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Fundanentals of Finance
 Category:Finance & Accounting
 Document type:Assignment
 Level:High School
 Page:1
 Words:548
Finance 6
PROJECT EVALUATION

Australian company tax: 30%

Application date for risk – free rate: 09May2016

10 – years riskfree rate: 2.320

4 – years riskfree rate: 1.625

Credit spread for corporate bonds: 345bp
Weighted average cost of capital
We will need to calculate the proportion for equity and debt in Collinwood Manufacturing Company Ltd. Capital structure.
Current market value of Equity = 1,100,000*7.92 + 400,000*11.63 = $ 13,364,600.
The price of ordinary share is p=D1/(rg) = $ 7.92
Current market value of Debt = $ 2,000,000
Total market value of Debt and Equity = 2,000,000 + 13,364,600 = $15,364,600.
Weights of Equity = 13,364,600/15,364,600 = 0.86983
Weights of Debts = 2,000,000/15,364,600 = 0.13018
Cost estimation of Equity and after tax costs of Debt.
Equity costs can be estimated using Capital Assets Pricing Model, CAPM or Dividends Discounts Model, DDM.

Cost of preference shares = expected dividends in 1 year/ current stock price + growth rate
= 1.37/11.63 + 0 = 11.7799%

Cost of ordinary shares = risk free rate + Beta * Market risk premium = 1.625 + 1.1*7.6 = 9.985%

Cost of debt = yields to bond maturity: Calculations using excel rate functions yielded: the results from excel we have 10.72%

After tax cost of debt = 10.72 % *(130%) = 7.504%
. : WACC = (Equity / Total Capital) * Cost of Equity + (Debt / Total Capital) * Cost of Debt * (1 — Tax Rate)
=(8,712,600/15,364,600)*9.985% + (4,652,000/15,364,600)*11.7799% + (2,000,000/15,364,600)*7.504%
WACC = 10.2%
Circumstances appropriate to use WACC discount rate in evaluating project
WACC is necessary in capital structure like one above since the cost varies with different components used hence the need to determine weights according to respective proportions they represent in capital structure employed by the business (Wilkinson, 2013).
Net present value
Figure 1. 

Additional 
cummulative 

Cashflows 
operations 
Maintainance 
cashflows 
cashflows 
cashflow 

0 
(17,000) 
recovered 

Additional net working capital ($ 1,600) — recovered from scrap value 

Rent foregone per year is $ 1,700 

Feasibility cost $2,000 

Acceptance payback is 4 years. 

Salvage value is $ 2,000 
cashflows 
PVIF(10.2%) 

0.907441 
8,166.97 

0.823449 
6,457.49 

0.747232 
5,032.60 

0.678069 
4,120.62 

23,777.69 
From the above data NPV = $ 23,777.69– $ (17,000 +2,000) = $ 4, 777.69
Internal rate of return
From excel function of calculating internal rate of return we have IRR = 11%
cash flows 

0 

8,166.97 

6,457.49 

5,032.60 

4,120.62 

Payback period
cumulative 

cashflows 
cash flow 

Initial outlay cost = $17,000 +$2,000 = $19,000
Payback period is the time required by the project to repay its initial cost incurred
PB = 2 years + (19,00016,842)/6,735
= 2 years and 3.845 months.
Method to be used in evaluating project
The best method will be the use of NPV which states that for a project to be accepted it should have its NPV greater than zero else be rejected; a positive NPV adds firm wealth (Wilkinson, 2013).
Recommendations
Collinwood Manufacturing Company Ltd. Should therefore go ahead and make investment of purchasing the new equipment since Net present value is positive for the project which is also supported by the payback period of 2years and 3.8 months which is less than maximum acceptable limit by the company of 4 years.
Reference
Wilkinson, J. 2013. Net present value method. (Online) Available at: http://strategiccfo.com/netpresentvaluemethod/> Accessed 9 May 2016.