QUESTION THREE

(25 Marks)

MiWay Transport has determined that a new specialised delivery truck needs to be purchased.

The truck can be leased from the manufacturer. The lease agreement requires:

5 annual payments of R800 000, with the first payment due on the delivery of the vehicle.

Service costs amount to R17 000 p.a

The lessee will exercise its option to purchase the truck at the end of the leasing period for R120 000.

The truck can also be purchased at: a cost of R2.8 million, inclusive of a 4-year maintenance contract with the manufacturer. The R2.8 million will be borrowed at an after-tax rate of 13% per annum. The loan would be secured against the truck and would be amortised over the useful economic life of the vehicle. The loan payments for each of the first four years are R791 000 payable at the end of each year.

The vehicle can be depreciated straight-line over the same period and will have a zero-market value at the end of 4 years. Interest payments n included in the year end loan payments for the respective four years are R364 000; R273 000;

R197 920 and R143 229.

Assume a current corporate tax rate of 30%. Required:

3.1 Determine the after-tax cash flows and the net present value of the cash outflows under each

alternative. (23 Marks)

3.2 Briefly indicate which alternative should be recommended. (2 Marks)

QUESTION FOUR (25 Marks)

Pretoria Traders uses a combination of shares and debt in their capital structure. The details are given below:

There are 5 million R4 ordinary shares in issue and the current market price is R5.80 per share. The latest dividend paid was 70 cents and a 9% average growth for the past six years was maintained.

The company has 3 500 000 R5, 8% preference shares with a market price of R4.80 per share.

Pretoria Traders has a public traded debt with a face value of R13 million. The coupon rate of the debenture is 7% and the current yield to maturity of 16%. The debenture has 8 years to maturity.

They also have a bank overdraft of R8million due in 3 years time and interest is charged at 15% per annum.

Additional Information:

Pretoria Traders has a beta of 1.7, a risk-free rate of 7.2% and a return on the market of 15.8%. Company tax rate is 30%.

Required:

4.1 Calculate the weighted average cost of capital, using the Capital Asset Pricing Model to calculate the cost of equity.

4.2 Calculate the cost of equity, using the Gordon Growth Model.

END OF PAPER

(22 Marks) (3 Marks)