The project has a debt capacity of 30% of the cost of the project, with an annual interest charge of 8%. The company currently has 3,000,000 of retained earnings available for this project, and the remainder would be potentially financed with rights issue. The rights issue incurs additional costs of 2% of the amount raised, and the debt issuance is a bit cheaper, costing 1%, where both issue costs are tax deductible.

The project has a debt capacity of 30% of the cost of the project, with an annual interest charge of 8%. The company currently has 3,000,000 of retained earnings available for this project, and the remainder would be potentially financed with rights issue. The rights issue incurs additional costs of 2% of the amount raised, and the debt issuance is a bit cheaper, costing 1%, where both issue costs are tax deductible.

Required:

The company believes it will be a successful project and will help to distinguish them from competitors. However, they would like you to evaluate the project using different methods and recommend a proposal to the investment committee in order for them to approve it:

a) ASOS Plc is considering financing the project with 30% debt. Using the Adjusted Present Value (APV), value the project. (Assume the same level of debt is held until the end of the project. Do not consider the repayment of the debt principal in any of the valuations.)

Hint: calculate the free cash flow of the project and use CAPM to compute the discount rate.

b) How would your evaluation change if the machinery manufacturer offered you purchase of the production machine with a three-year, 4,000,000, 8% loan (subject to 1% issue costs)? Assume the remainder of the initial outlay is equity. Discuss the benefits and disadvantages of the APV method.

Hint: use APV again, but this time do not forget to take into account the benefits but also the additional costs of this option.

c) Using NPV, evaluate the project using the Weighted Average Cost of Capital (WACC), assuming a 50% debt.

Hint: assume the Beta obtained is Equity Beta

d) Contrast the methods and scenarios, and give a final recommendation to the investment committee. Make sure you critically evaluate the methods and discuss other risk factors that were not included in the analysis.