Question 1

Curechem SA Limited is a large publicly traded firm on the Johannesburg Stock Exchange. Based on a $100 000 market feasibility study it is considering the manufacture and sale of a new line of products developed by its R&D research group at a cost of $ 250,000. The finance department has gathered the following information on the investment proposal:

Initial investment (straight line depreciation): $ 9 million

Scrap value (year 4; tax paid yr. 5) : $ 600 000

Selling price (current price) : $ 80 per year

Expected selling price inflation : 4% per year

Variable operating costs (current price): $ 35/unit

Fixed operating costs: $ 450 000

Expected operating cost inflation: 3% per year

Market research estimates that demand for the product will be as follows:

Demand (Units): $50 000 for year 1, $85 000 for year 2, $100 000 for year 3 and $75 000 for year 4

The company has a real return hurdle rate of 12%. Expected inflation over the project's lifespan is 2.5%. CureChem Limited pays income tax at 30% payable 1 year in arrears. The project would qualify for the tax offices "accelerated" capital cost allowance of 33.3% per year on a straight line basis.

Required:

1.1. Calculate the flowing values for the investment proposal:

i. Net present value

ii. Internal rate of return

1.2. Briefly discuss your findings and advise whether the proposal is financially attractive

1.3. Assuming that the stock market is semi-strong efficient, what will be the implication for the firm's stock price if CureChem goes ahead with the project?