Corporate Finance and Related Business Decision-Making Process

Part A

WACC Calculation

Given Information:

Equity = 74000000 $

Debt:

  • Bank overdraft $ 670,000
  • Commercial bills (due 30th Jun 2019) $ 3,000,000
  • 75% Coupon bonds (due Dec 2029 issued @$100 each) $ 150,000,000

Cost of Equity = 2

Cost of Debt = bank overdraft is 5.5% + commercial bills are 4.5% + 3.75% for coupons

Tax= 30%

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= (74000000/227670000*2)+(153670000/227670000*.1375(1-.4))

WACC= .65 + .05

WACC = .705

PART B

NPV Calculation for Option 1: In house Production

Where given Information is:

  • Cost of machinery & installation – 3500000 $ & economic life is 12 years
  • Salvage value – 0 after 12 years
  • Market value of machinery after 7 years – 1700000 $
  • Rental income – 200000 $ each year
  • Conversion Cost – 140000 $
  • Training Fees – 10000 $ ( which is tax deductable)
  • Annual maintenance cost- 160000 $
  • Collective cost of manufacturing hardware components – 1800000 $ (in year one and is expected to increase by 4% per annum)
  • Licensing fees - 57000 $ per year
  • Additional Working Capital at the beginning of production – 30000 $ (expected to increase by 3% per annum)

Calculation:

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

= -11850626

(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.

Option 2: Outsourcing

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.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Corporate Finance Assignment Help

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