BAO5734 - FINANCIAL ANALYSIS
ASSIGNMENT 3: CAPITAL BUDGETING PROJECT
It is now Feb 2019. ABC Pty Ltd has identified few potential projects that the firm could undertake, but is not sure how to determine the best projects to go ahead with. You have explained to your client that the first task to do is to figure out the firm's Weighted Average Cost of Capital (WACC), as it is the minimum return required on new projects in order to meet the cost of capital and increase the value of the firm. Based on the most recent financial data in 2018 which has been provided in Assignment 2, you will help the firm to calculate its WACC based on the sources of capital shown in the 2018 Balance Sheet.
You need to complete the following tasks in Cost of Capital tab.
1. Determine the cost of all sources of capital (i.e. all non-current liabilities, ordinary shares, preference shares) - Note that Retained Earnings are not included, since all reserves, including retained earnings, belong to the owners of ordinary shares, and market value of ordinary shares has included the value of these reserves).
2. Determine the market value of all sources of capital (excluding Retained Earnings).
3. Calculate the firm's WACC.
The interest rate on Bank Loan is 8.0%, and interest rate on the Mortgage Loan is 11.0%.
Market value of Bank Loan and Mortgage Loan can be presumed to be the values in the 2018 Balance Sheet.
The corporate bond issued by the firm is rated A+ and require 165bsp above the 5-year Government Securities rate of 3.5%. This bond is paying 6% coupon on annual basis and have 10 years to maturity.
The ordinary shares have a beta of 1.4, the risk-free rate applies for the CAPM to identify cost of equity is the 10-year Government Securities rate of 5.4%. Market Risk Premium is 4%.
The preference shares pay a fixed annual dividend of 10 cents per share.
After identifying the WACC, the firm is considering about two projects. You will be in the position to recommend the acceptance or rejection of the project to your client.
The project in question involves the acquisition of a new machine which will help the firm to increase its productivity of children toys. The firm has analysed the project and provided the following information, as shown below.
You need to complete the following tasks in Capital Budgeting tab.
1. Determine the incremental free cashflows if they would be accepted.
2. Calculate the NPV of the incremental free cashflows.
3. Provide the firm with your recommendation to accept or reject the project.
Following is the project's information (all values are in thousands of dollars).
A feasibility study has been performed at the cost of $25, which has generated the following data.
The machine will have a useful life of 5 years, will cost $400 to purchase and install.
This cost will be depreciated over the life of the project to a book value of zero using diminishing value depreciation.
The machine is expected to have a salvage value of $50, which will be received at the end of Year 5.
The project will require an increase in Net working capital of $10, which will be also recouped at the end of Year 5.
The new machine will generate an increased revenue of $150 in the first year of operation, $180 in the second and third year, and $140 in Year 4 and Year 5.
Use of the new machine will require an extra wage payment of $35 per year, extra maintenance costs of $9 per year.
The machine will be installed in a building that has been already owned by the firm. If the project does not go ahead, this building could be rented out for $15 per year.