CF plc is a Nottingham-based company that focuses on publishing textbooks in the area of corporate finance. Over the las

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CF plc is a Nottingham-based company that focuses on publishing
textbooks in the area of corporate finance. Over the last five
years, CF plc has spent £100,000 every year to hire practitioners
and researchers to publish papers in the area of fintech. The
company is considering an investment in a new textbook that
reflects the recent trends in fintech. The marketing team expects
that the textbook will remain in print for two years (Year 1 and 2)
at which point its contents will become obsolete. Market research,
which cost the firm £40,000, suggests that 4,000 and 10,000 copies
are expected to be sold in year 1 and 2. The textbook will be
initially priced at £50. The sale price is expected to grow at
5%/year. The launch of the new book project is expected to increase
CF plc’s sales in other products by £100,000 per year during year 1
and 2, those incremental sales in other products would require
£50,000 operating expenses per year. In order to print the new
book, the company will need to purchase a new machine that costs
£200,000 this year (year 0). The depreciation is based on the
straight-line method and the machine is assumed to have no market
value with the obsolescence of the book. The corporate tax rate is
20%. A single copy of the new text book will cost £20 to produce,
which is expected to increase at 10%/year. Finally, this project
requires an initial (t=0) investment in working capital of £20,000.
Thereafter, working capital is forecasted to be 10 % of sales of
the new textbook in year 1 and is completely recovered when the
project ends in year 2.
a). Given the information above, estimate the project’s free
cash flows.
b). The equity cost of capital is 12% and the pre-tax cost of
debt is 8%. The debt/equity ratio of ICF plc is 1/2. Assume that
the new textbook project has similar financing structure and risk
level of ICF plc, should the company proceed with the
investment?
c). Explain why NPV method may generate misleading results for
projects with embedded options.
d). Explain the decision criteria of NPV and IRR and describe
the advantages of NPV over IRR in capital budgeting.