Question 1 (25 marks) Home Guardian has recently completed a $200,000, two-year study on its new pest control device. It can go into production for an initial investment in equipment of $5 million....

Question 1 (25 marks)

Home Guardian has recently completed a $200,000, two-year study on its new pest control device. It can go into production for an initial investment in equipment of $5 million. The equipment will be depreciated straight line over the useful life of 5 years to a value of zero. The fully depreciated equipment is expected to sell for $1,200,000 at the end of its useful life. The project also requires investment in land value of $300,000 which is expected to have a realisable value of $500,000 at the end of the project. Investment of $400,000 in current assets will be recovered at the termination of the project. The marketing department has estimated that 200,000 units of its new device could be sold annually over the next five years at a price of $10 each. Fixed costs of $500,000 per annum will be incurred.

The firm is an ongoing profitable business and pays taxes at a 30% rate in the year of income. All capital gains will also be taxed at a rate of 30%. The company uses a 12% discount rate on the new project. Using the NPV approach, advise the firm whether the project should be undertaken.

HRE Mining Limited’s (HRE) is considering a major gold exploration project in South Sudan. Costs of financing have been declining recently causing the finance department to consider sourcing capital through debt and equity issues. The company’s bonds will mature in six years with a total face value of $100 million, paying a half yearly coupon rate of 10% per annum. The yield on the bonds is 15% per annum. The market value for the company’s preference share is $4.75 per unit while the ordinary share is currently worth $1.85 per unit. The preference share pays a dividend of $0.4 per share. The beta coefficient for the ordinary share is 1.4. No issue costs will be incurred by the company. The market risk premium is estimated to be 12% per annum and the risk-free rate is 4% per annum. The company is subject to a 30% corporate tax rate and intends to issue 200,000 preference shares and 5,000,000 ordinary shares. HRE’s current balance sheet shows the following information for bonds and shares:

$ Million

Preference shares 3

Ordinary shares 15

Bonds 100

a. Outline the necessary steps required to estimate the company’s weighted average cost of capital (2 marks).

b. Calculate the after-tax cost of each of the company’s current financing sources (7.5 marks).

c. Using the information provided, calculate the market values for the financing sources for HRE (7.5 marks).

d. Using the information from b.) and c.) calculate HRE’s after-tax weighted average cost of capital (5 marks).

e. The company’s finance department has confirmed that the proposed project will generate an IRR of 15% per year. Discuss whether or not the project should be undertaken (3 marks).

This task will assess your ability to meet the following learning outcomes:

• identify, analyse and solve financial problems confronting business enterprises, particularly problems relating to corporate investment, asset management and financing decisions;


• employ analytical techniques, using contemporary electronic aids appropriate to financial decision making;


• analyse the impact of economic, legal and tax changes on the financial position of the firm;


• demonstrate critical evaluation and communication skills relating to the scope,methodology, role, objectives and ethics of financial management within business organisations.

The feedback will assist you to determine where you may need to revise your work.

Please read the section ' Presentation' below after the marking guidelines.

Remember, you must reference accurately and failure to do so will attract a penalty of up to 10% of available marks of the assignment. Also please note, Assessment items should be typed as handwritten, hand drawn assignments will not be accepted.

Assignments should show all workings and students will be penalised for failing to do this. Please adhere to a convention of 4 decimal places for the answer and approximations without rounding for calculations prior to the answer. Where necessary, state any assumptions you have made.

You will be assessed on:

• your understanding of the problem;


• your choice of method for solving the problem;


• your application of techniques;


• the accuracy of your answer;


• written communication skills;


• critical thinking and analysis.