1. Given the following information:

Sales	$500,000 per year in perpetuity
Cash costs	72% of sales
Initial Investment	$500,000
Tax Rate	34%
Project debt-equity proportion	25/75
Interest on debt	10% per year
Company’s geared equity beta	1.8
Market return	5%
Risk-free rate	3%

Calculate the value of the project using the NPV-FTE method:

Assuming that the project has no impact on the company’s debt-equity ratio

Assuming that the company rebalances its debt-equity ratio

Gem Bhd. is considering an investment in new production line – plastic recycling division. To start this new production line, they need to purchase new machinery that costs RM7 million. It is expected to generate annual before-tax cash inflows of RM1.5 million into perpetuity. The cost of production is expected to be 60% of the cash inflows. The depreciation of the machinery is RM200,000 per annum; while the repair and maintenance costs for the machinery are RM100,000 per annum. No inflation is considered in this case.

To invest in this machinery, Gem needs to get 60% of non-traded irredeemable debenture with a coupon rate of 8%. The remaining of fund will come from retained earnings in the company.

The plastic recycling industry has a geared equity beta of 1.4 and a debt-to-asset ratio of 1:5 by market values. The company has ungeared equity beta of 1.2. The yield on short-term government debt is 4% per year and the market risk premium is 5% per year. GEM pays corporate tax at an annual rate of 30%.

Analyse and advise GEM whether they should invest in this project by calculating the net present value using flow-to-equity method. State clearly the assumptions you make. Assume that GEM rebalances their debt-equity ratio.

Answer rating: 100% (QA)

Calculation of NPV of the project using NPVFTE method Assuming the project has no impact on the comp... View the full answer