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2 (35 marks) Crazy Jim Limited (CJL) manufactures and sells various frozen novelties to customers island-wide since 1975. Currently the entity manufactures ice cream, ice cream cakes, fudges, and a wide variety of other frozen novelties. However, management wants to purchase a new machine that is expected to manufacture 150,000 super duper sandwiches in the first year, after which production is expected to increase by 10,000 units annually. The super dupers are considered an alternative to fudges and are expected to decrease fudge sales by 50,000 units annually. Each fudge yields a contribution margin of $60 per unit. While, each super-duper is expected to be sold for $300 and incur variable cost of $100 each. To produce the super dupers, the company expects to incur additional fixed costs of $10,000,000 annually. The fixed cost will not be incurred if the super dupers are not manufactured by Crazy Jim Limited. The project is expected to last for only four years. The machine is expected to have a purchase price of Jamaica dollar equivalent $2,500,000 and expects to incur shipping, custom duty and installation of $500,000, $1,200,000 and $1,000,000. The machine is to be bought in West Virginia, USA. Management thinks the machine will have an expected useful life of four years, after which it can realize a scrap value of $200,000. The machine is to be depreciated on a straight line basis based on the companys accounting policy. Additionally, the policy depicts that depreciation is to be charged on all assets in the year of disposal. The entity evaluates all projects using the WACC. All projects consist of 40% leverage with the remainder as equity. To finance the project, the entity floated a bond that has a yield of 12% which is twice the risk free rate of interest. Meanwhile, an average shareholder in the market requires a return of 18%. The stocks beta is currently 1.50. The entitys marginal tax rate is 25%. All cash flows occur at the end of each year and depreciation is an allowable deduction for income tax purposes. Required: (a) Compute the weighted average cost of capital. (5 marks) (b) As a financial consultant, write a memorandum to the Crazy Jims CEO advising of the viability of the project. Your analysis should include the following: computation of the NPV, ARR and payback period. Additionally, the analysis should briefly outline what these three techniques are, as well as two advantages and two disadvantages of each. (30 marks)

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