ASE Malaysia is part of Advanced Semiconductor Engineering (ASE) Group, the world’s largest provider of independent semiconductor manufacturing services in assembly and test based in Penang, Malaysia. As a global leader, ASE provides a complete scope of services for the semiconductor market; driven by superior technologies, breakthrough innovations, and advanced development program. The company is looking at setting up a manufacturing plant overseas to produce a new line of semiconductor product called XYZ. This will be a five-year project. The company bought some land three years ago for RM7.5 million in anticipation of using it as a toxic dump site for waste chemicals, but it built a piping system to safely discard the chemicals instead. The land was appraised last week for RM7.1 million. In five years, the after-tax value of the land will be RM7.4 million, but the company expects to keep the land for a future project. The company wants to build its new manufacturing plant on this land; the plant and equipment will cost RM40 million to build. The following market data on ASE's securities is current:
Debt: 260,000 6.8 percent coupon bonds outstanding, 25 years to maturity, selling for 103 percent of par; the bonds have a RM1,000 par value each and make semiannual payments.
Common stock: 9,500,000 shares outstanding, selling for RM67 per share; the beta is 1.25.
Preferred stock: 450,000 shares of 5.25 percent preferred stock outstanding, selling for RM84 per share and having a par value of RM100.
Market: 7 percent expected market risk premium; 3.6 percent risk-free rate.
ASE uses CIMBS Investment Bank Berhad as its lead underwriter. CIMBS charges ASE spreads of 6.5 percent on new common stock issues, 4.5 percent on new preferred stock issues, and 3 percent on new debt issues. CIMBS has included all direct and indirect issuance costs (along with its profit) in setting these spreads. CIMBS has recommended to ASE that it raise the funds needed to build the plant by issuing new shares of common stock. ASE's tax rate is 35 percent. The project requires RM1,400,000 in initial net working capital investment to get operational.
Assume CIMBS raises all equity for new projects externally.
i. Calculate the project's initial Time 0 cash flow, taking into account all side effects.
ii. The new XYZ project is somewhat riskier than a typical project for ASE, primarily because the plant is being located overseas. Management has told you to use an adjustment factor of +2 percent to account for this increased riskiness. Calculate the appropriate discount rate to use when evaluating ASE's project.
iii. The manufacturing plant has an eight-year tax life, and ASE uses straight-line depreciation. At the end of the project (that is, the end of Year 5), the plant and equipment can be scrapped for RM8.5 million. What is the after-tax salvage value of this plant and equipment?
iv. The company will incur RM7,900,000 in annual fixed costs. The plan is to manufacture 18,000 XYZs per year and sell them at RM10,900 per machine; the variable production costs are RM9,450 per XYZ. What is the annual operating cash flow (OCF) from this project?
v. ASE's comptroller is primarily interested in the impact of ASE's investments on the bottom line of reported accounting statements. What will you tell her is the accounting break-even quantity of XYZs sold for this project?
vi. Finally, ASE's president wants you to throw all your calculations, assumptions, and everything else into the report for the chief financial officer; all he wants to know is what the XYZ project's internal rate of return (IRR) and net present value (NPV) are. What will you report as final recommendation?