Question

Cathy Smith from Cathy’s Cool Constructions Pty. Ltd. is considering investing in some equipment to expand her business and has asked for your advice regarding the 2 options she has available, and has given the information below. The company pays a 30% flat rate of company tax.

The current sources of funds and associated costs are as follows:

Source of funds	Value ($)	Cost % before tax
Owners’ Equity (a)	$874,500	10.0%
Mortgage (b)	$525,000	4.0%
Vehicle Loan (c)	$41,000	12.0%

1A. Equipment Option 1 costs $50,000, will last 5 years and then become obsolete and be worth nothing. It is expected to bring in approximately $18,000 additional cash revenue each year.

i. Given the current sources of funds and capital structure above, calculate the Weighted Average Cost of Capital for Cathy’s Cool Constructions Pty. Ltd.

ii. Using the straight line method of depreciation, calculate the annual depreciation expense. Show your workings

iii. Calculate the additional profit per year after tax and the additional net cash inflow per year. Show your workings.

iv. What is the Average Rate of Return for Option 1?

v. What is the Payback Period (in years) for Option 1?

vi. What is the Net Present Value for Option 1?

vii. Is Option 1 a viable option? Discuss using your answers to parts iv, v and vi to support your reasoning.

(Total 1A. 32 marks)

1B. Equipment Option 2 costs $100,000, will last 8 years and then become obsolete and be worth nothing. It is expected to bring in approximately $35,000 additional cash revenue each year and will require Cathy to take out an additional loan of $50,000, with an interest rate of 12%p.a. before tax.

i. Given the change in sources of funds and capital structure above, calculate the new Weighted Average Cost of Capital for Cathy’s Cool Constructions Pty. Ltd.

ii. Using the straight line method of depreciation, calculate the annual depreciation expense. Show your workings

iii. Calculate the additional profit per year after tax and the additional net cash inflow per year. Show your workings.

iv. What is the Average Rate of Return for Option 2?

v. What is the Payback Period (in years) for Option 2?

vi. What is the Net Present Value for Option 2?

vii. Is Option 2 a viable option? Discuss using your answers to parts iv, v and vi to support your reasoning.

please answer 1b only

Answer 1