QUESTION

GOMEZ Co$.$ Ltd wishes to calculate its weighted Average Cost of Capital $($WACC$)$ before venturing in food processing project. As an expert, the company presented to you the current information relating to its capital structure as follows:

Number of ordinary shares

$20$ million

Number of $5\%$ Tsh$\mathrm{.}1000$ non$-$callable preferred stock

$10$ million

Book value of $10\%$ Tsh$\mathrm{.}10,000$ irredeemable bonds

Tsh$\mathrm{.}200$ million

Market price of ordinary shares

Tsh$\mathrm{.}500$ cum dividend

Market price of $5\%,$ Tsh$\mathrm{.}1000$ non$-$callable preferred stock

Tsh$\mathrm{.}430$ ex$-$dividend

Total dividend just paid

Tsh$\mathrm{.}40$ million

Market price of $10\%$ Tsh$\mathrm{.}10,000$ irredeemable debt

$105$ percent ex interest

Equity beta of Bamboo company

$1\mathrm{.}5$

Treasury bill rate

$5\%$

Expected return in the market

$12\%$

Additional Information

i$.$ The corporate tax applicable to GOMEZ Ltd is $35\%$

ii$.$ The dividends of GOMEZ Ltd are expected to grow at an average rate of $6\%$

The information related to the new project was presented to you as follows:

I. The project will transform an existing warehouse to house the food processing plant. This will require structural modifications estimated at a cost of TZS$\mathrm{.}5,000,000.$

I. Electrical installations and construction of access roads are estimated to cost the company TZS$\mathrm{.}2,500,000$

II$.$ The warehouse currently generates TZS$\mathrm{.}3,000,000$ in rent per annum.

III. Depreciation in warehouse is negligible.

IV$.$ Plant and machinery will be supplied by Fredrick Industries UK who have quoted price equivalent to TZS$\mathrm{.}125,000,000.$

V$.$ Insurance and freight charges are estimated at a cost of TZS$\mathrm{.}2,500,000.$

VI$.$ Plant installation and test runs are estimated at a cost of TZS$\mathrm{.}2,250,000.$

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VII. The plant has estimated useful life of $5$ years and a salvage value of TZS$\mathrm{.}1,250,000.$ Depreciation is on straight line method.

VIII. Due to the nature of the machinery to be imported, the project qualifies for an investment allowance of $10\%$ of the invoice value.

IX$.$ The project will be financed by both equity and loan funds. Interest of TZS$\mathrm{.}3750,000$ will be paid per year.

X$.$ The project will generate net revenues before depreciation and tax of TZS$\mathrm{.}100,000,000$ per annum.

XI$.$ The company will require initial working capital of TZS$\mathrm{.}1,500,000.$

XII. The training of technical staff to operate the machinery will be done by the supplier of the machinery at a cost of TZS$\mathrm{.}1,500,000$

XIII. You consultancy fee in preparing the feasibility study is estimated at TZS$\mathrm{.}8,500,000.$

REQUIRED:

$($a$)$ Estimate the Bamboo$$s Ltd equity risk premium and cost of equity using the Asset Pricing Model $($CAMP$).$

$($b$)$ Calculate the market value Weighted Average Cost of Capital of Bamboo Ltd Using:

i$.$ Dividend growth model

ii$.$ Capital Asset Pricing Model

$($c$)$ Discuss whether the dividend growth model or the CAPM offers the better estimate of the equity of the company.

$($d$)$ Discuss the circumstances under which the weighted average cost of capital can be used in investment appraisal.

$($e$)$ Derive relevant cash flows of the project.

$($f$)$ Calculate the payback period and the net present value of the project.

$($g$)$ Basing on results above, advise the Management of GOMEZ Ltd on the viability of the project.

$($h$)$ Explain other factors $($if any$)$ you would like to bring to the attention of the management before a final decision is reached.