Sussex Plc is planning a new product which will be sold to trade customers on 60 day credit terms. All investment and manufacturing costs will need to be paid either in the month of purchase or the month after.

The project has been appraised by discounting future cash flows at a rate equal to the weighted average cost of capital (WACC).

Budgets for the new product have determined that they need to raise long term finance of £50m, and short term finance of £10m.

Short term finance needs will be met using existing bank overdraft facilities. The long term finance will be raised entirely by the issue of new long-term debt.

Sussex Plc has historically financed its activities with 50% debt and 50% equity.

Current market data suggest that these sources of finance have the following costs:

Cost of equity 11%

Cost of debt 4%

Assume Corporation Tax rate to be charged at 25%

Required:

a) Calculate the (WACC) and discuss the appropriateness of using this as a discount rate to appraise the project. Include a comparison using the cost of equity or the cost of debt as a discount rate.

b) If Sussex Plc continues to use debt only to finance investments, what would the expected impact on the WACC over time be? Explain and discuss

c) Some of the managers were surprised that the project would require so much financing given the budget has shown it to be very profitable from the first month. Discuss the reasons why the new product will require so much investment, and the steps that were needed to identify the finance required.

Answer rating: 100% (QA)

a Calculation of WACC As from the information in question provides that Sussex is planning ... View the full answer