Question 1

The Great Flying Pterosaur Company (GFP) currently produces drones for commercial use. This product is expected to be in use for the foreseeable future, GFPs annual net profit after tax are expected to be $400,000 per annum. Capital allowances (straight-line) are $20,000 per annum for the companys existing non-current assets.

GFP issued preference shares (perpetual) with face value $1 million and a dividend rate is 5 percent. GFP is expected to pay its investors. There are 2,000,000 ordinary shares outstanding. GFPs cost of capital is 10 percent.

GFP is considering to put aside $270,000 to purchase a machine to produce an additional line of drones. This machine will operate for three years. At the end of its useful life, it be disposed for zero value. The risk level of the company will remain unchanged. The expected demand is 10,000 new drones per year.

Each new drone will be priced at $40 and thereafter rise at 8 percent per year. Total variable costs are expected to be $20 per drone in the first year and there after rise at 5 percent per year. The corporate tax is at 33 percent.

Required:

1. Compute the value of the firm before taking on the investment opportunity.

(10 marks)

2. Compute the value added to the firm if the investment opportunity is undertaken.

(35 marks)

3. What is the price per share of GFP if the investment opportunity is undertaken?

(5 marks)

(Total = 50 marks)