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Msc in Economics and Business Administration Master Thesis MSc in Finance

Valuation of Pfizer Inc. and analysis of new drug development project using a real option approach.

Author: Valdis Cvetkovs

Supervisor: Peter Lochte Jorgensen

April 2011 Aarhus

Abstract
This thesis investigates the world’s largest pharmaceutical company Pfizer Inc. from strategic and financial viewpoint in order to determine companies’ fair market value. The external analysis researches industry and global economic situation on the valuation date as well as states the future trends. Bases for valuation consist of discounted cash flow valuation. Additionally the real option valuation method is used to determine the value of experimental medicine at the beginning of its development process. The results are compared to the usual discounted cash flow valuation method and give an answer if development of new medicine shall or shall not be proceeded with.

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Acknowledgment
I express sincere acknowledgement to my supervisor, Peter Lochte Jorgensen, for his help and support during the thesis writing process. I am also thankful to personnel at Aarhus Business School during the whole study period. I would like to thank my family and friends for supporting and encouraging me to pursue with this degree. Special thanks for support, inspiration and being next to through this two year master’s program besides my family to Jan Bernatzky, Mihail Kuklin and Boriss Kuzmin.

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Table of contents:

1. Introduction .................................................................................................................. 6 1.1. 1.2. 1.3. 1.4. Methodology ..................................................................................................... 6 Problem Statement ............................................................................................. 7 Brief introduction to Pfizer ................................................................................ 7 Limitations: ........................................................................................................ 8

2. Analysis of companies’ historical performance: .......................................................... 9 2.1. 2.2. 2.3. 2.4. 2.5. 2.6. 2.7. 3. Accounting standards: ....................................................................................... 9 Reformulation of financial statements: .............................................................. 9 Capitalized expenses: .............................................................................. 9 Calculation of invested capital: ........................................................................ 11 Net operating profit less adjusted taxes ........................................................... 12 Revenue growth: .............................................................................................. 13 Return on invested capital: .............................................................................. 14 The Free Cash Flow: ........................................................................................ 16

2.2.1.

Estimating Weighted average cost of capital ......................................................... 18 3.1. 3.2. 3.3. 3.4. 3.5. 3.6. Estimating the cost of equity: .......................................................................... 18 Estimation of risk free rate: ............................................................................. 19 Estimation of beta: ........................................................................................... 19 Obtaining the Market risk premium: ............................................................... 22 Estimation of after tax cost of debt .................................................................. 23 Estimating the Capital Structure. ..................................................................... 23

3.7. Computing Weighted Average Cost of Capital and...
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