Part A- Capital Budgeting

Background: Electro Motors (Electro) is considering a new project to produce electric vehicles for the Australian domestic market and international markets. It has identified a property/plant that was formerly used to build petrol fuelled motor vehicles that could be refitted at minimal cost to manufacture the new electric vehicles. Electro is targeting Australian metropolitan centres for initial sales and expanding into regional centres over the next five years. International demand for electric vehicles is being driven by China and Electro has been in negotiation to provide vehicles to the Chinese market in 2025.
Electro has made the following projections:
• In the first year 2,000 units will be sold and growing at 10% pa. • The price for each unit in the first year will be AU$50,000. This price will increase by 5% pa. • Variable costs are 70% of the sales price in the first year’s total revenue and grow by 8% each year. • Fixed costs are $5 million pa, which are expected to grow by 4% each year. • The project is for a term of 5 years. The projected growth of the electric cars line is expected to outgrow the plant at this time, hence the plant will be sold at the end of 5 years.

• Initial investment into manufacturing equipment will be $100 million. • The equipment may be depreciated at 20% straight-line (prime cost) method to zero. • In 5 years, the plant will be worth 10% of the purchase price. • Working capital will be $3 million. • Electro’s required rate of return is 10%. • The tax rate for Electro is 30%. • Required payback is three (3) years.

a. Prepare an excel spreadsheet calculating:After-tax cash flows (in table format) (15 marks) 2. Payback period (3 marks) 3. Net present value (5 marks) 4. Profitability index (2 marks)

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. (10 marks)

c. It has come to your attention that variable costs are anticipated to rise by 12% per annum due to the prospective growth within the industry. Would you recommend to proceed with the project? (Show all calculations). (5 marks)

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

Part B – Cost of Capital (50 marks)
Bruhaha Ltd (BL) is an Australian publicly listed firm on the ASX. The company has a long-term target capital structure of 50% ordinary equity, 10% preference shares, and 40% debt. All shareholders of BL are Australian residents for tax purposes.
To fund a major expansion BL Ltd needs to raise a $200 million in capital from debt and equity markets.

BL’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 are 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 BL are currently trading at $4.50 per share and will pay a dividend of $0.15 this year. Ordinary dividends in BL are predicted to grow at a constant rate of 7% pa.
a. Calculate the total value and the quantity of debt BL will need to issue to maintain their target capital structure. (2 marks)

a. Calculate the total value and the quantity of debt BL will need to issue to maintain their target capital structure. (2 marks) b. What will be the appropriate cost of debt for BL? (8 marks) c. Calculate the total value and quantity of preference shares BL will need to issue to maintain their target capital structure. (2 marks) d. What will be the appropriate cost of preference shares for BL? (8 marks) e. Calculate the total value and quantity of ordinary shares BL will need to issue to maintain their target capital structure. (2 marks) f. What will be the appropriate cost of ordinary equity shares for BL? (8 marks) g. Calculate the Weighted Average Cost of Capital (WACC) for BL Ltd following the new capital raising. (10 marks) h. BL 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. (10 marks)

c. It has come to your attention that variable costs are anticipated to rise by 12% per annum due to the prospective growth within the industry. Would you recommend to proceed with the project? (Show all calculations). (5 marks)
d. You have been asked to provide a further evaluation regarding the alternative use of the plant for the purpose of manufacturing electric self-driving cars, however the project life will be for 10 years. Explain how financial managers may evaluate both projects that are of unequal lives. (10 marks)
Part B – Cost of Capital (50 marks)
Bruhaha Ltd (BL) is an Australian publicly listed firm on the ASX. The company has a long-term target capital structure of 50% ordinary equity, 10% preference shares, and 40% debt. All shareholders of BL are Australian residents for tax purposes.
To fund a major expansion BL Ltd needs to raise a $200 million in capital from debt and equity markets.