FBLT041 Accounting and Financial Management: Financial Analysis

FBLT041 Accounting and Financial Management: Financial Analysis

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FBLT041 Accounting and Financial Management

Questions:

JD Sports Fashion Plc is currently evaluating a new project that will expand its lines to include a designated golf line that will offer not only clothing but also golf equipment and accessories. The project will require an initial outlay of £20m on production machinery and other costs. The project is expected to have a three-year life span and the cash flows associated with the projected are projected in the below table:

The project has a debt capacity of 60% of the cost of the project, with an annual interest charge of 5%. The company currently has £3m of retained earnings available for this project, and the remainder would potentially be financed with a rights issue. The rights issue incurs additional costs of 2% of the amount raised, and the debt issuance is a bit cheaper, costing 1%, where both issue costs are tax deductible.

Required:

The company believes it will be a successful project and will help to distinguish it from its competitors. However, the company would like you to evaluate the project using different methods and present a proposal to the investment committee in order for them to approve it.

a) JD Sports Fashion Plc is considering financing the project with 60% debt. Using the Internal Rate of Return (IRR) and Net Present Value (NPV), appraise the project.

Hint: calculate the free cash flow of the project and use CAPM to compute the discount rate.

b) Evaluate the project using Adjusted Present Value (APV).

c) Assuming the market risk of the project is similar to the overall market risk of the firm, revise the project’s NPV using the Weighted Average Cost of Capital (WACC). Compare the answer to part a).

Note: Assume the same level of debt is held until the end of the project. Do not consider the repayment of the debt principal in any of the above valuations in parts a) to c).

d) Compare the methods used and give a final recommendation to the investment committee. Make sure you critically evaluate all methods and discuss other risk factors that were not included in the analysis.

FBLT041 Accounting and Financial Management

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