NOTE:

• Properly label the values such as amounts (with $), percentages (%), and other relevant items.

• Show $ values above $1,000 without decimals and show % in 2 decimal places.

• There is no need to insert text boxes on Excel to write formulas or texts.

Wave Co is considering investing $3.5 million in some projects. The finance manager has identified three possible options from three different product lines of the company for investment and you as a consultant have been assigned the job of appraising these projects for investment.

The following information is available about the capital structure of the company:

Authorized share capital, $0.50 each	109 million shares
Issued share capital, $0.50 each	89 million shares
10% Bonds issued, $100 each	2.1 million bonds

The current market price of a share is at $6 per share after the dividend has been just paid and next years dividend per share is expected to be 12 cents. The average annual dividend growth rate is at 13 percent.

The bonds which are compounded annually are currently being traded in the market for a price of $105 per bond and redeemable in 6 years at par.

The projects identified are not divisible and may not be postponed until a future period. The annual tax rate is 30%, and it is paid one year in arrears.

The details of the projects identified are as follows:

Project A

This project has been proposed by the Hardware Division for the expansion of production on an existing product and requires a machine costing $1,010,000 and an additional $180,000 is also needed as installation cost. The scrap value of the machine is 5% of the purchase price and the expected life is four years.

The following is forecasts of productions, sales, variable costs and selling prices.

Year	1	2	3	4
Production (units)	32,900	34,300	36,800	38,500
Sales (units)	31,500	33,800	37,300	39,900
Variable production cost per unit ($)	60	74	77	94
Selling price per unit ($)	95	109	112	129

The fixed overheads of $780,000 in the first year is expected to increase by $2,000 every year.

The initial investment will attract tax-allowable depreciation on 20% reducing balance basis. The company wants to finance this project fully using equity capital.

Project B

This project has been proposed by the Electronics Division for a new product and requires a plant costing $1,130,000. The scrap value of this plant is expected to be 15% of the initial investment at the end of fourth year.

Market research has been already done at a cost of $4,100 to forecast demand for the new product. The estimated demand for the first year is 4,100 units and it is expected to increase by 25% and 20% in the second and third year respectively. However, the demand will decrease by 10% in the final year.

The expected selling price is $450 per unit with 70% probability or it will be $380. Variable cost per unit is expected to be $250 with 60% probability or $180. Expected fixed cost in the first year will be $582,000 or $654,000 with 50% chance of each and it will increase by $51,000 annually .

Capital allowances would be available on the cost of the plant on straight-line basis over the four-year project life. The company plans to use a nominal after-tax cost of debt for the appraisal of this project.

Project C

This project has been proposed by the Fixtures Division of the company which is planning to expand the production level of an existing product due to increase in demand. The current annual demand and production capacity is 10,100 units. The demand forecasts of this product for the next four years are as follows:

Year	1	2	3	4
Demand (units)	12,900	14,300	16,800	18,500

A new machine is available now for a cost of $1,250,000, which has an annual production capacity of 7,100 units. This machine has an expected life of four years and nil scrap value. Also, investment in working capital of $43,000 is required now and it is expected to recover fully at the end of the fourth year.

The current selling price is $597 per unit and it is expected to increase by $15 every year. The variable cost is currently $497 per unit and it is also expected to increase by $14 annually. The current fixed overhead of $620,000 will increase by $2,000 for each additional 1,000 units produced over the current annual production level.

If the company buys the new machine a tax allowable depreciation on the investment on 25% reducing balance basis can be claimed. The company uses its after-tax weighted average cost of capital when appraising this project.

REQUIREMENTS

1. Determine the cost of equity, cost of debt and weighted average cost of capital for the company.

(10 marks)

2. For each project, calculate the expected net present value (NPV), internal rate of return (IRR), profitability index (PI), return on capital employed (ROCE), payback period (PP) and discounted payback period (DPP).

(60 marks)

3. Rank the projects according to NPV, IRR, PI, ROCE, and PP, and identify the best investment option, total value added, total investment needed, and any surplus of funds based on the total funds available

(10 marks)

4. Write a report in approximately 1,000 to 1,500 words on the impact of gearing on capital structure and unsystematic risk. Your discussion should include how the sources of funds proposed for the above projects impact the capital structure of the company.