Ocean Tide Industries is planning to introduce a new product with a projected life of eight years. The project is in the governments preferred industry list and qualifies for a one-time subsidy of $2,000,000 at the start of the project. Initial equipment (IE) will cost $14,000,000 and an additional equipment (AE) costing $1,000,000 will be needed at the end of year 2. At the end of 8 years, the original equipment, IE, will have no resale value but the supplementary equipment, AE, can be sold for its book value of $100,000. A working capital of $1,500,000 will be needed

. The sales volume over the eight-year period have been forecast as follows

: Year 1 80,000 units

Year 2 120,000 units

Years 3-5 300,000 units

Years 6-8 200,000 units

A sale price of $100 per unit is expected and the variable expenses will amount to 40% of sales revenue. Fixed cash operating expenses will amount to $1,600,000 per year. Additionally, an extensive advertising campaign will be launched, which will need annual expenses as follows:

Year 1 $3,000,000

Year 2 $1,500,000

Years 3-5 $1,000,000

Years 6-8 $400,000

The company falls in the 50% tax category and believes 12% to be an appropriate estimate for its after-tax cost of capital for a project of this nature. All equipment is depreciated on a straight-line basis. In the event of a negative taxable income, the tax is computed as usual and is reported as a negative number, indicating a reduction in loss after tax.

You are required to:

1 Compute the initial cash flow for the project 2 marks

2. Compute the earnings before taxes for years 1 through 8 2 marks

3. Compute the earnings after taxes for years 1 through 8 2 marks

4. Compute the OCF for years 1 through 8 2 marks

5. Compute the Terminal cash flow 1 mark

6. Compute the FCF for years 1 through 8 2 marks

7. Compute the NPV and IRR 3 marks

8. Should the project be accepted? 1 mark

Question 2 (5 marks) The target capital structure for Millennium Corporation is 50 percent common stock, 5 percent preferred stock, and 45 percent debt. Its cost of equity is 15 percent, the cost of preferred stock is 6 percent, and the cost of debt is 8 percent. The relevant tax rate is 35 percent.

a) What is Millenniums WACC?

2 marks b) The company president has approached you about its capital structure. He wants to know why the company doesnt use more preferred stock financing because it costs less than debt. What would you tell the president? 3 marks

Question 3 (10 marks)

The market risk premium for FCIB is 9 percent, and has a tax rate of 35 percent. The risk-free rate of interest is 5%. Willow-Woods Inc. has a capital structure comprised of the following:

8,500,000 shares of common stock outstanding,

200,000 shares of 7 percent preferred stock outstanding, and

85,000, 8.5 percent semiannual bonds outstanding, par value of $1,000 each.

The common stock currently sells for $34 per share and has a beta of 1.2, the preferred stock currently sells for $83 per share, and the bonds have 15 years to maturity and sell for 93 percent of par. a) What is the market value of Willow-Woods capital structure? 4 marks

b) What rate should Willow-Woods should use to discount the cash flows of a new investment project that has the same risk as the companys typical project? 6 marks