QUESTION 2 (20 MARKS) Tot Toys Limited ("TT") is a company that produces and sells children's toys. They produce soft toys which has always been very popular amongst children, but in recent years there has been a decline their sales due to technological advances in the toy market. TT is now considering to manufacture a doll that can respond to questions and move if it is told to do so. This doll will be called Ziri. After doing market research at a cost of R17 900, TT expects the following income from selling Ziri: 2019 R1 180 500 R800 200 2020 2021 2022 R60 000 R30 400 * You can assume that all income is only recognised at the end of each year. * Ziri will only be produced for four years, after which it is expected that new technological advances will be made in the toy market. TT requires the following to be able to produce Ziri: . Due to capacity and space constraints, TT will have to expand its current production plant so that it will be able to produce Ziri and to keep up with the current production of soft toys. The production of Ziri will thus have no impact on current production of toys. TT has provided you with the details of the expansion and current plant in the table below: Cost price CURRENT PRODUCTION PLANT EXPANSION OF PLANT R900 000 R400 000 Selling price NA N/A Tax value R180 000 NA Wear and tear 40% in first year and 20% per year for following three years. * The plant will not be sold when TT stops producing Ziri, as it will be used to continue with soft toy manufacturing * The expansion of the plant will be complete on 1 January 2019. Any tax implications on assets will occur at the end of the reporting period. Wear and tear can be claimed on the expansion at the same rate as the current production plant. TT will have to purchase artificial intelligence software to enable Ziri to move on command and talk. This software will need to be imported from the United States of America at a cost $50 000 on 1 January 2019. SARS allows for a 50% deduction of the cost in the year that it is incurred and 50% in the following year. TT will not be able to sell this software when they stop producing Ziri AMF 3660 Page 3 of 4 TT will have to take out a loan for the expansion of the plant and the artificial intelligence software and will incur an interest expense of R5 000 per year on the loan. TT will allocate R20 000 of the annual fixed cost of the plant to the production of Ziri. The variable cost to produce Ziri is 40% of sales per year. Additional information You can assume a tax rate of 28%. The Rand-Dollar exchange rate is expected to be $1:R14.30 on 1 January 2019. TT has correctly calculated the weighted average cost of capital as 13% REQUIRED: doritetet bould + Soludos botol MARKS QUESTION 1 (20 MARKS) You have been working as the financial manager of KicSa Limited ("KicSa) for the past two years. KicSa imports and distributes home appliances to various small-scale retail stores within South Africa. Most of the appliances are imported from suppliers in China and South America. A report was recently received from an external consulting company which estimated that KicSa's earnings will grow by 6% per year and this figure is expected to remain constant for the foreseeable future. At a recent board meeting held on 3 July 2018, the board discussed the possibility of an investment in Project Fitar. The company's year-end is 30 June 2018. The following brief from the meeting was presented to you: Project Fitar: This project was thoroughly analysed and it was estimated that the project will yield an internal rate of return of 10%. An extract from the statement of financial position as at 30 June 2018 is provided below: Notes 1 Ordinary share capital Retained earnings 9% Non-redeemable preference shares 11.5% Redeemable debentures 15.5% Bank overdraft Trade payables 2 3 4 R 10 000 000 2 600 500 12 000 000 11 000 000 1 800 000 840 000 Notes: 1. As at 30 June 2018 there were 10 000 000 ordinary shares in issue and the price-earnings ratio for companies similar to Kick Sa is 9. The company has a dividend payout ratio of 35%, and this has been maintained in the past and it is expected to remain the same in AMF 3660 Page 1 of 4 the future. The current year's net profit amounted to R11 450 600. The company's beta has been determined as 1.4. If new shares are issued, flotation costs of 4% will be incurred. 2. 400 000 non-redeemable preference shares were issued at a nominal value of R30 per share. Similar preference shares are currently trading at R41 per share in the market. 3. 200 000 redeemable debentures were issued at a nominal value of R60 per debenture. These debentures are currently trading at R55 per debenture. They will be redeemed on 30 June 2021 at a discount of 5%. 4. The company currently has a bank overdraft which is used to finance the working capital requirements. This overdraft is not a revolving facility and it is payable within 12 months, however the bank has renewed t in the past due to the good financial stability of KicSa. 5. You may assume tax rate of 28%. REQUIRED: MARKS (15) (a) Advise the management of Kic Sa whether or not they should accept Project Fitar by calculating the weighted average cost of capital (WACC). (b) Briefly discuss why the capital asset pricing model (CAPM) can be used to calculate the cost of equity by explaining why each of the components are included in the formula. (3)