Reference no: EM133113352

Question 1

Helao Limited ("HL") wants to replace their aging fleet. They think the old fleet is costing too much in repairs and maintenance and therefore would want a new fleet to reduce costs. They consider this fleet replacement a project and therefore they would like to know the cost of capital to use to assess the viability of the fleet replacement project. Their present capital structure is as follows:

• 600 000 N$2 ordinary shares now trading at N$2.40 per share.
• 200 000 10% N$3 preference shares trading at N$2.50 per share
• A bank loan of N$ 1 000 000 at 12% p.a. (payable in 5 years' time).

Additional information

• The company's beta is 1.4. The return on the market is 15% and the risk free rate is 6%.
• Its current tax rate is 28%.
• Its current dividend is 50c per share and it expects its dividends to grow by 7% p.a.

Required

1.1 Calculate HL's weighted average cost of capital using both methods of determining cost of equity.

Question 2

Namibia Trading Limited ("NTL") has the choice of purchasing one of two machines namely, Machine A and Machine B. Both machines have five year useful life, with only Machine A having a residual value of N$300 000. The annual volume of production for both machines is estimated at 200 000 units, which can be sold at N$20 per unit. Depreciation is calculated on the machines using the straight line method (cost method). Machine A costs N$4 800 000 excluding installation cost of N$300 000. The annual operating costs are estimated at N$380 000 (excluding depreciation). A major overhaul at a cost of N$200 000 is expected to be undertaken at the end of year three. Fixed costs are estimated at N$2 100 000 (excluding depreciation). Machine B costs N$5 100 000 including installation cost of N$400 000. The annual operating costs are estimated at N$330 000 (excluding depreciation). Fixed costs are the same as Machine A. The weighted average cost of capital is 14%.

2.1 Calculate the payback period of Machine A and Machine B (answer must be expressed in years, months and days).

2.2 Use the net present value method to determine which machine should be purchased by the company

2.3 Calculate the accounting rate of return (on average investment) of Machine B.