Herts Gadgets International plc (t0 = 2021)

Herts Gadgets International plc manufactures and sells a range of machine tool accessories.

The company is considering an investment of £13.0 million in new production plant and 

machinery for the product. The new facility is to be operational from 1 January 2022. It will have a life of five years and at the end of its life it will have a residual value of £1.0 million. It is expected that the facility will have significant benefits.

Firstly, it will increase Herts Gadgets' production output of diamond milling tools by 10%. Total contribution from new sales is expected to be £2,865,000 in 2022 increasing annually by 5% per annum until 2026. All the increased production will be exported in approximately equal proportions to South Korea, Spain and Canada. Thus, the firm will have cash flows denominated in Won, €, and $Ca and the contribution figure given above is the sterling equivalent of these cash flows at current exchange rates.

Secondly, it will reduce the product's direct labour and direct material costs by 20% per unit which will result in savings of £1,680,000 on existing production in 2022. Having made these cost savings, the company expect costs to remain constant to 2026 due to continual efficiency improvements. The project also requires additional working capital of £2.0 million.

Herts Gadgets pays corporation tax at the rate of 20% on its taxable profits which is paid one year in arrears. (Assume that net cash flow is the same as taxable profit).

A recent report by financial consultants suggests that the Herts Gadgets plc's equity has a beta of 1.2 and reported that medium term UK government bonds are earning 2.89% per =rf annum. In addition, the report noted that the FTSE All-share index increased by an average of 11.6% =Rm  compound in each of the last three years.

Herts Gadgets plc ordinary shares are trading on the stock exchange at £1.65 whilst their loan stock is trading at £104.70. During the last year the firm reported an operating profit of £969,000.

Inspection of the Herts Gadgets plc balance sheet reveals the following:

Long-term Liabilities:                                       £000

7% Loan Stock 2023                                          500

Shares & reserves:

Ordinary shares par value £1                         1200

Profit and loss account                                   942

Shareholders funds                                        2642

 

Please calculate WACC, Payback period, IRR and ARR

Answer rating: 100% (QA)

Answer ICost of capital Rf Beta Rm Rf 289 12 116 289 13342 Particulars 2022 2023 2024 2025 2026 Contribution 5 pa 2865000 3008250 3158663 3316596 3482425 Saving in cost 1680000 1680000 ... View the full answer