Lucent Limited is a manufacturing company producing microchips. It wishes to evaluate an investment in a new production machine. The machinery would enable the company to satisfy the increasing demand for existing products and the investment is not expected to lead to any changes in the existing level of business risk.
Investment details are as follows:
• The Machinery will cost Euro 2.5 million, payable at the start of the first year of operations, and it is not expected to have any scrap value
• Annual net cash flow (before tax and inflation) is Euro 680,000 in the current year per year
• Project operating life is of five years
• Initial Investment in working capital if of Euro 240,000
• Inflation rate if of 3%
• Tax rate is 25% payable 1 year in arrears.
• Capital allowance is applicable for 5 years
Lucent Limited has in issue five million shares with a market value of 3.81 per share. The equity Beta is 1.2. The yield on government debts is 2% per year and the equity risk premium is approximately 4%.
The Debt finance of Lucent Limited consists of bonds with a total book value of Our 2 Million. These bonds pay annual interest debt before tax of 7%. The pare values and market value of each bond is Our 100.
Questions
1. Using WACC identify the Cost of capital of Lucent Limited clearly showing your workings
2. Using appropriate investment appraisal techniques appraise the investment proposed by Lucent Limited and discuss the advantages and disadvantages of each technique
3. Discuss the Capital budgeting process
4. Discuss the stages in the capital investment decision-making process.

Answer rating: 100% (QA)

1 WACC is calculated by multiplying the cost of each capital source debt and equity by its relevant weight by market value and then adding the products together to determine the total The cost of equi... View the full answer