Uvrseon: Captul budgets 25 october 2001 (D0 @) 4(b)) 40 marks ao muutte's Salo Limited has the following capital structure: Issued 1 000 000 ordinary shares of RI each 500 000 6% RI preference shares 500 000 10% R1 unsecured debentures The ordinary shares are currently trading at R1.30 ex-div. A dividend of 20 cents per share has just been paid. Dividends are expected to grow by 2.5% per annum. The preference shares are currently trading at R0.66 cum div. The debentures are trading at R0.80 and the interest has just been paid. The directors of Salo Limited are currently evaluating a new project. The project requires initial investment in machinery of R600 000 at the beginning of the project. The project is expected to have a disposal value at the end of five years equal to 15% of the cost of a new machine at the end of year five. and inflation) No up-front investment in working capital is required, but there will be subsequent demands on work- ing capital once the project gets under way. For capital budgeting purposes, Salo Limited assumes that annual inflation will equal the govern- ment's targeted long-run inflation rate of 5% per annum. 34 The Marketing Director estimates the following annual sales revenues over the project's five- year life: Note: The sales revenues below are estimated values at year 1 price levels. Level of demand High Medium R'000 700 550 400 Probability 0.25 0.50 0.25 } expected sales R550 000 Low The company's current contribution margin of 0.45 is expected to remain unchanged. Project fixed costs are expected to be R100 000 in year 1. The sales revenue, as well as all costs, is expected to increase, in line with inflation. Working capital is expected to be 20% of sales reyenue in year 1, 30% in ye ir 2 and to stabilise at 40% of sales revenue thereafter. Working capital will be fully released in year 6. assume relevant for project! The machinery will qualify for a wear-and-tear allowance of 15% per annum, straight-line. Company tax is paid at the rate of 29% in two equal installments; the first in the year the profits are earned and the second in the ensuing year. All the values stated above are at today's prices. Ignore secondary tax on companies. All cash-flows will take place at the end of the year to which they relate with the exception of the initial investment. You are required to: 4 marks for logic 4 neat presentation. (a) Calculate Salo Limited's nominal after-tax cost of capital. (8 marks) (b) Irrespective of your answer to (a), assume a nominal after-tax cost of capital of 12% per annum. Determine whether Salo Limited should undertake the new project. (28 marks) (c) Calculate Salo Limited's real after-tax cost of capital, assuming a nominal after-tax cost of capital ( of 12%. Do not do this question Mv = [1+r.)(1+i))14 marks) Uvrseon: Captul budgets 25 october 2001 (D0 @) 4(b)) 40 marks ao muutte's Salo Limited has the following capital structure: Issued 1 000 000 ordinary shares of RI each 500 000 6% RI preference shares 500 000 10% R1 unsecured debentures The ordinary shares are currently trading at R1.30 ex-div. A dividend of 20 cents per share has just been paid. Dividends are expected to grow by 2.5% per annum. The preference shares are currently trading at R0.66 cum div. The debentures are trading at R0.80 and the interest has just been paid. The directors of Salo Limited are currently evaluating a new project. The project requires initial investment in machinery of R600 000 at the beginning of the project. The project is expected to have a disposal value at the end of five years equal to 15% of the cost of a new machine at the end of year five. and inflation) No up-front investment in working capital is required, but there will be subsequent demands on work- ing capital once the project gets under way. For capital budgeting purposes, Salo Limited assumes that annual inflation will equal the govern- ment's targeted long-run inflation rate of 5% per annum. 34 The Marketing Director estimates the following annual sales revenues over the project's five- year life: Note: The sales revenues below are estimated values at year 1 price levels. Level of demand High Medium R'000 700 550 400 Probability 0.25 0.50 0.25 } expected sales R550 000 Low The company's current contribution margin of 0.45 is expected to remain unchanged. Project fixed costs are expected to be R100 000 in year 1. The sales revenue, as well as all costs, is expected to increase, in line with inflation. Working capital is expected to be 20% of sales reyenue in year 1, 30% in ye ir 2 and to stabilise at 40% of sales revenue thereafter. Working capital will be fully released in year 6. assume relevant for project! The machinery will qualify for a wear-and-tear allowance of 15% per annum, straight-line. Company tax is paid at the rate of 29% in two equal installments; the first in the year the profits are earned and the second in the ensuing year. All the values stated above are at today's prices. Ignore secondary tax on companies. All cash-flows will take place at the end of the year to which they relate with the exception of the initial investment. You are required to: 4 marks for logic 4 neat presentation. (a) Calculate Salo Limited's nominal after-tax cost of capital. (8 marks) (b) Irrespective of your answer to (a), assume a nominal after-tax cost of capital of 12% per annum. Determine whether Salo Limited should undertake the new project. (28 marks) (c) Calculate Salo Limited's real after-tax cost of capital, assuming a nominal after-tax cost of capital ( of 12%. Do not do this question Mv = [1+r.)(1+i))14 marks)