ACC 515 : Accounting and Finance

Part A Capital Budgeting

GOGreen is targeting Australian metrolpolitan centres for initial sales and expanding into regional centres over the next five years. International demand for EV's is being driven by China and GOGreen has been in negotiation to provide vehicles to the Chinese market in 2020

Problem:

GOGreen has made the following projections:

• In the first year 2,000 units will be sold, growing at 10% per annum.
• The price for each unit in the first year will be AU$50,000. This price will increase each year by 5%.
• Variable costs are 60% of the sales price, which will grow by 3% each year.
• Fixed costs are $5 mil pa, which are expected to grow by 2% each year.
• The project is for a term of 5 years. The projected growth of the EV line is expected to outgrow the plant at this time, hence the plan will be sold at the end of 5 years.
• Initial investment into manufacturing equipment of $100 million;equipment may be depreciated at 20% straight-line (prime cost) method.
• In 5 years, the plant will be worth 10% of its' purchase price.
• Working capital $3 million.
• GOGreen's required rate of return is 4.5%.
• The tax rate for GOGreen is 30%.

(a) Prepare an excel spreadsheet calculating: After-tax cash flows (in table format)

• Payback period
• Net present value
• Profitability index

(b) You are asked to present a report on your findings regarding the upgrade proposal. Make a recommendation to Management on whether they should proceed with the project or not. Explain the criteria on which you have based your decision.
(c) It has come to your attention that variable costs are anticipated to rise by 10% per annum due to the prospective growth within the industry. Would you recommend to proceed with the project? (Show all calculations).

(d) You have been asked to provide a further evaluation regarding the alternative use of the plant for the purpose of manufacturing electric buses, however the project life will be for 10 years. Explain how financial managers may evaluate both projects that are of unequal lives.

Part B Cost of Capital

Grainwaves Ltd is an Australian firm which is publicly-listed on the ASX. The company has a long term target capital structure of 55% Ordinary Equity, 5% Preference Shares, and 40% Debt. All of the shareholders of Grainwaves are Australian residents for tax purposes. To fund a major expansion Grainwaves Ltd needs to raise a $150 million in capital fromdebt and equity markets. Grainwaves Ltd’s broker advises that they can sell new 10 year corporate bonds to investors for $105 with an annual coupon of 6% and a face value of $100. Issue costs on this new debt is expected to be 1% of face value. The firm can also issue new $100 preference shares which will pay a dividend of $7.50 and have issue costs of 2%. The company also plans to issue new Ordinary Shares at an issue cost of 2.5%. The ordinary shares of Grainwaves are currently trading at $4.50 per share and will pay a dividend of $0.15 this year. Ordinary dividends in Grainwaves are predicted to grow at a constant rate of 7% pa.

i. Calculate how much debt Grainwaves will need to issue to maintain their target capital structure.

ii. What will be the appropriate cost of debt for Grainwaves.

iii. Calculate how much Preference Share equity Grainwaves will need to issue to maintain their target capital structure.

iv. What will be the appropriate cost of Preference shares for Grainwaves?

v. Calculate how much Ordinary Share equity Grainwaves will need to issue to maintain their target capital structure.

vi. What will be the appropriate cost of Ordinary Equity shares for Grainwaves?

vii. Calculate how the Weighted Average Cost of Capital for Grainwaves Ltd following the new capital raising.

viii. Grainwaves Ltd has a current EBIT of $1.3 million per annum. The CFO approaches the Board and advises them that they have devised a strategy which will lower the company’s cost of capital by 0.5%. How will this change the value of the company? Support your answer using theory and calculations.