Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

OmiDel Inc., a newly established pharmaceutical company focusing on manufacturing covid-19 vaccines. The firms current capital structure is made up only of common stock (60%)

OmiDel Inc., a newly established pharmaceutical company focusing on manufacturing covid-19 vaccines. The firms current capital structure is made up only of common stock (60%) and long-term debt (40%). The firms financing cost for its debt (before-tax) is 5% and its corporate income tax rate is 20%. Market data relevant to OmiDels common stock (using CAPM) are as follows: Beta (common stock) = 1.5, rf = 2% and market-risk premium (RPM) = 8% (a) Compute the WACC of OmiDel Inc. (3 marks) (b) Briefly explain what would happen to the following variables (metrics) if WACC is used as the required return for a (new) project whose risk is lower than the average (risk) of the firms existing projects. i) The projects NPV (1.5 marks) ii) The chance of accepting / rejecting the project (1.5 marks) (c) Suppose OmiDel is currently considering building a new factory to increase its production capacity. The cash flows and information related to the project are summarized as follows: - The new factory, which is expected to have an economic life of 10 years, will be located right next to the firms existing factories. - The factory will be built on a piece of land provided by the local government, free of charge. OmiDel, however, has to pay a fixed year-end maintenance cost of $200,000 to the local government throughout the projects life. - The factory will be constructed at a cost of $20 million and will be depreciated at its full cost on a straight-line basis over its estimated useful life of 10 years, with zero salvage value. - Equipment will be purchased for the factory at a cost of $30 million. The equipment will be fully depreciated to zero value on a straight-line basis over its estimated useful life of 10 years. Salvage value of equipment at the end of project life is estimated to be $3 million. - The management of OmiDel believes that the new factory will generate after-tax cash operating income of $5 million a year in its first six years of operation and $10 million in each of the last four years. - Given the strong market demand for its vaccine products and sales arrangement, OmicDel DOES NOT need to put aside any working capital for the new project. Cont for part (c) i) Calculate the initial cost of investment. (2 marks) ii) Calculate the present value of after-tax operating cash income. (3 marks) [Hint: What discount rate should be used as the projects cost of capital?] iii) Calculate the present value of tax savings from depreciation for the factory and equipment. (4 marks) iv) Calculate the present value of after-tax salvage value for the factory and/or equipment. (2 marks) v) Based on the net present value method, should the project be undertaken? (3 marks)

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Finance

Authors: Angelico Groppelli, Ehsan Nikbakht

2nd Edition

0812043731, 978-0812043730

More Books

Students also viewed these Finance questions

Question

What made you decide on this subfield of psychology?

Answered: 1 week ago

Question

Th e last time I complained, nothing happened.

Answered: 1 week ago

Question

Th ey could have made my situation worse.

Answered: 1 week ago