Memo To: From: All Finance Staff George Lazyboy CEO Date: Re: 29 January 2021 Capital Expenditure As you know, PlastiTubes evaluates Capital Expenditure decisions using discounted cash-flows. The discount, or hurdle, rate is our company's weighted average cost of capital. This memo is to clarify our company's long-standing policy regarding hurdle rates for these investment decisions. PlastiTubes is considering an investment in a new FRP Filament Winder that will improve the quality and reliability of our manufacturing processes, simultaneously eliminating a significant proportion of our variable costs. In case you' re unaware, filament winding is the process of winding resin-impregnated fibre on a mandrel surface in a precise geometric pattern. This is accomplished by rotating the mandrel while a delivery head, under computer control, precisely positions continuous strands of fibres on the mandrel surface. Compared to our existing, labour intensive, manufacturing process this investment should provide us with significant advantages however, it does also significantly increases the company's operating leverage. Our target rate of return on equity has been 14% for many years. I realise that many new employees feel that this target is too high but I feel we need to aim for the highest profitability we can in order to keep our shareholders as happy as possible. The following table summarises the composition of PlastiTubes' financing: Amount ($000) Bonds 15,000 Preference Shares 5,000 Ordinary Shares 20,000 % of total 37.5% Rate of return 8.5% 12.5% 12.0% 50.0% 14.0% From this data I have estimated PlastiTubes' weighted average cost of capital as: WACC (0.375 x 0.085) + (0.125 x 0.12) + (0.50 x 0.14) = 0.1168 or 12% Therefore the official hurdle rate for this and all future CAPEX decisions is 12%. If you have any further questions about these calculations please direct those to our new project finance manager who has just graduated with a degree in finance and is more than qualified to explain things to you.