Question
Investment in new machinery $10,000,000 Useful life of the machinery 5 years Depreciated using straight line depreciation to zero salvage value over the useful life
Investment in new machinery $10,000,000 Useful life of the machinery 5 years Depreciated using straight line depreciation to zero salvage value over the useful life of machinery Expected life of the project 4 years Expected incremental annual sales in the next 4 years $12,500,000 Cost of goods sold 60% of sales Fixed Operating Expenses per year $500,000 Estimated selling price at the end of 4 years $1,750,000 Working capital needs to support sales of $12,500,000 $3,000,000 Working capital will be provided at the beginning of the project and recouped at the end of project Tax rate 40% Beta of HMM 1.5 Risk-free rate 3% Market risk premium 6% After tax cost of debt 6% Target debt ratio 40%
(a) HMM is looking at investment in the new machine. In order to evaluate the project, estimate the relevant cash flows and calculate the following: (i) Weighted average cost of capital (8 marks) (ii) Initial Investment (Investment in net working capital of $3,000,000 is at the start of the project and recovered at the end of the project) (4 marks) (iii) Annual cash flows (8 marks) (iv) Terminal Cash flows (4 marks) (v) Net present value (4 marks) (b) Recommend whether the project should be undertaken. (2 marks)
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