You have produced revenue and expense forecasts for the four years of operation of the proposed investment in Part (1). Year (1) sales revenue for the new machine is uncertain, but expected to be in the range of £32,000,000 - 80,000,000. Sales are expected to grow at an annual rate of 15%.
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Year (1) Sales revenue (£000)
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Probability
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32,000
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0.2
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60,000
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0.3
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80,000
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0.5
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Anticipated expenses related to the new machine are as follows:
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Expense Type
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£000
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Additional Information
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Cost of goods sold
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22,000
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Rise by 15% per annum
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Distribution costs:
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Depreciation
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4400
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No change
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Bad debts
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1200
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Rise by 15% per annum
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Advertising
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2800
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Rise by 10% per annum
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Administrative expenses:
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Rent
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1600
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No change
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Salaries and wages
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8,000
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Rise by 10% per annum
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Miscellaneous expenses
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4000
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Increase of 10% in Year 3
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Additional information:
- Tax is payable one year after the end of the company's accounting year, at a rate of 40% and full use can be made of tax refunds as fall due.
- The new machine will be funded by issuing a mix of new ordinary shares (£10,000,000) and new bonds (£10,000,000). The ordinary shares of AML plc sell for £2,000, and last year's dividend was £380.71 per share. A flotation cost of 10% would be required to issue new ordinary shares. Security analysts are projecting that the ordinary dividend will grow at a rate of 5% a year. The company can issue additional long-term bonds at an interest rate (or before-tax cost) of 8%. AML plc uses a target capital structure with 50% debt and 50% ordinary equity.
Required:
1- Calculate the NPV of the new machine and explain why it should be accepted or rejected. the companyplans to raise and invest £20,000,000