Question
There are 5 years of life remaining in our companys refinery, which is fully utilised processing 1.5 million barrels of crude oil per year at
There are 5 years of life remaining in our companys refinery, which is fully utilised processing 1.5 million barrels of crude oil per year at a processing cost of $10.00 real per barrel. The applicable current corporate tax rate is 30%. We could construct a new refinery in a special economic zone where the corporate income tax rate is 10% to process the remaining 5 years of throughput at a processing cost of $6.50 real per barrel. This new refinery will require a capital expenditure of $25.0 million (real), which can be fully depreciated on a straight line basis over the remaining 5 years. Under this scenario, the old refinery can be salvaged for $5.0 million (real) to offset a portion of the capital expenditure in year 0. Inflation is expected to be 1.8%, the pre-tax risk free rate of return is currently 1.5%, and the return on the market portfolio is 6%. If our company has a historical beta of 1.8, a current debt to capital ratio of 0.5 and our borrowing is at LIBOR + 150 basis points (LIBOR is currently 2.0%), should we build the new refinery if our target debt to capital ratio is 0.65? By how much would this project increase/decrease the value of the firm?
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