Part 3: Calculate the projects NPV, Payback Period, and Profitability Index (20 marks)

a) Calculate NPV, Payback Period, and Profitability Index (10 marks).

b) Should the project be accepted? Explain your answer (10 marks).

Project Information

The equipment will cost $880, is expected to have a working life of 4 years, and will be depreciated on a straight-line to a book value of zero.

The equipment is expected to have a salvage value of $150 at the end of 4 years.

The new equipment will improve efficiency and result in increased revenue of $860 in its first year of operation, but because of reduced efficiency from normal wear and tear, revenue will decrease by 5% (from the previous years revenue) for each of the remaining 3 years of the equipments life.

Excluding maintenance, all other costs from operating the equipment will be $200 per year. Maintenance costs will amount to $140 in the equipments first year of operation and will then increase by $10 per year for the remaining 3 years of the equipments life.

The equipment will require additional net working capital of $200. The net working capital will be recovered in full after the equipment is sold at the end of its working life

. The equipment will be installed in a building that is owned by the company but currently is not being used. If the project does not proceed, this building could be rented out for $200 per year.

A feasibility study has been undertaken on the purchase of the new equipment. The cost of preparing the feasibility study was $500.

The company has sufficient capital to undertake all positive-NPV projects. If the Payback Period method is used to evaluate projects, managements policy is that the maximum acceptable payback period is 4 years, and all cash flows in Year 0 would need to be recovered within 4 years for the project to be acceptable under this method. 1. The interest rate on the bank loan is 8.8% p.a. 2. The interest rate on the mortgage loan is 5.7% p.a. 3. The corporate bonds have a credit rating of BBB+ and have 3 years to maturity. They require semi-annual coupon payments at a coupon rate of 8% p.a. Page 2 of 6 4. 5. 6. 7. The ordinary shares are shown on the balance sheet at their book value of $1 per share. They have a beta of 1.2. They are expected to pay a dividend of $0.10 next year. The dividend is expected to grow at a rate of 10% p.a. for the following 4 years and, after that, it will grow at a constant rate of 4% p.a. in perpetuity. The preference shares have a par value of $1 each and are shown on the Balance Sheet at their par value. They pay a constant dividend of $0.11, and they are currently trading for $1.19. The market risk premium is 6.7%. The corporate tax rate is 30%. The 3-year risk-free rate is 2.93%. The 10-year risk-free rate is 3.56%

Credit Spread

Rating	1 yr	2 yr	3 yr	4 yr	5 yr	6 yr	7 yr	8 yr	9 yr	10 yr
AAA	125	155	185	215	245	275	305	335	365	395
AA+	135	165	195	225	255	285	315	345	375	405
AA	145	175	205	235	265	295	325	355	385	415
AA-	155	185	215	245	275	305	335	365	395	425
A+	165	195	225	255	285	315	345	375	405	435
A	175	205	235	265	295	325	355	385	415	445
A-	185	215	245	275	305	335	365	395	425	455
BBB+	195	225	255	285	315	345	375	405	435	465
BBB	205	235	265	295	325	355	385	415	445	475
BBB-	215	245	275	305	335	365	395	425	455	485
BB+	225	255	285	315	345	375	405	435	465	495
BB	235	265	295	325	355	385	415	445	475	505
BB-	245	275	305	335	365	395	425	455	485	515
B+	255	285	315	345	375	405	435	465	495	525
B	265	295	325	355	385	415	445	475	505	535
B-	275	305	335	365	395	425	455	485	515	545
CCC+	285	315	345	375	405	435	465	495	525	555
CCC	295	325	355	385	415	445	475	505	535	565
CCC-	305	335	365	395	425	455	485	515	545	575
CC	315	345	375	405	435	465	495	525	555	585
C	325	355	385	415	445	475	505	535	565	595

Plastic Manufacturing Company Ltd
Balance Sheet as at 31/12/21
ASSETS		LIABILITIES	Notes
Cash	110	Accounts payable		140
Accounts Receivable	210	Bank loan (interest only)	1	250
Inventory	620	Mortgage Loan	2	550
Property, plant & equipment	1,170	Corporate bonds	3	300
Total Assets	2,110	Total liabilities		1,240
		SHAREHOLDERSEQUITY
		Ordinary shares	4	410
		Preference Shares	5	210
		Retained earnings		250
		Total shareholders equity		870
		Total liabilities and shareholders equity		2,110