Due to the ongoing COVID 19 Pandemic, Sterilic Ltd had decided to expand their sanitation product line to include the production of disposable face masks. The equipment will cost Sterilic $1,575,000 and it will cost $425,000 to install. Sterilic believes there will be a steady demand of masks at least for next five years and so it expects this project will generate after-tax cash flows of $654,500 per year for the 5 year life of the project, with the first cash flow starting at the end of first year. Sterilic will raise the fund for the new project by a mix of new debt and new equity that will maintain its target debt
Due to the ongoing COVID 19 Pandemic, Sterilic Ltd had decided to expand their sanitation product line to include the production of disposable face masks. The equipment will cost Sterilic $1,575,000 and it will cost $425,000 to install. Sterilic believes there will be a steady demand of masks at least for next five years and so it expects this project will generate after-tax cash flows of $654,500 per year for the 5 year life of the project, with the first cash flow starting at the end of first year.
Sterilic will raise the fund for the new project by a mix of new debt and new equity that will maintain its target debt to equity ratio of 0.25. Sterilic wishes to raise the funds by:
- A new issue of ordinary shares. The floatation costs of the new share issue would be 10% of the amount raised. The beta for Sterilic is 1.75, the risk free rate is 2.5% and the market
rate of return is 9.5%. - A new issue of 5-year Bonds with yield to maturity of 6.25% pa. The floatation costs of the new debt would be 2.5% of the amount raised.
The company tax rate is 30%
You are the assistant to the finance manager and is given the responsibility to analyse the project to determine if Sterilic should accept this project or not.
- Calculate Sterilic Ltd’s average percentage floatation cost of the new fund raising. (Show answer as a percentage correct to 2 decimal places.)
- Calculate the true cost of the new project. (Show answer correct to 2 decimal places.)
- Calculate Sterilic Ltd’s weighted average cost of capital (WACC). (Show answer as a percentage correct to 3 decimal places.)
- Calculate the
net present value (NPV) of the new project. (Show answer correct to 2 decimal places.) - Explain if Sterilic Ltd should accept the new project or not.
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