Question
Q2. You have recently been appointed executive in charge of finance for Hufflepuff (Pty) Ltd. The company is considering investing in the production of UPS
Q2. You have recently been appointed executive in charge of finance for Hufflepuff (Pty) Ltd. The company is considering investing in the production of UPS machines and related products for its clientele. The junior accountant has provided you with the following information:
Details Year 1 Year 2 Year 3 Year 4 Year 5 Q2.
R000 R000 R000 R000 R000
Sales 35 000 49 000 53 200 57 400 55 200
Material 5 350 7 500 9 000 10 050 9 000
Labour 10 700 15 000 18 000 21 000 18 000
Other variable overheads 500 600 650 700 750
Fixed overheads 12 000 ? ? ? ?
Other operating costs 3 000 3 100 3 200 3 400 3 300
In addition, the junior accountant informs you of the following: All cash flows and profits forecasts were prepared in present terms and can be adjusted based on inflation in respective years; Fixed overheads are expected to suffer inflationary increases of 5% per year; Materials and labour costs are expected to increase by 10% per annum; Other operating costs are expected to increase by 4% per year; The tax rate is 28% and payable in the year profits are made; The company is financed by 75% equity and 25% debt, with market values of R75m and R25m respectively. The company has an equity beta of 1,2. The rate on Treasury bills is 5% and considered to have no risk. The market risk premium is 7,5%. The companys after-tax cost of debt is 6%; The following assumptions were made in preparing the financial information: o Profits are similar to cash flows for the purposes of this project evaluation; o All receipts and payments arise at the end of the year to which they relate, except for the projects initial outlay of R30m, which is to be paid immediately; and o Other operating costs figures have already adjusted for tax capital allowances and noncash depreciation adjustments.
The noncurrent asset bought for the project has no residual value. Given the information above, calculate the following:
ii. Weighted average cost of capital (5 marks)
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