JA believes that, as the Johnsons Acoustics (JA) is the market leader in acoustic equipment. As...

 

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JA believes that, as the Johnsons Acoustics (JA) is the market leader in acoustic equipment. As there is no major technological breakthrough in the acoustic industry, there is little growth in this industry. JA decides to diversify to a new business area: optical instruments. demand of optical lens for mobile phones is huge, the diversification will bring an excellent growth opportunity to the company. In the diversification plan, the optical instruments project The construction of the new factory will last for 5 years and a new factory will be built. requires $280 millions and it will be financed by issuing both common stocks and bonds. The information about the company's current capital structure is as follows: 1 The common stock is now trading at $15.65. We have used analysts' estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 20 million. 2 The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 100,000 bonds outstanding. The annual revenue, cost and profit forecast for the coming 5 years is as follows: Revenue Variable cost 39 35 54.6 101.4 Assume that Johnsons Acoustics has a 35% tax rate. At the end of year 5, an additional cost of $50 millions (net of tax) will be incurred. a Compute the cost of equity of JA by dividend growth model. What is the after-tax cost of debt of JA? Fixed cost Tax (35%) Net Profit C d $(Million) 230 e (5 marks) (5 marks) If JG wants to maintain its current capital structure after issuing new equity and debt, (5 marks) compute is the WACC of JA. The project manager of JA feels that the appropriate discount rate of the new project should be 3% above the WACC. Compute the NPV, payback period and IRR of the new (15 marks) project. As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. Two additional scenarios, namely, best scenario and worst scenario, will be considered. In the best scenario, the revenue and variable cost will be increased by 20%. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the additional two scenarios. Should JA accept the new project? Discuss in detail. JA believes that, as the Johnsons Acoustics (JA) is the market leader in acoustic equipment. As there is no major technological breakthrough in the acoustic industry, there is little growth in this industry. JA decides to diversify to a new business area: optical instruments. demand of optical lens for mobile phones is huge, the diversification will bring an excellent growth opportunity to the company. In the diversification plan, the optical instruments project The construction of the new factory will last for 5 years and a new factory will be built. requires $280 millions and it will be financed by issuing both common stocks and bonds. The information about the company's current capital structure is as follows: 1 The common stock is now trading at $15.65. We have used analysts' estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 20 million. 2 The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 100,000 bonds outstanding. The annual revenue, cost and profit forecast for the coming 5 years is as follows: Revenue Variable cost 39 35 54.6 101.4 Assume that Johnsons Acoustics has a 35% tax rate. At the end of year 5, an additional cost of $50 millions (net of tax) will be incurred. a Compute the cost of equity of JA by dividend growth model. What is the after-tax cost of debt of JA? Fixed cost Tax (35%) Net Profit C d $(Million) 230 e (5 marks) (5 marks) If JG wants to maintain its current capital structure after issuing new equity and debt, (5 marks) compute is the WACC of JA. The project manager of JA feels that the appropriate discount rate of the new project should be 3% above the WACC. Compute the NPV, payback period and IRR of the new (15 marks) project. As optical instrument is a completely unrelated to the company's current business, the managers worries about the risk of the diversification strategy. They want to study how sensitive is the NPV to change in the cash flow estimate and hence a scenario analysis will be conducted. Two additional scenarios, namely, best scenario and worst scenario, will be considered. In the best scenario, the revenue and variable cost will be increased by 20%. In the worst scenario, the revenue and variable cost will be decreased by 20%. The fixed cost and tax rate remain unchanged in both scenarios. Compute the NPVs of the additional two scenarios. Should JA accept the new project? Discuss in detail.