Reference no: EM132418034

Part A:

ABC Inc. is considering a proposal to manufacture a new product and add it to the existing lines of their products. The project requires the use of an existing warehouse, which the firm acquired three years ago for £1 million and which it currently rents out for £120,000 per year. Rental rates are not expected to change going forward. In addition to using the warehouse, the project requires an up-front investment into machines and other equipment of £1.4m. This investment can be fully depreciated straight-line over the next 10 years for tax purposes. However, ABC Inc. expects to terminate the project at the end of eight years and to sell the machines and equipment for £500,000. Finally, the project requires an initial investment into net working capital equal to 10% of predicted first-year sales. Subsequently, net working capital is 10% of the predicted sales over the following year and it is fully recovered at the end of the project. Sales of the new product are expected to be £4.8 million in the first year and to stay constant for eight years. Total manufacturing costs and operating expenses (excluding depreciation) are 80% of sales, and profits are taxed at 30%.

i. What are the free cash flows of the project? Show your calculations.

ii. If the cost of capital is 15%, what is the NPV of the project?

Part B:

Colgate-Palmolive Company has just paid an annual dividend of £1.50. Analysts are predicting dividends to grow by £0.12 per year over the next five years. After then, Colgate's earnings are expected to grow 6% per year, and its dividend payout rate will remain constant.

If Colgate's equity cost of capital is 8.5% per year, what price does the dividend-discount model predict Colgate stock should sell for today?