Question 3 (20 marks) Suppose you have been hired as a financial consultant to Shelby Ltd. Below is the sample of historical returns of S&P 500 index, Year Rm (Market Return) 1 +6% 2 +8% 3 -7% 4 3% 5 5% According to the historical returns, covariance between Shelby and S&P 500 is 0.00552. The company is looking at setting up a manufacturing plant to produce new digital equipment. This will be a four-year project. The company bought some land five years ago for $12 million in order to use it to produce the new digital equipment. If the company sold the land today, it would receive 8 million after taxes. In four years the land can be sold for 6.5 million after taxes and reclamation costs. The company wants to build its new manufacturing plant on this land, which will cost $20 million to build. The following market data on Shelby's securities are current: Debt: Zero coupon bond: 20,000 zero coupon bonds outstanding, 10 years to maturity, selling for 80% of face value; the bonds have a $1,000 par value each and it is based on semi-annual compounding Level coupon bond: 10,000 level coupon bonds outstanding, 15 years to maturity, 6% coupon rate, sells at par; the bonds have a $1,000 par value and make annual coupon payments Common Stock: 450,000 shares outstanding, selling for $60 per share; Market: 10% expected return on S&P 500 index; 3% risk-free rate. The corporate tax rate is 35%. The project requires $600,000 in initial net working capital investment and it is supposed to be recovered at the end of the project. a) Calculate Shelby's B by using the historical data in the above table. (5 marks) b) Calculate Shelby's WACC (5 marks) c) The new digital equipment project is somewhat riskier than a typical project for Shelby Ltd. Management suggests use an adjustment factor of +1.59 percent to account for this increased riskiness. Calculate the appropriate discount rate when evaluating the new digital equipment project. (1 mark) d) The manufacturing plant has an eight-year tax life, and Shelby Ltd, uses straight- line depreciation to zero over the 8-year life. At the end of the project (i.e., the end of year 4), the plant can be scrapped for 8.5 million. What is the after-tax salvage value of this manufacturing plant at the end of the project? (5 marks) e) If the annual operating cash flow from this new digital equipment project is 10 million, calculate the NPV of the project? (4 marks)