11 Understanding the advantages and disadvantages of using WACC for project evaluation [LO 9] sources: rainfall...

 

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11 Understanding the advantages and disadvantages of using WACC for project evaluation [LO 9] sources: rainfall and an annual allocation from the Bullamakanka Water Supply Authority. In recent years Verity Cotton Ltd (VCL) operates a large cotton farm near Bullamakanka. Its water supply comes from wo has been difficult to obtain sufficient water to produce a good crop. Geoff Singh, the managing director d opening a camping ground to serve visitors to the recently-opened Bullamakanka National Park and Her VCL, has recently received a report from the Bullamakanka Tourism Board suggesting that VCL should consid Site, which is located near the farm. Such a development would take about 10 per cent of VCL's land outd cotton production. Geoff prepared an NPV analysis of the proposal, which he presented to a recent meetings the VCL board of directors. At the meeting, there was some disagreement over two aspects of Geoff's analys These aspects were: a) Geoff ignored the fact that 10 per cent of the land would no longer be used for cotton production. Some directors felt that because 10 per cent of the land would no longer be used to produce cotton, the analys should include a 10 per cent reduction in the net cash flow expected from cotton production. b) In his analysis, Geoff had used an estimate of VCL's cost of capital to discount the forecast net cash flow the camping ground project. However, Geoff noted in his analysis that all of the costs of the project would be financed by a bank loan. Some directors argued that, in view of this fact, the appropriate discount to use is the interest rate that the bank would charge. As Hank, one of the directors, explained, "Since nor of the shareholders' money will be used in the project, we don't need to reward the shareholders; we only need to ensure that the cash flows are sufficient to meet the bank's requirements'. Provide the board with your advice on each of the two matters raised in (a) and (b). 11 Understanding the advantages and disadvantages of using WACC for project evaluation [LO 9] sources: rainfall and an annual allocation from the Bullamakanka Water Supply Authority. In recent years Verity Cotton Ltd (VCL) operates a large cotton farm near Bullamakanka. Its water supply comes from wo has been difficult to obtain sufficient water to produce a good crop. Geoff Singh, the managing director d opening a camping ground to serve visitors to the recently-opened Bullamakanka National Park and Her VCL, has recently received a report from the Bullamakanka Tourism Board suggesting that VCL should consid Site, which is located near the farm. Such a development would take about 10 per cent of VCL's land outd cotton production. Geoff prepared an NPV analysis of the proposal, which he presented to a recent meetings the VCL board of directors. At the meeting, there was some disagreement over two aspects of Geoff's analys These aspects were: a) Geoff ignored the fact that 10 per cent of the land would no longer be used for cotton production. Some directors felt that because 10 per cent of the land would no longer be used to produce cotton, the analys should include a 10 per cent reduction in the net cash flow expected from cotton production. b) In his analysis, Geoff had used an estimate of VCL's cost of capital to discount the forecast net cash flow the camping ground project. However, Geoff noted in his analysis that all of the costs of the project would be financed by a bank loan. Some directors argued that, in view of this fact, the appropriate discount to use is the interest rate that the bank would charge. As Hank, one of the directors, explained, "Since nor of the shareholders' money will be used in the project, we don't need to reward the shareholders; we only need to ensure that the cash flows are sufficient to meet the bank's requirements'. Provide the board with your advice on each of the two matters raised in (a) and (b).

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a Geoffs decision to ignore the fact that 10 percent of the land would no longer be used for cotton ... View the full answer