Singaporean electronic gadget manufacturer Kevin Ltd has designed a new product that could become a real top-seller in Japan. According to its most conservative market study, it estimates that over the next 4 years, it could sell 375,000 units of the gadget. To manufacture these products, Kevin Ltd would need to invest in a new machine, costing S$4,000,000, that could begin production 1 year from now. The revenues, variable costs per product, fixed costs, depreciation, change in working capital and inflation all combine to deliver expected net operating cashflows after tax of S$1,332,000, S$932,000, S$1,258,000, S$540,000 over the next 4 years respectively (starting next year). On top of that, due to the fast-moving nature of electronic gadgets, it is anticipated though that after 4 years, the product would be discontinued, and the machine, only half depreciated by then, would be sold for S$2,100,000.

You have just joined the firm as the new CFO. You have not been able to firmly assess the cost of capital of the firm, but have observed the following:

Kevin Ltd is operating in a sector where beta is 1.34.

The company issued a 15-year annual-coupon bond 5 years ago with a coupon rate of 10% and this bond currently trades at 97.37% of face value.

The risk-free rate and market risk premium are 4% and 8.5% respectively.

Kevin Ltd has and aims at maintaining a debt-to-equity ratio of 2.

Kevin Ltd pays an average tax rate of 17.5%.

Mrs Kevin, founder and CEO, is entirely confident in the potential commercial success of her new gadget. She thus turns to you with a simple question: Is this project financially viable, and should we do it? Note that she usually wants her money back in 3 years.

(a) Appraise the WACC of Kevin Ltd.

(b) Use the appropriate method to assess the financial viability of the project that Kevin Ltd is considering and answer Mrs Kevins question with justification.

(c) Compute and compare the IRR, PI and payback period (PBP) of the project. Assess why the PBP method is less optimal for decision-making.