QUESTION 1:Weighted Average Cost of Capital & Capital BudgetingUniversal Electricals Limited (UEL) is a large, rapidly growing wholesaler of consumer electrical products. Thecompany's main product lines are kitchen appliances and power tools. The senior management team, includingthe chief financial offer, oversees the budgeting process and recognises the importance of capital budgeting forplanning and control. The company plans a new eight-year project to manufacture Fridge Freezers. For that, thecompany will build a new manufacturing plant on the land the company had bought five years ago for $9.25million. The land is currently valued at $14.75 million. The management estimates the land can be sold for $18.25million after taxes in eight years. The Plant for the project will cost $185 million to build, and the company isexpecting a four-year payback period for the entire project.The manufacturing plant has a ten-year tax life, and the company uses the Diminishing value method ofdepreciation at 20% per annum. The Plant can be scrapped for $ 42.5 million at the end of Year eight. Thecompany's estimations show that 123,000 Fridge Freezers can be manufactured and sold per year (Years 1-8),and the selling price per unit in year one is $2,195, but the price is expected to increase by 1.25% per year.Similarly, the variable costs per unit are expected to be $932 in year one, and the costs will increase by 1.65%per year in the subsequent periods. The project will incur $88 million per annum in fixed costs (fixed costs includecoupon payments to bondholders). The company will sell the land at the end of year eight.The following market data on Universal Electricals Limited's securities are current:Debt●EquityNon-redeemablePreference shares$120,000,000,3.25% coupon bonds outstanding with 20 years to maturityredeemable at par, selling for 98 percent of par; the bonds have a $1000 par valueeach and make semi-annual coupon payments.15,000,000ordinary shares, selling for $51.50 per share12,000,000 shares (par value $ 10 per share) with 4.05% dividends (after taxes),selling for $18.65 per shareThe company's tax rate is 28%. The project requires $ 12.75 million in initial net working capital at periodzero. The company had been paying dividends to its ordinary shareholders consistently.Dividend information for the past six years is as follows:Year (-6) ($)Year (-5) ($) Year (-4) ($) Year (-3) ($)0.600.640.670.69Year (-2) ($)0.73Year (-1) ($)0.79Year (0) ($)0.85Required:1. Calculate the project's initial (time 0) cash flows2. Compute the weighted average cost of capital (WACC) of Universal Electricals Limited. Show allworkings.3. Make a recommendation about whether Universal Electricals Limited should proceed with this project.Justify your recommendation by explaining why or why not.Note: To make a recommendation use the following methods. Where relevant, the WACC calculated inquestion 2 should be used as your discount rate.a) Net Present Value (NPV),b) Internal Rate of Return (IRR)c) Profitability Index (PI),d) Payback period, ande) Discounted payback periodNote: Work all solutions to the nearest two decimals, show the depreciation table, and calculategain/loss on the sale of Plant and Land. Record tax effects in the income statement.

Initial investment: Cost of building the manufacturing plant = $185,000,000 Initial net working…

QUESTION 1: Weighted Average Cost of Capital & Capital Budgeting Universal Electricals Limited (UEL) is a large, rapidly growing wholesaler of consumer electrical products. The company's main product lines are kitchen appliances and power tools. The senior management team, including the chief financial offer, oversees the budgeting process and recognises the importance of capital budgeting for planning and control. The company plans a new eight-year project to manufacture Fridge Freezers. For that, the company will build a new manufacturing plant on the land the company had bought five years ago for $9.25 million. The land is currently valued at $14.75 million. The management estimates the land can be sold for $18.25 million after taxes in eight years. The Plant for the project will cost $185 million to build, and the company is expecting a four-year payback period for the entire project. The manufacturing plant has a ten-year tax life, and the company uses the Diminishing value method of depreciation at 20% per annum. The Plant can be scrapped for $ 42.5 million at the end of Year eight. The company's estimations show that 123,000 Fridge Freezers can be manufactured and sold per year (Years 1-8), and the selling price per unit in year one is $2,195, but the price is expected to increase by 1.25% per year. Similarly, the variable costs per unit are expected to be $932 in year one, and the costs will increase by 1.65% per year in the subsequent periods. The project will incur $88 million per annum in fixed costs (fixed costs include

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