Ori plc is evaluating two projects. The first involves a $ 4.725m expenditure on new machinery to expand the company’s existing operations in the textile industry. The second is the diversification into the packing industry and will cost $ 9.275m. Ori’s summarized balance sheet and those of Canal plc and Sealalot plc companies in the packaging industry are shown below.
Ori plc ($m) Canall plc ($m) Sealalot plc($m)
Fixed Assets 96 42 76
Current Assets 70 82 65
Less Current Liabilities (70) (72) (48)
121 52 93
Financed by:
Ordinary shares 15 10 30
Reserves 50 27 50
Medium and Long term loans 56 15 13
121 52 93
Ordinary share price (pence) 380 180 230
Debenture ($) 104 112 -
Equity beta 1.2 1.3 1.2

1. Ori and Sealalot 50 pence par value, Canal 25 pence par value
2. Ori 12% debentures 1998-2000, Canal 14% debentures 2003, Sealalot medium-term bank loan. Ori proposes to finance the expansion of textile operations with a $ 4.725 m 11% loan stock issue, and the packaging investment with a $ 9.275 m rights issue at a discount of 10% on the current market price. Issue cost may be ignored. Ori’s managers are proposing to use a discount rate of 15% per year to evaluate each of these
projects. The risk-free rate of interest is estimated to be 6% per year and the market return 14% per year. Corporate tax is at the rate of 33% per year.
Required.
a. Determine whether 15% per year is an appropriate discount rate to use for each of these projects. Explain your answer and state clearly any assumptions that you make
b. Ori’s marketing director suggests that it is incorrect to use the same discount rate each year for the investment in packaging as the early stages are riskier and should be discounted at a higher rate. Another board member disagrees saying that more distant cash flows are riskier and should be discounted at a higher rate. Discuss the validity of the views of each of the directors Ori and Sealalot 50 pence par value, Canal 25 pence par value.

Answer rating: 100% (QA)

Ans to Qa It is asked whether 15 per year is an appropriate rate of discount To answer this question ... View the full answer