Submission date is 03 October 2015 for all classes. Format 12pt Times New Roman 1.15 spacing 2cm margins Answer to 2 decimal places Question 1: WACC...

Question 1: WACC (20)

Sivuyile Construction is financed by R100 million long-term debt, R20 million preferred

shares and 5 million issued ordinary shares. The firm can raise debt by selling R1000 par

value, 10% coupon rate (paid semi-annually), 10 year bonds at a discount of R50 and has to

pay R20 in floatation cost. It can also sell 9% preferred shares with a par value of R100 at a

discount of 10% on par value and has to pay R7 per share in floatation cost. Sivuyile’s

ordinary shares have a beta of 1.5, trades at R30 each, and a dividend of R5 per share has just

been paid. The risk free rate is currently 8% while the total market return for the past amounts

to 15%. The company’s tax rate is 30%. Calculate Sivuyile’s weighted average cost of capital

(WACC)

Note:

I = annual coupon rate

Nd = net proceeds from the sale of debt (bond)

n = number of years to a bond’s maturity

Question 2: Capital Structure (20)

Ntombi Consulting is presently reviewing its capital structure and the following two capital

structures are presently under consideration. Structure A is made up of 60% debt ratio and

ordinary shares for the balance. It is expected that the ordinary shareholders required rate of

return will be 20%. Structure B is made up of 10% preferred shares, 20% debt and ordinary

shares for the balance. It is expected that the ordinary shareholders’ required rate of return

will be 25%.

The following information is supplied:

 The total assets for each of the two capital structures are R4 million. The required rate of

return on the preferred shares is 10%

 The par value of the ordinary shares is R25 per share

 The interest rate on all loans is 12%

 The company tax rate is 30%

 Assume an EBIT level of R450 000

At a R450 000 EBIT level, which capital structure will you chose if you want to

a. Maximize earnings per share?

b. Maximize share price

Question 3: Capital Budgeting (20)

You are tasked to perform an analysis of the manufacturing plant and to present your

recommendation on whether the company should open the new plant or not. If the new plant

is opened, it will cost R500 million today and the expected cash flows are shown in the table

below. The company’s required rate of return is 12%

Year Cash Flow

0 -500 000 000

1 60 000 000

2 90 000 000

3 170 000 000

4 230 000 000

5 205 000 000

6 140 000 000

7 110 000 000

8 70 000 000

9 -80 000 000

Required:

a. Calculate the payback period, modified payback period and net present value of the

proposed plan.

b. Based on your analysis, should the company open the new plant?

Question 4: Capital Budgeting (15)

Assume that Thabile Engineering is planning to add new machinery to its current plant. There

are 2 machines under consideration with cash flows as follows in Rand:

0 1 2 3 4 5 6

Machine A -5000 500 1000 1000 1800 2800 1000

Machine B -5500 500 1500 1800 1800 1500 1500

Calculate the NPV for each machine and decide which machine Thabile should invest in.

Thabile’s cost of capital is 12%.

Question 5: Capital Budgeting – Replacement (25)

Primrose manufacturing has an old machine that is 2 years old and which it would like to

replace with a brand new one that will cost the company R160 000. The new machine

requires R4 000 shipping costs and R2 000 installation costs. The economic life of the new

machine is 3 years with tax allowable depreciation of R75 000 for the first 2 years. If the new

machine is acquired, the inventory will increase by R13 000, accounts receivable by R9 000

and accounts payable by R15 000. The new machine will result in sales revenue of R120 000

and cash operating costs of R23 000.

The current machine was purchased for R75 000 and is expected to last for 3 more years after

which it will be worthless. The current machine provides sales revenue of R100 000 and cash

operating cost of R20 000. Its current market value is R25 000.

The expected resale value of the old and new machine in 3 years’ time would be R14 000 and

R16 600 respectively. The corporate tax rate is 30%

Required:

a. Calculate the initial investment associated with the proposed replacement decision

b. Calculate the incremental operating cash flows of the proposed replacement decision

c. Calculate the terminal cash flow associated with the proposed replacement decision

d. Calculate the NPV of the replacement project assuming a discount rate of 6% per

annum

e. Use the computed NPV results an discuss the decision to accept or reject the project

Total [100]