Reference no: EM132423103

a) A beauty product company is developing a new fragrance. There is 50% probability that consumers will love the new product, in this case the annual sales will be 1 million bottles. There is a 40% probability the consumers will find the smell acceptable and annual sales will be 200,000 bottles. With10% probability consumers will find the smell unusual and annual sales will be only 50,000 bottles. The selling price is £38 and the variable cost is £8 per bottle. Fixed production costs are £1 million per year and depreciation is £1.2 million per year. Assume that the tax rate is 40%. What are the expected annual incremental cash flows for the new fragrance?

b) Information Systems Ltd is planning to issue 10-year bonds with £1,000 face value. The market rate for such bonds (yield) is 8.125%. Assume that coupon payments will be semi-annual. The firm is deciding between issuing an 8% coupon bond or a zero- coupon bond. The company needs to raise £1 million.

i) What will be the price of the 8% coupon bonds? How many coupon bonds would have to be issued?

ii) What will be the price of the zero-coupon bonds? How many zero-coupon bonds will have to be issued?

c) You know that the return of ordinary shares of ABC company reacts to macroeconomic information 1.6 times more than the return of the market. If the risk-free rate of return is 4% and the market risk premium is 6%, what is ABC's cost of equity?