Question

As the financial manager of Wilmore Company Limited, with a passion to boost employment creation through intraregional tourism in Ghana, you have acquired a land at Ho to put up an exquisite amusement park that features a number of attractions including games, pools, gardens, rides etc. The project will cost a total of GH₵100,000. The following cash flows are expected from the project. The beta of the project is 1.5 and the market return is 15%. The risk-free rate of return is 8%.
Year
₵

0
(100,000)

1
20,000

2
25,000

3
32,000

4
35,000

Using the CAPM approach, what is the cost of equity on this project?
[2 marks]
Wilmore Company Limited is a levered entity with percentage of debt out of total capital being 40%. If the interest rate on a bank loan is 10%, the tax rate is 20%, and the cost of equity is as computed in (a), what will be the after tax cost of debt? [2 mark]
What will be the weighted average cost of capital (WACC)? [2 mark]
Using the WACC computed in (c), what will be the NPV of the investment? ` [3 marks]
Compute the IRR for the project? [3 marks]
What will be your overall advice concerning viability of the project?
[2 marks]

Answer 1

cost of equity if firm is unlevered :-

Cost of equity = Rf + Beta * (Rm - Rf)

= 8% + 1.5 * (15% - 8%)

Cost of equity = 18.5%

Calculation of cost of equity if firm has debt :-

Levered beta = unlevered beta * ( 1 + ( 1 - tax rate) *Debt / equity)

= 1.5 * ( 1 + (1 - 0.20) * 0.40/0.60)

= 1.5 * (1 + 0.80 * 0.666667)

1.5 * 1.5333333

levered beta = 2.3

cost of levered equity = Rf + levered beta * (Rm - Rf)

= 8% + 2.3 * ( 15% - 8%)

cost of levered equity = 24.1%

cost of debt after tax = interest rate * ( 1 - tax rate) = 10% * ( 1 - 0.20) = 8%

Calculation of the weighted average cost of capital :-

WACC = cost of debt after tax * weight of debt + cost of equity * weight of equity

= 8% *0.40 + 24.1 * 0.60

WACC = 17.66%

Calculation of the NPV :-

years	Cash flow	[email protected]%	PV of Cf
0	-100000	1	-100000
1	20000	0.84990651	16998.13
2	25000	0.722341076	18058.53
3	32000	0.613922383	19645.52
4	35000	0.52177663	18262.18
NPV	-27035.6

Calculation of IRR :-

The project should not accept because of NPV is negative and IRR is lower than WACC.