Covidam Company clinches a contract to supply cleaning services to a nursing home for the next 5 years. Under the contract, the Company will be paid $1 million a year. To take up this contract, it would have to invest in new cleaning equipment costing $600,000 which will be depreciated straight line to zero over 5 years. There is no salvage value at the end of 5 years. Labour cost will be $300,000 per year and overheads $250,00 per year. The Company will need to invest in net working capital of $350,000. It plans to issue $1 million worth of bonds for 5 years at a coupon rate of 6% and will price the bonds at par. The Company has an existing bank loan of $9 million. The cost of debt from the bank loan is the same as the bonds. The common stock of the Company is selling for $10 per share and it has 2 million shares outstanding. Expected dividend next year is $1 per share and dividends are expected to grow at 2% per annum into the foreseeable future. The tax rate is 20%. a) Calculate the initial cash flow of the project. (b) Determine the operating cash flows of the project by filling in the following table (Unit: $) according to the context. Year 1 2 3 4 5 Sales Labour cost Overheads Depreciation EBIT Taxes Net income (NOPAT) Operating cash flow (c) Compute the cash flow from assets for the project. (d) Compute and analyse whether the project should be accepted using NPV and a required return of 10%. Without doing any calculations, explain what you expect the IRR to be relative to the required rate of return. (h) Describe two (2) other measures besides NPV that give the same accept/reject decision as NPV. You need to show how these two (2) measures are related to NPV. (Note: No calculation is needed.)
Covidam Company clinches a contract to supply cleaning services to a nursing home for
the next 5 years. Under the contract, the Company will be paid $1 million a year. To take
up this contract, it would have to invest in new cleaning equipment costing $600,000
which will be
the end of 5 years. Labour cost will be $300,000 per year and overheads $250,00 per
year. The Company will need to invest in net working capital of $350,000.
It plans to issue $1 million worth of bonds for 5 years at a coupon rate of 6% and will
price the bonds at par. The Company has an existing bank loan of $9 million. The cost
of debt from the bank loan is the same as the bonds.
The common stock of the Company is selling for $10 per share and it has 2 million shares
outstanding. Expected dividend next year is $1 per share and dividends are expected to
grow at 2% per annum into the foreseeable future.
The tax rate is 20%.
a) Calculate the initial cash flow of the project.
(b) Determine the operating cash flows of the project by filling in the following table
(Unit: $) according to the context.
Year 1 2 3 4 5
Sales
Labour cost
Overheads
Depreciation
EBIT
Taxes
Net income (
Operating cash flow
(c) Compute the cash flow from assets for the project.
(d) Compute and analyse whether the project should be accepted using
required return of 10%. Without doing any calculations, explain what you expect
the
(h) Describe two (2) other measures besides NPV that give the same accept/reject
decision as NPV. You need to show how these two (2) measures are related to
NPV. (Note: No calculation is needed.)
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