Bega Cheese currently has 185,000,000 shares of ordinary shares outstanding that trade at a price of $7.03 per share.
Bega Cheese also has 300,000 bonds outstanding that currently trade at $92.34 each.
The company has no preferred shares outstanding and has an equity beta of 1.13. The risk-free rate is 3.5%, and the market is expected to return 12.52%. The company’s bonds have a 20-year life, a $100 face value, a 10% coupon rate and pay interest semi-annually.
The Board of Directors is now considering adding to its product mix a range of Yogurt products to capitalise on the growing demand for natural yogurt range.
The initial outlay for the project is expected to be $3,000,000, which will be depreciated using the straight-line method to a zero salvage value.
Sales are expected to be 1,250,000 units per year at a price of $1.25 per unit.
Variable costs are estimated to be $0.24 per unit, and fixed costs of the project are estimated at $250,000 per year.
The project is expected to have a three-year life and a terminal value (excluding the operating cash flows in year 3) of $300,000.
Bega Cheese has a 34% tax rate. (For the purposes of this project, working capital effects will be ignored).
The yogurt range is expected to have different risk characteristics from the company’s current products.
You have recently graduated with a degree in finance. Your employer, Bega Cheese wants you to work with the provided to data to address the given problems
a. Determine the weighted average cost of capital for Bega Cheese.
b. Should the management go ahead with its proposed project of introducing the range of yogurt under the normal conditions as stated previously?
c. Should Bega Cheese go ahead with its proposed project of introducing the ranges of yogurt under the following best case and worst case scenarios?
· Best – Case Scenario
Selling 2,500,000 units at a price of $1.24 per unit, with variable production costs of $0.22 per unit.
· Worst – Case Scenario
Selling 950,000 units at a price of $1.32 per unit, with variable production costs of $0.27 per unit.
d. What would you do as the financial analyst? Which investment would you recommend, and why?