Eric Coli is the financial manager Preserved Foods, a manufacturer of packaged foods. The company is considering an investment of $180 million in a new production facility. The facility is to be valued over 5 years and will be depreciated straight-line to zero over this period. Details on the Facility The facility is expected to generate revenue of $44 million per year and incur cash expenses of $14 million per year. These expenses do not include interest on debt, which Eric estimates to be $4 million per year. The new facility will also result in cost savings in other areas of the plant and these are estimated to be $18 million per year. Eric estimates that the facility will require an increase in working capital for the company of $20 million. Based on similar facilities in operation in Europe, the facility is expected to have a salvage value of approximately $60 million after 5 years. Details on the Company The balance sheet of Preserved Foods is currently as follows: Assets $800m Debt $300m Shareholders Funds $500m The company has 100 million shares on issue and the current share price $6.22. The debt is in the form of a bond issue that has five years remaining to maturity. The bond requires an annual payment of interest at 9.5% (the coupon rate) and the face value is paid at maturity. Preserved Foods has a BBB credit rating, and this means it can currently raise 5-year funds at an interest rate of 8%. The beta of Preserved Foods is currently 1.077. The government bond rate is 6% and the market risk premium is considered to be approximately 7%. The company pays tax at 30% and inflation is expected to be zero. Details on the Financing Proposal Eric is considering two alternative financing proposals. (1) A combination of debt and equity to finance the facility. The relative proportion of debt to equity would approximately match the balance sheet at market value. (2) Finance the facility entirely with new debt. Eric likes the second option because debt is considerably cheaper than equity. Which financing option should Eric take? Should the project proceed?