FIN3701 Assignment 1 (DETAILED ANSWERS) Semester 1 2024 - DISTINCTION GUARANTEED. Answers, guidelines, workings and references..... ........ QUESTION 1 [10 marks] Kaufold Ltd, a large manufacturer of aircraft components, has a capital budget of R and is evaluating the replacement of its existing machine with a more sophisticated model. The CFO determined the initial investment required and the terminal cash flow associated with the replacement to be R and R254 000 respectively. Both the usable life of the proposed and the remaining life of the current machine are 5 years. Expected cash inflows relating to the investments are as follows: Year Proposed machine Current machine 1 986 000 895 000 2 986 000 881 000 3 986 000 819 000 4 986 000 805 000 5 986 000 791 000 Kaufold Ltd’s weighted average cost of capital (WACC) is 15% and it is taxed at 29%. REQUIRED: 1.1 Calculate the incremental cash flows relating to the replacement decision. (6 marks) 1.2 Calculate the NPV and IRR relating to the two investments (using incremental cash flows calculated above). (2marks) KINDLY NOTE THAT THERE ARE TWO COMPULSORY ASSIGNMENTS FOR THE FIRST SEMESTER. The purpose of this assignment is to evaluate your knowledge of the fundamental aspects of decision making for long-term investment. Study Chapters 9, 10, 11 and 12 of the prescribed book and the relevant learning units to complete this assessment. 11 1.3 Based on the NPV and IRR calculated above, would you advise Kaufold Ltd to invest their funds in the replacement? Provide a reason for your answer. (2 marks) QUESTION 2 [20 marks] Suppose Hagar PLC has two alternative uses for a warehouse The company can store toxic waste containers or electronic equipment. Cash flows and risk associated with the two independent investments are given below. Toxic waste containers Year Cash inflows Certainty equivalents 0 40 000 1.00 1 20 000 0.90 2 16 000 0.80 3 12 000 0.60 4 10 000 0.50 5 10 000 0.40 Cash inflows are discounted at the risk-free rate of 9%. Electronic equipment Year Cash inflows 0 56 000 1 19 000 2 22 500 3 12 750 4 16 000 5 8 000 The risk-free rate is 8% and the risk premium is 2%. REQUIRED: 2.1 Calculate the NPV and IRR relating to the investment in toxic waste containers. (9 marks) 2.2 Calculate the NPV and IRR relating to the investment in electronic equipment. (9 marks) 2.3 Based on the NPV and IRR calculated in 1.1 and 1.2, which investment would you advise Hagar PLC to invest their funds in? Provide a reason for your answer. (2 marks) 12 QUESTION 3 [20 marks] Vendata Resources seeks to invest R10 million in a new mining project in order to expand its gold production capacity. The management of the company prefers to maintain the present 35% debt, 55% equity and 10% preference shares capital structure. Debt financing can be obtained by issuing a 5-year R1 000,00 bond. The current price of the bond is R1 123,00 and it pays 10% coupons. Vendata Resources has a beta of 1.3. The expected return on the market portfolio is 16% and the current risk-free rate is 8%. The company is contemplating issuing 10% preference shares that are expected to sell for a par value of R60,00 per share. The cost of issuing and selling the shares is expected to be 5%. The tax rate is 29%. REQUIRED: 3.1 Calculate Vendata Resources’ component costs. (11 marks) 3.2 Calculate the company’s weighted average costs of capital. (9 marks)
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