It is 30 November 2022.

Monriche Ltd, trading as Monriche, is a listed company that sells products that enhance health and fitness. Some of the products sold by the company are manufactured in-house, whilst other products sold are sourced from other suppliers. Examples of products in Monriches sales range include accessories for swimming pools, equipment for school gymnasiums and fittings for basketball courts.

Monriches research and development department has been investigating scope for new products and has established that there is a market for flat-packed exercise equipment for niche markets. In particular, Monriche believes that specialised flat-packed exercise equipment for very young children, for people with mobility issues and for the frail elderly would sell particularly well. The cost of this research to date is $120,000. Given the findings of the research, Monriche is developing plans to make sets of flat-packed exercise equipment.

To make the equipment and flat- package it, Monriche needs to purchase a specialised machine. At a cost of $80,000 Monriches engineering department has reviewed available machines and has narrowed the choice to just two, the Packwell and the Smartpack. Information about both machines is set out below. However, it is important to know that, no matter what machine is chosen, the sales of flat-packed exercise equipment will be the same, and, likewise, the associated cost of goods sold for each set of flat-packed exercise equipment will be identical, no matter what machine is chosen.

Packwell

The Packwell machine has a price of $224,000 and a life of 4 years. If chosen, this machine will be installed in a space in the Monriche factory that is currently not being used. Getting this space ready to house the Packwell machine and then installing the machine will cost $40,000. Initial staff training will cost $15,000

There will need to be a maintenance contract put in place with the vendor of the Packwell machine. Discussions with this vendor have resulted in the maintenance for each of the 4 years being $23,000. This maintenance fee must be paid at the beginning of each year the machine is in operation.

The staffing cost for the 2023 calendar year will be $80,000. This cost is expected to increase by 2.5% annually.

If Packwell is chosen, there will be additional net working capital of $60,000 for the life of the project.

At the end of the four years, it is expected that the Packwell machine can be sold for $7,000.

Smartpack

The Smartpack machine has a price of $330,000 and a life of 6 years. If chosen, this machine will be installed in the same space in the Monriche factory that would be used for the Packwell machine. However, getting this space ready to house the Smartpack machine and then installing the machine will cost $60,000. Initial staff training will cost $16,000

The maintenance contract for the Smartpack ,machine will be $21,000 for the first year with an annual increase of 2% per annum across the 6 years that the machine will be in place

The staffing cost for the 2023 calendar year will be $70,000. This cost is expected to increase by 2.5% annually.

If Smartpack is chosen, there will be additional net working capital of $70,000 for the life of the project.

At the end of the six years, it is expected that the Smartpack machine can be sold for $4,500.

Further information:

Both the production machineries must be depreciated using the straight-line method to reduce the value to zero during the life of the project.

The net working capital invested to run either of the projects may be assumed to be recoverable in its entirety at the end of the project.

The production machine maintenance cost for both options needs to be paid at the beginning of each year.

The applicable tax rate for Monriche Ltd is 25%.

Capital Structure Data Monriche Ltd.

Monriche has four types of debt, i.e. bonds, a mortgage, a commercial business loan and a line of credit facility which it uses on an ongoing basis

The mortgage is for $40 million at a rate of 3.6% per annum compounding monthly. The commercial business loan - is for $10 million at a rate of 4.2% per annum compounding quarterly The line of credit facility is for $800,000 at a rate of 11% per annum compounding daily.

Monriche has 100,000 bonds on issue. These bonds are selling today at $1020.40 per bond, with each bond having face value of $1,000 and maturing on 31 May 2027. These bonds have a coupon rate of 4.5% per annum, with coupons paid half yearly. A coupon payment was made this morning i.e. the morning of 30 November 2022. The next coupon payment will be on 31 May 2023.

Monriche has 67.5 million shares on issue. These shares are trading today (30 November 2022) at $2.80 per share, and the company has just paid its yearly dividend of $0.40. Its dividends have been growing consistently at 1.2% per annum for the past 6 years.

Financial advisors advise that the risk of this capital investment can be considered as equal to the present risk of the company as it is structured now.

Whichever option is decided upon, the machine will be purchased in the next month i.e. December 2022 and will be installed and ready for service by January 1 2023.

The applicable taxation rate is 25%.

Questions:

1.Determine the weighted average cost of capital (WACC) that should be used in NPV analysis to evaluate Monriche Ltds choice between the Packwell machine and the Smartpack machine. (8 marks)

2. Using the WACC you have established for Monriche Ltd, undertake an NPV analysis of the two alternatives machines. (16 marks)

3.Based on your analysis from question 2, provide a recommendation to Monriche Ltd, explaining your reasoning, setting out the assumptions you have made and explaining any limitations of your study. (Between 200 250 words, referenced using the RMIT Harvard (author-date) method). (6 marks)

4. Monriche Ltd has a capital structure that includes both shares and bonds. Explain one way in which shares and bonds are similar, and two ways in which they are different. (Between 300 and 400 words, referenced using RMIT Harvard (author-date) method). (10 marks)

5. As recently as two years ago, Monriche Ltd used Internal Rate of Return (IRR) as its analysis approach to capital investment. However, in 2020, a new Chief Financial Officer (CFO) was appointed and this person argued successfully to the Board of Monriche Ltd that NPV is a superior analysis approach when making decisions for capital expenditure. Explain two issues with IRR that are not problems when using NPV analysis that the CFO might have used in a presentation to the Board about assessment of possible capital expenditure projects. (Between 300 and 400 words, referenced using RMIT Harvard (author-date) method).