QUESTION 2: 1II'II'EI'GI'HTED AVERAGE COST OF CAPITAL [45 Marks] 2.1. Marshall Industries IJ'mited is a large publicly listed company and is the market leader in vacuum cleaner manufacturing in New Zealand. The company is undertaking a sixyear project to set up a manufacturing plant overseas to produce a new line of commercial vacuum cleaners. The company bought a piece of land four years ago for S 8 million in anticipation of using it for its proposed manufacturing plant. If the company sold the land today, it would receive 2; 9.25 million after taxes. In six years, the land can be sold for $14 million after taxes and reclamation costs. The manufacturing plant will cost $225 million to build. The following market data on Marshall Industries Ltd are current: $120,00,,?.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 95 per cent of par; the bonds have a $10 par value each and make semiannual coupon payments. Equity 15,000,00tiordinary shares, selling for $55 per share Non-redeemable 12,,D shares [par value 5 1D per share] with 5.5% dividends {after taxes], selling Preference shares for $32 per share The following information is relevant: I Marshall Industries Limited's tax rate is 28% I The company had been paying dividends on its ordinary shares consistently. Dividends paid during the past six years is as follows YearI-SIISI \"Heart-4H5}- 'I'earI-BIISI YearI-EII5i iFear {-11 {SI YearIOI-ISI 4.5 4.? 5.0 5.3 5.5 5.0 I The project requires 5 8.25 million in initial net working capital investment in year zero. Required: 1. Calculate the project's initial (time 0} cash flows. {2 marks] 2. Compute the weighted average cost of capital {WACC} of Marshall Industries Ltd. Show all workings and state any assumptions underlying your computations. [13 marks] 3. Using the WACC computed in part (2] above and assuming the following, compute the project's Net Present Value {NPV}, Internal Rate of Return HRH], Payback Period and the Protability Index {PI}. a. The manufacturing plant has a tenyear tax life, and Marshall Industries Ltd uses Diminishing value method of depreciation for the plant using a 25% depreciation rate per annum. At the end ofthe project, [i.e., at the end of year 5], the plant can be scrapped for S 22 million. b. The proJect will incur $250 million per annum in xed costs c. Marshall Industries Ltd will manufacture 300,000 commercial vacuum cleaners per year in each of the years and sell them at 5 2,200 per vacuum cleaner. d. The variable production costs are S 950 per vacuum cleaner. e. At the end of year 5, the company will sell the land. More: Work off solutions to the nearest two decimals. {16 marks] 2.2. What are the pros and cons of using riskadJusted costs of capital for individual investments? [4 marks]
