(a) Discuss the advantages and limitations of using the weighted average cost of capital (WACC) method of investment appraisal.
(b) Lucky John plc has the opportunity to manufacture a particular type of self-tapping screw for a client company. Development of the product requires an initial investment of £200,000 in the project. It has been estimated that the project will yield cash returns before interest of £35,000 per annum in perpetuity. Lucky John plc is financed by equity and loans, which are always maintained as two thirds and one third of the total capital respectively. The cost of equity is 18% and the pre-tax cost of debt is 12%. The corporation tax rate is 40%.
If Lucky John plc’s weighted average cost of capital (WACC) is used as the cost of capital to appraise the project, discuss whether the project should be undertake
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