QUESTION 2 [12 marks]

Thuthuka Manufacturers is considering to launch a new product. It has estimated the project lifespan to be 4 years, after which the product will be replaced by a newer and updated version. They are planning on financing the project through the following sources:

Source	% of funding	Cost of funding (before tax)
Draw-down on current bond	20%	11.50%
New bank loan	40%	10.00%
Issue of preference shares	40%	10.25%

The marginal tax rate applicable is 28%.

The following after tax cash-flow was drawn up specifically for the launch of the new product:

Annual Cash Flows for new product
	year 0	year 1	year 2	year 3	year 4
Initial Outlay	-540000
Sales		258000	283800	312180	343398
Variable cost		96000	105600	116160	127776
Fixed Costs		30000	33000	36300	39930
Depreciation Expense		18000	18000	18000	18000
Taxable Cash flows		114000	127200	141720	157692
Taxes		31920	35616	39682	44154
Add: Depreciatio		18000	18000	18000	18000
Annual After-Tax Csh flows		100080	109584	120038	131538
Terminal Cash flow					270000
Total Annual Cash flows	-540000	100080	109584	120038	401538
Net Present Value	a
Internal Rate of Return	b

REQUIRED:

2.1 Based on the information provided, calculate Thuthuka Manufacturers Weighted Average Cost of Capital (WACC).

Using your answer in 2.1 calculate:

2.2 (a) the Net Present Value (NPV) of the new product and

(b) the Internal Rate of Return (IRR) of the product cash flows.

Your answer should include the Excel formula used.

2.3 Based on your calculations comment on whether Thuthuka Manufacturers should invest in the new product or not. Motivate your answer.