You work for an Australian business located in Tasmania. Your organisation is considering investing in an environmentally friendly wood chipping project. The project will take six years to complete and require the purchase of a new woodchip furnace costing $6,000,000. The installation cost of the new furnace is expected to cost $100,000. Estimates prepared by the company show sales of 50,000 tonnes in year 1 and are expected to grow at the rate of 20% per annum thereafter. Expected selling price is $40 per tonne, and the variable costs are expected to remain constant at $15 per tonne. Fixed costs are expected to remain at $45,000 per annum. Revenue and expense forecasts for the project are presented below. The project will require the organisation to make an initial investment of $20,000 in working capital. Working capital is predicted to increase by 20% each year. The company can depreciate its woodchip furnace on a straight-line basis over six years. The project has an estimated salvage value at the end of six years of $50,000. The company’s overall cost of capital is 12%, the annual inflation rate for the next six years is estimated at 2% and the company is subject to a 30% corporate income tax rate. Assuming the company is a proprietary limited company founded 20 years ago, suggest how best to finance this new project. Consider a few appropriate alternative sources of finance and compare and contrast them.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter14: Capital Structure Management In Practice

Section14.A: Breakeven Analysis

Problem 8P

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You work for an Australian business located in Tasmania. Your organisation is considering investing in an environmentally friendly wood chipping project. The project will take six years to complete and require the purchase of a new woodchip furnace costing $6,000,000. The installation cost of the new furnace is expected to cost $100,000. Estimates prepared by the company show sales of 50,000 tonnes in year 1 and are expected to grow at the rate of 20% per annum thereafter. Expected selling price is $40 per tonne, and the variable costs are expected to remain constant at $15 per tonne. Fixed costs are expected to remain at $45,000 per annum. Revenue and expense forecasts for the project are presented below. The project will require the organisation to make an initial investment of $20,000 in working capital. Working capital is predicted to increase by 20% each year. The company can depreciate its woodchip furnace on a straight-line basis over six years. The project has an estimated salvage value at the end of six years of $50,000. The company’s overall cost of capital is 12%, the annual inflation rate for the next six years is estimated at 2% and the company is subject to a 30% corporate income tax rate. Assuming the company is a proprietary limited company founded 20 years ago, suggest how best to finance this new project. Consider a few appropriate alternative sources of finance and compare and contrast them.

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