Novis Corporation, a medical supplies and equipment company based in San Francisco, has a capital structure comprising 30% debt & 70% equity. It plans to finance an ear and eye equipment plant which requires an initial investment of 10 million. 3 million of the initial investment will be financed by debt and the rest by equity. This new plant is expected to generate pre-tax cash flows of $1.6m a year in perpetuity.

Assume pre-tax cost of debt = 5%, levered equity beta = 2, risk free rate = 4%, market risk premium = 4%, corporate tax rate = 40%

a) What is a scale-enhancing versus non-scale-enhancing project? Is Novis’s new investment scale-enhancing or not?

b) Use the FTE approach to evaluate what is the NPV of this project. What will be the value of Debt and Equity after this new investment?

c) Based on your answer in a), what is WACC for the new plant? What is the NPV of the investment under the WACC approach? Is the answer the same in part a)?

d) For this specific problem, which approach would you prefer, FTE or WACC? Why?