Engro Fertilizer has a current debt to equity ratio of 55%. The company is planning to expand its fertilizer business in Africa and will require a new facility to produce fertilizer. The estimated cost of the new facility is expected to be Rs. 50 million. It is expected that the plant will generate after tax cashflows of Rs. 6.7 million a year in perpetuity. Engro will need to raise all the cost through external financing and three options are available. Issuance of new common equity: Engro’s required rate of return on new equity financing is 14% and it will have to incur 8% of the amount raised as the flotation cost. Issuance of bonds with the maturity of 20 years: The pretax cost of capital of the bond is 8% and Engro would incur a floation cost of 4% on the amount raised through bonds Short term financing through accounts payable: Since Engro needs to meet its day-to-day expenses with this financing, it has no floatation cost and the cost of this short term financing is equal to Engro’s weighted average cost of capital (WACC). Engro’s board has instructed to maintain a target accounts payable to long term debt ratio of 20%, which will be meet all the time (Assume same pretax and aftertax cost of short-term financing) Calculate the NPV of the new facility? Engro’s corporate tax rate is 35%
Engro Fertilizer has a current debt to equity ratio of 55%. The company is planning to expand its fertilizer business in Africa and will require a new facility to produce fertilizer. The estimated cost of the new facility is expected to be Rs. 50 million. It is expected that the plant will generate after tax cashflows of Rs. 6.7 million a year in perpetuity. Engro will need to raise all the cost through external financing and three options are available. Issuance of new common equity: Engro’s required rate of return on new equity financing is 14% and it will have to incur 8% of the amount raised as the flotation cost. Issuance of bonds with the maturity of 20 years: The pretax cost of capital of the bond is 8% and Engro would incur a floation cost of 4% on the amount raised through bonds Short term financing through accounts payable: Since Engro needs to meet its day-to-day expenses with this financing, it has no floatation cost and the cost of this short term financing is equal to Engro’s weighted average cost of capital (WACC). Engro’s board has instructed to maintain a target accounts payable to long term debt ratio of 20%, which will be meet all the time (Assume same pretax and aftertax cost of short-term financing) Calculate the NPV of the new facility? Engro’s corporate tax rate is 35%
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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Q3: Engro Fertilizer has a current debt to equity ratio of 55%. The company is planning to expand its fertilizer business in Africa and will require a new facility to produce fertilizer. The estimated cost of the new facility is expected to be Rs. 50 million. It is expected that the plant will generate after tax cashflows of Rs. 6.7 million a year in perpetuity. Engro will need to raise all the cost through external financing and three options are available.
- Issuance of new common equity: Engro’s required rate of
return on new equity financing is 14% and it will have to incur 8% of the amount raised as the flotation cost. - Issuance of bonds with the maturity of 20 years: The pretax cost of capital of the bond is 8% and Engro would incur a floation cost of 4% on the amount raised through bonds
- Short term financing through accounts payable: Since Engro needs to meet its day-to-day expenses with this financing, it has no floatation cost and the cost of this short term financing is equal to Engro’s weighted average cost of capital (WACC). Engro’s board has instructed to maintain a target accounts payable to long term debt ratio of 20%, which will be meet all the time (Assume same pretax and aftertax cost of short-term financing)
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