QUESTION 1 [25 MARKS] a) Sync Diamonds makes synthetic diamonds by treating carbon in a very technologically
Question:
QUESTION 1 [25 MARKS]
a) Sync Diamonds makes synthetic diamonds by treating carbon in a very
technologically advanced and secret process. Each diamond can sell for R100.
The material cost for a diamond is R40. The fixed costs incurred each year for
factory upkeep and administrative expenses are R200 000. The machinery
costs R1 million and it is depreciated straight-line over 10 years to a salvage
value of zero.
i)
What is the accounting break-even level of sales in terms of the number
of diamonds sold?
[4 Marks]
ii)
What is the NPV break-even level of sales assuming a tax rate of 35%,
a 10-year project life, and a discount rate of 12%?
[6 Marks]
iii)
Would the accounting break-even point in the first year of operation
increase or decrease if the machinery were depreciated over a five-year
period? Motivate your answer.
[2 Marks]
iv)
Would the NPV break-even point increase or decrease if the machinery
were depreciated over a five-year period? Motivate your answer.
[2 Marks]
b)
Bokke's
management anticipates that, after five years of paying a constant
dividend of R2 per year, they will be able to secure new markets. Management
thus feels that, commencing with the dividend in year 6, dividends should grow
at a rate of 20% per annum for two years (i.e., in years 6 and 7); then there
should be 18% growth for one year (i.e., in year 8), settling down thereafter to
a constant growth of 10% per annum indefinitely. The required return has
increased to 20% per annum.Calculate the price of Bokke
's shares today.
[11 Marks]