Reliant Corporation is a large Australian company in construction industry. The company is listed on the ASX. The company's current capital structure consists of $3,000m of equity and $950m of debt quoted at current market values. The current cost of its debt finance is $LIBOR plus 200 basis points. $LIBOR is currently 3.80%, which is 50 basis points above the one-month Treasury bill rate. The equity risk premium is 6% and the company's beta is 1.20 Reliant is considering investing in a large project costing $320 million on 1 July 2021. The project aims to manufacture specialist equipment for mining excavation. The company proposes to finance this project by a new bond issue. The bond issue will incur transaction costs of 3% of the issue value. The projected revenues over five years of the project are as follow: 30 June 30-Jun 30 Jun 30-Jun 30 Jun Year ended 2022 2023 2024 2025 2026 Revenue (sm) 281 360 370 290 Costs are 55% of revenues. The equipment will have a residual value after five years' operation of $16m. The company accountant explains that the company depreciates plant and equipment on a straight-line basis and, in this case, the annual charge will be allocated to the project as an indirect charge. The company pays tax at 30% on its taxable profits and can claim a 45% first year allowance on qualifying capital expenditure followed by a writing down allowance of 40% applied on a reducing balance basis. Assume that tax credits and charges will be paid or received 12 months after they arise. In evaluating the technical feasibility of the project the company spent a total $15m over the previous three years and this amount will be charged to the project in the first year of operation. If the project is implemented, before-tax cash flows of an existing division of the company is expected to decrease by $30m for each of the first three years of the project 138 Required: Professional marks will be awarded in this question for the appropriateness and format of the report. Prepare a report to the Board of Directors of Reliant Corporation which should contain responses to the following requirements: 1. A board member has expressed concerns about funding the project exclusively with debt. Instead, she would like the company to finance the project with internally generated funds of the existing business without raising any external debt or equity. Further, since the market for the project is different from Reliant's existing market, the board member believes that using the company's current cost of capital for evaluating the investment may not be appropriate. The equity beta of SRK Ltd, a company which manufactures equipment for mining excavation is estimated at 1.8. SRK has debt/equity ratio of 1.5:1 based on market values of debt and equity. Assume debt of both the companies has a beta of zero. 1. Evaluate the financial feasibility of the project using NPV method 2 m Discuss the key assumptions in undertaking the estimation in (1) above. Reliant Corporation is a large Australian company in construction industry. The company is listed on the ASX. The company's current capital structure consists of $3,000m of equity and $950m of debt quoted at current market values. The current cost of its debt finance is $LIBOR plus 200 basis points. $LIBOR is currently 3.80%, which is 50 basis points above the one-month Treasury bill rate. The equity risk premium is 6% and the company's beta is 1.20 Reliant is considering investing in a large project costing $320 million on 1 July 2021. The project aims to manufacture specialist equipment for mining excavation. The company proposes to finance this project by a new bond issue. The bond issue will incur transaction costs of 3% of the issue value. The projected revenues over five years of the project are as follow: 30 June 30-Jun 30 Jun 30-Jun 30 Jun Year ended 2022 2023 2024 2025 2026 Revenue (sm) 281 360 370 290 Costs are 55% of revenues. The equipment will have a residual value after five years' operation of $16m. The company accountant explains that the company depreciates plant and equipment on a straight-line basis and, in this case, the annual charge will be allocated to the project as an indirect charge. The company pays tax at 30% on its taxable profits and can claim a 45% first year allowance on qualifying capital expenditure followed by a writing down allowance of 40% applied on a reducing balance basis. Assume that tax credits and charges will be paid or received 12 months after they arise. In evaluating the technical feasibility of the project the company spent a total $15m over the previous three years and this amount will be charged to the project in the first year of operation. If the project is implemented, before-tax cash flows of an existing division of the company is expected to decrease by $30m for each of the first three years of the project 138 Required: Professional marks will be awarded in this question for the appropriateness and format of the report. Prepare a report to the Board of Directors of Reliant Corporation which should contain responses to the following requirements: 1. A board member has expressed concerns about funding the project exclusively with debt. Instead, she would like the company to finance the project with internally generated funds of the existing business without raising any external debt or equity. Further, since the market for the project is different from Reliant's existing market, the board member believes that using the company's current cost of capital for evaluating the investment may not be appropriate. The equity beta of SRK Ltd, a company which manufactures equipment for mining excavation is estimated at 1.8. SRK has debt/equity ratio of 1.5:1 based on market values of debt and equity. Assume debt of both the companies has a beta of zero. 1. Evaluate the financial feasibility of the project using NPV method 2 m Discuss the key assumptions in undertaking the estimation in (1) above