Reference no: EM133133253
Question - Solar Power (SP) is considering building a specialized solar power generator with only a 10-year life. This generator qualifies for a CCA rate of 20 percent. The generator will cost $1 million; accompanying building will cost another $200,000. The buildings are Class 1 with a CCA rate of 4 percent. SP will use land it acquired eight years ago to assemble this project. The land was purchased for $500,000, and it is now worth $2 million. Annual cash flows before amortization from the generator and taxes for the 10-year period are estimated at $625,000. In 10 years, the buildings and generator will be worthless, but the land will be worth $4.5 million. Environmental clean-up costs at the end of the project are expected to be $1.2 million. SP has a tax rate of 30 percent, and its cost of capital is 14 percent. Capital gains are taxed at 50 percent of the gain. Additional working capital required for the new generator of $150,000 is required for the life of the project. SP intends to borrow $350.000 to finance the project at 7%.
Required -
Part 1 - You are the trusted financial adviser of SP Board of Directors and you are asked a detailed report to assess the investment and provide recommendations. You report should include the following:
1. Introduction explaining the investment and your approach for the analysis of the project,
2. Quantitative analysis including at least NPV, IRR and Payback period including explaining the results.
3. Qualitative analysis explaining pros and cons of undergoing such an investment and any assumptions taken.
4. Conclusion and Recommendations.
Part 2 - Last week in a call with Janice Taylor, the CFO of SP she expressed her frustration with choosing the 14% as a cost of capital. Janice feels that 14% does not reflect the true financial structure of SP." We did not review our WACC in the last 5 years". Janice asked your assistance in calculating the current WACC of SP given the following information:
$8 Million outstanding bonds, required return 8%
$15Million Common Stock, required return 12%
$5Million Preferred Stock, required return 12%
Part 3 - How will your answer differ for part 1 based on your calculation in Part 2?