M100Cl Corporate Finance|Managerial Agents Assessment Answer

The directorof DesignXhas proposed the purchase ofalarge six-colour presses designed for long, high-quality runs. The purchase of a new press would enable the firm to reduce its cost of labour and therefore the price to the clients, putting the firm in a more competitive position. The key financial characteristics of the existing press and the proposedpress are summarised below.Old press: Originally purchased three years ago at an installed cost of $1,000,000, it is being depreciated using a straight-line method over a 10-year effective life. The old press has a remaining economic life of five years. It can be sold today to net $500,000 before taxes. If the old press is retained, it can be sold to net $200,000 before taxes at the end of five years.Press A:This highly automated press can be purchased for $2,000,000. It will be depreciated using the straight-line method over a five-year effective life. At the end of the five years, the machine could be sold to net $200,000 before taxes.Additional information:The company had previously spent $30,000 on consultation to determine the viability of incorporating the new press into existing operation, and projections of cashflows associated with this project. The acquisition of the new press requiresadditional installation work to be carried out, as well as the removal and clean-up of the old press, which totals $50 000. Net working capital of $60 000 is incurred for initial operations of the new press, after which it will be released at the end of working life.The new press will incur an annual fixed cost of $150 000 per year. The firm estimates that its cash flowsbefore depreciation and taxes with the old press and with the new press for each of the five years will be as show in the table below. Assume the firm is subject Tax Writing Down Allowance on depreciation, and the tax rate on ordinary income and capital gainis 30%. The firm’s cost of capital applicable to the proposed replacement is 14%

Prepare cash flow forecastfor the appropriate period, showing the relevantinvestment and the net cash flows in each yearPart 2:DesignX would like to raise some private equity to fund the replacement, and use the weighted average cost of capital(WACC)as an appropriate discount rate to evaluate the above replacement project. However, as the company is not publicly traded, they havebeen advisedto use a similar company to derive the cost of equity.DesignY is a close competitor in the industry, is listed on the stock exchange, and has a 5 year Beta of 1.25.The company’s share price is $3.80, and there are 12 million shares in issue. DesignY had issued $8 million of 8 years floating rate debt 2 years ago, with an annual coupon rate of 8%, redeemableat par; which is currently trading with a yield to maturity of 7%. The risk free rate of the US Treasury Bills rate is currently 5.5%, and the average return on the S&P500 index is 12.8%.Determine what the discount rate DesignXshoulduse in assessing the replacement project, taking into account the information provided to you regard its competitor. You should support your answer with relevant calculations and state any assumptions you makeCalculate the NPV and IRR for the proposed replacement projectusing the WACC. How much value is created for DesignX by opting to replace the old press? Discuss what the twoinvestment appraisal techniques tell you. Part 4The owners of DesignX are keen to eventually go public with the company and list on the stock exchange. They are aware that an IPO is a complicated process and companies have to be prepared to meet the many related reporting and corporate governance requirements that begin to apply immediately following the closing of the offering. One topic that can be overlooked in the early planning stages is the internal governance mechanism that have to be in place post-IPO.Critically discuss how is each of the THREEinternal governance mechanisms-Ownership Concentration, Boards of Directors, and Executive Compensation used to align the interests of managerial agents with those of the firm's own