Please explain and show calculation in detail. Specify whether it should go ahea
ID: 1172815 • Letter: P
Question
Please explain and show calculation in detail. Specify whether it should go ahead or not.
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Question 2 (15 marks) Zamba Limited is intending to expand its business by investing in a new patent. This new investment, costing $50 million, will result in a net after tax cash flow of $12M for the next 10 years. Due to the recent credit downgrade on the company from A to BB, the expected long term cost of debt would increase. As a result, management is uncertain if they should still proceed with the investment. A similar BB rated 10 year bond is currently selling for $908.72 per $1000 bond with a coupon rate of 9% paid semi-annually. Using the financial information below, ignoring taxes, show evidence of whether to go ahead with the investment or not. Price per share S50 0.8 $25 10,000 10%, 30%, 20%, 20% 5%, 15%, 25%, 15% 5% $300,000 Number of shares of common stock Share returns of the coy of the past four years | Risk-free rate 15%Explanation / Answer
Cost of equity
RM = (5 + 15 + 25 + 15)/4 = 15%
Re = 5 + (0.80)(15 - 5) = 13%.
Cost of Debt
N = 20
PMT = $45; (Coupon payment is paid semiannually, so, 1000*9%/2 = $45)
FV = $1000;
PV = -$908.72;
YTM = 5.25*(2) = 10.5% per annum
Asset position
Total equity = 50 * 10,000 = 500,000
Total debt = 300,000
Company’s cost of capital
r = [(300,000/800,000)*0.105] + [(500,000/800,000)*0.13]
=12.06%
Investment assessment
PMT = $12M
PV = -$50M
N = 10
R = 12.06%
NPV = $12M/(1.1206^1) + $12M/(1.1206^2) + $12M/(1.1206^3) + $12M/(1.1206^4) + $12M/(1.1206^5) + $12M/(1.1206^6) + $12M/(1.1206^7) + $12M/(1.1206^8) + $12M/(1.1206^9) + $12M/(1.1206^10) - $50M
= $17.64M