third year of operation. The projected revenue for the first year of operation is $500,000, although it is expected to decline at 5% per annum due to market competition. The annual operating costs are estimated at 20% of the annual revenue. The machine has a lifespan of 5 years, after which it is expected to be sold for 10% of its original cost. The purchase of the production line will be financed 60% through debt, which carries an interest rate of 6% per annum, while shareholders expect a return that is 3% higher than creditors. a) Draw the timeline and set out net cash flows by year. b) Calculate the weighted average cost of capital (WACC)
Bulla Dairy Foods is evaluating acquiring a new production line to manufacture a flavoured thick cream. The cost of purchasing and installing the equipment is estimated to be $1,500,000 today, with an additional $10,000 required for maintenance in the third year of operation. The projected revenue for the first year of operation is $500,000, although it is expected to decline at 5% per annum due to market competition. The annual operating costs are estimated at 20% of the annual revenue. The machine has a lifespan of 5 years, after which it is expected to be sold for 10% of its original cost. The purchase of the production line will be financed 60% through debt, which carries an interest rate of 6% per annum, while shareholders expect a return that is 3% higher than creditors.
a) Draw the timeline and set out net cash flows by year.
b) Calculate the weighted average cost of capital (WACC) of this project.
c) Calculate the
d) Identify which of the following changes may likely change the decision made to this project, i.e. your answer to part c). Explain why or why not.
i. The credit rating of Bulla Dairy Foods unexpectedly changes from AA to BBB, holding everything else equal.
ii. The proportion of debt in the total fund raised for this project increases.
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