Semester 2, 2019

ENGINEERING MANAGEMENT 3000/5039

TUTORIAL SET 10

Q1. A company buys a CNC drilling machine for $600,000 which has a useful life of 5 years
with zero salvage value. The company estimates the following revenue and expenses for
each year of operation: Revenue = $800,000; Cost of Goods Sold (COGS) = $300,000 and
Operating Expenses = $200,000. Assuming a 30% tax rate and straight-line depreciation,
calculate Net Income and Net Cashflow. (ANS: $126k, $246k)

Q2. A DVD manufacturer is assessing whether to establish a new manufacturing facility in

Australia. The current market price of a blank DVD’s is $4ea. A feasibility study into an 8m
DVD per annum facility has shown that development costs include $20m to build a
production facility (building, plant and equipment) and $2m for land. The facility will have a
useful life of 10 years and will be depreciated to zero, using straight line depreciation. At
the end of the project’s life, the building will be gutted, all production equipment removed
and be refurnished as a warehouse at a cost of $1m, at which point the building and land
is expected to be sold for $6m a year later (Ignore Capital Gains Tax). Direct production
costs in making DVD’s (i.e. labour, materials and electricity) are estimated at $3 per CD
and fixed operating expenses to be $3m per annum. Assuming corporate tax rate of 30%
and MARR of 15%, calculate the NPV to assess the investment. (ANS: -$0.34m, Don’t
Invest)

Q3. Q3 Continues. As the Australian Government is trying to pro mote manufacturing

development in this country, it’s offering the DVD manufacturer an accelerated
depreciation of 5 years (straight-line) for its facility. Does this have any impact upon its
investment decision? (ANS: +$0.66m, Invest)

Q4. Assume an Ultra Smart Engineering Consultant, Co. has a target debt ratio of 30% and is
raising $100m to finance a new project. If funding cost of debt is 3% and funding cost of
equity is 12%, what is the true cost to raise funds for the new project? (ANS: $110.3m)

Q5. A steel production company has a target debt ratio of 40%. It is considering building a
new printing plant for $5.8m. Expected after-tax cashflow is $700,000 per year in the first
10 years and $500,000 per year from Year 11 to perpetuity. The same Beta value of 1. 2
can be used (as it’s staying in the same business and staying in the same c o u n t r y ).
Assume a corporate tax rate of 30% and using the following financial information calculate
the NPV of the expansion:

Risk Free Rate = 6% ; Market Risk Premium = 6.4%; Interest Rate on Debt = 8%;
Funding cost for new equity = 10%; Funding cost for new debt = 3%
(ANS: -$0.25. Don’t invest)

ENGINEERING MANAGEMENT 3000/5039 -1- Tutorial 10

Q6. You require to raise funds to finance your project to take it to the next stage. You manage
to raise the required funds from multiple sources and lending institutions.
If you borrow $30,000 at a rate of 10%, $50,000 at a rate of 8%, $10,000 at a rate of 6%
and $20,000 at a rate of 7%, calculate the overall cost of debt. (Ans:8.19%)

Q7. A steel Printing Power Pty. Ltd. has borrowed $4m at a compounded interest rate of
9% p.a. The company had also borrowed $6m two years ago and $5m last year with
an annual compound interest rate of 7% and 8% respectively. The total debt of the
company now stands at $15m. The company is listed on the stock exchange with a β
value of 1.3 and now has a debt ratio of 60%. The company expects to maintain the
existing capital structure at a risk free rate of 7% and a risk premium of 7.4%. The
corporate tax rate is 30%.

Calculate the following:

a) Cost of Equity
b) Cost of pre tax Debt
c) The WACC

The company hopes that the new expansion will increase revenues by $7m p.a.
However this will cause annual increases in labour costs of $2.6m, material costs of
$2.0m and direct manufacturing overheads by $1.0m p.a. In addition $0.4m p.a. needs
to be allocated for all other overhead costs. Land for the expansion was purchased 4
years ago for $9m. Upfront equipment development cost is $5m and is to be
depreciated using the straight line method to zero salvage value as the equipment is
expected to operate for 10 years. Funding cost of raising new equity is 10%. The
funding cost of new debt is 2%.

d) Calculate the “Operating Net Cash flow” in today’s dollars.

e) Using NPV analysis and taking into account the true cost of funding show if the
company should go ahead with the expansion.
(Ans: a) 16.62%, b) 7.867%, c) 9.952 %, d) $5.23m, e) - $0.0443m Don’t invest)

Q8. A robotics company is evaluating an investment into a new production plant. The cost of
the new plant is $460k with an estimated useful life of 10 years. The company decides to
raise the equity required by issuing common stock onto the share market. The cost of the
company’s equity is 15%. Issuing the stock generates a cost of funding the equity of 8%.
The incremental after tax cash flow is $95k. The corporate tax rate in Australia is 30%.
The capital structure is such that the company has a 25% debt ratio. The cost of the debt
capital is 9% whereas the cost of funding the debt raised is 4%.

a) Draw the cash flow diagram that represents the above investment scenario.

b) Calculate the NPV of the project.

c) Taking into account the true cost of funding the project determine if you would proceed
with the investment.

(Ans: b) +$519,337.41, c) +$24,753.75 positive so ok to invest)

ENGINEERING MANAGEMENT 3000/5039 -2- Tutorial 10