QUESTION 4

1. As the financial manager of Silicon Valley Enterprise, you are considering investing in a project that is estimated to cost GH100,000. The following cash flows are expected from the project. The cash flow in year four includes a residual value of GH15000. The beta of the project is 1.5 and the market return is estimated at 15%. The risk-free rate of return is 8%.

Year GH

1. (100,000)
2. 20,000

2. 25,000

3. 32,000

4. 35,000

1. What is the expected return on this project?

[4 marks]

2. Now assume Silicon Valley Enterprise employs both debt and equity in its capital structure and the percentage of debt out of total capital is 40%. If the interest rate on a bank loan is 10% and the tax rate is 20%, what is the after-tax cost of debt?

[4 marks]

3. Using the expected return computed in (i) as cost of equity and the after-tax cost of debt computed in (ii) what will the weighted average cost of capital (WACC) be?

[3 marks]

4. Using the WACC as the appropriate discount rate, what will be the NPV of the investment?

[4 marks]

5. Reinvesting at overall cost of capital, what will be the MIRR for the proposed investment?

[4 marks]

6. Whenever there are conflicting conclusions between the NPV and the IRR, the NPV is always superior. Comment on this assertion.

[3 marks]

7. The WACC computed in iii will be used as the effective discount rate in all cases for Silicon Valley. Comment on this assertion.

[3 marks]