Rare Agri

$-$

Products Ltd

$.$

$$is considering a new project with a projected

life of seven

$($

$7$

$)$

$$years$.$ The project falls under the government

$$

s

subsidy program for encouraging local agricultural products and is

eligible for a one

$-$

time rebate of

$2$

$5$

$\%$

$$on any initial equipment

installed for the project. The initial equipment

$($

IE

$)$

$$will cost

$

$4$

$1$

$,$

$0$

$0$

$0$

$,$

$0$

$0$

$0$

$.$

$$At the end of year

$1$

$,$

$$an additional equipment

$($

AE

$)$

$$costing

$

$2$

$,$

$5$

$0$

$0$

$,$

$0$

$0$

$0$

$$will be needed at the end of year

$3$

$.$

$$At the end of seven

$($

$7$

$)$

$$years$,$ the original equipment, IE

$,$

$$will have no resale value but

the supplementary equipment, AE

$,$

$$can be sold for $

$5$

$0$

$,$

$0$

$0$

$0$

$.$

$$A working

capital of $

$1$

$,$

$3$

$5$

$0$

$,$

$0$

$0$

$0$

$$will be needed.

The project is forecast to generate sales of agri

$-$

products over the

seven years as follows:

Year

$1$

$-$

$7$

$0$

$,$

$0$

$0$

$0$

$$units

Year

$2$

$-$

$1$

$0$

$0$

$,$

$0$

$0$

$0$

$$units

Years

$3$

$-$

$5$

$2$

$5$

$0$

$,$

$0$

$0$

$0$

$$units

Years

$6$

$-$

$7$

$3$

$2$

$5$

$,$

$0$

$0$

$0$

$$units

A sale price of $

$1$

$5$

$0$

$$per unit for the first two years is expected and

then decline to $

$9$

$0$

$$per unit thereafter as the newness of the product

loses some sheen. The variable expenses will amount to

$3$

$0$

$\%$

$$of sales

revenue. Fixed cash operating expenses will amount to $

$1$

$,$

$1$

$0$

$0$

$,$

$0$

$0$

$0$

$$per

year.

The company falls in the

$2$

$5$

$\%$

$$tax category for ordinary income and

$4$

$0$

$\%$

$$

tax category for capital gain.

The initial equipment is depreciated as per the

$7$

$-$

year MACRS system

and the additional equipment is depreciated on a straight

$-$

line basis.

In the event of a negative taxable income, the tax is computed as

usual and is reported as a negative number, indicating a reduction in

loss after tax.

The initial financing of the project will be carried out as follows:

$-$

$5$

$5$

$\%$

$$equity and

$4$

$5$

$\%$

$$debt$.$ The company paid $

$1$

$.$

$5$

$0$

$$per share in the form

of dividend this year, which is likely to increase at a rate of

$3$

$\%$

$$

per year for the near future. The current price of the company

$$

s stock

is $

$9$

$.$

$5$

$0$

$$per share. The bank loan is likely to be arranged at an

interest rate of

$1$

$3$

$.$

$5$

$\%$

$$p

$.$

a

$.$

You are required to:

$1$

$.$

$$Compute the appropriate rate for discounting the cash flows of

the project

$$

$5$

$$marks

$2$

$.$

$$Compute the initial investment required

$$

$4$

$$marks

$3$

$.$

$$Compute the earnings before taxes for years

$1$

$$through

$7$

$$

$5$

$$marks

$4$

$.$

$$Compute the earnings after taxes for years

$1$

$$through

$7$

$$

$1$

$$mark

$5$

$.$

$$Compute the OCF for years

$1$

$$through

$7$

$$

$1$

$$mark

$6$

$.$

$$Compute the Terminal cash flow

$$

$3$

$$marks

$7$

$.$

$$Compute the FCF for years

$1$

$$through

$7$

$$

$1$

$$mark

$8$

$.$

$$Compute the NPV and IRR

$$

$4$

$$marks

$9$

$.$

$$Should the project be accepted?

$$

$1$

$$mark