Question

Galaxy Industries Limited is a large publicly listed company and is the market leader in vacuum cleaner
manufacturing in New Zealand. The company is looking to set up a manufacturing plant overseas to produce a
new line of commercial vacuum cleaners. This will be a six-year project. The company bought a piece of land
four years ago for $ 8 million in anticipation of using it for its proposed manufacturing plant. If the company
sold the land today, it would receive $ 10.25 million after taxes. In six years the land can be sold for $11.5 million
after taxes and reclamation costs. Galaxy Industries Ltd wants to build a new manufacturing plant on this land.
The plant will cost $295 million to build.

The following market data on Galaxy Industries Ltd are current:

Debt	$120,000,000,6.25% coupon bonds outstanding with 20 years to maturity redeemable at par, selling for 95 percent of par; the bonds have a $1000 par value each and make semi-annual coupon payments.
Equity	15,000,000ordinary shares, selling for $55 per share
Non-redeemable Preference shares	12,000,000 shares (par value $ 10 per share) with 6.5% dividends (after taxes), selling for $32 per share

The following information is relevant:
• Galaxy Industries Ltd’s tax rate is 28%.

The project requires $ 8.5 million in initial net working capital in year 0 to become operational.
• The company had been paying dividends on its ordinary shares consistently. Dividends paid
during the past five years is as follows

Year (-4) ($)	Year (-3) ($)	Year (-2) ($)	Year (-1) ($)	Year (0) ($)
4.6	4.8	5.2	5.3	5.9

The manufacturing plant has a ten-year tax life, and the company uses Diminishing value method of depreciation at 25% per annum for the Plant.

At the end of Year 6, the Plant can be scrapped for $ 52 million. The company estimations show that 280,000 vacuums are manufactured and sold per year (Years 1-6) and selling price per unit in year one is $2,100, but the price will increase by 2% per year. Similarly, the variable costs per unit are expected to be $900 for year one but will increase by 2.5% per year in the subsequent periods. The project will incur $220 million per annum in fixed costs (fixed costs includes coupon payments to bondholders). At the end of year 6, the company will sell the land.

Required:
1. Calculate the project’s initial, (time 0) cash flows.

2. Compute the weighted average cost of capital (WACC) of Galaxy Industries Ltd. Show all workings and
state clearly any assumptions underlying your computations.

3. Using the WACC computed in part (2) above and assuming the following, compute the project’s Net
Present Value (NPV), Internal Rate of Return (IRR) and the Profitability Index (PI).
Note: Work all solutions to the nearest two decimals, show depreciation table, calculate gain/loss on the sale of Plant, and Land. Record tax effects in the income statement.

Answer 1