Question 1 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-downvalue method. You are required to: 1. Compute the cost of equity for this project 2. Compute the relevant cost of debt for this project. 3. Compute the WACC 4. Determine the initial cash flow for the project.
Question 1
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
to a tax rate of 30%
Plant and machinery will be depreciated at the rate of 25% per year as per the written-downvalue method.
You are required to:
1. Compute the
2. Compute the relevant cost of debt for this project.
3. Compute the WACC
4. Determine the initial cash flow for the project.
5. Determine the earnings before taxes for years 1 through 5
6. Compute the OCF for years 1 through 5
7. Compute the Terminal cash flow.
8. Compute the FCF for years 1 through 5
9. Compute the project’s
10. Should the project be accepted or rejected?
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