Due to the ongoing COVID 19 pandemic, Asepsis Ltd had decided to expand its sanitation product line
Question:
Due to the ongoing COVID 19 pandemic, Asepsis Ltd had decided to expand its sanitation product line to include the production of disposable face masks. The equipment will cost Asepsis $1,575,000 and it will cost $425,000 to install. Asepsis believes there will be a steady demand for masks in the coming 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 the first year. Asepsis will raise the funds 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. Asepsis wishes to raise the funds by:
1. A new issue of ordinary shares. The flotation costs of the new share issue would be 10% of the amount raised. The beta for Asepsis is 1.75, the risk-free rate is 2.5% and the market risk premium is 7%.
2. A new issue of 5-year bonds with a yield to maturity of 6.25% pa. The flotation costs of the new debt would be 2.5% of the amount raised. The company tax rate is 30%
a. Calculate Asepsis Ltd.’s average percentage flotation cost of the new fundraising. (Show answer as a percentage correct to 2 decimal places.)
b. Calculate the true cost of the new project. (Show answer correct to 2 decimal places.)
c. Calculate the company’s WACC. (Show answer as a percentage correct to 3 decimal places.)
d. Calculate the net present value (NPV) of the new project. (Show answer correct to 2 decimal places.)
e. Explain if Asepsis Ltd should accept the new project or not.
Intermediate Accounting
ISBN: 978-0324300987
10th Edition
Authors: Loren A Nikolai, D. Bazley and Jefferson P. Jones