Horizon Co is a manufacturing company that wishes to evaluate an investment in new production machinery. The machinery would enable the company to satisfy increasing demand for existing products and the investment is not expected to lead to any change in the existing level of business risk of Horizon Co. The machinery will cost Rs.25 million, payable at the start of the first year of operation, and is not expected to have any scrap value. Annual before-tax net cash flows of Rs. 680,000 per year would be generated by the investment in each of the five years of its expected operating life. These net cash inflows are before taking account of expected inflation of 3% per year. Initial investment of Rs. 240,000 in working capital would also be required, followed by incremental annual investment to maintain the purchasing power of working capital.

Horizon Co has in issue five million shares with a market value of Rs. 381 per share. The equity beta of the company is 12. The yield on short-term government debt (Risk free rate) is 45% per year and the equity risk premium is approximately 5% per year. The debt finance of Horizon Co consists of bonds with a total book value of Rs. 2 million. These bonds pay annual interest before tax of 7%. The par value and market value of each bond is Rs. 100. 2 Horizon Co pays taxation one year in arrears at an annual rate of 25%. Capital allowances (taxallowable depreciation) on machinery are on a straight-line basis over the life of the asset.

Required:

a. Calculate the after-tax weighted average cost of capital of Horizon Co. b. Prepare a forecast of the annual after-tax cash flows of the investment in nominal terms, and calculate and comment on its net present value.