Davidson and Samuels PLC, is an industrial company that operates in several different ines of business. It is evaluating a new project that would involve the production of new children's toy, which would expand its toy business. You can assume that Davidson and Samuels is a continuously profitable company overall. (a) You need to estimate the discount rate for this project. Davidson and Sarnuels PLC can borrow aapre-tax rate of 5% Itisplanning to trd the progect via a new equity issue and has a target debt to fim value of 0.45. The expected equity returm af Davidson and Samuels PLC is 13% and the expected equity return of a company with smilar gearing that is in the chidren's toy industry is 11.5%. The affective tax rate is 17 5% What is the appropriate weighted average cost of capital? Explain the key assumptions you have made. 20 marks) Question 1 continuedl.... Page 1 of4 Question 1 continued (b) In arder to undertake this project, it is necessary to purchase a new piece of mechinery immediately at a cost of 10,00o,0oo. It is anticipated that this will have a resale value of 2,000,000 at the end of year 4. For tax purposes, capital allawanoes are caiculated on a straight-line basis. Identify al the relevant post-tax nominal cash flows for capital budgeing purposes that are associated with this capital investment (20 marks) (c) t is estimated that the folowing items will be incurred during the first year of the project. All igures are expressed in nominal year one terms The firm is aready committed to spending E100,000 on developing this new product over the next year and will spend an additional 550,000 on adapting the product to market requirements if the project goes atead. There is a fee of 25,000 to undertake the project evaluation It has been estimated that sales will be 300,000 items of the new praduct in year 1. You expect items to sell at 25 per item in nominal terms. The nominal variable oosts of production wil be 10 per item in year 1. The propct will lead to an increase in the firm's fxed costs of 500,000 but the tay division will be allocated with 750,000 of fixed costs. The project is expected to increase dividend payments by 75,000. For capital budgeting purposes, calculate the year 1 pre-tax nominal cashflows associated with income statement nems (which are not included in your answer to question 1) (15 marks) (d) Assume that for this project a negigble amount of working capital wil be held. Assume that sales will grow from year 1 to year 3 at 20% per annum but will decline by 40% in year 4 The firm expected to sell the machinery at the end of year 4 rather than continue production into year 5. Iration is expected to be 5% per annum and will impact all revenues and costs What is the NPV of this project? Interpret the NPV value. 25 marks) (e) Evaluate the primary limitations of the NPV analysis conducted and disouss if sensitivity analysis can help overcome these imitations Davidson and Samuels PLC, is an industrial company that operates in several different ines of business. It is evaluating a new project that would involve the production of new children's toy, which would expand its toy business. You can assume that Davidson and Samuels is a continuously profitable company overall. (a) You need to estimate the discount rate for this project. Davidson and Sarnuels PLC can borrow aapre-tax rate of 5% Itisplanning to trd the progect via a new equity issue and has a target debt to fim value of 0.45. The expected equity returm af Davidson and Samuels PLC is 13% and the expected equity return of a company with smilar gearing that is in the chidren's toy industry is 11.5%. The affective tax rate is 17 5% What is the appropriate weighted average cost of capital? Explain the key assumptions you have made. 20 marks) Question 1 continuedl.... Page 1 of4 Question 1 continued (b) In arder to undertake this project, it is necessary to purchase a new piece of mechinery immediately at a cost of 10,00o,0oo. It is anticipated that this will have a resale value of 2,000,000 at the end of year 4. For tax purposes, capital allawanoes are caiculated on a straight-line basis. Identify al the relevant post-tax nominal cash flows for capital budgeing purposes that are associated with this capital investment (20 marks) (c) t is estimated that the folowing items will be incurred during the first year of the project. All igures are expressed in nominal year one terms The firm is aready committed to spending E100,000 on developing this new product over the next year and will spend an additional 550,000 on adapting the product to market requirements if the project goes atead. There is a fee of 25,000 to undertake the project evaluation It has been estimated that sales will be 300,000 items of the new praduct in year 1. You expect items to sell at 25 per item in nominal terms. The nominal variable oosts of production wil be 10 per item in year 1. The propct will lead to an increase in the firm's fxed costs of 500,000 but the tay division will be allocated with 750,000 of fixed costs. The project is expected to increase dividend payments by 75,000. For capital budgeting purposes, calculate the year 1 pre-tax nominal cashflows associated with income statement nems (which are not included in your answer to question 1) (15 marks) (d) Assume that for this project a negigble amount of working capital wil be held. Assume that sales will grow from year 1 to year 3 at 20% per annum but will decline by 40% in year 4 The firm expected to sell the machinery at the end of year 4 rather than continue production into year 5. Iration is expected to be 5% per annum and will impact all revenues and costs What is the NPV of this project? Interpret the NPV value. 25 marks) (e) Evaluate the primary limitations of the NPV analysis conducted and disouss if sensitivity analysis can help overcome these imitations