A 5-year proj

FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
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A 5-year project will require an investment of $100 million. This comprises of plant and machinery worth $80 million and a net working capital of $20 million. The entire outlay will be incurred at the project’s commencement. 
Financing for the project has been arranged as follows: 
80,000 new common shares are issued, the market price of which is $500 per share. These shares will offer a dividend of $4 per share in year 1, which is expected to grow at a rate of 9% per year for an indefinite tenure. 
Remaining funds are borrowed by issuing 5-year, 9% semi-annual bonds, each bond having a face value of $1,000. These bonds now have a market value of $1,150 each. 
At the end of 5 years, fixed assets will fetch a net salvage value of $30 million, whereas the net working capital will be liquidated at its book value. 
The project is expected to increase revenues of the firm by $120 million per year. Expenses, other than depreciation, interest and tax, will amount to $80 million per year. The firm is subject to a tax rate of 30% 
Plant and machinery will be depreciated at the rate of 25% per year as per the written-downvalue method. 
You are required to: 


1.    Compute the cost of equity for this project .

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