Question
Engineering = 2.2 Sportswear = 1.1 Water utility = 0.6 The companys financial structure is presently 70% equity and 30% debt. The cost of debt
Engineering = 2.2
Sportswear = 1.1
Water utility = 0.6
The companys financial structure is presently 70% equity and 30% debt. The cost of debt is 8% and the cost of equity is calculated using the Capital Asset Pricing Model (CAPM) where the industry average asset beta is 1.2; the risk free rate is 6% and the market risk premium is 8%. The corporate tax rate is 30%.
The financial manager has provided the following estimates of after-tax cash flow for the three projects which are assumed to have equal lives of 5 years.
Year
Engineering
(in GHm)
Sportswear
(in GHm)
Water Utility
(in GHm)
0
(5)
(3)
(15.0)
1
2.00
1.80
5.60
2
2.50
1.25
4.85
3
2.70
0.85
4.50
4
1.50
0.50
3.70
5
0.90
0.30
2.80
(i) Calculate the benchmark cost of capital (5 marks) (ii) Calculate the appropriate cost of capital for each project. (15 marks) (iii) Evaluate the viability of each project using NPV. (15 marks) (iv) As part of your evaluation, explain the reasons behind your choice of the cost of capital for each project
Engineering = 2.2
Sportswear = 1.1
Water utility = 0.6
The companys financial structure is presently 70% equity and 30% debt. The cost of debt is 8% and the cost of equity is calculated using the Capital Asset Pricing Model (CAPM) where the industry average asset beta is 1.2; the risk free rate is 6% and the market risk premium is 8%. The corporate tax rate is 30%.
The financial manager has provided the following estimates of after-tax cash flow for the three projects which are assumed to have equal lives of 5 years.
Year | Engineering (in GHm) | Sportswear (in GHm) | Water Utility (in GHm) |
0 | (5) | (3) | (15.0) |
1 | 2.00 | 1.80 | 5.60 |
2 | 2.50 | 1.25 | 4.85 |
3 | 2.70 | 0.85 | 4.50 |
4 | 1.50 | 0.50 | 3.70 |
5 | 0.90 | 0.30 | 2.80 |
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