The target capital structure for Acme is 60% debt and 40% equity. The risk-free rate is 2%. The market risk premium is 5%. The beta of Acme against a relevant stock index is 0.8. The pre-tax cost of debt for Acme is 4%. Assume an effective corporation tax of 17%.

Question 3 Acme is considering investing in the new machine. (a) Calculate the cost of equity capital using the Capital Asset Pricing Model (CAPM). (b) Calculate the weighted average cost of capital. (c) Calculate the initial investment as of 1 January 2019. (d) Calculate the annual after-tax cash flows (illustrate your calculations for the years ending 2019, 2020, and 2021). (e) Calculate the terminal cash flow in 2021. (f) Calculate the net present value of the project as of 1 January 2019 considering that it will be financed using the same capital structure as the company. (g) Recommend whether the project should be undertaken.

Data for new project under consideration $1,000,000 5 Investment in new machinery Useful life of the machinery (years) Expected life of the project (years) Salein the first year from new machine implementation COGS as a percentage of sales Estimated selling price at the the end of 3 years Additional working capital is 20% of sales attributed to new machine $800,000 70% $450,000 $160,000 sales is expected to increase 15% per year from the new machine project. Working capital at the beginning of a given year is 20% of sales for that year, allocated at the beginning of the project and recouped at the end of project life. Depreciation uses straight line method and reduces the machine salvage value to zero over its useful life. The CFO is confident of this project and expects the company-wide dividends to grow at the same rate as the sales growth of this new project for the next 3 years before reverting to a constant perpetual rate of 49 Acme Corporation equity rights issuance data Current share price Suggested subscription price $20 $15 Data for new project under consideration $1,000,000 5 Investment in new machinery Useful life of the machinery (years) Expected life of the project (years) Salein the first year from new machine implementation COGS as a percentage of sales Estimated selling price at the the end of 3 years Additional working capital is 20% of sales attributed to new machine $800,000 70% $450,000 $160,000 sales is expected to increase 15% per year from the new machine project. Working capital at the beginning of a given year is 20% of sales for that year, allocated at the beginning of the project and recouped at the end of project life. Depreciation uses straight line method and reduces the machine salvage value to zero over its useful life. The CFO is confident of this project and expects the company-wide dividends to grow at the same rate as the sales growth of this new project for the next 3 years before reverting to a constant perpetual rate of 49 Acme Corporation equity rights issuance data Current share price Suggested subscription price $20 $15