Question Three Answer all parts Alliance Smelting (AS) has incorporated NewCo., a Special Purpose Vehicle, to develop an aluminium smelting plant in France. This is a short-lived project, after four years NewCo. will be sold to the French Government for 1,000,000. The plant would be constructed at the outset of the project for 8,000,000. This plant will have zero residual value at the end of the project (4 years). The expected production of aluminium is as follows: Year 1 2 3 4 Tons 2,200 2,900 3,600 1,000 NewCo. will enter into a contract to sell all aluminium extracted at a pre-agreed price of 1,500 per ton. Payment will be received for aluminium at the end of the year it is produced. Total costs are expected to be 600,000 in each year. Capital Allowances will be 2,000,000 per year. The project will require an investment in Net Working Capital (NWC) of 300,000 at the outset and NWC will be recovered in full at the end of the project. The marginal corporation tax rate is 45%. AS has estimated that the unlevered Beta for a listed smelting firm, with a similar risk profile to NewCo., is 0.75. The project will be financed with an 8% fixed rate project loan of 7,500,000, with the remainder financed using an equity investment from AS. Interest is payable annually, capital repayments of 1,750,000 (end Year 1), 2,500,000 (end Year 2) and 3,250,000 (end Year 3) will be made. The risk free rate is 2% and the market risk premium is estimated to be 5.0%. Required: (i) Using the Adjusted Present Value (APV) approach, estimate the value of this project. (25 Marks) (ii) Briefly comment on why APV rather than the Weighted Average Cost of Capital and Net Present Value is the appropriate approach to estimating the value of this project (5 Marks) (iii) One of the Directors of AS is concerned about the highly leveraged nature of this proposal and is proposing a much lower level of debt. In light of your results from section (i), briefly comment on this concern. Calculations are not required for your answer. 15 Question Three Answer all parts Alliance Smelting (AS) has incorporated NewCo., a Special Purpose Vehicle, to develop an aluminium smelting plant in France. This is a short-lived project, after four years NewCo. will be sold to the French Government for 1,000,000. The plant would be constructed at the outset of the project for 8,000,000. This plant will have zero residual value at the end of the project (4 years). The expected production of aluminium is as follows: Year 1 2 3 4 Tons 2,200 2,900 3,600 1,000 NewCo. will enter into a contract to sell all aluminium extracted at a pre-agreed price of 1,500 per ton. Payment will be received for aluminium at the end of the year it is produced. Total costs are expected to be 600,000 in each year. Capital Allowances will be 2,000,000 per year. The project will require an investment in Net Working Capital (NWC) of 300,000 at the outset and NWC will be recovered in full at the end of the project. The marginal corporation tax rate is 45%. AS has estimated that the unlevered Beta for a listed smelting firm, with a similar risk profile to NewCo., is 0.75. The project will be financed with an 8% fixed rate project loan of 7,500,000, with the remainder financed using an equity investment from AS. Interest is payable annually, capital repayments of 1,750,000 (end Year 1), 2,500,000 (end Year 2) and 3,250,000 (end Year 3) will be made. The risk free rate is 2% and the market risk premium is estimated to be 5.0%. Required: (i) Using the Adjusted Present Value (APV) approach, estimate the value of this project. (25 Marks) (ii) Briefly comment on why APV rather than the Weighted Average Cost of Capital and Net Present Value is the appropriate approach to estimating the value of this project (5 Marks) (iii) One of the Directors of AS is concerned about the highly leveraged nature of this proposal and is proposing a much lower level of debt. In light of your results from section (i), briefly comment on this concern. Calculations are not required for your answer. 15