ECON 393 – CORPORATE FINANCE

DEPAUW UNIVERSITY ECONOMICS & MANAGEMENT DEPARTMENT

Spring 2020

Integrated Case Assignment

Claxton Viro-Pharma, Inc. (CVP), is a privately-held company founded 15 years ago by two
physician scientists Dane Michler and Alexa Philbin. CVP develops, obtains FDA approval for,
and licenses for production various medical tests and pharmaceuticals. For many years, Dane and
Alexa shared a common passion for and extraordinary skill at developing treatments and
vaccines for viral illnesses, but the company has developed therapeutic and prophylactic
treatments as well as tests for bacterial and fungal infections. Although highly successful in its
space, CVP has no manufacturing capacity, and none of the products it has developed bear its
name. Thus, most people are unaware of its existence.
Much of CVP’s work is performed on a contact basis for large pharmaceutical manufacturers. In
return for CVP’s efforts, these sponsor companies reimburse it for its direct costs, including
overhead, and pay it a percentage of their sales of the CVP-developed products. A significant
portion of CVP’s work, however, is in the area of pure research undertaken on its own behalf.
The contract work provides the funding that allows the research team to pursue their own
research ideas.
In addition to Dane and Alexa, Julia Wyatt, an investor who provided start-up capital for the
company, is the third primary owner. Each owns 30 percent of the 1 million shares outstanding.
Several other individuals, all current employees, own the remaining company shares. Because
CVP is privately held, it has no publicly traded shares.
Julia’s investment in CVP is a minor portion of her portfolio, and she generally does not
participate in the firm except to vote her shares during the annual meeting. Alexa is CVP’s CEO,
and Dane is the company’s chief operating officer. Several years ago, the three principal owners
hired a CFO, Mitch Rogers. Mitch has many years of accounting experience in the
pharmaceutical industry before joining CVP. Over the course of here venture capital career, Julia
had noticed that most firms like CVP awarded their CFOs shares of the firm’s common stock.
Figuring that there likely was “something to it,” she convinced Dane and Alexa to award Mitch 2
percent of the CVP’s stock.
CVP averages having $250,000,000 of debt outstanding all of which is in the form of draws
against its $1 billion revolving line of credit with JPMorgan-Chase. CVP typically borrows the
money needed to fund its development projects and repays those amounts upon receiving
reimbursement from the project sponsors. For the reasons note in the following, CVP’s current
borrowing is almost triple the normal amount.
In addition to engaging in its normal activities, CVP recently has devoted a significant amount of
its resources to efforts around COVID-19. Under contract, it has been developing a 2-minute test
to determine whether a person has active virus. The test is exceptionally simple to administer,
provides correct results 99.9% of the time, and all incorrect test results are false positive. CVP
spent $220 million developing the test, owns the patent for the test, and its licensing agreement
calls for it to receive 50¢ for the first 200,000,000 test sold, and 20¢ per test for each test sold
thereafter. Management at the product’s sponsor company believes that it can manufacture the
tests for $3.50 each and sell them for $7.00 each. The sponsor has solid orders for 200,000,000
million tests from the federal government and that price, and is negotiating with it and other
governments for an additional 2,200,000,000 tests at an average price of $5.50 per test.
On its own, CVP has been developing a test to detect COVID-19 antibodies. Public health
professionals consider such a test essential to managing and controlling the virus’ progression.
CVP previously created similar tests for SARS and MERS, and Dane and Alexa are confident
that technology can be easily and effectively adapted to COVID-19. Working with Mitch, they
have developed a cost projection of $250 million to complete the project and have an approved
test in only 3 weeks. Mitch has been negotiating licensing deals with two of their “regular”
sponsor companies/manufacturers, and expects to sign deals with both. Both deals call for CVP
to receive 40¢ per test for the first 500,000,000 sold, and 20¢ per test sold thereafter. Experts see
a need for such a test to be administered every three to every person on the planet until an
effective vaccine has been administered to everyone. These same experts foresee such a vaccine
becoming available in 15 months. Until then, the manufacturers believe that CVP’s product will
capture 30% of the world-wide market for such antibody detection tests.
Because of the lengthy lead time for development and approval and because at least 20
companies already are pursuing one, Alexa and Dane have agreed that CVP will not pursue a
COVID-19 vaccine on its own.
While none of the parties believe the situation will persist beyond the introduction of a viable
vaccine, all of the parties agree that for approximately the next 15 months CVP is going to
experience a significant influx of cash the likes of which none of the owners ever imagined.
Mitch has initiated discussion with each of the primary owners to ascertain their respective
preferences for the use of the cash. To his dismay, each of Alexa, Dane, and Julia have their own
strongly held beliefs as to how to employ the money.
Historically, CVP has reinvested approximately half of its earnings each year and has distributed
the remaining earning to the shareholders as dividends. Julia favors viewing CVP as two
companies—the old CVP and the two COVID-19-related products. She would use the earnings
from old CVP as before—reinvest half and distribute half as dividends; she would distribute all
of the earnings from the two new products as dividends. Dane believes that CVP leaves an
incredible amount of money on the table when it licenses its intellectual property; he has always
wanted CVP to get into manufacturing. Thus, he prefers that CVP invest the extra cash in
manufacturing capability so that it can fully exploit the future unique opportunities he expects
will arise from the company’s ongoing research activities. In confidence, Alexa disclosed to

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Mitch that she has lost her passion for research and has been looking to move on. Her preference
would be to use the money repurchase shares, particularly hers.
Alexa and Dane receive the same salary and bonus, both of which are adjusted each year in line
with CVP’s annual earnings.
Julia, Alexa, and Dane are at an impasse and have hired you to advise them with respect to
(1) the best use of the influx of cash,
(2) CVP’s investment, dividend, and capital structure policy, generally.
In light of Alexa’s recent confidential disclosure to him, Mitch also is concerned about the
company’s ability to succeed and grow, and the likelihood that situation together with the
concentration of equity ownership and lack of professional management will CVP’s ability to
fully exploit even the “normal” opportunities that present themselves to it.
Although they are quite intelligent, neither Julia, Dane, nor Alexa has any training in finance.
While nominally the CFO, Mitch is really a “debit and credit guy,” and not a finance expert.
Thus, they have asked your firm to prepare a report and a presentation that includes well-
developed and clearly expressed conceptually sound arguments for and against each alternative
use of the cash together with a recommendation for the single action to be taken supported by the
conceptual arguments. They are particularly interested in obtaining from you a framework they
can employ in the future when making seemingly integrated investment, financing and
distribution decisions for CVP. Finally, they would appreciate your thoughts on the corporate
and personal costs and benefits of (1) reducing their ownership stakes, and (2) raising new,
external equity or selling a significant amount of debt (i.e., using debt for other than temporary,
project funding). Mitch has asked that you address separately his concerns with respect to the
company’s ability to succeed and grow, and the likelihood that situation together with the
concentration of equity ownership and lack of professional management will CVP’s ability to
fully exploit even the “normal” opportunities that present themselves to it. Privately, Alexa has
asked that you not disclose her desire to retire.

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 Appendix

Latest EBIT $5,250,000.00

Unlevered competitor’s equity beta 1.4
Risk free rate 1.5%
Corporate tax rate 21.0%
Market risk premium 7.0%
Borrowing cost 4.5%
Current retention ratio 50.0%
Return on reinvested equity 20.0%