Nicky "O" is a transport company that wishes to evaluate an investment in new production machinery. The machinery would enable the company to satisfy increasing demand for existing services and the investment is not expected to lead any change in the existing level of business risk of Nicky "O". The machinery will cost GH¢3 million, payable at the start of the first year of operation, and is expected to have a scrap value of GH¢600,000. Annual before-tax net cash flows of GH¢780,000 per year would be generated by the investment in each of the four years of its expected useful life. The company's required rate of return is 9%. Nicky "O" has in issue four million shares with market value of GH¢2.50 per share. The equity beta of the company is 1.29. The income on short-term government debt is 3.5% per annum and the equity risk premium is estimated 5% per annum. The company also has 8% five million Preference shares which is currently trading at GH¢0.70. The debt finance of Nicky "O" consist of bonds with a total book value of GH¢S million. These bonds pay annual interest before tax of 6%. The par value and market value of each bond is GH¢100. The company pays tax 35% per annum. Note that, for investment purposes, the company cash flows are not taxed. Required: a. Calculate the after-tax Weighted Average Cost of Capital of Nicky 'O' Co. b. State five factors affecting WACC in investment appraisal.
Nicky "O" is a transport company that wishes to evaluate an investment in new production machinery. The machinery would enable the company to satisfy increasing demand for existing services and the investment is not expected to lead any change in the existing level of business risk of Nicky "O". The machinery will cost GH¢3 million, payable at the start of the first year of operation, and is expected to have a scrap value of GH¢600,000. Annual before-tax net cash flows of GH¢780,000 per year would be generated by the investment in each of the four years of its expected useful life. The company's required rate of return is 9%. Nicky "O" has in issue four million shares with market value of GH¢2.50 per share. The equity beta of the company is 1.29. The income on short-term government debt is 3.5% per annum and the equity risk premium is estimated 5% per annum. The company also has 8% five million Preference shares which is currently trading at GH¢0.70. The debt finance of Nicky "O" consist of bonds with a total book value of GH¢S million. These bonds pay annual interest before tax of 6%. The par value and market value of each bond is GH¢100. The company pays tax 35% per annum. Note that, for investment purposes, the company cash flows are not taxed. Required: a. Calculate the after-tax Weighted Average Cost of Capital of Nicky 'O' Co. b. State five factors affecting WACC in investment appraisal.
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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Transcribed Image Text:Nicky "O" is a transport company that wishes to evaluate an investment in new production
machinery. The machinery would enable the company to satisfy increasing demand for existing
services and the investment is not expected to lead any change in the existing level of business
risk of Nicky "O".
The machinery will cost GH¢3 million, payable at the start of the first year of operation, and is
expected to have a scrap value of GH¢600,000. Annual before-tax net cash flows of
GH¢780,000 per year would be generated by the investment in each of the four years of its
expected useful life. The company's required rate of return is 9%.
Nicky "O" has in issue four million shares with market value of GH¢2.50 per share. The cquity
beta of the company is 1.29. The income on short-term government debt is 3.5% per annum and
the equity risk premium is estimated 5% per annum. The company also has 8% five million
Preference shares which is currently trading at GH¢0.70.
The debt finance of Nicky "O" consist of bonds with a total book value of GH¢5 million. These
bonds pay annual interest before tax of 6%. The par value and market value of each bond is
GH¢100. The company pays tax 35% per annum.
Note that, for investment purposes, the company cash flows are not taxed.
Required:
a. Calculate the after-tax Weighted Average Cost of Capital of Nicky O' Co.
b. State five factors affecting WACC in investment appraisal.
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