Question $240$ Marks

Operation Phakisa is a South African government initiative envisaging that aims to fast$-$track certain projects and initiatives. One of the focus areas is the Oceans Economy, which boasts a wide variety of projects that span from Marine Logistics, Manufacturing, Bunkering, Offshore Oil and Gas Exploration, Aquaculture, Marine Protection Services, Small Harbours Development, and Marine Tourism. The projects have other benefits ranging from job security, training, and small business upliftment, etc. Two high$-$intensive Capital investment companies, Opportunity Investment Ltd and Doordie Investment Plc have formed a consortium to evaluate these opportunities. They have identified three projects: Project M $($Chemicals Manufacturing Hubby Project Station$),$ Project W $($Sweet Waters Project$),$ and Project Z $($Security of Fuel Supply Oil & Gas Exploration$).$ These projects comprise the business portfolio of two ambitious companies that have requested your consulting company to evaluate the financial viability in Rand currency.

Your company project team has managed to collect the following information:$($a$)$ Production rates Project M W $-$Z

Sector Manufacturing Water Energy $($Petroleum$)$

Production rate Product $1$: $75$ tons per day

Product $2$: $32$ tons per day $125000($m$2/$ day$)120000($ Barrels per day$)$

Operation Days per year $330330330$

Electricity requirements R $2335$ kWh $/$ ton Product $1$ Included in Operating Costa Fuel used included in Operating costs

Oerating costs @ Year $0$ price R $1920/$ ton Product $1$ R$16\mathrm{.}45/$ m$3$ water volume $ $35/$ barrel crude oil equivalent production rate.Notes:

$$ Project M: Chemicals Manufacturing Hubby Project Station $1$

$$ Project W: Sweet Waters Project

$$ Project Z: Security of Fuel Supply Oil & Gas Exploration

$330$ days per year have incorporated capacity utilization and unforeseen downtimes.

$$ Chemicals Manufacturing Hubby Project Station $1$ :$($Project M$)$ Operating costs are expected to escalate at $3\%$ per year.

$$ The Sweet Waters Project $($Project W$)$: Operating costs are expected to escalate at $6\%$ per annum.

$$ Security of Fuel Supply Oil & Gas Exploration Project $($Project Z$)$ Operating costs are expected to escalate at $3\%$ per annum.$($b$)$ General Project Information DataProject M W Z

Sector Manufacturing Water Energy $($Petroleum$)$

Development Costs $($Rmil$)302002500$

Initial Outday $($R bln$)4\mathrm{.}00\mathrm{.}96085$

Facilities & Equipment life span $252030$

Project life $10$ years $10$ years $10$ years.Notes:

$$ Depreciation on straight line basis for $10$ years. The Investors might relinquish control after $10$ years and sell the facilities at scrap value.

$$ The Rand$/$USD Exchange is estimated to average $20$ during project life.

$$ Tax rate: $28\%.($c$)$ Price Forecasts in $10$ years. Project Manufacturing Products Water petroleum

Product Electricity Product $1$ Product $2$ Water Crude oil equivalent

Units R$/$kWh R$/$ton R$/$ton R$/$ m$2$ $$/$ barrel

Year

$13\mathrm{.}3848\mathrm{.}92815\mathrm{.}61838\mathrm{.}264\mathrm{.}799$

$23\mathrm{.}6559\mathrm{.}54116\mathrm{.}39940\mathrm{.}166\mathrm{.}107$

$33\mathrm{.}94710\mathrm{.}95117\mathrm{.}21942\mathrm{.}167\mathrm{.}420$

$44\mathrm{.}26312\mathrm{.}50618\mathrm{.}25244\mathrm{.}268\mathrm{.}422$

$54\mathrm{.}47614\mathrm{.}76319\mathrm{.}34746\mathrm{.}469\mathrm{.}437$

$64\mathrm{.}70017\mathrm{.}62820\mathrm{.}50848\mathrm{.}870\mathrm{.}457$

$74\mathrm{.}93519\mathrm{.}56521\mathrm{.}73851\mathrm{.}271\mathrm{.}515$

$85\mathrm{.}18222\mathrm{.}03923\mathrm{.}04253\mathrm{.}872\mathrm{.}578$

$95\mathrm{.}44124\mathrm{.}10424\mathrm{.}54056\mathrm{.}473\mathrm{.}640$

$105\mathrm{.}7132662826\mathrm{.}13559\mathrm{.}373643$d$)$ Cost of capital

In estimating the after$-$tax cost of capital for budgeting purposes, the companies provided you with the following information:

$$ The investing companies should maintain the $60\%($equity$)$ and $40\%($debt$)$ long term capital structure.

$$ The equity capital of $60\%$ will be maintained by $20\%$ common stock and $40\%$ retained earnings.

$$ The company has determined that the debt can be sold to yield $9\mathrm{.}5\%.$

$$ The new common stock could be sold to provide proceeds of R$252$ to the company.

$$ The companies are currently paying an average dividend of R$35$ per share and expect it to grow annually at a constant rate of $6\%$ per share.

Required:

a$.$ Calculate the after$-$tax cost of capital for budgeting purposes. $(5)$

b$.$ Determine the payback period and recommend the projects that you would choose, based on payback period. $(4)$

c$.$ Determine the discounted payback period and recommend the projects that you would choose. $(4)$

d$.$ Calculate the net present value of each project and recommend a project$($s$)$ that you would choose. $(10)$

e$.$ Calculate the internal rate of return $($IRR$)$ for each project and recommend a project$($s$)$ that you would choose.f$.$

If the three projects are independent, which project$($s$)$ should be accepted? $(2)$

g$.$ If the three projects are mutually exclusive, which project should be selected? $(2)$

h$.$ If Chemicals Manufacturing Hubby Project Station $1$ and Sweet Waters Project are dependent projects, what would be your recommendation? $(2)$

i$.$ Based on the answers above, what would be the recommendations? Suggest improvements that can be adopted to improve profitability. $(3)$

j$.$ Demonstrate how the terminal value approach would impact the valuation of the high Capex projects and discuss some of the pitfalls inherent in this approach. $(5)$