Question
You have some extra cash that you want to invest for the next three years and are considering buying shares in an established small distribution
You have some extra cash that you want to invest for the next three years and are considering buying shares in an established small distribution company called Max Distributors (Pty) Ltd. The price per share available to you is R3000.00. The company owns a few trucks whilst renting their administrative office and depot building. In order to determine the value of this investment opportunity, you requested more information about the projected free cash flows for the company FSAO LMA12A2 _________________________________________________________________________________ _________________________________________________________________________________ Page 10 of 11 over the next three years as well as the terminal value after three years. The management of Max Distributors (Pty) Ltd. provided the following budgeted future free cash flow information to you: After 1 year: R300 000.00 After 2 years: R400 000.00 After 3 years: R550 000.00 3.1 Based on your assessment of the risk of the investment, you decided to assign a Beta factor of 1.3 for Max Distributors (Pty) Ltd. Provided that the risk free rate of return after tax (based on government bonds) is 8% and the market risk premium is 6%, What is the expected rate of return on your investment in Max Distributors (Pty) Ltd.? (Show all your calculations). (2) 3.2 You have been informed that the company will have a terminal value of R1200 000.00 in three years and currently has 600 shares. What is the present value of a share in Max Distributors (Pty) Ltd. based on the cost of equity determined in the first question? (Show all your calculations). (6) 3.3 Does the purchasing price of the share offered to you represent good or poor value? Briefly motivate your answer. (2) 3.4 Management can increase the market value by either increasing and expediting the projected free cash flow of the company; or reducing the risk of the company, thereby reducing the cost of equity. Discuss two practical ways in which each of these can be achieved. (6) 3.5 Use an example to explain the difference between the concepts Market Risk Premium (MRP) and the Beta factor in the calculation of cost of equity. (4)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started