Syfy is considering investing in the project with following details.
The initial cost of investing in equipment is estimated to be Rs1, 200,000. But, the project is deemed to generate operating cash flows (after tax) of Rs323, 000 each year until infinity excluding the interest tax shield.
The project is anticipated to be about 34.26% more revenue volatile than the rest of the company’s products, and will have fixed costs equivalent to 40% of operating profit compared with a corresponding figure of 5% for the rest of company. The project will be financed in such a way that the capital structure of project will be same as that of Syfy. The project will be partly financed by debt and investment bankers will necessitate a return (project cost of debt) of 10% per annum.
Syfy’s shares are traded on the stock exchange and have a beta coefficient of 1.0885. The company also has debt outstanding, comprising 35% of Syfy’s total value and having a beta value of 0.20.
The risk free return is 5% per annum and the average market risk premium is 10%. The tax rate is 15% and is levied on operating net cash flows.
Required:
The directors of Nose plc have the following queries:
Question1. What is the current WACC of the Syfy plc and can this be employed as a discount rate to evaluate the project?
Question2. Provide appropriate computation and supporting descriptive notes on how an appropriate discount rate for the project could be determined?
Question3. Is the project acceptable? Give supporting computations.
Question4. Describe the usefulness of the adjusted present value technique as a technique for evaluating projects.