Question 115 Marks

You are a project specialist for software related projects. One of the projects under your portfolio is the acquisition of a private software company that produces software for finance and economics focus areas. One of the conditions for the acquisition of the private software

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company is a non-negotiable, all-cash purchase price of R20 million. The following marginal cash flows are evaluated for the project:

YearCash Flow 1 R1,000,000

YearCash Flow 2 R3,000,000

YearCash Flow 3 R5,000,000

YearCash Flow 4 R7,500,000

YearCash Flow 5 R7,500,000

Of the R20 million in cash is needed for the purchase, R5 million is available for retained earnings, with a required return of 12%, and the remaining R15 million will come from new debt issue yielding 8%. Applicable tax rate for the company is 40%.

Required:

Should an acquisition of a private software company be considered?

Question 212 Marks

Your company has recently appointed you as a finance specialist and your company is in a financial distress with R5 million in loans coming due in 30 days. Your company has R4 million cash on hand. Suppose that a long-time supplier of materials to your company is planning to exit the business but has offered to sell your company a large supply of material at a bargain price of R4.5 million - but only if payment is made immediately in cash. If you choose not to acquire this material, the supplier will offer it to a competitor, and your company will have to acquire the materials at market prices totalling R5 million over the next few months.

Required:

2.1. Assume that you are operating the company in shareholders' best interest, would you accept the project? Why or why not? 2.2. Would you accept this project if the company were unlevered? Why or why not? 2.3. Would you accept the project if the company were organised as a partnership? Why or why not?

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Question 320 Marks

Your company is considering a recapitalisation plan that would convert it from its current allequity capital structure to one including some financial leverage. Your company now has 10,000,000 shares of common stock outstanding, which are selling for R40 each. You expect the company's EBIT to be R50,000,000 per year, for a foreseeable future.

The recapitalisation proposal is to issue R100,000,000 worth of long-term debt, at an interest rate of 6.50%, and use the proceeds to repurchase as many shares as possible, at a price of R40 per share. Assume there are no market frictions such as corporate or personal income taxes. Calculate the expected return on equity for the shareholders, under both the current all-equity capital structure and under the recapitalisation plan.

Required:

3.1. Calculate the number of shares outstanding, the per share price, and the debt-toequity ratio for the company if it adopts the proposed recapitalisation. 3.2. Calculate the earnings per share (EPS) and the return on equity for the company shareholders, under both the current all-equity capitalisation and the proposed mixed debt/equity capital structure. 3.3. Calculate the break-even level of EBIT, where earnings per share for the shareholders are the same, under the current and proposed capital structures. 3.4. At what level of EBIT will your company shareholders earn zero EPS under the current and proposed capital structures?

Question 48 Marks

Consider an increase of company's EBIT of 12% after sales change from R2.3 million to R2.507 million.

Required:

4.1. What is the company's operating leverage?4.2. If the company's sales increase to R2.7577 million with EBIT increasing by only 11%, what is the new operating leverage for the company?

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Question 512 Marks

Consider a company asset with a beta of 1.0. Assume that the debt beta equals 0.0 and that there are no taxes.

Required:

Calculate the company's equity beta under the following assumptions:

5.1. The company's capital structure is 100% equity. 5.2. The capital structure is 20% debt and 80% equity. 5.3. The capital structure is 40% debt and 60% equity. 5.4. The capital structure is 60% debt and 40% equity. 5.5. The capital structure is 80% debt and 20% equity. 5.6. Do you believe that the assumption of a zero-debt beta is equally valid for each of capital structures? Why or why not?

Question 615 Marks

Consider a project that cost R1.1 million and next year it will generate either R2 million or R100,000 with equal probabilities. Assume 5% discount rate, what is the NPV of the project based on the expected cash flows next year? If the company could pay R50,000 today for an exclusive right to manufacture the product, this would allow the company to make the R1.1 million investments under conditions of generating R2 million in cash flow, and not manufacture the product under the R100,000 cash flow scenario. Assess the NPV of this exclusive right to manufacture (a type of abandonment option allowing the company to not manufacture under poor conditions) by calculating the profit under both cash flow scenarios:

Required:

6.1. R2 million less R1.1 million for the R2 million scenario. 6.2. Zero for the R100,000 cash flow scenario (Note: there is an assumption that the company can manufacture the product immediately and that manufacturing costs do not increase, which may not be realistic). 6.3. Should the company pay R50,000 for the exclusive right to manufacture?

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Question 718 Marks

Consider a project generating the following cash flows over six years:

Year Cash Flow (R in millions) 0 -59.00 1 4.00 2 5.00 3 6.00 4 7.33 5 8.00 6 8.25

Required:

7.1. Calculate the NPV over the six years. The discount rate is 11%. 7.2. This project does not end after the sixth year, instead will generate cash flows far into the future. Estimate the terminal value, assume that cash flows after year 6 will continue at R8.25 million per year in perpetuity, and then recalculate the investment's NPV. 7.3. Calculate the terminal value, assume that cash flows after the sixth year grow at 2% annually in perpetuity, and then recalculate the investment's NPV.