Question
A laser pointer manufacturer currently produces 300,000 units a year. It buys laser diodes from an outside supplier at a price of $3 a diode.
A laser pointer manufacturer currently produces 300,000 units a year. It buys laser diodes from an outside supplier at a price of $3 a diode. The plant manager believes that it would be cheaper to make these diodes rather than buy them. Direct production costs are estimated to be $2.2 a diode. The necessary machinery would cost $230,000 and would last 15 years. This investment could be written off immediately for tax purposes. The plant manager estimates that the operation would require additional working capital of $50,000 but argues that this sum can be ignored since it is recoverable at the end of 15 years. This operation is considered as risky as the manufacturers normal operations. The manufacturer has a market beta of 1.4. The risk-free rate is 2% per annum. The market risk premium is 10% per annum. The company pays tax at a rate of 28%.
(a) Using the capital asset pricing model (CAPM), calculate the expected rate of return on the proposed investment. (5 marks)
(b) Calculate the net present value of the proposed investment
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