Question 3: Applications of finance-capital budgeting [20 Marks]

Show all your workings when calculations are required and round off your FINAL result to TWO decimal places.

CSL Limited is considering installing a production line to manufacture the Covid-19 vaccine, which was successfully developed by an Australian university.

The production line costs $15,000,000 to install today and it is projected to have revenue in the first year of $8,000,000. Revenue is projected to decrease at 5% p.a. due to the fall in demand for the products. The operating cost is 20% of annual revenue. The life of the production line is 3 years after which it is expected to be sold for 10% of the original cost. The purchase of the machine is financed 70% through debt which has a cost of 6% p.a. and shareholders expect a 12% p.a. return

a) Set out the project time line complete with cash inflows, outflows and net cash flows by year. [6 marks]

b) Determine the required rate of return of CSL limited to be used as the discount rate in the analysis of this project. [4 marks]

c) What is the Net Present Value (NPV) of this project? Explain if this project should be accepted according to the NPV rule. [4 marks]

d) Given the result to part c), without calculation, identify which of the following statements could be possibly true. Explain why. [6 marks]

• Internal rate of return > WACC
• Internal rate of return < WACC
• Payback period > cut-off point
• Payback period