CJ Co is a profitable company which is financed by equity with a market value of...
Fantastic news! We've Found the answer you've been seeking!
Question:
Transcribed Image Text:
CJ Co is a profitable company which is financed by equity with a market value of $180 million and by debt with a market value of $45 million. The company is considering two investment projects, as follows. Project A This project is an expansion of existing business costing $3.5 million, payable at the start of the project, which will increase annual sales by 750,000 units. Information on unit selling price and costs is as follows: Selling price: Selling costs: $2.00 per unit (current price terms) $0.04 per unit (current price terms) $0.80 per unit (current price terms) Variable costs: Selling price inflation and selling cost inflation are expected to be 5% per year and variable cost inflation is expected to be 4% per year. Additional initial investment in working capital of $250,000 will also be needed and this is expected to increase in line with general inflation. Project B This project is a diversification into a new business area that will cost $4 million. A company that already operates in the new business area, GZ Co, has an equity beta of 1.5. GZ Co is financed 75% by equity with a market value of $90 million and 25% by debt with a market value of $30 million. Other information CJ Co has a nominal weighted average after-tax cost of capital of 10% and pays profit tax one year in arrears at an annual rate of 30%. The company can claim capital allowances (tax-allowable depreciation) on a 25% reducing balance basis on the initial investment in both projects. Risk-free rate of return: 4% Equity risk premium: 6% General rate of inflation: 4-5% per year Directors' views on investment appraisal The directors of CJ Co require that all investment projects should be evaluated using either payback period or return on capital employed (accounting rate of return). The target payback period of the company is two years and the target return on capital employed is 20%, which is the current return on capital employed of CJ Co. A project is accepted if it satisfies either of 517 these investment criteria. The directors also require all investment projects to be evaluated over a four-year planning period, ignoring any scrap value or working capital recovery, with a balancing allowance (if any) being claimed at the end of the fourth year of operation. Required: (a) Calculate the net present value of Project A and advise on its acceptability if the project were to be appraised using this method. (12 marks) (b) Critically discuss the directors' views on investment appraisal. (7 marks) (c) Calculate a project-specific cost of equity for Project B and explain the stages of your calculation. (6 marks) (25 marks) CJ Co is a profitable company which is financed by equity with a market value of $180 million and by debt with a market value of $45 million. The company is considering two investment projects, as follows. Project A This project is an expansion of existing business costing $3.5 million, payable at the start of the project, which will increase annual sales by 750,000 units. Information on unit selling price and costs is as follows: Selling price: Selling costs: $2.00 per unit (current price terms) $0.04 per unit (current price terms) $0.80 per unit (current price terms) Variable costs: Selling price inflation and selling cost inflation are expected to be 5% per year and variable cost inflation is expected to be 4% per year. Additional initial investment in working capital of $250,000 will also be needed and this is expected to increase in line with general inflation. Project B This project is a diversification into a new business area that will cost $4 million. A company that already operates in the new business area, GZ Co, has an equity beta of 1.5. GZ Co is financed 75% by equity with a market value of $90 million and 25% by debt with a market value of $30 million. Other information CJ Co has a nominal weighted average after-tax cost of capital of 10% and pays profit tax one year in arrears at an annual rate of 30%. The company can claim capital allowances (tax-allowable depreciation) on a 25% reducing balance basis on the initial investment in both projects. Risk-free rate of return: 4% Equity risk premium: 6% General rate of inflation: 4-5% per year Directors' views on investment appraisal The directors of CJ Co require that all investment projects should be evaluated using either payback period or return on capital employed (accounting rate of return). The target payback period of the company is two years and the target return on capital employed is 20%, which is the current return on capital employed of CJ Co. A project is accepted if it satisfies either of 517 these investment criteria. The directors also require all investment projects to be evaluated over a four-year planning period, ignoring any scrap value or working capital recovery, with a balancing allowance (if any) being claimed at the end of the fourth year of operation. Required: (a) Calculate the net present value of Project A and advise on its acceptability if the project were to be appraised using this method. (12 marks) (b) Critically discuss the directors' views on investment appraisal. (7 marks) (c) Calculate a project-specific cost of equity for Project B and explain the stages of your calculation. (6 marks) (25 marks)
Expert Answer:
Answer rating: 100% (QA)
a Calcul ate the net present value of Project A and advise on its accept ability if the project were ... View the full answer
Related Book For
Intermediate Accounting
ISBN: 978-0176509736
10th Canadian Edition, Volume 1
Authors: Donald Kieso, Jerry Weygandt, Terry Warfield, Nicola Young,
Posted Date:
Students also viewed these finance questions
-
AYR Co. is considering two separate projects known as Aspire and Wolf which are quite different but each of which has the potential to increase AYR Co.s market share. To date $120,000 has been spent...
