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Fundamentals of Finance - Essay Example

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This essay will cover the analyses of the various cost alternatives, as well as additional assumptions that might have to be introduced in order to make this a more real-world example.This case illustrates the relative costs of capital, but it does so in a bit of a vacuum…
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Download file to see previous pages The company’s current drill and platform was purchased 3 years ago for £10M. The firm depreciates the machine using MACRS over a 5 year recovery period when the assets are replaced due to very high maintenance costs. The company’s management estimates that after removal costs are taken into consideration, this platform can be sold for £3.5M. The company can also buy a new high specification platform at a cost of £14M plus installation costs of £1M and still has an estimated life of 5 years. If they decide to go ahead with this purchase then the company’s working capital needs will change; accounts receivable will increase to £1.5M, accounts payable will also increase to £1M and inventory will increase to £2M.
Swindon is expected to be able to sell the new, proposed machine at the end of the 5-year period for £4M while the present machine at the end of the same period is expected to generate £2.5M. All else equal, the company expects to recover their Net Working Capital Investment at the end of the same period. The company’s tax rate is at 40%. The existing machine is expected to net £3,500,000 each year for the next 5 years. Along with the C.F.O, the Operations Officer has also laid down the estimated cash flows of the company from the new drilling platform as follows: 1) DEBT: the company can raise an unlimited amount of debt by selling £1,000 par value, 6.5% coupon interest rate, 10 year bonds on which annual interest payments will be made. To sell the issue, an average discount of £20 per bond needs to be given. There also is an associated flotation cost of 2% of par value. 2) PREFERRED STOCK: the company can raise an unlimited amount of preferred stock under the following terms; (a) the security has a par value of £100/share, (b) the annual dividend rate is 6% of the par value, (c) the flotation cost is expected to be £4 per share. The preferred stock is expected to sell for £102 before cost considerations. ...Download file to see next pagesRead More
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