Question 5 (20 marks) OmiDel Inc., a newly established pharmaceutical company focusing on manufacturing covid-19 vaccines. The firm's current capital structure is made up only of common stock (60%) and long-term debt (40%). The firm's financing cost for its debt (before-tax) is 5% and its corporate income tax rate is 20%. Market data relevant to OmiDel's common stock (using CAPM) are as follows: Beta (common stock) - 1.5, re= 2% and market-risk premium (RPM) = 8% (a) Compute the WACC of OmiDel Inc. (3 marks) (b) Briefly explain what would happen to the following variables (metrics) if WACC is used as the required return for a (new) project whose risk is lower than the average (risk) of the firm's existing projects. i) The project's NPV (1.5 marks) ii) The chance of accepting/rejecting the project (1.5 marks) (c) Suppose OmiDel is currently considering building a new factory to increase its production capacity. The cash flows and information related to the project are summarized as follows: The new factory, which is expected to have an economic life of 10 years, will be located right next to the firm's existing factories. The factory will be built on a piece of land provided by the local government, free of charge. OmiDel, however, has to pay a fixed year-end maintenance cost of $200,000 to the local government throughout the project's life. Question 5 (20 marks) OmiDel Inc., a newly established pharmaceutical company focusing on manufacturing covid-19 vaccines. The firm's current capital structure is made up only of common stock (60%) and long-term debt (40%). The firm's financing cost for its debt (before-tax) is 5% and its corporate income tax rate is 20%. Market data relevant to OmiDel's common stock (using CAPM) are as follows: Beta (common stock) - 1.5, re=2% and market-risk premium (RPM) = 8% (a) Compute the WACC of OmiDel Inc. (3 marks) (b) Briefly explain what would happen to the following variables (metrics) if WACC is used as the required return for a (new) project whose risk is lower than the average (risk) of the firm's existing projects. i) The project's NPV (1.5 marks) ii) The chance of accepting / rejecting the project (1.5 marks) (c) Suppose OmiDel is currently considering building a new factory to increase its production capacity. The cash flows and information related to the project are summarized as follows: The new factory, which is expected to have an economic life of 10 years, will be located right next to the firm's existing factories. The factory will be built on a piece of land provided by the local government, free of charge. OmiDel, however, has to pay a fixed year-end maintenance cost of $200,000 to the local government throughout the project's life. i) The project's NPV (1.5 marks) ii) The chance of accepting/rejecting the project (1.5 marks) Suppose OmiDel is currently considering building a new factory to increase its production capacity. The cash flows and information related to the project are summarized as follows: The new factory, which is expected to have an economic life of 10 years, will be located right next to the firm's existing factories. The factory will be built on a piece of land provided by the local government, free of charge. OmiDel, however, has to pay a fixed year-end maintenance cost of $200,000 to the local government throughout the project's life. The factory will be constructed at a cost of $20 million and will be depreciated at its full cost on a straight-line basis over its estimated useful life of 10 years, with zero salvage value. Equipment will be purchased for the factory at a cost of $30 million. The equipment will be fully depreciated to zero value on a straight-line basis over its estimated useful life of 10 years. Salvage value of equipment at the end of project life is estimated to be $3 million. The management of OmiDel believes that the new factory will generate after-tax cash operating income of $5 million a year in its first six years of operation and $10 million in each of the last four years. Given the strong market demand for its vaccine products and sales arrangement, OmicDel DOES NOT need to put aside any working capital for the new project. Con't for part (C) i) Calculate the initial cost of investment. (2 marks) ii) Calculate the present value of after-tax operating cash income. [Hint: What discount rate should be used as the project's cost of capital?] (3 marks) iii) Calculate the present value of tax savings from depreciation for the factory and equipment. (4 marks) iv) Calculate the present value of after-tax salvage value for the factory and/or equipment. (2 marks) v) Based on the net present value method, should the project be undertaken? (3 marks) -End
