Shabanie plc has been listed on a stock exchange for 20 years and now has a large number of diverse shareholders none of whom exceeds a 5% stake. The Board of Directors has pursued a policy of financing all investments through debt and not by raising new equity capital. The companys loan notes are rated A and the Board is determined to maintain that investment rating. It has been advised that if seeks to borrow in excess of a further 500m it will be down graded and accordingly the maximum funds available to invest are 500m.

The company has identified three indivisible projects for investment.

Summarised financial statements for the last financial year for Shabanie plc

Shabanie plcs shares have a par value of 0.25. The loan notes have a market value equal to their nominal value.

Shabanie plcs policy is to depreciate capital expenditure in equal amounts over the estimated useful life of the asset. This policy matches the tax regulations that also state that tax must be paid at the appropriate rate on accounting profits on the last day of the year in which they are earned.

Required

Calculate Shabanies weighted average cost of capital, capital gearing ratio and interest cover.

Calculate the net present value for each of Shabanie plcs three projects and select the preferred project(s) discussing the reasons for your selection.

Income statement '000 Revenue 1,200,000 Cost of sales (660,000) 540,000 ( 240,000) Gross profit Overhead expenses Operating profit Interest payable 300,000 ( 200,000) Profits before tax 100,000 Corporation tax (20,000) 80,000 Earnings Dividends Retained earnings (50,000) 30,000 25,000 Statement of financial position Share capital (par value 0.25) Share premium Retained earnings Total equity 250,000 300,000 575,000 Non-current liabilities 10 year loan notes 5% 4,000,000 Capital employed 4,575,000 Other information Current share price 8.00 Interest rate on loan notes 5.0% Beta factor for Shabanie plc 1.26 Equity risk premium 3.0% Yield on government bonds 2.3% Tax rate 20.0% Project summaries (' 000 unless stated otherwise) The projects all have a limited lifespan and are indivisible. The key figures from the project proposals are: Project A Project B Project Project life (years) 5 5 6 Capital expenditure in to 320,000 400,000 350,000 Residual value 200,000 32,000 Additional working capital 60,000 55,000 100,000 Annual revenues 500,000 425,000 475,000 Gross profit % 45% 42% Additional annual fixed costs 125,000 100,000 90,000 38% Income statement '000 Revenue 1,200,000 Cost of sales (660,000) 540,000 ( 240,000) Gross profit Overhead expenses Operating profit Interest payable 300,000 ( 200,000) Profits before tax 100,000 Corporation tax (20,000) 80,000 Earnings Dividends Retained earnings (50,000) 30,000 25,000 Statement of financial position Share capital (par value 0.25) Share premium Retained earnings Total equity 250,000 300,000 575,000 Non-current liabilities 10 year loan notes 5% 4,000,000 Capital employed 4,575,000 Other information Current share price 8.00 Interest rate on loan notes 5.0% Beta factor for Shabanie plc 1.26 Equity risk premium 3.0% Yield on government bonds 2.3% Tax rate 20.0% Project summaries (' 000 unless stated otherwise) The projects all have a limited lifespan and are indivisible. The key figures from the project proposals are: Project A Project B Project Project life (years) 5 5 6 Capital expenditure in to 320,000 400,000 350,000 Residual value 200,000 32,000 Additional working capital 60,000 55,000 100,000 Annual revenues 500,000 425,000 475,000 Gross profit % 45% 42% Additional annual fixed costs 125,000 100,000 90,000 38%