Question

Galaxy Industries Limited is a large publicly listed company and is the market leader in vacuum cleaner
manufacturing in New Zealand. The company is looking to set up a manufacturing plant overseas to produce a
new line of commercial vacuum cleaners. This will be a six-year project. The company bought a piece of land
four years ago for $ 8 million in anticipation of using it for its proposed manufacturing plant. If the company
sold the land today, it would receive $ 9.75 million after taxes. In six years the land can be sold for $14 million
after taxes and reclamation costs. Galaxy Industries Ltd wants to build a new manufacturing plant on this land.
The plant will cost $275 million to build. The following market data on Galaxy Industries Ltd are current:

Debt	$120,000,000,7.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 95 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments.
Equity	15,000,000ordinary shares, selling for $55 per share
Non-redeemable Preference shares	12,000,000 shares (par value $ 10 per share) with 6.5% dividends (after taxes), selling for $32 per share

The following information is relevant:
• Galaxy Industries Ltd’s tax rate is 28%
• The company had been paying dividends on its ordinary shares consistently. Dividends paid
during the past five years is as follows

Year (-4) ($)	Year (-3) ($)	Year (-2) ($)	Year (-1) ($)	Year (0) ($)
4.6	4.8	5.3	5.5	6.0

•The project requires $ 7.95 million in initial net working capital investment in year 0 to

become operational.

Required:
1. Calculate the project’s initial, (time 0) cash flows.
2. Compute the weighted average cost of capital (WACC) of Galaxy Industries Ltd. Show all workings and
state clearly any assumptions underlying your computations.

3. Using the WACC computed in part (2) above and assuming the following, compute the project’s Net
Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI).
a. The manufacturing plant has a ten-year tax life, and Galaxy Industries Ltd uses Diminishing
value method of depreciation for the plant using a 25% depreciation rate per annum. At the
end of the project, (i.e., at the end of year 6), the plant can be scrapped for $ 22 million.
b. The project will incur $250 million per annum in fixed costs
c. Galaxy Industries Ltd will manufacture 300,000 commercial vacuum cleaners per year in each
of the years and sell them at $ 2,200 per vacuum cleaner.
d. The variable production costs are $ 950 per vacuum cleaner.
e. At the end of year 6, the company will sell the land.
Note: Work all solutions to the nearest two decimals.
2.2. What are the pros and cons of using risk-adjusted costs of capital for individual investments?

Answer 1

The following are the data inputs in the spreadsheet:

The following are the obtained results in the spreadsheet: