Green Energy Ltd. has a target capital structure that consists of 55 percent debt. 10 percent preferred stock and 35 percent equity. The companys 9% debentures have 20 years to maturity and are currently selling at $1 025. The 13% preferred stock has a $10 par value and is currently being traded at $15. The companys common stock trades at $30 a share its current dividend of $3 per share is expected to grow at a constant rate of 7% per year. The tax rate is 32%

Green Energy Ltd. are considering the introduction of a component, the Zero Waste, which significantly increase fuel efficiency in motor vehicles. To produce the component the company would have to acquire new equipment. This equipment would cost $300 000, with installation costs of $20 000, and be usable for 10 years, after which it would have a salvage value equal to 5% of the original purchase cost. Production and sale of the component would require a working capital investment of $45 000 to finance accounts receivable, inventories and day to day cash receipts.

Sales in the first year are expected to be $750 000 and this is expected to grow by an average of 4% for each year of the projects life. Variable costs for production, administration and sales will be $225000 per year (these costs are expected to vary proportionately). Advertising costs are expected to be $200 000 annually for the first two years, after which these costs are expected to amount to $75 000 per year. Other fixed costs will total $80 000 per year (including depreciation of $30,500).

Required

a) Compute the cost of capital to be used to discount the projects cash flows

b) Compute the relevant after-tax net cash flows of the project.

c) Using Excel, compute the following:

i. Discounted Payback

ii. NPV

iii. PI

iv. IRR

v. MIRR

d) Explain TWO disadvantages of using discounted cash flow methods to evaluate capital projects

e) Using examples, describe FOUR types of real options.