Japan Power operates in Pakistan and is considering installing a new computer system in order to...

 

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Japan Power operates in Pakistan and is considering installing a new computer system in order to upgrade the web based sales system to bring it in line with that of Japan power's main competitors. The cost of Rs.10 million is payable up front but the new system will take a full year to implement. Increased pretax operating earnings of Rs.770,000 a year are expected from year 2 onwards indefinitely to reflect increased operational efficiencies and increased revenue from web based sales. Japan power is currently funded by ordinary shares and an irredeemable bond as follows: Nominal Value 2million Ordinary share Rs.10 each 5.4 % Bonds Rs.33 million Market Value Rs. 25 Trading at par Additional debt finance of Rs. 10 million will be taken out also at 5.40% if the project is approved. Additional information: 1. Cost of equity is 6.20% 2. The project is not expected to have any impact on either the current cost of equity or the cost of debt. 3. The share price is expected to react very quickly on announcement of the project to reflect the anticipated NPV of the project. 4. Business tax is payable and refundable at 35% in the year in which it is incurred. 5. Assume earnings equal net cash inflow 6. Cash flows arise at the end of a year Required: a. Calculate current WACC of Japan Power before taking the project into account. (Marks 5) Evaluate the project using the current WACC calculated above (NPV). (Marks 5) b. C. Calculate the post project WACC for Japan Power after the increased debt, and discuss your result. Discuss which WACC should be used to evaluate the project. (Marks 5) (Total Mark 15) Japan Power operates in Pakistan and is considering installing a new computer system in order to upgrade the web based sales system to bring it in line with that of Japan power's main competitors. The cost of Rs.10 million is payable up front but the new system will take a full year to implement. Increased pretax operating earnings of Rs.770,000 a year are expected from year 2 onwards indefinitely to reflect increased operational efficiencies and increased revenue from web based sales. Japan power is currently funded by ordinary shares and an irredeemable bond as follows: Nominal Value 2million Ordinary share Rs.10 each 5.4 % Bonds Rs.33 million Market Value Rs. 25 Trading at par Additional debt finance of Rs. 10 million will be taken out also at 5.40% if the project is approved. Additional information: 1. Cost of equity is 6.20% 2. The project is not expected to have any impact on either the current cost of equity or the cost of debt. 3. The share price is expected to react very quickly on announcement of the project to reflect the anticipated NPV of the project. 4. Business tax is payable and refundable at 35% in the year in which it is incurred. 5. Assume earnings equal net cash inflow 6. Cash flows arise at the end of a year Required: a. Calculate current WACC of Japan Power before taking the project into account. (Marks 5) Evaluate the project using the current WACC calculated above (NPV). (Marks 5) b. C. Calculate the post project WACC for Japan Power after the increased debt, and discuss your result. Discuss which WACC should be used to evaluate the project. (Marks 5) (Total Mark 15)