Question

Part (a) Ventura pic (Ventura) is a technology company. Details of their long-term finance are as follows: Ordinary share capital: 4 million 50p shares, current market price 1.60. 8% preference shares: 2 million 1 shares, current market price 1.10. 7% irredeemable debentures: 20,000 100 debentures, current market price 105. The Beta factor for the company is 1.4. The rick fro rate in the economy is 3% and the expected return on a market portfolio is 10%. The corporation tax rate is 20%

Required: Calculate the weighted average cost of capital (WACC) for Ventura and explain what the WACC represents.

Part (b)

Ventura is preparing a tender to supply a large housing association with a new system for holding and maintaining their tenants' housing rent accounts. The system that Ventura will supply has a life of 10 years. Ventura will supply software updates and maintenance through an annual contract in each of the 10 years. The initial investment to build the system will cost 200,000 and will be incurred immediately. Capital allowances are available on the initial investment costs on a straight-line basis over 10 years. Income and other costs expected from the project, and the timing of the cash flows, are as follows: Income Sale of system Year 1 400,000 Annual updates and maintenance costs Years 1-10 40,000 Labour costs for software updates and maintenance Years 1-10 25,000 Ventura has a corporation tax rate of 20%. Assume tax is paid at the end of the year in which the profits are earned. Ignore inflation.

Required:

(i) Calculate the NPV of the project and recommend whether Ventura should proceed with the project on financial grounds. You should use a discount rate of 10%,

(ii) Explain one alternative model that ventura could use to calculate the cost of equity, provided the information is made available

(iii) Explain what is meant by the term 'marginal cost of capital. 'Explain why the weighted average cost of capital is generally considered more appropriate to use as a discount rate than the marginal cost of capital when appraising investments.