A company has designed a new product and conducted a market survey costing $500,000 to assess its

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Question:

A company has designed a new product and conducted a market survey costing $500,000 to assess its viability. The survey has determined that the new product will generate sales of $9,000,000 per year. Annual total cost (excluding depreciation expense) will come to $X,XXX,XXX [use your student ID*]. * please use your student ID as the cost figure for each year – for example if your student ID was 1234567, your annual total cost figure would be $1,234,567 - Student ID is 1771732

The equipment necessary for production will cost $8,000,000 and is to be depreciated evenly over the project’s life of 4 years (prime cost method). In addition, $250,000 in net working capital is required to fund the project. The tax rate is 30%.

The company believes the risk of the new project is the same as the risk of the company’s existing assets.

UoA’s capital consists of the following :

Ordinary Shares :

The company has 1,5 million ordinary shares outstanding, currently sell for $50 per share and a beta of 1.6.

The market risk premium is 12% and risk free rate is 5%

Preference shares :

The company has 200,000 preference shares, currently sell for $45 and pay $5 dividend.

Bonds :

The company has 150,000 bonds outstanding that mature in 5 years with an annual coupon of 7.5%, making half yearly payments. The bonds have a face value of $1,000 and currently sell in the market for $1080.

(a) Calculate the company’s weighted average cost of capital (WACC).

(b) Using the NPV criterion, should the project go ahead?