A 5-year project will require an investment of $100 million. This comprises of plant and machinery worth $80 million and a net working capital of $20 million. The entire outlay will be incurred at the project’s commencement.
Financing for the project has been arranged as follows:
80,000 new common shares are issued, the market price of which is $500 per share. These shares will offer a dividend of $4 per share in year 1, which is expected to grow at a rate of 9% per year for an indefinite tenure.
Remaining funds are borrowed by issuing 5-year, 9% semi-annual bonds, each bond having a face value of $1,000. These bonds now have a market value of $1,150 each.
At the end of 5 years, fixed assets will fetch a net salvage value of $30 million, whereas the net working capital will be liquidated at its book value.
The project is expected to increase revenues of the firm by $120 million per year. Expenses, other than depreciation, interest and tax, will amount to $80 million per year. The firm is subject to a tax rate of 30%
Plant and machinery will be depreciated at the rate of 25% per year as per the written-down-value method.
You are required to:
- Compute the cost of equity for this project
- Compute the relevant cost of debt for this project.
- Compute the WACC
- Determine the initial cash flow for the project.
- Determine the earnings before taxes for years 1 through 5
- Compute the OCF for years 1 through 5
Prepared and Released by the CC, MGMT2023, Semester 2, 2022
Release date: March 14, 2022, Due Date: April 8, 2022
- Compute the Terminal cash flow.
- Compute the FCF for years 1 through 5
- Compute the project’s NPV and IRR
- Should the project be accepted or rejected?