soap manufacturing company is considering to diversify into alcohol business. It has decided toto set up an alcohol plant at a total cost of GHS 200 m. The project is to be financed as below: Equity GHS 75m 12% Debt GHS 125m The managing director of the company has asked the finance director to estimate the net present value of the alcohol business using the discounted cash flow method. The finance director was facing problem in estimating cost of equity for the alcohol business. He collected information with respect to the beta (market risk) of a comparable alcohol company and found 0.90. However, the proposed alcohol company will be riskier than existing comparable firm since it will be highly levered. Thus, market risk of the proposed alcohol company will be 80% higher than the existing comparable alcohol compa
A soap manufacturing company is considering to diversify into alcohol business. It has decided
toto set up an alcohol plant at a total cost of GHS 200 m. The project is to be financed as below:
Equity
GHS 75m
12% Debt
GHS 125m
The managing director of the company has asked the finance director to estimate the net present
value of the alcohol business using the discounted cash flow method. The finance director was
facing problem in estimating
with respect to the beta (market risk) of a comparable alcohol company and found 0.90.
However, the proposed alcohol company will be riskier than existing comparable firm since it
will be highly levered. Thus, market risk of the proposed alcohol company will be 80% higher
than the existing comparable alcohol company.
Required
a. Aid the finance director to estimate the cost of equity and hence the WACC for the
proposed alcohol company. The tax rate for the companies is 35%. Use a risk-free rate
of 7.5% and expected market risk premium of 8%.
b. Assuming that the company wants to raise additional capital through additional term loan of
GHS 40,000,000 @ 15% to finance expansion, calculate the new WACC and advise.
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