Reference no: EM132756938

Question - ABC Company owns a department store selling clothes and fashion accessories. It is thinking of expanding its business by opening a new store.

ABC intends to run the store for only 3 years. The details relating to the project are as follows:

Renovation costs of new store is $60,000. This amount will be paid by the landlord who will adjust the rent to reflect this cost.

No additional working capital is required.

Sales of the new store for the 3 years are $260,000, $280,000 and $300,000, respectively.

Rent for the new store is $100,000 each year.

Variable costs are 50% of sales.

Financial data pertaining to ABC are as follows:

Common shares issued: 1 million shares

Share price: $5 a share

Bonds issued: 10,000 bonds

Face value of bond: $1,000

Price of bond: $1,044.52

Coupon rate of bond: 5%

Maturity of bond: 5 years

Information obtained from the Bloomberg terminal:

ABC's beta = 1.2 times of market beta

10-year Treasury bond yield = 3%

5-year AA bond yield = 3.5%

5-year A bonds have a spread of 0.5% above AA bond yields

Expected return of the stock market = 9%

Corporate tax rate = 20%

Required -

a) Calculate ABC's cost of equity, cost of debt as well as the weighted average cost of capital.

b) Calculate the operating cash flows related to the project.

c) Calculate cash flows from assets for the project.

d) Calculate the NPV of the project using a discount rate of 8%. Should the firm go ahead with the project?

e) Identify the issue and discuss why IRR cannot be used to evaluate this project.