Question

Dean & Deluca Ltd (D&D) is listed on Singapore Exchange and the following information was extracted from Thomson Reuters Eikon:

• Share price = $1.50 • Number of outstanding shares = 5 million • Beta = 0.8 • Last traded price of each 5% bond = $920 • Bonds pay coupons semi-annually and mature in 6 years • Face value of bond =$1,000 • Number of bonds issued = 5,000
Yield on government long-term bond = 3% Equity risk premium = 6% Singapore corporate tax rate = 20%

D&D has received a new order for its products. However, its machines are all working at full capacity. In order to accept the new order, the company needs to buy a new machine. The details relating to the order, the new machine and other costs are shown below: Year 1 2 3 Sales $160,000 $180,000 $200,000

Variable cost = 20% of sales The project requires an additional net working capital of $40,000, which is sufficient for the duration of the project.

Cost of new machine = $300,000 Life of machine = 3 years Salvage value of machine at end of 3 years = $60,000 Depreciation is straight line over 3 years. Maintenance cost of machine per year = $10,000
(a) Calculate to estimate D&D’s cost of equity, cost of debt and weighted average cost of capital (WACC).
(b) Calculate the operating cash flows relating to the new order.
(c) Calculate the free cash flows relating to the new order.
(d) Assess and advise D&D whether it should accept the new order. Justify the choice of the method you use to make the decision.

Answer 1

A) Cost of Equity = dividend/ share price = 0.09 /1.5 = 6%

Cost of debt = cost of debt before tax ( 1- tax rate) = 3(1-.20)= 3*.80 = after tax cost of debt is = 2.4

WACC = Total portfolio incude 5 million equity shares and 5000 bond so 5005000

Cost of equity weight = .99 and cost of debt weight = 1%

WACC = .99*6+.01*2.4= 5.964

B) Calculating operating cash flows

Year 1 = 160000 Year 2 = 180000 Year 3 = 200000

Variable cost 20% of sales, Machine maintenance is $10000 per year and dep is Machine cost-salvage value/ no.of years

So depreciation is = $300000-60000/3 = 80000

Operating cash flow formula = sales- variable cost-maintanance cost-depreciation

Year 1 = 160000-32000-10000-80000= 38000

Year 2 = 180000-36000-10000-80000=54000

Year 3 = 200000-40000-10000-80000= 70000

C) So The operating cash flow is compounded 3 years is =38000+54000+70000=162000

After paying corporate tax it will be free cash flow for the equity shareholders

= 162000-20% = 129600

D) Now we are working in full capacity, if we are accepted a new order we have to buy new machinery and use it.

It cost net 240000 for machinery alone and consume 10000 for machine maintenance. We already find a conclusion that only 162000 making profit by the way of getting production in a new machine, so considering net factor it would be loss for the company so not accepting new order and follow the current production method is good for the company.