GAG plc wishes to undertake a new project. This is a four years project. As a result, GAG Plc. is required to invest 100,000 in the purchase of a plant. The plant would be sold for 7,000 on 1st January in the year 5. A working capital of 20,000 would be introduced at the start of the project and 100% is recoverable at the end of year 4. The expected cash inflows for the project are given in the table below. The cost of capital is 10%. Year Cash inflow (in ) 1 40,000 2 60,000 3 60,000 4 80,000 Required: a) Estimate cash flow for the project (6Marks) b) Estimate Net Present Value of the project (5Marks) c) State the NPV decision rule and use NPV calculation of the project and advise whether the project should be undertaken (5Marks) d) Comment on the strengthen and weaknesses of the NPV approach for appraising investment projects (4marks)

Discuss any limitations of WACC and why it may lead to difficulties when applied by Hinkle in investment appraisal in the years ahead (10marks)

(2marks for any point discussed)

Students should draw on and show knowledge of the academic literature and theory of weighted average cost of capital as well as including any specifics under the following points:

Cost of equity is difficult to calculate because

To estimate cost of equity CAPM is used and it has limitations

CAPM is the is a static model

Risk free and market return can change

Optimal capital structure is not achievable in the real world

It is derived from past information

It is appropriate as a discounting rate assuming the risk of the project is equal to the business risk of the firm

Tax rate is assumed to be static