Question
Toyota is considering installing a new production line which is forecasted to start earning $5 million of revenue in the second year of operation. Revenue
Toyota is considering installing a new production line which is forecasted to start earning $5 million of revenue in the second year of operation. Revenue is projected to decrease at 10% p.a., operating costs are 25% of annual revenue and the production line is kept till the end of year 4, after which it is sold for $2 million. Setting up the production line requires $2 million today and $4 million in the first year. 40% Toyota capital is financed through equity which has a cost of 14% and the creditors are willing to charge 6% less than what the shareholders earn
(a) Draw timeline and set out the cash flows by year
(b) Calculate the required rate of return of this project
(c) What is the IRR of this project? Explain if Toyota should accept this project according to the IRR rule.
(d) What is the NPV of this project? Explain if Toyota should accept this project according to the NPV rule?
(e) If Toyota's credit rating upgrades from A to AA, holding other factors constant, explain
- how this change would affect WACC?
- how the IRR and NPV of the project and the capital budgeting decision made by using IRR approach and NPV approach would be affected
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