As a consultant for Health & Vitalize Inc. (HVI), you have been asked to compute the cost of capital to use in the evaluation of the purchase of a new warehouse facility. You have determined the market value of the firms current capital structure (which the firm considers to be its target mix of financing sources) as follows:

To finance the purchase, the company will sell 20-year bonds with a RM1 000 par value paying 8% coupon per year, at market price of RM1 000. The company also will issue preferred stock with a RM2.50 dividend per share and can be sold for RM35. The flotation cost for preferred stock is 2 percent. In addition to that, HVI will finance this new warehouse facility with common stock which is currently selling for RM50 per share. The company paid a RM2 dividend per share last year and expects dividend to continue growing at a rate of 4 percent per year into the indefinite future. The companys corporate tax rate is 23%.

Source of Capital	Market Value (RM)
Bonds Preferred Stock Common stock	500,000 100,000 400,000

Using all relevant information given:

1. (a) calculate the cost of debt.

2. (b) calculate the cost of preferred stock.

3. (c) calculate the cost of common stock.

(4 marks) (3 marks) (4 marks)

4. (d) discuss the different methods in calculating cost of common stock. Does the cost differed when using this different method? Which method is more practical to be used?

   (4 marks)

5. (e) calculate the weighted average cost of capital (WACC) for the company. (6 marks)

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(f) If prevailing interest rate in the marketplace is 8%, should the firm proceed with the financing decision given the capital structure? State your reasons.

(2 marks)

2. In addition to purchasing the warehouse facility, HVI is also considering producing a new health supplement product involving the purchase of a new machine which costs RM250 000. Additional RM50 000 will be needed for transportation and modification of the machine. This new machine will expect to generate sales of this new product for RM150 000 in this first year, and for 15% sales increase annually until the end of the machine economic life. The firm would use the 3-year MACRS (modified accelerated cost recovery system) to depreciate the machine, and the company anticipates the machine would have a value of RM23 000 at the end of its 4-year economy life. The annual maintenance cost is RM25 000. This new machine would require working capital which is 10% of sales annually. However, the increase in working capital will be recovered at the end of the 4 years projects life. Firms corporate tax rate is 23% and a 10% WACC is appropriate for this project.

MACRS TABLE

YEAR	3-YEAR
1 2 3 4	33% 45% 15% 7%

(a) Calculate the cost of the machine and estimate the net cash flows of the project from year 0 to year 4. Discuss what is an incremental cash flow and why it is applicable in estimating the projects net cash flow.

(10 marks)

3

2. (b) Calculate the payback period for the project and discuss the acceptance criteria for this method.

   (5 marks)

3. (c) Calculate the net present value (NPV) for the project. If the NPV is negative

what does it means? (d) Calculate the profitability index (PI) for the project.

(6 marks)

(3 marks)

(e) Based on your answers in (a), (b), (c) and (d), should the company purchase the machine? State your reasons in regards if this project is an independent or mutually exclusive project.