3.In the first year,it is estimated that the total direct material,labour and variable overheads costs will be $1,200 per unit produced.After the first year,the direct costs are expected to increase by an annual inflation rate of 8%.

　　4.Annual fixed overhead costs would be $2.5 million of which 60% are centrally allocated overheads.The fixed overhead costs will increase by 5% per year after the first year.

　　5.Fubuki Co will need to make working capital available of 15% of the anticipated sales revenue for the year,at the beginning of each year.The working capital is expected to be released at the end of the fourth year when the project is sold.

　　Fubuki Co's tax rate is 25% per year on taxable profits.Tax is payable in the same year as when the profits are earned.Tax allowable depreciation is available on the plant and machinery on a straight-line basis.It is anticipated that the value attributable to the plant and machinery after four years is $400,000 of the price at which the project is sold.No tax allowable depreciation is available on the premises.

　　Fubuki Co uses 8% as its discount rate for new projects but feels that this rate may not be appropriate for this new type of investment.It intends to raise the full amount of funds through debt finance and take advantage of the government's offer of a subsidised loan.Issue costs are 4% of the gross finance required.It can be assumed that the debt capacity available to the company is equivalent to the actual amount of debt finance raised for the project.

　　Although no other companies produce mobility vehicles in Megaera,Haizum Co,a listed company,produces electrical-powered vehicles using similar technology to that required for the mobility vehicles.Haizum Co's cost of equity is estimated to be 14% and it pays tax at 28%.Haizum Co has 15 million shares in issue trading at $2.53 each and $40 million bonds trading at $94.88 per $100.The five-year government debt yield is currently estimated at 4.5% and the market risk premium at 4%.

　　Required:

　　(a)Evaluate,on financial grounds,whether Fubuki Co should proceed with the project.(17 marks)

　　(b)Discuss the appropriateness of the evaluation method used and explain any assumptions made in part(a)above.(8 marks)

　　(25 marks)

　　Section B–TWO questions ONLY to be attempted

　　3 The treasury division of Marengo Co,a large quoted company,holds equity investments in various companies around the world.One of the investments is in Arion Co,in which Marengo holds 200，000 shares,which is around 2% of the total number of Arion Co's shares traded on the stock market.Over the past year,due to the general strength in the equity markets following optimistic predictions of the performance of world economies,Marengo’s investments have performed well.However,there is some concern that the share price of Arion Co may fall in the coming two months due to uncertainty in its markets.It is expected that any fall in share prices will be reversed following this period of uncertainty.

　　The treasury division managers in Marengo,Wenyu,Lola and Sam,held a meeting to discuss what to do with the investment in Arion Co and they each made a different suggestion as follows:

　　1.Wenyu was of the opinion that Marengo's shareholders would benefit most if no action were taken.He argued that the courses of action proposed by Lola and Sam,below,would result in extra costs and possibly increase the risk to Marengo Co.

　　2.Lola proposed that Arion Co's shares should be sold in order to eliminate the risk of a fall in the share price.

　　3.Sam suggested that the investment should be hedged using an appropriate derivative product.

　　Although no exchange-traded derivative products exist on Arion Co's shares,a bank has offered over-the-counter (OTC)option contracts at an exercise price of 350 cents per share in a contract size of 1，000 shares each,for the appropriate time period.Arion Co's current share price is 340 cents per share,although the volatility of the share prices could be as high as 40%.