After graduating, you have been employed by a company called PlastiTubes Ltd., as a project finance manager. PlastiTubes is a variety of Fibre Reinforced Polymer (FRP) pipes and containers used for transporting and storing corrosive liquids. PlastiTubes supplies customers involved in the petrochemical and wastewater (sewage) treatment industries. Their main product, FRP pipe, has an exceptional strength to weight ratio, and weight for weight is stronger than steel. The pipes also have good shock and impact resistance and excellent flow characteristics as a smooth glass-like interior finish reduces material build-up and improves fluid transmission. PlastiTubes is a medium sized company listed on the NZX and has 20 million shares on issue - the current share price is $2.40. In addition, PlastiTubes issued 5 million preference shares three years ago. These preference shares have a $1 face value and a fixed dividend of 12% p.a. The preference shares are currently trading at $1.50 each. The company's equity beta (B) is 1.20, the New Zealand market risk premium is estimated at 6.0% p.a., the yield on 10-year New Zealand government bonds is 2.50% p.a., and the company tax rate is 28%. The company's long-term debt consists entirely of 15,000 10-year bonds issued exactly five years ago (these are listed on NZDX). Each bond has a face value of $1,000 and an annual coupon rate of 8.5% (paid semi-annually). The bonds are currently trading at a yield to maturity of 5.23% p.a. Extracts from PlastiTubes' latest financial statements show the following: Balance Sheet of PlastiTubes as at 31 September 2020 (5000) Current Assets Non-Current Assets 4,000 Current Liabilities 2,000 47,000 Non-current Liabilities 15,000 Preference Shares 5,000 Ordinary Shares 20,000 Retained Earnings 9,000 Total Assets 51,000 Total L&OE 51,000 You have just received the following memo from the company's Chief Executive Officer George Lazyboy and have decided you need to prepare thoroughly for any questions that might arise from your colleagues. On first glance you are a little concerned with some of the calculations and feel you might have to talk briefly with Mr Lazyboy before the meeting as well. 1. Prepare your own detailed calculation of PlastiTubes' WACC. (Round your answer up to the nearest %) 2. Clearly identify all parts of your calculations that differ from Mr. Lazyboy's and thoroughly explain/justify your assumptions and calculations. Memo To: All Finance Staff From George Lazyboy - CID Date: 29 January 2001 Re Capital Expenditure As you know. PlastiTubes evaluates Capital Expenditure decisions using discounted cash-flows. The discount, or hurdle, rate is our company's weighted average cost of capital. This is to clarify our company's long-standing policy regarding hurdle rates for these investment decisions. PlastiTubes is considering an investment in a new FRP Filament Finder that will improve the quality and reliability of our manufacturing processes, simultaneously eliminating significant proportion of our variable costs. In case you re unaware, filament winding is the process of winding resin-impregnated fibre on a sandrel surface in a precise eric pattern. This is accomplished by rotating the mandrel shile a delivery bead, under computer control, precisely positions continuous strands of fitres on the sandrel surface. Compared to our existing. Labour intensive, manufacturing process this investast should provide us with significant advantages however, it does also significantly increases the company operating Leverage Our target rate of return on equity has been 105 for many years. I realise that many new employees feel that this target is too high but I feel we need to aim for the highest profitability we can in order to keep our shareholders as happy as possible. The following table summarises the composition of PlastiTubes Boods Preference Shares Ordinary Shares Amount (5000) 15,000 5,000 20,000 financing S of total 37.06 Rate of returs 8.06 12.0 12.09 50.0% 14.0% From this data I have estimated PlastiTubes weighted average cost of capital as RACC (0.375 x 0.085) + (0.125 x 0.12) (0.50 x 0.14) - 0.1158 or 12% Therefore the official hurdle rate for this and all future CE decisions is 125. If you have any further questions about these calculations please direct those to our new project finance ager she has just graduated with a degree in finance and is more than qualified to explain things to you. As stated in Mr. Lazyboy's memo from Part 1, PlastiTubes is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of its manufacturing processes, simultaneously eliminating a significant proportion of its variable costs. Filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to its existing, labour intensive, manufacturing process this investment significantly increases the company's operating leverage. The plant will cost $10 million plus a further $100,000 investment in inventory at the start of the project, and is expected to last for seven years before it needs replacing. The new plant is expected to generate an additional $6.8 million revenue in its first year and achieve a growth rate in revenues of 10% for the next two years, flattening out at 5% for the remainder of the plant's life. Variable costs are projected to be 45% of sales in the first year and will then grow at a constant rate of 4% thereafter (ie. they are not 100% variable with respect to sales). Fixed costs (excluding depreciation) of $2.5 million are anticipated each year. The new plant would be depreciated on a straight line basis over the seven years to a residual value of $3 million. The company's production manager has asked your finance team to complete a financial analysis for the investment. He will make a recommendation to the board of directors based, in part, on your financial analysis and report. 1. Prepare a thorough analysis of the proposal on Excel. Print a copy of this analysis on a single A4 sheet and attach it to your assignment. 2. From your analysis, recommend whether PlastiTubes should accept the proposed investment and explain why or why not. 3. From your analysis, explain what might have happened if PlastiTubes had used Mr. Lazyboy's WACC (from Part 1) to evaluate this proposal