Question
Axis Co is a small company and because it finds it difficult to raise new financing, investments are subject to capital constraints. An investment is
Axis Co is a small company and because it finds it difficult to raise new financing, investments are subject to capital constraints. An investment is currently being considered and there are two potentially beneficial projects: Cylinder and Sphere. There is only financing for one of the two projects and the projects are mutually exclusive. Each project will last for five years, financial information is as follows:
Project Cylinder:
Net present value (NPV)
£2,000,000
Internal rate of return (IRR)
16·2%
Payback
4 years 2 months
Project Sphere, annual after-tax cash flows expected at the end of each year:
Current - (15,500)
Year 1 - 1,540
Year 2 - 7,100
Year 3 - 5,440
Year 4 - 6,800
Year 5 - 2,750
Cashflows £000s
Further information:
Axis Co has 1,000,000 shares in issue with a nominal value of 50p and a market value of £3.10. It currently has debt redeemable in three years with a nominal value of £1 million and a market value of 95%. The cost of equity is 11.75% and the pre-tax cost of debt is 6%. Corporation tax is 25%.
Required:
a) Calculate the weighted average cost of capital.
(4 marks)
b) Calculate the NPV, IRR and payback figures for project Sphere and recommend which project should be accepted. You must show all workings.
(6 marks)
c) Provide a reasoned justification for your recommendation
(5 marks)
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