The company has spent 5.75m in the last twenty-four months on this unique smart television set called the Boxe, and initial tests carried out have confirmed its technical viability and the directors are confident that introduction of the product will be successful.

Following a successful market survey which cost 5.5m, the company is planning to produce and sell Boxe in the UK and outside the EU for the next five years.

Production of Boxe will require an investment of 200m in manufacturing equipment. It is expected that the manufacturing equipment could be sold for cash of 20m, at year 5 prices, at the end of the life of the project. The manufacturing equipment will be depreciated over 5 years using the straight-line method.

The following additional information is available

1. Production of Boxe will commence from 1 January 2024 and it is estimated that 720,000 units of Boxe will be sold throughout the five-year life cycle of the product. The pattern of production and sales volume over the life cycles of the product is expected to be as follows:

Year 1 10%

Year 2 20%

Year 3 25%

Year 4 30%

Year 5 15%

The initial selling price for the Boxe has been set at 2,000 per unit and the company expects to maintain this selling price for the first year; thereafter, the price will reduce by 10% per annum (round the prices to the nearest whole numbers).

1. Production ofBoxe requires two types of materials: copex and dixe.

1 kilo of copex is required for the manufacture of each unit of Boxe. Its current replacement cost is 400 per kilo and this cost is expected to rise by 6% per annum.

Manufacture of one unit of Boxe requires 2 kilos of dixe.The company has reached an agreement with a supplier for the annual purchase and quantities for all its requirements of dixeat a current cost of 60 per kilo and this cost will rise by 3% per annum.

1. Production of each Boxewould require 8 hours of skilled labour which is paid for at an hourly rate of 20. Having negotiated a redundancy pay settlement of 35m (at Year 5 prices) payable at the termination of production of Boxe,the staff union have agreed to maintain the hourly labour rate at 20 for the first three years and 25 for the last two years.

1. The total fixed costs in Year 1 will be 50m, including depreciation. The fixed costs are expected to increase, thereafter, by the general rate of inflation each year.

1. Production of Boxewill also require an investment of 60m in working capital at the beginning of the project. The amount of investment in working capital is expected to increase by the general rate of inflation.

Assume that all operating cash flows occur at the end of the year to which they relate, except those in Year 0, which occur immediately.

Hunters Plc uses WACC as the discount rate and pays tax at an annual rate of 35% on its taxable profits. Half of the tax is payable in the year in which it arises, the balance is paid in the following year. The company can claim tax-allowable depreciation (capital allowance) on a 25% reducing balance basis.

General inflation rate is expected to be 5% per annum.

PART A

REQUIRED

(a) Using all relevant information of the company:

i Calculate the current after-tax cost of the bond and the cost of current equity. (8 marks)

ii Calculate the current weighted average cost of capital (WACC). (6 marks)

iii Calculate the discount rate (risk adjusted WACC) the company should use to evaluate the viability of the new business, assume the current capital structure remains unchanged and the calculated discount rate is the real cost of capital and adjust accordingly for nominal discount rate [leave your answer in two decimal places to use as the discount rate]. Show relevant calculations.

(10 marks)

(b) Using the information provided and all relevant cash flows for the investment proposal calculate the net present value (NPV) of the project and advise the company if it should undertake it and if the project maximises shareholder wealth?

(36 marks)

(c) What factors [other than your answer to part (a) above] would you advise the company to take into consideration if it decides to embark on the project.

(10 marks)

PART B

How Risk may be incorporated in business investment decision-making Process.

You are required to research the academic and professional literature on how risk may be incorporated in business investment decision-making process, and write a reportincluding but not limited to the following that:

1. Gives a critical review of risk assessment methods in investment appraisal such as, Sensitivity analysis, Profitability Index, NPV and Simulation models.

1. Includes any empirical investigations of investment appraisal, indicating the investment appraisal methods used by companies.

1. Explains where future advances can be made in respect to risk assessments in investment decision-making process.