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Michael Wright graduated from the University College in June and has been working for about a month as a junior financial analyst at Caledonia Products
Michael Wright graduated from the University College in June and has been working for about a month as a junior financial analyst at Caledonia Products Ltd. When Michael arrived at work on Monday morning, he found the following memo in his e-mail. TO: Michael Wright FROM: V. Morrison, CFO, Caledonia Products Ltd. RE: Capital Budgeting Analysis Provide an evaluation of the three proposed projects whose cash flow forecasts are found below: Product A Product B Product C Initial cost Expected life Scrap value expected $760,000 5 years $30,000 $650,000 5 years $35,000 $512,000 4 years $20,000 Expected cash inflows: Year -ati 320,000 300,000 240,000 320,000 180,000 200,000 240,000 210,000 260,000 180,000 200,000 210,000 180,000 160,000 Since these projects involve additions to Caledonia's highly successful Avalon product line, the company uses the WACC of the line to evaluate the additions. The projects are independent. 1. Cost of Debt is 15.63% and the tax rate is 20%; 2. The dividend paid out for preference shares is $6. Each share currently trades at $21 and has a floatation cost of $3; 3. Ordinary shares receive a dividend of $1.50 per share. It has growth rate of 10% and it is currently trading at $15 with a floatation cost of $2.31. Note: The Debt : Preference Shares : Ordinary Shares ratio is 3 : 2:5 Calculate for each project: A. The payback period for each project B. The Net Present value (NPV) C. The Profitability Index (PI) D. Which project should be accepted and why
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