11. Peter Limited has spent $3 billion on developing a new single board computer over the...

    

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11. Peter Limited has spent $3 billion on developing a new single board computer over the past four years. The company now has three mutually exclusive options: 111. 1) The company can manufacture the single board computer itself in which case the plant will cost $5 billion. Additional working capital of $2.1 billion will be required when production commences. The expected sales and selling prices are as follows: Year 1 2 Number sold (in million) 100 100 3 100 120 4 80 5 80 Selling price ($) 120 120 100 The company usually depreciates plant of this type over five years using the straight-line method and assumes no scrap value. Variable costs are expected to be $65 per unit and other fixed cost is 2,000 million per year. Applicable tax rate for the company is 20%. The company will accept the new product if the new product can payback within three years. 2) Sell the know-how to one of its major competitors for a single payment of $3.5 billion. 3) Sell the know-how for a royalty of $10 per unit. 90 The information about the company's current capital structure are as follows: i The common stock is now trading at $15.65. We have used analysts' estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 200 million. For option 1), the company may accept the new product if the new product can payback within 3 years and it can generate sufficient profit to the company. For option 2) and 3), the company will not manufacture the product itself. The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 500,000 bonds outstanding. The price company's 8% preferred share is 93% of its par value ($100). The number of: res outstanding is $10 million. Required: a. Compute the WACC of Peter Limited. b. Calculate the relevant cash flow for option 1, 2 and 3. c. Compute the NPV, payback period and IRR for all 3 options. d. What would your final decision be? Discuss your decision in detail. e. As the cost of debt is apparently lower than other sources of fund, the company's CFO, David, suggests that the company should use debt financing exclusively in funding this new project. Do you agree with his suggestion? Please discuss in detail according to the Modigliani and Miller's theory. f. Jason, the company's finance manager, suggests that the company may consider issuing equity warrant as a new source of fund. Do you agree? Please discuss in detail. g. David believes the company should use the extra cash to pay a special one-time dividend. How will this proposal affect the stock price? Please discuss in detail. h. Angela, the company's accountant, believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Angela's proposal affect the company? Please discuss in detail. i. Jason is in favor of a share repurchase. He argues that a repurchase will increase the company's P/E ratio. Is his argument correct? How will a share repurchase affect the value of the company? Please discuss in detail. j. Another option discussed by David, Angela and Jason would be to adopt the residual dividend policy. How would you evaluate this proposal? Please discuss in detail. 11. Peter Limited has spent $3 billion on developing a new single board computer over the past four years. The company now has three mutually exclusive options: 111. 1) The company can manufacture the single board computer itself in which case the plant will cost $5 billion. Additional working capital of $2.1 billion will be required when production commences. The expected sales and selling prices are as follows: Year 1 2 Number sold (in million) 100 100 3 100 120 4 80 5 80 Selling price ($) 120 120 100 The company usually depreciates plant of this type over five years using the straight-line method and assumes no scrap value. Variable costs are expected to be $65 per unit and other fixed cost is 2,000 million per year. Applicable tax rate for the company is 20%. The company will accept the new product if the new product can payback within three years. 2) Sell the know-how to one of its major competitors for a single payment of $3.5 billion. 3) Sell the know-how for a royalty of $10 per unit. 90 The information about the company's current capital structure are as follows: i The common stock is now trading at $15.65. We have used analysts' estimates to determine that the market believes our dividends will grow at 6% per year and the expected dividend next year will be $2. The number of shares outstanding is 200 million. For option 1), the company may accept the new product if the new product can payback within 3 years and it can generate sufficient profit to the company. For option 2) and 3), the company will not manufacture the product itself. The company's 20-year bonds that pay semi-annual coupon rate of 9% is now selling at $975. The face value of the bond is $1,000 and there are 500,000 bonds outstanding. The price company's 8% preferred share is 93% of its par value ($100). The number of: res outstanding is $10 million. Required: a. Compute the WACC of Peter Limited. b. Calculate the relevant cash flow for option 1, 2 and 3. c. Compute the NPV, payback period and IRR for all 3 options. d. What would your final decision be? Discuss your decision in detail. e. As the cost of debt is apparently lower than other sources of fund, the company's CFO, David, suggests that the company should use debt financing exclusively in funding this new project. Do you agree with his suggestion? Please discuss in detail according to the Modigliani and Miller's theory. f. Jason, the company's finance manager, suggests that the company may consider issuing equity warrant as a new source of fund. Do you agree? Please discuss in detail. g. David believes the company should use the extra cash to pay a special one-time dividend. How will this proposal affect the stock price? Please discuss in detail. h. Angela, the company's accountant, believes that the company should use the extra cash to pay off debt and upgrade and expand its existing manufacturing capability. How would Angela's proposal affect the company? Please discuss in detail. i. Jason is in favor of a share repurchase. He argues that a repurchase will increase the company's P/E ratio. Is his argument correct? How will a share repurchase affect the value of the company? Please discuss in detail. j. Another option discussed by David, Angela and Jason would be to adopt the residual dividend policy. How would you evaluate this proposal? Please discuss in detail.

Answer rating: 100% (QA)

a The cost of equity for Peter Limited is Re D1 P0 g 2 1565 006 01667 006 02267 The cost of debt for Peter Limited is Rd 9 093 00837 The weighted average cost of capital for Peter Limited is WACC 200 ... View the full answer