Problem 01.

The company is now considering developing a new product for customers in their Telstra Consumer and Small Business segment. Development of the new product will initially require an initial capital expenditure equal to 10% of TLS's Property, Plant, and Equipment (PPE) at the end of the most recent reporting period for which data is available. The project will then require an additional investment equal to 10% of the initial investment after the first year of the project, a 5% increase after the second year, and a 1% increase after the third and fourth years. Assume that TLS will fully depreciate these assets by the straight-line method over a ten-year life. These assets will have a combined salvage value of $1 billion at the end of the fifth year of the project. The project will also require additional net working capital of $25,000,000 at the beginning of the project with an expected increase of 5% per annum in the following years.

Corporate Financial Management (BAFI3257) S1 2021 Pa-ge 3 of 9

The company has recently completed a $500,000 two-year market study to judge the likely popularity of the new product. Based on the results of the study, they have estimated that the product is expected to have a life of five years. First-year revenues for the new product are expected to be 8% of TLS's total revenue for the most recent reporting period for which data is available. The new product's revenues are expected to grow at 15% for the second year then 10% for the third and 5% annually for the final two years of the expected life of the project. Assume that the project's profitability will be similar to TLS's existing projects in the latest reporting period. As a result, operating costs can be estimated by using the latest EBITDA/Sales profit margin.

TLS's accounting information can be obtained from Eikon.

(a) Estimate the investment outlay of the project.

(b) Estimate the annual after-tax operating cash flow.

(c) Estimate the terminal-year net cash flow.

(d) Calculate the NPV of the project. Your team decides to use the Telstra's WACC computed in Part 1 as the required rate of return for the project. Which implicit assumptions do you need to make for this use?

(e) Advise if the project should be undertaken.

Problem 02.

The directors of CSR Industries have appointed you as their financial consultant. They are seeking new project investments and require you to calculate the present cost of capital of the company. The capital structure is listed below: 2 million ordinary shares with a par value of 50 cents each, currently trading at R4 per share. The company has a beta () of 1.4, a risk free (Rf) rate of 9% and a return on the market (Rm) of 17%. 1.5 million 13%, R2 preference shares, with a market value of R2.5 per share. R3 million 11%, debentures due in 5 years and the current yield-to-maturity is 8%. R800 000 16%. Bank loan. The company also has a general reserve of R3 500 000 and a retained income of R4000 000.

Additional information:

The dividend growth of 12% per annum was maintained for the past 4 years. The latest dividend paid was 80 cents per share.

Assume a company tax rate of 30%.

Required:

4.1 Calculate the weighted average cost of capital. Use the Capital Asset Pricing Model to calculate the cost of equity.

4.2 Calculate the cost of equity, using the Gordon Growth Model.

C...

Colfax Inc. manufactures high-end ice cream makers to sell to companies across the globe. The following market data on Colfax are current and available: Debt - 130,000 bonds outstanding, selling for 104 percent of par; the bonds have a YTM of 4.5%. The par value is $1,000. Common stock - 9,900,000 shares outstanding, selling for $68 per share; the beta is 1.20. Market - 7 percent expected market risk premium; 3.1 percent risk-free rate. Tax - 34%

a. Calculate the cost of equity. Show your complete work and present your answer in % rounded to two decimal places (e.g., 12.34%). 7 pts.

b. Calculate the WACC. Present your answer as % rounded to two decimal places (e.g., 12.34%). Show your complete work and present your answer in % rounded to two decimal places (e.g., 12.34%). 8 pts.

c. Suppose Pullman Inc., Colfax's biggest competitor, has a debt-to-equity ratio of 3 but its costs of debt and equity are identical to those of Colfax's. Using 34% as the tax rate, calculate Pullman's WACC. Show your complete work and present your answer in % rounded to two decimal places (e.g., 12.34%). 7 pts.

d. Based on your answer in 3.c., is Pullman's WACC higher or lower than Colfax' WACC? Explain why it is higher/lower with supporting logic/intuition/theory.