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Real Options: Arturo Berhad Should Expand The Business

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(a) (i)

WACC= E/V × Re+ D/V × Rd × (1-TC)

*Re = Cost of Equity = 16.65%

Rd = Cost of Debt = 7.00%

E/V=Percentage of financing that is equity= 100/130

D/V=Percentage of financing that is debt= 30/130

TC = Corporate tax rate = 0.25 = 25%

WACC= 100/130 × 16.65%+ D30/130 × 7.00% × (1-0.25)

Cost of Capital = 14.02% - 2.5%

= 11.52%

*Re = 3% + 2.1 (6.5%)

= 16.65%

(a) (ii)

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Unit Sales (A) 2,000 3,500 4,200 5,000 5,100

Revenues (B) 17,000,000 29,750,000 35,700,000 42,500,000 43,350,000

Production cost (3,400,000) (5,950,000) (7,140,000) (8,500,000) (8,670,000)

Direct Marketing Expenses (1,700,000) (2,975,000) (3,570,000) (4,250,000) (4,335,000)

Depreciation (10,000,000) (10,000,000) (10,000,000) (10,000,000) (10,000,000)

Earning before Tax 1,900,000 10,825,000 14,990,000 19,750,000 20,345,000

Tax @ 25% (475,000) (2,706,250) (3,747,500) (4,937,500) (5,086,250)

Profit after tax 1,425,000 8,118,750 11,242,500 14,812,500 15,258,750

Add: Depreciation 10,000,000 10,000,000 10,000,000 10,000,000 10,000,000

Cash flow-operation 11,425,000 18,118,750 21,242,500 24,812,500 25,258,750

Working Capital @ 12% 2,040,000 3,570,000 4,284,000 5,100,000 5,202,000 0

Increase in Working Capital (2,040,000) (1,530,000) (714,000) (816,000) (102,000) 5,202,000

Initial investment of plant (50,000,000) 8,000,000

Tax on gain @ 25% (2,000,000)

Net Cash Flow (52,040,000) 9,895,000 17,404,750 20,426,500 24,710,500 36,460,750

Discount factor @12% 1.0000 0.8967 0.8041 0.721 0.6465 0.5797

Present Value (52,040,000) 8,872,846.50 13,995,159.48 14,727,506.50 15,975,338.25 21,136,296.78

Net present value 22,667,148

Since the...

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Peavler, R. (2014). Calculate Weighted Average Cost of Capital. [online] About.com Business Finance. Available at: http://bizfinance.about.com/od/cost-of-capital/a/Calculate-Weighted-Average-Cost-Of-Capital.htm [Accessed 28 Apr. 2014].

Peavler, R. (2014). Debt and Equity Financing - Advantages and Disadvantages. [online] About.com Business Finance. Available at: http://bizfinance.about.com/od/generalinformatio1/a/debtequityfin.htm [Accessed 29 Apr. 2014].

Sorid, D. (2014). Weighted Average Cost of Capital. [online] About.com Investing for Beginners. Available at: http://beginnersinvest.about.com/lw/Business-Finance/Personal-finance/Weighted-Average-Cost-of-Capital.htm [Accessed 29 Apr. 2014].

Investopedia, (2009). Cost Of Equity Definition | Investopedia. [online] Available at: http://www.investopedia.com/terms/c/costofequity.asp [Accessed 29 Apr. 2014].
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