Question 3 XYZ Company has been offered a new contract to supply food and beverage to a large corporate customer EAT Com

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Question 3 Xyz Company Has Been Offered A New Contract To Supply Food And Beverage To A Large Corporate Customer Eat Com 1 (247.09 KiB) Viewed 225 times

Question 3 XYZ Company has been offered a new contract to supply food and beverage to a large corporate customer EAT Company for a period of 5 years. It pays Analytics Consultants Company (ACC) $20,000 to conduct an analysis of the profitability of the venture to determine whether to take up the contract. EAT Company will pay XYZ Company $1 million per year under the contract. According to ACC's calculations, XYZ company would incur fixed costs of $200,000 per annum, while variable costs will account for 30% of sales. XYZ company will need to invest in a new equipment which will cost $500,000. The equipment will be depreciated on a straight-line basis to zero over the 5-year life. The equipment can be sold for its book value at the end of the contract. The company will need to increase net working capital by $2 million. In addition, it plans to issue bonds of $1 million for a 5- year term at a coupon of 5% priced at par. The company has an existing bank loan of $2 million. The tax rate is 30%. This new contract has the same risk as the average risk of the company. The beta of the XYZ Company is 0.8. Current Treasury bills yield is 3%. The return on the stock market is 10%. The Company has 1 million common shares with a market price of $3 per share. (a) Calculate the cost of equity of XYZ company. (5 marks) (b) Without calculation, determine the cost of debt of XYZ company. (3 marks) (c) Determine the weighted average cost of capital of XYZ company. (5 marks) (d) What is the initial cash flow of the project? (5 marks)