Answer Happy

Question 2 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. [40 marks] 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? [20 marks] c). Explain why NPV method may generate misleading results for projects with embedded options [20 marks] d). Explain the decision criteria of NPV and IRR and describe the advantages of NPV over IRR in capital budgeting. [20 marks]