Question Three (25 marks) The Go Energy company is evaluating an investment of building a new production plant. The cost of the new plant is $2m. The GO Energy company decides to raise the equity required by issuing common stock onto the share market. The company is listed on the stock exchange with a B value equal to the volatility of the stock market. The company expects to maintain the existing capital structure at a risk free rate of 4% and a risk premium of 7%. Issuing the stock generates a cost of funding the equity of 5%. The corporate tax rate in Australia is 30%. The capital structure is such that the company has a 35% debt ratio. The cost of the debt capital is 8% whereas the cost of funding the debt raised is 4%. It is estimated that the annual inflows and outflows will be as shown in figure 3a below. A. Calculate the weighted average cost of capital. [8 marks] B. Using the discount rate (WAC) from part (b) carry out an NPV of the project by using the inflows and outflows shown in Figure 3a and determine the $Y value, such that the company would make a profit of $3m after eight years of operation. (8 marks] C. Taking into account the true cost of funding the project, determine if you would proceed with the investment. [4 marks] D. 1. Explain what the B value of a stock represents. [1 mark] 2. What is the B value of the stock market? [1 mark] 3. Explain the significance of a negative B value. [1 mark] 4. By what percentage would a stock with a beta of 1.8 move by if the market rose by 10%? [1 mark] 5. What does the capital asset pricing model (CAPM) enable us to calculate? [1 mark] $800k $500K $600k $100k $100k $500k $500k $500k Out Flows 0 2 3 4 5 In Flows $Y $2Y $3Y Figure 3a Question Three (25 marks) The Go Energy company is evaluating an investment of building a new production plant. The cost of the new plant is $2m. The GO Energy company decides to raise the equity required by issuing common stock onto the share market. The company is listed on the stock exchange with a B value equal to the volatility of the stock market. The company expects to maintain the existing capital structure at a risk free rate of 4% and a risk premium of 7%. Issuing the stock generates a cost of funding the equity of 5%. The corporate tax rate in Australia is 30%. The capital structure is such that the company has a 35% debt ratio. The cost of the debt capital is 8% whereas the cost of funding the debt raised is 4%. It is estimated that the annual inflows and outflows will be as shown in figure 3a below. A. Calculate the weighted average cost of capital. [8 marks] B. Using the discount rate (WAC) from part (b) carry out an NPV of the project by using the inflows and outflows shown in Figure 3a and determine the $Y value, such that the company would make a profit of $3m after eight years of operation. (8 marks] C. Taking into account the true cost of funding the project, determine if you would proceed with the investment. [4 marks] D. 1. Explain what the B value of a stock represents. [1 mark] 2. What is the B value of the stock market? [1 mark] 3. Explain the significance of a negative B value. [1 mark] 4. By what percentage would a stock with a beta of 1.8 move by if the market rose by 10%? [1 mark] 5. What does the capital asset pricing model (CAPM) enable us to calculate? [1 mark] $800k $500K $600k $100k $100k $500k $500k $500k Out Flows 0 2 3 4 5 In Flows $Y $2Y $3Y Figure 3a
