decision tree process could be used to evaluate the project.

Raw Materials are available

NPV of Success =

Construct new Sections

Chance of Success =

Raw Materials are banned

EMV = Chance of Failure = NPV of Failure =

Dont construct New sections

NPV =

= Uncertainty

= Decision Diagram 1

This process can be used to illustrate possible returns from apply for raw materials after constructing the required new section for those products and then getting those raw materials from the government.

Diagram 2
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The diagram shows how inputs from pharmacists, engineers, chemists and the marketers can be used for the calculation of the value which is related to both external data and internal data. The models could be developed by the managers that project the estimated revenues and costs of developing new fields. The major components of these models are: Revenues Costs Government take (e.g. taxes and policies)

Global Pharmaceuticals then uses all of this information to calculate the EMV of decisions. The EMV is equal to: EMV = (NPV of success x chance of success) plus (NPV of failure x chance of failure). Global Pharmaceuticals decided to invest in the Psychotropic and Narcotic sections and with the help of EMV that can provide the estimated returns expected from Global Pharmaceuticals by constructing new medical products sections. The net present cost will be 10 million rupees. There is a 66% chance that the three year projects will be a success, yielding a return at NPV of 28m rupees in three years time. According to the Diagram 1: There are two choices available for the Global Pharmaceuticals whether to construct new sections or don't construct new sections. Next step is to set out the probabilities of raw materials being available and the NPV of success or failure. If the Psychotropic and Narcotics sections are not constructed then there will be a return of 0 and if sections are constructed and no raw materials are available or it is banned by the government due to international policies then there will be a loss of 10 million rupees. There is 34% chance of this could be the case. If the Psychotropic and Narcotics sections are constructed and raw materials are available there will be a gain of 28 million rupees. There is a 66% chance of this happening.

According to the EMV: EMV = (28m*66%) + (-10m*34%) = 15.08m

Therefore, as it can been seen that projects will provide the 15.08m of profit on a risked basis so, constructing the new sections is an attractive proposition on the economic grounds as it provide positive EMV.

Portfolio Consideration:
The numbers of factors must be considered at this phase of the investment decisions as the major goal for the Global Pharmaceuticals is to create the maximum value to the shareholders. In order to achieve the optimal growth for an acceptable level of risk Global Pharmaceuticals invests on a portfolio basis. This means that it will invest in a number of different sections and raw materials and at times share the costs and working interest with partners in order to improve the risk and reward balance and stay within a budget. As these new psychotropic and narcotics sections are weakly correlated or uncorrelated so the overall portfolio is risk is less than investing in just a single section or in a single product. This is very important and cannot be ignored at the exploration stage as risk of failure could be high so with more than one section, the loss will be minimized As according to the estimated profit of both the projects, it will provide good value to the Global Pharmaceuticals so it could be a wise decision to invest on both the projects. There are also other factors that must be considered also just like strategic fit to the current business and whether Global Pharmaceuticals have best suitable employees for the new sections. It is a investment decision and there is always so certain amount of portfolio risk in involved in these type of decisions so after considering all the aspects only then Global Pharmaceuticals can decide to invest in the project.

Conclusion:
The pharmaceutical market is an exciting one to be involved in as Pakistan industry is growing in every field and demand for medicines is growing rapidly too due to environment and bacterial issues. Global Pharmaceuticals is the one of the major company in the pharmaceutical industry and it constantly needs to make the right sorts of investment decisions which balance the needs of its consumers, its shareholders, the communities in which it operates. The proposed project involved few risk with it but after evaluating it and estimating the future result, it could prove to be a profitable project for the Global Pharmaceuticals so it will be a wise decision to go ahead with the constructing of new sections of psychotropic products and narcotics products.