Project Proposal – 800 words
You have identified a potential opportunity for the Whizz Bang Corporation Ltd (WBC), which involves undertaking a project that will have a ten-year life. The project requires an initial purchase of equipment and furniture totalling $4,500,000, plus ancillary programming capability and machinery costing $1,500,000. The equipment and furniture will depreciate and have a salvage value of $500,000 at the end of the project’s life, and the programing machinery will have nil salvage value at the end of the project’s life. Depreciation is calculated on a straight-line basis over five years. Information related to the project is as follows:
• Sales will be $3,050,000, $4,000,000 and $5,000,000 respectively in each of the first three years of operation, expected to grow at 10 per cent per annum for a further four years thereafter, and then settle to a growth of 5 per cent per annum indefinitely thereafter. In the event of not undertaking this project, all of this income would be lost.
• Variable costs associated with the project will be 65 per cent of sales.
• Fixed costs associated with the project will be $400,000 in the first year and expected to grow at 5 per cent per annum thereafter.
• Even though this project will not add additional expenses to head office, WBC has a policy of allocating a ‘head office’ charge of $200,000 a year to each major project.
• Research for this project and its capability was conducted during the previous year at a cost of $300,000. It yielded valuable information.
• The corporate tax rate is 30 per cent.
• Financiers of this type and risk in this industry are presently requiring a rate of 12 per cent after corporate tax.
In order to undertake this project, WBC is considering various financing options. One option is to borrowing $5,000,000 at 7 per cent per annum. This loan will be paid off in 10 equal annual instalments.
Evaluate this project, and provide a report to WBC management discussing whether or not you recommend it should undertake the project, providing a full explanation of your recommendation.
As support for your recommendation ensure your answer includes the following:
• Calculations of the NPV, IRR and the payback for the project and an analysis of the results.
• Justification for the correct discount rate to be used in evaluating the project.
• Your assessment of the advantages and disadvantages of each methodology (NPV, IRR and payback), and which you therefore recommend is applied to evaluate this project.
• Details of any other (financial and non-financial) matters you would consider before making a recommendation in respect of this project.
Scenario 3: Project Financing – 700 words
WBC is currently financed using debt and equity with a targeted debt to equity ratio of one (D/E = 1). Its debt financing is from three sources, overdraft, bank bills and debentures, with the ratio of overdraft to bank bills to debentures of 1:2:3. Its equity is ordinary shares. These ratios represent the long-term capital structure target for WBC. The debenture pays an annual coupon of 12 per cent per annum on its $1,000 face value. The remaining term of the debenture is six years. The debenture is currently priced $922.23. The bank bills issued by WBC are ninety-day bills, with a face value of $100,000 and are currently priced at $97,593.58. The bank overdraft rate is 1 per cent per annum above the bank bill rate. The ordinary shares sell for $8.00. The projected dividend for year one is $1.10. Dividends are expected to grow at 6 per cent per annum indefinitely.
Calculate the Weighted Average Cost of Capital (WACC) for WBC, assuming a tax rate of 30 per cent. Hint: this requires a calculation of the effective annual cost for each source of finance. Discuss whether the WACC could be used in the above project evaluation, and if so how. Include a discussion of any restrictions that apply to the use of WACC?