Question

In: Finance

suppose ABC firm is considering an investment that would extend the life of one of its...

suppose ABC firm is considering an investment that would extend the life of one of its facilities for 5 years. the project will require upfront cost of 8 m plus (35+2) 37 millions investment in equipment. The equipment will be obsolete in 2 years and will be depreciated via straight line over that period (assume that the equipment can’t be sold). During the next 5 years ABC expect annual sales of 55 M per year from this facility. Material cost and operating expenses are expected to total 40 M and 6.8 M respectively per year. ABC expect no networking capital requirement for the project, and it pays a tax rate of 38%. ABC has 70% of equity and the remaining is in debt. if the cost of equity and debt are 8% and 6% respectively, should they take the project? a) WACC (in percentage, thus 3.8% must be entered as 3.8); b) Incremental FCF at 0; c) Incremental FCF from year 1 to year 5; d) NPV. All dollars’ answers must be submitted in Millions, thus 4.56M must be entered as 4.56. Round to the second decimal in each case.

Solutions

Expert Solution

a). WACC = (equity ratio*cost of equity) + (debt ratio*cost of debt*(1-Tax rate))

= (70%*8%)+(30%*6%*(1-38%)) = 6.716% or 6.7%

b). Incremental FCF at Time 0 = upfront cost + equipment cost = 8 + 37 = 45 million

c). Incremental FCFs calculation:

d). NPV = -11.23 million (Note: NPV has been calculated at the exact discount rate of 6.716% and not 6.7%, as the question does not specify it)

The project should not be undertaken as it is a loss making project given its negative NPV.


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