Erwin Enterprises is a large publicly listed company and is the market leader in vacuum cleaner manufacturing. The company is looking to set up a manufacturing plant overseas to produce a new line of commercial vacuum cleaners. This will be a six-year project. The company bought a piece of land four years ago for $ 8 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive $ 9.75 million after taxes. In six years the land can be sold for $7 million after taxes and reclamation costs. Erwin Enterprises wants to build a new manufacturing plant on this land. The plant will cost $320 million to build. The following market data on Erwins securities are current:

Debt	$120,000,000,7.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 95 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments.
Equity	15,000,000ordinary shares, selling for $55 per share
Non-redeemable Preference shares	12,000,000 shares (par value $ 10 per share) with 6.5% dividends (after taxes), selling for $32 per share

The following information is relevant:

Erwin Enterprises tax rate is 28%

The company had been paying dividends on its ordinary shares consistently. Dividends paid during the past five years is as follows

Year (-4) ($)	Year (-3) ($)	Year (-2) ($)	Year (-1) ($)	Year (0) ($)
4.6	4.8	5.2	5.5	6.1

The project requires $ 8.25 million in initial net working capital investment in year 0 to become operational.

Work all solutions to the nearest two decimals.

Required:

Calculate the projects initial, (time 0) cash flows, taking into account all side effects.

(2 marks)

Compute the weighted average cost of capital (WACC) of Erwin Enterprises. Show all workings and state clearly the assumptions underlying your computations.

(10 marks)

Using the WACC computed in part (2) above and assuming the following, compute the projects Net Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI)

The manufacturing plant has a ten-year tax life, and Erwin Enterprises uses Diminishing value method depreciation for the plant at 25% per annum. At the end of the project, (i.e. at the end of year 6), the plant can be scrapped for $ 42 million.

The project will incur $220 million per annum in fixed costs

Erwin Enterprises will manufacture 280,000 commercial vacuum cleaners per year in each of the years and sell them at $ 2,200 per vacuum cleaner.

The variable production costs are $ 800 per vacuum cleaner.

At the end of year 6, the company will sell the land.

(7 marks)

2.2. What are the pros and cons of using risk-adjusted costs of capital for individual investments?

(5 marks