Question One:

a) Project E is a strategically important project which the board of the TM Co have decided should be undertaken in order for the company to remain competitive. Information relating to the future cash flows of this project are as follows:

Year 1 2 3 4

Sales volume (units) 12,000 13,000 10,000 10,000

Selling price ($per unit) 455 470 530 560

Variable Cost ($per unit) 260 280 295 320

Fixed costs (000) 750 750 750 750

These forecasts are before taking into account of selling price inflation of 5% per year, Variable cost inflation of 6% per year and fixed cost inflation of 3.6% per year. The fixed costs are incremental fixed costs which are associated with project E. The decision to invest in the project was as a result of the market survey that the company had carried out. This survey cost the the Company $800,000. At the end of four years, machinery from the project will be sold for scrap with a value of $750,000. Tax allowable depreciation on the initial investment cost of the project is available on machinery at 25% reducing balance basis and the Company pays corporation Tax of 30% per year, one year in arrears. A balancing charge or allowance is available at the end of the four years of operation. The Company has a nominal after-tax cost of capital of 13% per year. The initial investment for Project E is $5,000,000

Required:

Calculate the Net Present Value (nominal after-tax NPV) of project E and the IRR and comment on the financial acceptability of the project.

b) Discuss in detail what you understand by the term Capital Structure of a Company including discussing at least three theories of capital structure.