Question
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
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 |
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