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Question 1 Best Option manufactures and sells consumer products. The company is considering a five-year project to launch a new product M1 (the M1 project).

image text in transcribed Question 1 Best Option manufactures and sells consumer products. The company is considering a five-year project to launch a new product M1 (the M1 project). M1's production will require a raw material R1; one unit of R1 is necessary for each unit of M1. Taking advantage of a special offer by the supplier, Best Option recently purchased 100,000 units of R1 at a cost of $5 per unit. If M1 is not launched, these 100,000 units will be sold, and the company expects to recoup the cost of $5 per unit. M1's estimated sales are 300,000 units per year and the estimated selling price is $26 per unit. For each unit of M1, besides requiring one unit of R1, there will also be other variable costs totalling $10. The expected future cost of R1 is $6 for each unit of R1. Best Option's factory is fully utilised and the M1 project will need to rent additional factory space. Including this expected rental payment, the project anticipates a fixed cost of $550,000 per year. The project will require a $5,000,000 machine, which has an expected end-of-project salvage value of $150,000. Working capital of $900,000 will also be required at the project's beginning. Best Option believes that the appropriate required rate of return for the M1 project should be the company's weighted average cost of capital plus two percentage points. The company has only two long-term funding sources, preference shares and equity. For the preference shares, their current market value is $20m and the cost of these shares is 10.5%pa. Best Option has 20 million ordinary shares with a current market value of $2.0 per share. The company pays ordinary dividends annually and has just paid an ordinary dividend of $0.255 per share for the current year. Dividends are expected to remain at this level in the future. The company pays profit tax in the same year at 30% pa. Ignore tax allowable depreciation. Required: (a) Determine the appropriate required rate of return for the M1 Project. (7 marks) (b) Calculate M1 project's net present value. (14 marks) (c) Determine the following sensitivities: i) The sensitivity of the project to M1's future selling price per unit. (3 marks) ii) The sensitivity of the project to R1's future cost per unit. (3 marks) iii) The sensitivity of the project to the project's required rate of return. (You can assume that the M1 project has an internal rate of return of 16.5%.) (3 marks) (d) The company believes that it has controlled adequately the carbon dioxide (CO2) emissions of its existing operations. But they are concerned about the M1 Project as the related production processes are likely to cause a significant amount of CO2 emissions. Basing on the results in (b) and (c) above and the other information provided, advise Best Option whether they should launch the M1 project. (10 marks)

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