Marston Co is a manufacturing company that wishes to evaluate an investment in new production machinery. The machinery would enable the company to satisfy increasing demand for existing products and the investment is not expected to lead to any change in the existing level of business risk of Marston Co. The machinery will cost $4.5 million, payable at the start of the first year of operation and is not expected to have any scrap value. Annual before tax net cash flow of $850,000 per year would be generated by the investment in each of the five years of its expected operating life. These net cash inflows are before taking account of expected inflation of 4% per year. Initial investment of $480,000 in working capital would also be required, followed by incremental annual investment to maintain the purchasing power of working capital. Marston Co has in issue seven million shares with a market value of $4.30 per share. The equity beta for the company is 1.4. The yield on short term government debt is 4.5% per year and the equity risk premium is 5% per year. The debt finance of Marston Co consists of bonds with a total book value of $2 million. These bonds pay annual interest before tax of 8%. market value of each bond is $100. The par value and Marston Co pays taxation one year in arrears at an annual rate of 25%. Tax - allowable depreciation on machinery is on a straight line basis over the life of the asset. Required: a) Calculate the after- tax weighted average cost of capital of Marston Co. Prepare a forecast of the annual after-tax cash flows of the investment in nominal terms, calculate and comment on the Net Present Value.
Marston Co is a manufacturing company that wishes to evaluate an investment in new production machinery. The machinery would enable the company to satisfy increasing demand for existing products and the investment is not expected to lead to any change in the existing level of business risk of Marston Co. The machinery will cost $4.5 million, payable at the start of the first year of operation and is not expected to have any scrap value. Annual before tax net cash flow of $850,000 per year would be generated by the investment in each of the five years of its expected operating life. These net cash inflows are before taking account of expected inflation of 4% per year. Initial investment of $480,000 in working capital would also be required, followed by incremental annual investment to maintain the purchasing power of working capital. Marston Co has in issue seven million shares with a market value of $4.30 per share. The equity beta for the company is 1.4. The yield on short term government debt is 4.5% per year and the equity risk premium is 5% per year. The debt finance of Marston Co consists of bonds with a total book value of $2 million. These bonds pay annual interest before tax of 8%. market value of each bond is $100. The par value and Marston Co pays taxation one year in arrears at an annual rate of 25%. Tax - allowable depreciation on machinery is on a straight line basis over the life of the asset. Required: a) Calculate the after- tax weighted average cost of capital of Marston Co. Prepare a forecast of the annual after-tax cash flows of the investment in nominal terms, calculate and comment on the Net Present Value.
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
Problem 1PS
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Transcribed Image Text:Marston Co is a manufacturing company that wishes to
evaluate an investment in new production machinery. The
machinery would enable the company to satisfy increasing
demand for existing products and the investment is not
expected to lead to any change in the existing level of
business risk of Marston Co.
The machinery will cost $4.5 million, payable at the start of
the first year of operation and is not expected to have any
scrap value. Annual before tax net cash flow of $850,000
per year would be generated by the investment in each of
the five years of its expected operating life. These net cash
inflows are before taking account of expected inflation of
4% per year.
Initial investment of $480,000 in working
capital would also be required, followed by incremental
annual investment to maintain the purchasing power of
working capital.
Marston Co has in issue seven million shares with a
market value of $4.30 per share. The equity beta for the
company is 1.4.
The yield on short term government
debt is 4.5% per year and the equity risk premium is 5%
per year.
The debt finance of Marston Co consists of bonds with
a total book value of $2 million.
These bonds pay
annual interest before tax of 8%.
market value of each bond is $100.
The par value and
Marston Co pays taxation one year in arrears at an
annual rate of 25%. Tax - allowable depreciation on
machinery is on a straight line basis over the life of the
asset.
Required:
a) Calculate the after- tax weighted average cost of
capital of Marston Co.
Prepare a forecast of the annual after-tax cash flows of the
investment in nominal terms, calculate and comment on the
Net Present Value.
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