Industry division - capital investment

Sonkrag Inc. is now considering undertaking a capital investment in the UK to manufacture industrial solar panels. The project would require immediate capital expenditure of 10m, plus 1m of working capital which would be recovered at the end of the project's five year term.

It is estimated that annual revenue of 2m would be generated by the project, with annual operating costs of 1m. Capital allowances equivalent to straight-line depreciation over the term of the project are an allowable expense against company tax in the UK which is charged at a rate of 40%, payable at each year-end. The project can be assumed to have a zero scrap value.

Sonkrag plc plans to finance the project with a 9m four-year loan at 6% from the corporate finance market, plus 2m of retained earnings. The proposed financing scheme reflects the belief that the project would have a debt capacity of two-thirds of capital cost. Issue costs on the debt will be 3% and are tax deductible.

In the UK the industrial solar industry has an equity beta of 1.40 and an average debt: equity gearing ratio of 1:4. Debt capital can be assumed to be virtually risk-free. The current return on UK government stock is 9% and the excess market return is 9.17%.

Corporate tax in the UK is at 35% and can be assumed to be payable at each year-end without delay. Because of a double-taxation agreement, Sonkrag plc will not have to pay any US tax on the project. The company is expected to have a substantial US tax liability from other operations for the foreseeable future.

The current spot rate is 1 = $1.60 and the GBP () is expected to depreciate against the $ at an annual rate of 10%.