ABC, Inc. is currently evaluating a new project that will expand
its lines to include a designated golf line that will offer not only
clothing but also golf equipment and accessories. The project will
require an initial outlay of £22m on production machinery and
other costs. The project is expected to have a three-year life span
and the cash flows associated with the projected are projected in
the below table:
Table 1: ABC, Inc. potential project’s cash flow information
All figures in £'m 2022, 2023, 2024
Sales 46.0, 53.0, 57.0
COGS (22.7), (27.5), (31.6)
Gross Profit 23.3, 25.5, 25.4
Operating Expenses (2.0), (2.5), (3.0)
EBITDAa
21.3, 23, 22.4
Depreciation (1.0), (1.0), (1.0)
EBITa
20.3, 22, 21.4
Tax Expense (3.5), (3.6), (4.2)
EBIATa
16.8, 18.4, 17.2
CAPEXb
3, 1, 1
Investment in Working
Capital 0, 0, 2
EBITDA: Earnings Before Interest, Taxes, Depreciation and
Amortisation. EBIT: Earnings before Interest and Taxes. EBIAT:
Earnings Before Interest and After Taxes. For simplicity, taxes
calculated assuming no interest expense. COGS: Cost of Goods
Sold. CAPEX: Capital Expenditures.
bAnnual capital expenditures in addition to the initial outlay, and
assumed to cease at the end of the project.
The project has a debt capacity of 65% of the cost of the project,
with an annual interest charge of 5.75%. The company currently
has £3.5m of retained earnings available for this project, and the
remainder would potentially be financed with a rights issue. The
rights issue incurs additional costs of 2.5% of the amount raised,
and the debt issuance is a bit cheaper, costing 1%, where both
issue costs are tax deductible.
Table 2: Additional information
Key Rates and Figures
Risk-free Rate (irf)=?
Project Cost of Debt (id) pre-tax= 5.75%
Market return=?
Marginal Corporate Tax Rate = 23.00%
ABC, Inc. unlevered Beta (β)=1.23
You will need to research the additional values required to
complete Table 2. For the Risk-Free Rate, find the rate of return
on 10-15-year UK government securities. For the market return,
use the return from the FTSE-100 UK Index.
Required: The company believes it will be a successful project
and will help to distinguish it from its competitors. However, the
company would like you to evaluate the project using different
methods and present a proposal to the investment committee in
order for them to approve it.
a) Evaluate the project for ABC, Inc., considering 65% debt
financing, by analysing the Internal Rate of Return (IRR)
and Net Present Value (NPV) to determine its financial
viability. Hint: calculate the free cash flow of the project
and use CAPM to compute the discount rate. [12 marks]
b) Assess the project's financial viability using the Adjusted
Present Value (APV) method to account for the effects of
financing decisions on its value. [12 marks]
c) Recalculate the project's Net Present Value (NPV) using
the Weighted Average Cost of Capital (WACC),
assuming the project's market risk aligns with the firm's
overall market risk. Relate this revised NPV with the
result obtained in part a). [12 marks]
Note: Assume the same level of debt is held until the end of the
project. Do not consider the repayment of the debt principal in
any of the above valuations in parts a) to c).
d) Evaluate the results obtained from the various methods
used and provide a final recommendation to the
investment committee. Critically assess each method's
strengths and limitations and discuss any additional risks.
[14 marks] [Total Q2: 50 marks]
Suggested Structure: The structure of the report is open to
your own interpretation of the project, but should include the
following items as a minimum:
1. Executive summary (objectives and content)
2. Rationale for the project (describe the current situation)
3. Ratio analysis (financial and non-financial)
4. Project financials (investment valuation methods)
5. Project risks (minimum one each of financial and nonfinancial)
6. Critical discussion of the methods (if the company did
not invest in the Page 6 project)
7. Final recommendation to the investment committee for
the chosen funding method and supporting reasons for
the choice