Pre mock exam Dec 23

This is the question. Please help me to answer above question 1 and 2. Thank you.

The following exhibits, available on the left-hand side of the screen, provide information relevant to the question
1. Redwood Co – Diversification
2. Project cash flows
3. Other financial information
(a) Estimate the Adjusted Present Value (APV) of the proposed investment.(10marks)
(b) Explain the difference between APV and NPV as methods of investment appraisal and comment upon the circumstances under which APV might be a better method of evaluating a capital investment than NPV.(5marks)
(c) Explain the major differences between Islamic finance and other conventional forms of finance such as those being considered by Redwood Co. Identify, and briefly discuss, two Islamic financial instruments that could be of use to Redwood Co in the above situation.(5marks)
Professional marks will be awarded for the demonstration of skill in analysis and evaluation, scepticism and commercial acumen in your answer.(5 marks)

1. Redwood Co – Diversification
Redwood Co, a company known for its success in the paper manufacturing industry, are planning for a transformative change. The managers of Redwood Co are investigating a potential $25 million investment.
This venture represents a diversification away from their familiar mainstream activities and into the printing industry. To make this vision a reality, they intend to allocate $6 million from their own internal funds, generate $10 million through a rights issue, and secure an additional $9 million through long-term loans. This strategic move signifies Redwood Co’s commitment to a dynamic future, one where they blend their established expertise with the evolving world of printing.
2. Project cash flows
The investment is expected to generate earnings before depreciation& tax of approximately $5 million per year, for a period of ten years. The residual value at the end of Year 10 is forecast to be $5 million after tax.
What makes this investment even more compelling is its alignment with the government’s development goals. In a move to foster growth in this specific sector, a favorable opportunity presents itself: a subsidized loan worth $4 million out of the overall $9 million required for the investment. This specialized loan comes at an attractive interest rate, standing at 2% below the company’s normal cost of long-term debt finance, which typically rests at 8%. This subsidy not only enhances the feasibility of the investment but also underscores the government’s commitment to nurturing and bolstering the industry.
3. Other financial information
Redwood Co’s financial profile is a critical component of their investment evaluation. Their equity beta,stands at 0.85. In terms of financial structure, they maintain a balance of 60% equity and 40% debt based on market value.
Comparatively, when assessing the broader printing industry, the industry norm presents an average equity beta of 1.2. The industry tends to have an even split between equity and debt financing, with a 50-50 ratio based on market value.
To calculate this cost of capital, the risk-free rate, currently at 5.5% per annum, and the market return, standing at 12% per annum, are taken into account.
Furthermore, it’s important to note that the funds raised for this investment are net of issue costs. These issue costs are estimated to be 1% for debt financing (excluding the subsidized loan) and 4% for equity financing. These expenses are non-deductible for tax purposes. The corporate tax rate is 30%.