You are a financial manager at ENIGMA, a high-performance cycling brand that makes frames and after-market bike parts. Market data at the end of 2021 shows that they have 12 million ordinary shares outstanding on the NYSE with a current market value of $45m. According to CAPM the firm has a beta of 0.91. The expected return on the NYSE composite index is 11% per annum and the risk-free rate is 1.50% per annum. ENIGMA has 79,650 zero coupon bonds in issue each with a par value of $500 that expire in 5 years. Their current market value is $30m. Corporate taxes are 18% per annum. ENIGMA requires the purchase of a new machine to prepare the raw materials for their products. They have two contract alternatives. The first contract costs $500,000 and generates cash flows of $100,000 for the next 8 years. The second contract costs $750,000 and generates gross cash flows of $125,000 for the next 20 years, but requires an annual service cost of $25,000. ENIGMAs end of year 2021 financial statements show they had earnings of $25m, Cash of $74m, and total assets of $165m. Your analysis of the 2021 annual report reveals that ENIGMA expects earnings to grow by 6% over the next financial year.

Required: a) Compute the Net-Present Value for the two contract alternatives and make a recommendation using the NPV decision rule. [40 marks]

b) Calculate the Payback and Internal Rate of Return for both contracts. Interpret your results and in particular comment on whether you are able to make a choice between these contracts using only Internal Rate of Return. [20 marks]

c) Assuming ENIGMAs earnings growth is met over the next financial year and the ordinary share price rises by the expected return according to CAPM, what do you expect the 2022 price-to-earnings ratio to be and how does it differ from the 2021 price-to-earnings ratio? [20 marks]

d) If ENIGMAs corporate bond price rises by $50. What is the new Weighted Average Cost of Capital? Without doing any calculations, how will this affect the NPV for each contract?