Reference no: EM132971058

Question - Kapit Microprocessor Company (KEC) is considering developing and market a new appliance using microprocessor technology.

KEC's marketing manager believes that annual sales would be 31,000 units if the units were priced at RM2,100 each. The engineering department has reported that the firm would need additional manufacturing capability, and KEC currently has an option to purchase an existing building, at a cost of RM22 million which would meet this need. The building would be bought and paid for at the end of the year, i.e., December 31, 2021.

The necessary equipment would be purchased, installed, and paid at the end of 2021. It would cost RM11 million, including transportation, installation, and training.

The project would require an initial investment of RM6 million net working capital. The initial working capital investment would also be made at the end of 2021.

The project's estimated economic life is five years. At the end of that time, the building is expected to have a market value of RM4 million and a book value of RM2 million, where the equipment would have a market value of RM1.5 million and a book value of RM1 million.

The production department has estimated that the variable manufacturing costs would total 62% of annual sales, and that of fixed overhead costs, excluding depreciation, would be RM4 million per year.

The depreciation for building and equipment would be determined using the straight-line depreciation method.

For capital budgeting purposes, the company's policy is to assume that operating cash flows occur at the end of each year. Because the plant would begin its operations on January 1, 2022, the first operating cash flow would occur on December 31, 2022.

a. By taking into consideration the working capital requirement, what is the project's total net investment in the initial year?

b. Calculate the annual operating cash flows of the project.

c. Calculate the terminal value of the project if the capital gain tax is the same as the company's tax rate.

d. What is the simple and discounted payback period of this project? Based on the payback methods, should the project be considered?

e. Using the given capital structure, cost of each source of capital, and the tax rate, what is the weighted average cost of capital (WACC) to be used to evaluate this project?

f. Using the computed WACC, determine the net present value (NPV) of the project. Should the project be accepted?

g. What is the internal rate of return (IRR) of the project? Is it higher or lower than its WACC? Using IRR, should the project be considered? Justify.

h. What is the MIRR of the project using the estimated WACC? Should the project be accepted or rejected? Justify.

i. Briefly explain how the sensitivity analysis and scenario analysis can be applied in evaluating the riskiness of this project.