Question 1 (15 marks) California Mining is evaluating the introduction of a new ore production…

Question 1 (15 marks) California Mining is evaluating the introduction of a new ore production…

Question 1 (15 marks)

California Mining is evaluating the introduction of a new ore production process. Two alternatives are available. Production Process A has an initial cost of $25,000, a 4-year life, and a $5,000 net salvage value, and the use of Process A will increase net cash flow by $13,000 per year for each of the 4 years that the equipment is in use.

Production Process B also requires an initial investment of $25,000, will also last 4 years, and its expected net salvage value is zero, but Process B will increase net cash flow by $15,247 per year. Management believes that a risk=adjusted discount rate of 12 percent should be used for Process A.

If California Mining is to be indifferent (same NPV for Process A and B) between the two processes, what risk-adjusted discount rate must be used to evaluate B?

Question 2 (25 marks)

Part A

ABC Corp Ltd has 10 million shares and $600,000 of debt (issues bonds @ 7% p.a.). EBIT is projected to be $3 million. The company tax rate is 20%.Preference shares pay an annual dividend of $100,000. Management is considering two options for capital restructure:

Option 1: The Company would borrow $3.5 million at 8% interest rate and use the proceeds to engage in share repurchase program for 3.5 million shares at the current market price of $1.

Option 2: Company can raise $3.5 million by issuing new shares at the current market price of $1.

Required:

a) What is the current EPS for shareholders? (5 marks)

b) What will be the EPS after the change in capital structure under option 1 and option 2? Hint: show full working from EBIT to Net Profit (12 marks)

c) Does it make sense for management to go ahead with either of the capital restructure options? If yes, which of the two options is EPS accretive? (2 marks) d) What is meant by the term ‘capital structure’ and what circumstances with respect to Weighted Cost of Capital (WACC) and the value of the firm define an optimal capital structure? (6 marks)

Question 1 (15 marks) California Mining is evaluating the introduction of a new ore production…

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