Determine most appropriate discount rate to use for project

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Reference no: EM133927101

Problem

Mapex Ltd., a geoinformatics company is expanding into drone manufacturing to diversify its operations. This project has an initial life of 4 years and the initial costs of the machinery (which is the only significant initial cost) is R800 000 while the related installation costs is R200 000. The projects are expected to generate sales of R1 500 000 each year (expressed in real terms). Variable costs are expected to amount to 60% of sales while fixed costs are expected to be R200 000 (in real terms). The machinery for the project can be depreciated over 4 years and the tax rate is 27%. The machinery can be sold for R1 200 000 at the end of the project (in nominal terms). The company is wholly financed by equity. The risk-free rate is 10% and the market risk premium is 5%. The company currently has a beta of 1.5 while that of the drone industry is 1.5. Inflation is 4%.

Task

1) Adjust the cash flows for inflation where necessary and identify the relevant cash flows of the project.

2) Determine the most appropriate discount rate to use for the project. Get the instant assignment help.

3) Discuss the acceptability of the project, mention how you adjusted for inflation and risk and what impact this had on the resultant NPV.

Reference no: EM133927101

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