Question 1:
Greengage Ltd is considering to buy a main equipment to increase the company's production capacity. The equipment is expected to have a four year useful life. The capital outlay and annual net income after depreciation related to the equipment are below.
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Capital Outlay
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$210,000
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Annual net income after depreciation
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$
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Year 1
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28,500
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Year 2
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24,000
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Year 3
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22,000
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Year 4
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18,500
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The equipment is depreciated on a straight-line basis with a total of $10,000 salvage value. The company uses 12% as its cost of capital, 2.5 years as its benchmark payback period, and 20% as its benchmark accounting rate of return (ARR) for capital projects. Assuming no tax and interest.
Required
a) Should the company purchase the equipment using the Net Present Value technique, payback technique, and average ARR technique based solely on quantitative considerations?
b) Identify and explain four factors that would have been considered by the management of Greengage Ltd when deciding on 2.5 years as an appropriate benchmark for the company's payback period.
c) Which technique among NPV, payback period, and ARR would you select as the best method in evaluating the above capital project of Greengage Ltd? You are expected to justify you opinions based on both quantitative and qualitative factors for each technique.
Question 2:
The following information regards the financial profile of Bellara Ltd as at 30 November 2015. The company's financial year ends on 30 June.
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Forecast dividend growth rate
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1.5%
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Current share price
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$15.50
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Estimated dividend per share for next financial year
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$0.60
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rf
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5.75%
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Rm
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6.25%
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βi
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1.65
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Required:
a) Identify and describe two different approaches that can be used to determine the company's cost of capital using the given information.
b) Discuss, in your own words, the strengths and weaknesses of each approach identified in Part (a).
c) Determine the company's cost of capital using two approaches identified in Part (a). Explain the cause(s) of any difference in your answers.