Suppose today is 1 September 2021. The Royal ltd has 140 million R10 ordinary shares in issue. On 31 August 2021 the shares were trading at R28.30 cents ex-dividend. The dividends for royal ltd for the year ended 31 December 2021 are expected to be R2.20 per share. The company maintains the 4% increase in dividends that has been achieved in recent years. The declared dividends are paid on 31 December each year.

Investment opportunity

The Newspaper division has identified an investment opportunity. They would print an African wide sports only Magazine. The Magazine would be called the African sports fan. It will be commenced on 1 January 2022. The Magazine would be in English and it would report on a range of popular African sports. The proposal for the project has been under consideration since December 2020.

The project is expected to be initially launched in South Africa. It will then be extended to other African countries over time. The new printing facilities will be added to Chronicle ltd 's site to support the investment in this project. The project will be evaluated over six years beginning 1 January 2022. The net operating cash flows of the project have been estimated as follows:

YearRandPula

130000000-10000000

280000000110000000

3130000000190000000

4-6150000000 230000000

Assume that all cash flows arise on 31 December each year. You must also assume that annual cash flows are paid across to South Africa on the final day of each year.

The cost of the initial investment in plant and equipment at the beginning of January 2022 is P900000000. The plant and equipment is depreciated at 5% per annum using the straight line method. An amount of P50000000 would be required to finance working capital at the beginning of January 2022.

In addition to the cash flows above, the company hopes to develop mobile phone apps. This would generate further revenue, which could add up to 5% of the net operating cash flows from year 4 of the project. The estimates are based on the "gut feeling" of the sales director. The gut feeling has not been verified though.

Exchange rates

At 1 January 2022 the spot exchange rate is expected to be R1/P1.1 (that is R1=P1.1). The Pula is expected to weaken against the Rand. This is in line with the differential in the long term interest rates between the two countries over the life of the project. The interest rates are expected to remain stable at 0.5% per annum in South Africa and 1.5% per annum in Botswana for the foreseeable future.

Funding the project

The initial investment of P950000000 will be funded by a rights issue at the beginning of January 2022. The realisable value for the plant and equipment is estimated at P630000000. This amount will be repaid in full to South Africa. In December 2021 the Royal ltd announced a rights issue of 1 for 4 to fund the proposed P950000000 capital investment project. The proposal for the new Magazine was accepted a week ago. Royal ltd would like to proceed without delay. The company will temporarily reduce the dividend growth rates during the development stage of the project.

Investment criteria

Criterion 1

T Royal ltd assesses international projects using the NPV criterion. A risk adjusted discount rate of 12% is used.

Criterion 2

The royal requires international projects to generate an accounting rate of return of at least 25% per year. ARR is defined as follows:

Average accounting profit before interest and taxes /average annual investment

Ignore taxes in your calculations

Required:

a)Discuss the reasons for the volatile movements in Royal's share price (no calculations required)[5 marks]

b)Discuss the risks that should be considered by Royal in evaluating the project(show calculations where necessary) [7 marks]

c)Determine the fair market price of the shares after acceptance of the project and after the rights issue [7 marks]

d)Determine the impact of the project on Royal's financial objectives[6 marks]

e)Evaluate the project using the NPV criterion [10 marks]

f)Evaluate the project using the ARR criterion[5 marks]