Electrolar AB is planning to set up new operations in northern Sweden. Having established that the investment has a positive net present value, they now have to consider their financing decision. The underwriters to the company state that the total funding required amounts to SKr0.5 billion and that this can be raised through a debt issue or an equity issue.

1. Their first option concerns the use of debt financing. The underwriters suggest that a 10-
year bond issue with a 7 per cent coupon may be a sensible route to raising these funds. If interest payments are tax deductible and the tax rate is 26.33 per cent, estimate the required rate of return for debt financing to the nearest half per cent. (25 marks)

2. The second option relates to equity financing. The underwriters believe that if the company were to issue shares to fund the proposed project, they would have to be sold at a discount of 20 per cent. Issue expenses will be 1 per cent of the funding requirement.
Estimate the return required by investors when investing in Electrolar plc’s new share issue. (25 marks)

3. Review the ways in which positive net present value opportunities may arise when a company wishes to raise funds in the financial markets. Use an example to illustrate your answer. (25 marks)

4. Compare and contrast the strengths and weaknesses of the adjusted present value, weighted average cost of capital, and flow to equity approaches to investment appraisal. Which method, in your opinion, is the best? Explain. (25 marks)