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Answered: - Good day, I need help in this 4 questions. I believe doing all

Good day,

I need help in this 4 questions.

I believe doing all this 4 questions in excel will be a better choice and I need them to be in details answer and explanation.

Thank you.

Best Regards,

Kid

Question 1

Capitol Company is considering whether to replace an existing machine or spend money on

overhauling it. The replacement machine would cost $18,000 and would require maintenance of

$1,500 at the end of every year. At the end of 10 years, it would have a scrap value of $2,000 and no

maintenance costs will be incurred in the terminal year.

The existing machine requires increasing amounts of maintenance at the beginning of each year, and

its salvage value (at the end of the respective year) is falling as shown below:

If Capitol Company faces an opportunity cost of capital of 15%, calculate the future cashflows and

evaluate when it should replace the machine. Assume no tax on disposal of machine.

(10 marks)

Question 2

Kenny?s Pizza is a new company that is setting up in Singapore. It is a pizza maker and deliverer. The

capacity of the proposed operation is 1,500 pizzas per day 365 days a year. It has conducted a

feasibility study into the idea. The decision to proceed was then taken.

Equipment and set-up costs of $4 million will be incurred immediately. Of these costs $2.4 million is

for the special pizza equipment. This equipment will be depreciated on a straight line basis to zero

value over 8 years. Working capital of $1 million will be needed to start the operation. It is assumed

that no extra working capital will be required during the project. The life of the project will be 8

years.

The average sale price of the pizzas is fixed at $7 per pizza. This includes delivery within the city.

Because of the strong competition it is not expected that there will be any price rises over the project

life.

However, the city is very prosperous, there is a tight labour market and the expectation is that labour

costs will rise by 4% per annum. The wage cost for the first year of operations is estimated to be

$300,000. The variable cost element of the operation is incurred at a rate of 50% of sales revenues

and this is expected to remain constant. The premises that will be used are rented at a rate of

$150000 per annum, which has been fixed for the project life. The rent is payable at the end of each

year. Tax is payable in the year it is incurred and is charged at a rate of 17%.

The project will be funded entirely by equity. As Super Pizza is a private company, estimating the cost

of capital will have to be done by taking a proxy company. The closest company on the stock market

is Pizza Spezia, a pizza maker and deliverer. It has an unlevered beta of 0.96, the risk free rate is 5.5%

and the market risk premium is 7%.

(a) Calculate the cost of capital for Super Pizza.

(5 marks)

(b) Calculate the future cash flow for this project and calculate the NPV of the project. (15 marks)

(c) For capital budgeting purposes (in general) how are the following treated in project cash flow

analysis?

(i) Replacement decisions for machines with different lives

(5 marks)

(ii) Investment inter-relatedness

(5 marks)

(iii) Company overheads

(5 marks)

(iv) Creditors

(5 marks)

Question 3

Union Met Manufacturing is considering a project, which requires an investment of $2 million. The

project is expected to generate sales revenue of $1m in the first year and grow at an additional $1

million per year until the 3rd when it remained constant until the 5th year. The project is sold at the

end of the 5th year with a salvage value of $300,000. The tax rate for the company is 17%.

UnionMet Manufacturing has an opportunity cost of capital at 12%.

To support this project, Union Met Manufacturing must purchase a new equipment and received two

proposals:

Equipment from Company A: Initial cost of $34,000, annual operating costs of $6,000 and an

operating life of 4 years.

Comparable Equipment from Company B: Initial costs of $24,000, annual operating costs of

$8,000 and an operating life of 3 years.

The cost of goods sold is expected to be 75% of sales revenue. Other operating costs are expected to

be 7% of the sales in the first year and 5% of sales thereafter. The project will need an initial working

capital of $200,000 and will increase by $100,000 in the next year. After which, no incremental

working capital is required. This will be fully recovered in the terminal year.

The investment plant is depreciated to zero using a straight line method over 5 years. Assume the

equipment purchased will operate for 5 years and expected to be disposed off for $300,000, which is

subject to tax.

(a) Compute the net present value of the new project and advice whether Union Met Manufacturing

should proceed with this investment.

(20 marks)

(b) Compute the equivalent annual cost for each proposal and advice which one management should

select.

(10 marks)

Question 4

Cradle Print Ltd is a Singapore listed company. Currently, its target debt-equity ratio is 1. It is

considering building a new $500,000 plant in Kallang Industrial Park. This new plant is expected to

generate after-tax cash flows of $73,150 per year perpetually. The tax rate is 17%. There are 2

financing options:

A $600,000 new issue of common stock. The issuance costs of the new common stock would

be about 10% of the amount raised. The cost of equity is 20%.

A $600,000 issue of 20-year bonds. The issuance costs of the new debt would be 2% of the

proceeds. The Company can raise new debt at 10%.

(a) Compute the Weighted Average Cost of Capital for Cradle Print Ltd.

(b) Compute the Net Present Value (NPV) of the new printing plant:

(i) without flotation costs and

(ii) with flotation costs?

Will Cradle Print Ltd accept the new printing plant project in either cases?

(15 marks)

(5 marks)

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