Equity = 74000000 $
Cost of Equity = 2
Cost of Debt = bank overdraft is 5.5% + commercial bills are 4.5% + 3.75% for coupons
The Solution Part
WACC = (Equity/Debt + Equity* Re) + (Debt / Debt +Equity*Rd*(1-T))
WACC = (74000000/74000000+153670000*2)+(153670000/74000000+153670000*.1375*(1-.4)
WACC= .65 + .05
WACC = .705
Where given Information is:
NPV = initial investment + C1/1+R+C2/ (1+R) 2………
NPV = -5437000 + (-2349767/1.09)+ (-2423720/(1.09)2)+ (-2500640/(1.09)3)+( -2276447/(1.09)4)+( 2663863/(1.09)5)+( -1050418/(1.09)6)
= -5437000 – 2155749.5 – 2039996.6 – 3126598.8 – 1614501.41 – 1741086.92 – 628992.8
(Note: For understanding the above amounts, excel file has been attached for the reference.)
Gauging the investment’s profitability with NPV depends heavily on assumptions and estimates, so there must be substantial room for error. Estimated factors include investment costs, discount rate, and projected returns. A project may often require unforeseen expenditures to get off the ground or may require additional expenditures at the project’s end.
So as per me WACC is the best way to do capital budgeting, as we can see in NPV method our net present value is in negative figures.
However, outsourcing the production activity from the other firm leads to many advantages. Such as cost advantage, better quality service and swift service, increased efficiency, saves blocking of huge amount of money in infrastructure.
And in the case of YDL, it is clearly mentioned above that from the accounting perspective, equipment that are procured from IEL may be classified as cost of goods sold in the books of YDL & the same will be treated as operating expense for the business & moreover, as in Option 1 YDL still requires the warehouse to store the hardware while on the other side, in outsourcing there is no as such requirement, so obviously outsourcing the production activity would be the beneficial option for YDL as there is only 50% of the cost has to be invested by YDL & rest will be bear by IEL.
Hence, outsourcing may probably leads to profit in future.
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