90.2K

Verified Solution

Link Copied!

There has been much recent volatility within a specific highly technical sector of the

electronic components industry. This industry sector comprises specialist businesses

delivering essential components, custom solutions and highly technical servicing

support. The industrys operating environment has experienced many changes in

recent years, driven by technological developments. This has been both challenging

and exciting for those doing business within the environment. The focus of question 5 concerns a decisionmaking

problem of Peppermint.

A company operating within the electronic components sector is Peppermint plc; the

management are currently considering an exciting potential new project. If

undertaken, it would maintain the company in its current risk environment. One

senior member of the management team considers it preferable to seek projects that

would move the company to a different risk environment.

The business operates two distinct divisions: Components and Services. The

Components Division supplies highly specialised consumables, with an expertise

recognised in the market. The Services Division involves the customised design,

commissioning, installation and servicing of systems to a wide range of users within

the entertainment industry. This division is a recent addition to the operations via

merger activity; it is still working on consolidating the forecast synergies.

The directors of Peppermint plc have been looking to invest in new projects with similar

risk characteristics as Peppermint plcs existing projects. They are considering a

project that requires an initial outlay of 9 million. The Directors estimate that this

project will produce after tax cash flows of 1.24 million per year in perpetuity.

Peppermint plc is a company that consists entirely of equity. Peppermint plcs

authorised share capital consists of 25 million 1 ordinary shares of which 7 million

have yet to be issued. Peppermint plcs ordinary shares are currently trading at 4.31

each. Peppermint plc currently has an after tax cost of capital of 17%.

If the Directors of Peppermint plc decide to undertake the project, they need to decide

how to finance the project. The choice available to them is to finance the cost of the

project by issuing equity or alternatively by issuing debt which carries a return of 8%.

However, there may be opportunities to gain from both a government subsidised

loan scheme and an eco-grant. The energy efficient innovative technology

equipment and systems software are forecast to cost 50% of the initial outlay, which

includes 1.5m of installation costs. It is anticipated, that these will qualify for

enhanced capital allowance thereby gaining 100% offset against taxable profits of

the energy saving equipment and up to 40% of installation costs. The estimated

administration costs associated with registering for the scheme is 80,000.

Another government initiative to support the financing of this project is a subsidised

loan scheme. This would allow up to 500,000 loan at a reduced interest rate of 5%

with a 5 year term and the government paying all of the first years interest.

Required Please note that your response should be structured in a way that provides useful information to the decision-maker. Hence, the marks awarded include those for clear problem introduction, full explanations and critical analysis relevant to the finance decision context, not just the computations alone. (a) (i) Adopting the Adjusted Present Value method advise the Directors of Peppermint plc as to whether the project should be undertaken if firstly the project is financed entirely by issuing equity and secondly if it is financed entirely by issuing debt. Fully explain your answer. 50 marks (ii) Calculate the expected return on the ordinary shares if the project is accepted and 1. financed by equity or 2. financed by debt. Explain the reason for the difference. 30 marks (b) 'Investment and financing decisions are separate focuses, therefore should be made independently of one another.' Discuss this statement using your findings in part (a) for examples. 20 marks Required Please note that your response should be structured in a way that provides useful information to the decision-maker. Hence, the marks awarded include those for clear problem introduction, full explanations and critical analysis relevant to the finance decision context, not just the computations alone. (a) (i) Adopting the Adjusted Present Value method advise the Directors of Peppermint plc as to whether the project should be undertaken if firstly the project is financed entirely by issuing equity and secondly if it is financed entirely by issuing debt. Fully explain your answer. 50 marks (ii) Calculate the expected return on the ordinary shares if the project is accepted and 1. financed by equity or 2. financed by debt. Explain the reason for the difference. 30 marks (b) 'Investment and financing decisions are separate focuses, therefore should be made independently of one another.' Discuss this statement using your findings in part (a) for examples. 20 marks

Answer & Explanation Solved by verified expert

See Answer