1
MAC2602
MAY/JUNE 2016 SOLUTION
QUESTION 1
1.1 (c)
1.2 (a)
1.3 (d)
1.4 (a)
1.5 (c)
QUESTION 2
a) 200 x 160 = 32 000
1 123 000 = R35.11
𝐷1
b) 𝑘𝑒 = +g
P0
1.5 𝑥 (1+0.08)
= + 0.08
29.2
= 1.62/29.2 + 0.08
= 0.1355 = 13.55%
c) 𝑘𝑒 = 𝑅𝑓 + β (𝑅𝑚– 𝑅𝑓)
= 0.1 + 1.2 (0.13 - 0.1)
= 0.136 = 13.6%
d) The CAPM was developed to eliminate the limitations of the constant growth model. The
CAPM is based on the principle that investors in ordinary shares should be rewarded for
the risk they bear. Thus, the higher the risk, the higher the return in order to compensate
for the higher risk. The CAPM attempts to quantify the level of risk in respect of a specific
share investment and to ascertain the required rate of return in respect of the share
investment.
e) After tax kd = 11% x (1 – 0.28)
= 7.92%
, 2
f)
Form Weighting Cost WACC
Equity (1) 23 360 000 0.8500 14.00 11.90
Debentures 1 123 556 0.0409 7.92 0.32
Loan 3 000 000 0.1091 12.00 1.31
27 483 556 1.0000 13.53
(1) Equity = 800 000 x R29.20 = 23 360 000
, 3
QUESTION 3
a) PVIF = (1 + 𝑖)−𝑛
= (1 + 0.21)−3
= 0.5645
Tractors project Years
0 1 2 3
R R R R
Cost price (4 500 000) - - -
Net income 2 100 000 2 205 000 2 315 250
Realisable value - - - 900 000
Taxation (273 000) (302 400) (270 270)
Net cash flow (4 500 000) 1 827 000 1 902 600 2 944 980
Factor at 21% 1.0000 0.8264 0.6830 0.5645
Present value (4 500 000) 1 509 833 1 299 476 1 662 441
NPV at 21% (28 250)
Calculations:
Taxation Years
1 2 3
Net income 2 100 000 2 205 000 2 315 250
Wear and tear (4 500 000/4) (1 125 000) (1 125 000) (1 125 000)
Scrapping allowance (225 000)
Taxable amount 975 000 1 080 000 965 250
Taxation at 28% 273 000 302 400 270 270
Scrapping allowance
Cost 4 500 000
Less: Wear and tear (4 500 000 x ¾) (3 375 000)
Tax value at end of useful life (1 125 000)
Realisable value 900 000
Scrapping allowance (loss) (225 000)
I would choose the OQ Limited project as its net present value (R1 000 000) is positive and
higher than the tractors project (- R28 250).
, 4
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥
c) Accounting rate of return (ARR) = x 100
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
= (327 000 + 402 600 + 1 444 980)/3 x 100
4 500 000/2
= 724 860 x 100
2 250 000
= 32.22%
Net profit after tax Years
1 2 3
Net income 2 100 000 2 205 000 2 315 250
Depreciation (4 500 000/3) (1 500 000) (1 500 000) (1 500 000)
Accounting profit on sale 900 000
Tax (273 000) (302 400) (270 270)
Net profit after tax 327 000 402 600 1 444 980
d) Profitability index (PI): The PI is the ratio of the present value of cash flows (PVCF) to the
initial investment of the project. PI is also known as a benefit/cash ratio.
The PI method is closely related to the NPV approach: If the net present value of a
project is positive, the PI will be greater than 1. On the other hand, if the net present value
is negative, the project will have a PI of less than 1.
MAC2602
MAY/JUNE 2016 SOLUTION
QUESTION 1
1.1 (c)
1.2 (a)
1.3 (d)
1.4 (a)
1.5 (c)
QUESTION 2
a) 200 x 160 = 32 000
1 123 000 = R35.11
𝐷1
b) 𝑘𝑒 = +g
P0
1.5 𝑥 (1+0.08)
= + 0.08
29.2
= 1.62/29.2 + 0.08
= 0.1355 = 13.55%
c) 𝑘𝑒 = 𝑅𝑓 + β (𝑅𝑚– 𝑅𝑓)
= 0.1 + 1.2 (0.13 - 0.1)
= 0.136 = 13.6%
d) The CAPM was developed to eliminate the limitations of the constant growth model. The
CAPM is based on the principle that investors in ordinary shares should be rewarded for
the risk they bear. Thus, the higher the risk, the higher the return in order to compensate
for the higher risk. The CAPM attempts to quantify the level of risk in respect of a specific
share investment and to ascertain the required rate of return in respect of the share
investment.
e) After tax kd = 11% x (1 – 0.28)
= 7.92%
, 2
f)
Form Weighting Cost WACC
Equity (1) 23 360 000 0.8500 14.00 11.90
Debentures 1 123 556 0.0409 7.92 0.32
Loan 3 000 000 0.1091 12.00 1.31
27 483 556 1.0000 13.53
(1) Equity = 800 000 x R29.20 = 23 360 000
, 3
QUESTION 3
a) PVIF = (1 + 𝑖)−𝑛
= (1 + 0.21)−3
= 0.5645
Tractors project Years
0 1 2 3
R R R R
Cost price (4 500 000) - - -
Net income 2 100 000 2 205 000 2 315 250
Realisable value - - - 900 000
Taxation (273 000) (302 400) (270 270)
Net cash flow (4 500 000) 1 827 000 1 902 600 2 944 980
Factor at 21% 1.0000 0.8264 0.6830 0.5645
Present value (4 500 000) 1 509 833 1 299 476 1 662 441
NPV at 21% (28 250)
Calculations:
Taxation Years
1 2 3
Net income 2 100 000 2 205 000 2 315 250
Wear and tear (4 500 000/4) (1 125 000) (1 125 000) (1 125 000)
Scrapping allowance (225 000)
Taxable amount 975 000 1 080 000 965 250
Taxation at 28% 273 000 302 400 270 270
Scrapping allowance
Cost 4 500 000
Less: Wear and tear (4 500 000 x ¾) (3 375 000)
Tax value at end of useful life (1 125 000)
Realisable value 900 000
Scrapping allowance (loss) (225 000)
I would choose the OQ Limited project as its net present value (R1 000 000) is positive and
higher than the tractors project (- R28 250).
, 4
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑛𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥
c) Accounting rate of return (ARR) = x 100
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
= (327 000 + 402 600 + 1 444 980)/3 x 100
4 500 000/2
= 724 860 x 100
2 250 000
= 32.22%
Net profit after tax Years
1 2 3
Net income 2 100 000 2 205 000 2 315 250
Depreciation (4 500 000/3) (1 500 000) (1 500 000) (1 500 000)
Accounting profit on sale 900 000
Tax (273 000) (302 400) (270 270)
Net profit after tax 327 000 402 600 1 444 980
d) Profitability index (PI): The PI is the ratio of the present value of cash flows (PVCF) to the
initial investment of the project. PI is also known as a benefit/cash ratio.
The PI method is closely related to the NPV approach: If the net present value of a
project is positive, the PI will be greater than 1. On the other hand, if the net present value
is negative, the project will have a PI of less than 1.
