Your company is planning to expand its existing business to meet projected increases in demand for...

 

 

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Your company is planning to expand its existing business to meet projected increases in demand for its products. The cost to do this has been estimated at $7m, with projected annual after-tax cash flows of $1,300,000 over the next 10 years. The company's financial advisers have indicated the project could be financed entirely with equity, entirely with debt, or with the current mix of the company's debt and equity. The company has minimal retained profits, pays tax at 30% and has a majority of shareholders who cannot utilize imputation credits. The financial advisers have gathered the following information: The company has 100,000 existing bonds with $100 face value, paying a coupon rate of 8% p.a. half yearly and have 10 years remaining to maturity. New bonds could be issued at the same price, term and coupon as the existing bonds which currently have a yield of 12% p.a. However, transaction costs to issue new bonds are estimated at 2% of issue price. The company currently has 5 million issued ordinary shares that paid a dividend last year of $0.20 per share. Earnings and dividends are expected to have steady growth for the foreseeable future of 5% p.a. The current market value the company's shares is $2, and legal and other costs associated with the issuing new shares are estimated to be 5% of market price. a) How would you suggest the company finance this expansion project? Why? b) Calculate the discount rate that should be used to evaluate this project. c) Calculate the project's NPV and recommend whether the project is acceptable. Activ Go to Your company is planning to expand its existing business to meet projected increases in demand for its products. The cost to do this has been estimated at $7m, with projected annual after-tax cash flows of $1,300,000 over the next 10 years. The company's financial advisers have indicated the project could be financed entirely with equity, entirely with debt, or with the current mix of the company's debt and equity. The company has minimal retained profits, pays tax at 30% and has a majority of shareholders who cannot utilize imputation credits. The financial advisers have gathered the following information: The company has 100,000 existing bonds with $100 face value, paying a coupon rate of 8% p.a. half yearly and have 10 years remaining to maturity. New bonds could be issued at the same price, term and coupon as the existing bonds which currently have a yield of 12% p.a. However, transaction costs to issue new bonds are estimated at 2% of issue price. The company currently has 5 million issued ordinary shares that paid a dividend last year of $0.20 per share. Earnings and dividends are expected to have steady growth for the foreseeable future of 5% p.a. The current market value the company's shares is $2, and legal and other costs associated with the issuing new shares are estimated to be 5% of market price. a) How would you suggest the company finance this expansion project? Why? b) Calculate the discount rate that should be used to evaluate this project. c) Calculate the project's NPV and recommend whether the project is acceptable. Activ Go to

Answer rating: 100% (QA)

a In determining how the company should finance the expansion project it is important to consider the cost of capital associated with each financing o... View the full answer