-
Managing Scope Changes Case Study Scope changes on a project can occur regardless of how well the project is planned or executed. Scope changes can be the result of something that was omitted during...
-
Diana has recently followed a course in furniture making and has decided to set up her own workshop from which she will be producing wooden chairs. She starts renting a small workshop at an annual...
-
About "Hilton Honors" 1) Explain what creates value and identify if there are aspects that do not create value. (Please include the citation and references) 2)What is the strength of the Hilton Honor...
-
Wild River Tours Co. is a travel agency. The nine transactions recorded by Wild River Tours during May 2012, its first month of operations, are indicated in the following T accounts: Indicate for...
-
Consider the tensile stress-strain diagrams in Figure 8 - 20 labeled 1 and 2 and answer the following questions. These curves are typical of metals. Consider each part as a separate question that has...
-
Identify the main users of financial information and discuss their needs.
-
A security firm needs to connect alarm systems to the firms main control site from five potential trouble locations. Since the systems must be fail-safe, the cables must be run in special pipes....
-
1 Explain five ecosystem services on which you rely. 2. Explain the idea of moral extensionism, and give an example. 3. What is the "green revolution," and why was it important? 4. State and explain...
-
On January 1, 2025, Carla Vista Company has the following defined benefit pension plan balances. Projected benefit obligation Fair value of plan assets $4,569,000 4,160,000 The interest (settlement)...
-
You have crashing information for a project that needs to be finished one week earlier than it is currently expected to complete. Activity 1 2 3 4 Normal Duration (weeks) 4 7 12 5 (a) Which activity...
-
Called the "Ban the Box" movement, Koch Industries is the latest large U.S. corporation (employing more than 60,000 people in the United States alone) to drop its application question about prior...
-
The policy defined women capable of bearing children as "all women except those whose inability to bear children is medically documented." The policy defined unacceptable lead exposure as the OSHA...
-
Kimberly Cloutier was a member of the Church of Body Modification. In 1997, during her job interview for a position at Costco, Ms. Cloutier sported four tattoos and multiple earrings, but she had no...
-
T-Mobile's CEO, John Legere, has made T-Mobile the "best wireless carrier," according to consumer reports. At the time of that glowing report, T-Mobile had passed by Sprint to become the third...
-
On January 11, 1993, young Michael Nole and his family ate dinner at a Jack-in-the-Box restaurant in Tacoma, Washington, where Michael enjoyed his \(\$ 2.69\) "Kid's Meal." The next day, Michael was...
-
Case Study 2 Farooq Farooq is 28 years old. He works in a call centre at a major bank and his net earnings are approximately $1800 per month. He also works as a bartender at a restaurant Friday...
-
Anna, a high school counselor, devised a program that integrates classroom learning with vocational training to help adolescents at risk for school dropouts stay in school and transition to work...
-
Rachel Timber Inc., a small private company that follows Canadian ASPE, owns 9,000 hectares of timberland purchased in 2001 at a cost of $1,400 per hectare. At the time of purchase, the land without...
-
Explain the rights and obligations created in the following transactions. (a) A manufacturer sells goods with terms FOB shipping point. (b) A manufacturer sells goods with terms FOB destination...
-
Use the information for Qilin Corp. given in BEll-11. By the end of the following year, the machinery's fair value has increased to $490,000. In exercise Qilin Corp., a small company that follows...
-
What are the major elements of risk assessment?
-
How does an organization go about identifying, measuring, and prioritizing risks? Who is responsible for the assessment of risk in an organization?
-
What is risk? How does management generally perceive the dimensions of risk?
Study smarter with the SolutionInn App