Final

PVCCATsQuestioncorrectedNWCdocx.docx

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A company is considering the purchase of a major piece of equipment for its manufacturing plant. The project would cost $22m in initial investment and would result in cost savings, before tax, of $3.25m per year for five years.

The equipment could be sold for $4.5m at the end of the five years. The equipment would also result in an increase in NWC of $50,000, which will be recovered at the end of the project.

The company’s CCA rate is 25% and the corporate tax rate is 34%.

The company’s target capital structure is 70% equities and 30% debt.

The cost of equity is 12% while the cost of debt before tax is 5%.

a) What is the WACC ? (3 marks)

WACC = 0.3(0.05)((1-0.34) + 0.7(0.12) = 9.39%

b) Calculate NPV. Should the company go ahead with the purchase?

(12 marks)

Step 1: Initial cost - $22m + $50,000 = 22,050,000 -22,050,000

Step 2: Cost savings = 3.25m(1-.34) = $2.145m + 8,259,500

PV of cost savings = + 4,494,158

N=5, i=9.39, PMT=2.145 PV = 8.2595 + 2,905,000

Step 3; Calc PVCCATs

Using formula = 4.494.158

NPV = -6,391,342

Step 4: Calc PV of terminal CFs

4.5m + 50,000 = 4,550,000

PV = N=5, FV=4.55, i=9.39 Do not proceed.

Calc PV = 2.905m

c) Using only the after tax cost savings, what is the MIRR?

Step 1: N=5, PMT =2.145, i=9.39, FV = 12.937

Step 2: MIRR = N=5, FV=12.937, PV=22.050, i=10.188

MIRR = 10.19%