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Problem:

Alert Ltd is the Mauritian-based company dealing in business procedure outsourcing sector. Wycom plc, has outsourced the appraisal of all projects under USD2 million to Alert Ltd.

Wycom  plc is the stock market listed company which manufactures panels for vans. The business is profitable and demand has been rising. The machine at the company is dated and the company is measuring whether to replace it. The new machine would cost $1,500, 000 to purchase plus $180 000 in shipping costs and installation. The machine would have a useful life of 6years and would be depreciated down to zero on the straight line basis. As a result of the new machine, revenues will raise by $400 000 per annum over its 6year life, and the machine will also generates cost savings of $200 000 per annum.

There will be extra stock required for the new machine; this is expected to be $120 000. Accounts payable will raise as a result of the new machine as will accounts receivable, by $80 000 and $100 000 correspondingly. These figures are anticipated to remain constant till the end of the project at which time the investment in working capital will be completely recouped.

The new machine will require the employ of an extra depot for storage; the depot is being rented out at moment for $100 000 a year, however would become employed by the project if the project was adopted. The machine will require a full overhaul at end of 3years; this is expected to cost $100 000. A mechanic which already works for the company will be assigned to maintain the new machine; his salary is $60 000 a year. The company will have to fill his previous position.

The old machine, which has the book value of $300 000 and 3 years of life left, will be sold if the project is accepted for $200 000. It is expected that the new machine will be sold at the end of project for $240 000. The project is a routine replacement project for company; it is small in size in relation to the company. The company is currently 25% financed by debt; there is an unalterable bond (coupon rate 8%) outstanding with which is priced at $94.12 (Nominal value, $100) in the market. The risk free rate of interest is 5%. The company’s equity has the beta of 1.384. Wycom faces a tax rate of 30% levied on accounting profits in the year in which profit is reported.  The average stock market risk premium is 6%.

Required:

Demonstrate with, supporting computations, whether or not the project must be accepted.

Financial Management, Finance

  • Category:- Financial Management
  • Reference No.:- M99766

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