Question 1 Use the following information to answer question 11 and 12 (m indicates that the...
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Question 1 Use the following information to answer question 11 and 12 ("m" indicates that the amount is given in millions) [25 Marks] Slinky Ltd manufactures toys and recently listed on the Johannesburg Stock Exchange (JSE) It is planning to expand by using the cash raised from the listing as well as its increased debt capacity The company's first project will be to diversify vertically by designing and building a PVC manufacturing plant it can use downstream to manufacture its toys At the moment the company has R1 000m in total debt outstanding with a debt ratio of 10% Equity holdings consist solely of cash raised from the listing The board of the company has established a target debt ratio of 30,77% and has authorised management to use debt financing for the project up to the target ratio being reached Currently, the company is paying interest of R100m per year on its outstanding obligations, however, similar firms listed on the JSE recently issued new bonds with a coupon rate of 7% It is expected that the initial equipment and building costs of the new plant will amount to R4 000m An increase of R500m in net operating working capital (NOWC) is also expected which could be sold at purchase price at the end of the life cycle of the plant The plant is expected to generate sales of R600m per year with variable costs amounting to 50% of sales and fixed costs amounting to R100m per year It is expected that the plant will be sold at the end of five years for R2 000m due to the company moving to a safer type of plastic for its toys For tax purposes the plant can be written off over a period of 20 years by using the straight-line method The company is taxed at 30% and inflation is expected to be 5% over the life cycle of the project The company adjusts for inflation, using the real approach Slinky Ltd has a beta of 1,2 associated with its current operations (share price-based beta) while the plastics sub-industry has a market beta (already re-levered) of 1,3 associated with it The company always adjusts its discount rate for risk for all of its projects, and also values its sources of finance at market values The market risk premium can be assumed to be 6% and the risk-free rate is 8% Question 11 (10 Marks) Determine the expected weighed average cost of capital (WACC) of the company if the project is accepted and carried out, also provide a brief evaluation of how the project will affect the capital structure and risk profile of the company Evaluate whether or not the company should undertake the project, taking inflation and risk into account Provide a brief overview on the acceptability of the project, and mention one way in which the analysis could have been made more accurate Question 1 Use the following information to answer question 11 and 12 ("m" indicates that the amount is given in millions) [25 Marks] Slinky Ltd manufactures toys and recently listed on the Johannesburg Stock Exchange (JSE) It is planning to expand by using the cash raised from the listing as well as its increased debt capacity The company's first project will be to diversify vertically by designing and building a PVC manufacturing plant it can use downstream to manufacture its toys At the moment the company has R1 000m in total debt outstanding with a debt ratio of 10% Equity holdings consist solely of cash raised from the listing The board of the company has established a target debt ratio of 30,77% and has authorised management to use debt financing for the project up to the target ratio being reached Currently, the company is paying interest of R100m per year on its outstanding obligations, however, similar firms listed on the JSE recently issued new bonds with a coupon rate of 7% It is expected that the initial equipment and building costs of the new plant will amount to R4 000m An increase of R500m in net operating working capital (NOWC) is also expected which could be sold at purchase price at the end of the life cycle of the plant The plant is expected to generate sales of R600m per year with variable costs amounting to 50% of sales and fixed costs amounting to R100m per year It is expected that the plant will be sold at the end of five years for R2 000m due to the company moving to a safer type of plastic for its toys For tax purposes the plant can be written off over a period of 20 years by using the straight-line method The company is taxed at 30% and inflation is expected to be 5% over the life cycle of the project The company adjusts for inflation, using the real approach Slinky Ltd has a beta of 1,2 associated with its current operations (share price-based beta) while the plastics sub-industry has a market beta (already re-levered) of 1,3 associated with it The company always adjusts its discount rate for risk for all of its projects, and also values its sources of finance at market values The market risk premium can be assumed to be 6% and the risk-free rate is 8% Question 11 (10 Marks) Determine the expected weighed average cost of capital (WACC) of the company if the project is accepted and carried out, also provide a brief evaluation of how the project will affect the capital structure and risk profile of the company Evaluate whether or not the company should undertake the project, taking inflation and risk into account Provide a brief overview on the acceptability of the project, and mention one way in which the analysis could have been made more accurate
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