Essentials Of Investments
11th Edition
ISBN: 9781260013924
Author: Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher: Mcgraw-hill Education,
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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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