Reference no: EM132827053

Financial Management

QUESTION ONE

1 Discuss the firm's dividend payout policy and whether it has an impact on share price?

2 Explain why the different sources of capital have different levels of risk and return.

3 Discuss whether the dividend growth model or the capital asset pricing model should be used to calculate the cost of equity.

4 Using the dividend growth model, an analyst has estimated that her company's cost of equity capital is 13% per annum. The current ex-dividend share price is 345.5 Rand, and the current dividend is 14 cents per share. Do calculations to show what rate of dividend growth the analyst is assuming.

QUESTION TWO

The directors of Ole Industries have appointed you as their financial consultant. They are seeking new project investments and require you to calculate the present cost of capital of the company.

The capital structure is listed below: -

• 2 million ordinary shares, with a par value of 50 cents each, currently trading at R4 per share. The company has a beta (ß) of 1.4, a risk free (Rf) rate of 8% and a return on the market (Rm) of 18%.
• 1 million 13%, R2 preference shares, with a market value of R3 per share
• R3 million 11%, debentures due in 5 years and the current yield-to-maturity is 8%.
• R900 000 16%. Bank loan, due in January 2012
• The company also has a general reserve of R3 200 000 and a retained income of R3 000 000.

Additional information:
- The dividend growth of 11% per annum was maintained for the past 4 years. The latest dividend paid was 80 cents per share.
- The company has a tax rate of 30%.

Required:

Calculate the weighted average cost of capital. Use the Capital Asset Pricing Model to calculate the cost of equity.

Calculate the cost of equity, using the Gordon Growth Model.

QUESTION THREE

Marv Limited has determined that a new specialised delivery truck needs to be purchased. The truck will generate a positive net present value of R480 000, calculated using the company's WACC of 20%. The truck can be leased from the manufacturer.

LEASE OPTION	The lease agreement requires 5 annual payments of R520 000, with the first payment due on the delivery of the truck. Insurance costs of R12 000 are borne by the lessee. The lessor will bare the cost of R10 000 pa for maintenance. Marv Limited will purchase the truck for R50 000 at the end of the lease agreement.
PURCHASE OPTION	The truck can also be purchased at a cost of R2 million, inclusive of a 4 year maintenance contract with the manufacturer. The R2 million will be paid in cash. The vehicle can be depreciated straight-line over the four years and will have a zero-market value at the end of its useful life.

Additional information:
• Assume a current corporate tax rate of 30%.
• Cost of debt is 12%

Required:
Determine the after-tax cash flows and the net present value of the cash outflows under each alternative.
Briefly indicate which alternative should be recommended.

QUESTION FOUR

Hobs Limited is a Zimbabwean based manufacturer of heavy-duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with.

Project Alpha:

Project Beta:

Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of ZW$50 million. This would result in an additional ZW$19 900 000 profit being earned in each of the 10 years that the project would last. The new plant to be fully depreciated over the 10 years, on a straight-line basis, in accordance with the company's accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to ZW$200 000 per annum. These expenses were also included in the profit calculation. Consultant fees cost R200 000.

Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R300 million. Annual sales for the 10 year period is expected to be R220 million annually, and fixed and variable cost of R70 million and R64.4 million respectively. The fixed cost includes depreciation of R30 million per annum. Consultants fees is expected to be R0.25 million.

Additional information:

- The South African inflation is expected to exceed the Zimbabwean inflation by 2% throughout the life of the project.
- Hobs Limited cost of capital is currently 12%.
- The current spot exchange rate is R8/ZW$.

Required:

Make all the necessary calculations for the two options.

Advise Hobs Limited if it is worth investing in neither, in one or in both of these projects.

Attachment:- Financial Management.rar