126.23 126.23 12. 106.30 89.5175 As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. An additional scenario will be considered. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the worst scenario. (5 marks) Should JA accept the new project? Discuss in detail. (7 marks) The project manager of JA suggests that the company should use more debt rather than equity to finance this project since debt is cheaper than equity. Will you take this advice? Explain your answer by using M&M capital structure theory. (8 marks) f + 65 1 41.23 2 comwon stock -15.65 stment Case study 1 Johnsons Acoustics (JA) is the market leader in acoustic equipment. As there is no major technological breakthrough in the acoustic industry, there is little growth in this industry. JA demand of optical lens for mobile phones is huge, the diversification will bring an excellent JA believes that, as the growth opportunity to the company. In the diversification plan, the optical instruments project will last for 5 years and a new factory will be built, requires $280 millions and it will be financed by issuing both common stocks and bonds. The The construction of the new factory information about the company's current capital structure is as follows: The common stock is now trading at $15.05. We have used analysts estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 20 million. The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 100,000 bonds outstanding. The annual revenue, cost and profit forecast for the coming 5 years is as follows: $(Million) dividends & 6% / your Revenue 230 Variable cost expected duidend 2 39 Fixed cost 35 share outstanding -20000000 Tax (35% 54.6 Net Profit 101.4 Assume that Johnsons Acoustics has a 35% tax rate. At the end of year 5, an additional cost of $50 millions (net of tax) will be incurred. Compute the cost of equity of JA by dividend growth model. (5 marks) b What is the after-tax cost of debt of JA? (5 marks) If JG wants to maintain its current capital structure after issuing new equity and debt, compute is the WACC of JA. (5 marks) d The project manager of JA feels that the appropriate discount rate of the new project should be 3% above the WACC. Compute the NPV, payback period and IRR of the new project (15 marks) e As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. Two additional scenarios, namely, best scenario and worst scenario, will be considered. In the best scenario, the revenue and variable cost will be increased by 20%. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the additional two scenarios. Should JA accept the new project? Discuss in detail, (10 marks) sh Flow it Cas 126.23 126.23 12. 106.30 89.5175 As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. An additional scenario will be considered. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the worst scenario. (5 marks) Should JA accept the new project? Discuss in detail. (7 marks) The project manager of JA suggests that the company should use more debt rather than equity to finance this project since debt is cheaper than equity. Will you take this advice? Explain your answer by using M&M capital structure theory. (8 marks) f + 65 1 41.23 2 comwon stock -15.65 stment Case study 1 Johnsons Acoustics (JA) is the market leader in acoustic equipment. As there is no major technological breakthrough in the acoustic industry, there is little growth in this industry. JA demand of optical lens for mobile phones is huge, the diversification will bring an excellent JA believes that, as the growth opportunity to the company. In the diversification plan, the optical instruments project will last for 5 years and a new factory will be built, requires $280 millions and it will be financed by issuing both common stocks and bonds. The The construction of the new factory information about the company's current capital structure is as follows: The common stock is now trading at $15.05. We have used analysts estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 20 million. The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 100,000 bonds outstanding. The annual revenue, cost and profit forecast for the coming 5 years is as follows: $(Million) dividends & 6% / your Revenue 230 Variable cost expected duidend 2 39 Fixed cost 35 share outstanding -20000000 Tax (35% 54.6 Net Profit 101.4 Assume that Johnsons Acoustics has a 35% tax rate. At the end of year 5, an additional cost of $50 millions (net of tax) will be incurred. Compute the cost of equity of JA by dividend growth model. (5 marks) b What is the after-tax cost of debt of JA? (5 marks) If JG wants to maintain its current capital structure after issuing new equity and debt, compute is the WACC of JA. (5 marks) d The project manager of JA feels that the appropriate discount rate of the new project should be 3% above the WACC. Compute the NPV, payback period and IRR of the new project (15 marks) e As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. Two additional scenarios, namely, best scenario and worst scenario, will be considered. In the best scenario, the revenue and variable cost will be increased by 20%. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the additional two scenarios. Should JA accept the new project? Discuss in detail, (10 marks) sh Flow it Cas