Vertex Pharmaceuticals Inc. Project
Calculating the free cash flow for Vertex Pharmaceuticals
To calculate the operating cash flows, the formulation that this analysis will be using is the differences between the operating cash flows and the capital expenses for the vertex pharmaceutical as a company from 2010 – 2015 (data represented in millions).
Year
2010
2011
2012
2013
2014
2015
Operating cash flows
(635)
144
268
(52)
(513)
(365)
Less Capital expense
(38)
(95)
(71)
(51)
(61)
(125)
Free cash flow
(673)
49
197
(103)
(574)
(491)
(a) Calculating the cost of equity using the CAPM
Having developed the returns of the VRTX stocks performance from the year 2000 – 2015 and that of the market index (S&P 500) also from the year 2000- 2015, Using the development of the covariance for the returns of the VRTX and the S&P 500 the beta is estimated at 0.9290. Using the second method, which is involving of the regression analysis the beta that is developed is estimated as by the regression analysis is 1.00269. With the help of the p-value providing a 0.000401 (0.04%) almost a zero, the suggestion is that the regression beta is very significant in this case. The difference between the two answers is less difference and in this case, the calculations will take the regression beta as the true beta based on the values provided by the p- value at an almost zero.
Identifying the risk-free rate from the average of returns of the treasury bills (Rf) = 5.61%
The expected rate of return, in this case, calculated as the average of the returns of the S&P 500 = 0.29%.
Therefore, the equity premium = Rm – Rf = 0.29 – 5.61 = -5.32%.
Therefore, the cost of equity as calculated by the CAPM = Re = Rf – β(Rm-Rf)
Re = 0.0561 – 1.00269(-0.0532)
Re = 0.1094 = 10.94%
(b) The WACC
From the excel calculations the WACC is developed as 5.761% using the provided estimations on the cost of equity by the 112-year treasury bills; however using our calculations the WACC is established as 9.812%.
(c) Bloomberg WACC for the Vertex Pharmaceuticals
This is provided as an 11.4%, the assumption that this presentation takes is that the website uses the discounted cash flows methods in calculating the WACC for the company (Bloomberg 2016).
Present values
Using the cost of equity
Year
2010
2011
2012
2013
2014
2015
Operating cash flows
(635)
144
268
(52)
(513)
(365)
Less Capital expense
(38)
(95)
(71)
(51)
(61)
(125)
Free cash flow
(673)
49
197
(103)
(574)
(491)
PV (at 10.94%)
$556.52
$360.95
$174.33
$270.72
$592.06
$805.48
Using the calculated WACC
Year
2010
2011
2012
2013
2014
2015
Operating cash flows
(635)
144
268
(52)
(513)
(365)
Less Capital expense
(38)
(95)
(71)
(51)
(61)
(125)
Free cash flow
(673)
49
197
(103)
(574)
(491)
PV (at 9.812%)
$580.42
$366.68
$173.61
$277.83
$614.62
$830.34
Using the provided WACC
Year
2010
2011
2012
2013
2014
2015
Operating cash flows
(635)
144
268
(52)
(513)
(365)
Less Capital expense
(38)
(95)
(71)
(51)
(61)
(125)
Free cash flow
(673)
49
197
(103)
(574)
(491)
PV (at 11.4%)
$547.17
$358.67
$174.58
$267.92
$583.21
$795.71
looking at the calculations of the discount rates are provided by the CAPM, the WACC, and the provided WACC which has been developed using the discounted cash flows, the solutions of the present values are developed above appear almost the same. However, the use of the CAPM appears advantageous based on the application of a detailed analysis. The WACC borrows some indices from it, therefore, making it less reliable. Looking at the Bloomberg position, the use of the dividends cannot be the sole position form, which the company’s returns are measured from. This focuses the reliability on using the CAPM model as shared by Beaulieu, Dufour and Khalaf (2012).
Reference List
Beaulieu, MC, Dufour, JM & Khalaf, L 2012, ‘Identification-robust estimation and testing of the zero-beta CAPM’, The Review of Economic Studies, vol 1, no. 44, pp. 21-38.
Bloomberg.com. (2016). VRTX: NASDAQ GS Stock Quote – Vertex Pharmaceuticals Inc. [online] Available at: http://www.bloomberg.com/quote/VRTX:US [Accessed 3 May 2016].
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