Question
JJ Plc a Pharmaceutical company is considering an investment in the production of COVID19 testing kit. The following information relates to the investment under consideration:
JJ Plc a Pharmaceutical company is considering an investment in the production of COVID19 testing kit. The following information relates to the investment under consideration: Year 1 2 3 4 Sales and production(units) 150,000 62,000 60,000 57,000 Unit selling price (K) 25 23 22 20 Direct material cost per unit (K) 5.2 5.3 5.4 5.6 Other variable cost per unit (K) 5.67 5.68 5.69 5.73 Fixed costs (K) 682,500 282,100 273,000 259,350 The COVID19 testing kit will be produced on a new production machine costing K1million. The current financing structure will not change significantly. JJ Plc is financed by Ordinary shares (50ngwee par value) K1 million trading at K1.69 per share and 10% bonds K900, 000 with par value of K100 on which the interest is payable annually on 31 December. The debt is due for redemption at par in four years time. The market price of the bonds is K95. The market expected rate of return is 7%. KB Plc a company in the same industry as JJ Plc has an expected return of 8% from its ordinary shares and have a beta of 1.2. JJ Plc has a beta of 1.8 and pays tax on profit at a rate of 30% per year. Tax liabilities are settled in the year in which they arise. Required: a) Calculate the weighted average cost of capital using the market values as weighting factors. b) Calculate the net present value of the investment and advise whether the investment is acceptable. c) Calculate the Internal Rate of Return of the investment and advise whether the investment is acceptable.
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