QUESTION 1: WEIGHTED AVERAGE COST OF CAPITAL (50 Marks)

1.1. AH Liki Manufacturing Limited is a New Zealand company that specialises in manufacturing robots for the hospitality sector. To drive an intelligent revolution of the industry and create higher-level value for the industry, the company is undertaking a six-year project to set up a manufacturing plant overseas to produce a new line of robots. The company bought a piece of land five years ago for $ 8.2 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive $ 14.25 million after taxes. In six years, the land can be sold for $21.25 million after taxes and reclamation costs. The manufacturing plant will cost $360 million to build. The following market data on Ah Liki Manufacturing Ltd are current:

Equity Non-redeemable Preference shares Debt

10,000,000ordinary shares, selling for $46 per share

11,000,000 shares (par value $ 8.50 per share) with 4.5% dividends (after taxes), selling for $10.25 per share

$100,000,000,4.65% coupon bonds outstanding with ten years to maturity redeemable at par, selling for 95 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments.

Additional Information:

• a) The project requires $ 23.25 million in initial net working capital investment in year zero.

• b) The manufacturing plant has a ten-year economic life, and Ah Liki Manufacturing Ltd uses the Diminishing Value method of depreciation for the plant using a 30% annual depreciation rate. At the end of the project (i.e., at the end of year 6), the plant can be scrapped for $ 49 million.

• c) The project will incur $625 million per annum in fixed costs

• d) Ah Liki Manufacturing Ltd will manufacture and sell 150,000 robots in year one, and the production is expected to increase at 1.25 per cent per year for the rest of the project period.

• e) The expected average selling price per robot is $10,500.

• f) The variable production cost in year one is expected to be $3,675 per robot. However, the management estimates that the cost will increase by 1.15 per cent per year for the rest of the project.

• g) At the end of year 6, the company will sell the land.

• h) Ah Liki Manufacturing Ltds tax rate is 28%

• i) The company had been paying dividends on its ordinary shares consistently. Dividends paid in the past six years are as follows. The average growth rate in dividends is expected to continue in the coming years.

Year(-6) ($)	Year(-5) ($)	Year (-4) ($)	Year (-3) ($)	Year (-2 ($)	Year (-1) ($)	Year (0) ($)
3.95	4.02	4.09	4.14	4.21	4.18	4.21

Required:

(4 marks)

1. Calculate the projects initial (time 0) cash flows.

2. Compute the weighted average cost of capital (WACC) of Ah Liki Manufacturing Ltd. Show all workings and state any assumptions underlying your computations. (16 marks)

3. Using the WACC computed in part (2) and assuming the following, compute the projects Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period and the Profitability Index (PI). (25 marks) Note: Work all solutions to the nearest two decimals.

4. Based on your analysis, make a recommendation to AH Liki Manufacturing Ltd whether the company should go ahead with the project. Justify your recommendation. (5 marks)