The directors of Dell Limited have appointed you as their financial consultant. They are considering new investment projects and need you to calculate the cost of capital for the company.
The present capital structure is as follows:
Two million ordinary shares with a par value of 75 cents per share. These shares are currently trading at R4.50 per share and the latest dividend paid is 30 cents. An average dividend growth of 13% is maintained.
One and a half million 14% R3.00 preference shares, with a market value of R5.00 per share.
R2 000 000 non-distributable reserves
R800 000 8% debentures due in 6 years’ time and the current yield-to-maturity is 6%, and
R900 000 13% bank loan.
Additional information:
The company has a beta of 1.7, a risk-free rate of 5% and enjoys a premium of 8%
The company's tax rate is 30%
Question 2 Questions:
2.1 Calculate the weighted average cost of capital, using the Gordon Growth Model to calculate the cost of equity. (20 marks)
2.2 Calculate the adjusted weighted average cost of capital, using the Capital Asset Pricing Model as the Cost of equity. (5 marks)
QUESTION 3 (25 Marks)
P.L.U.S City urgently needs to upgrade its utility capacity. They require a new generator costing R120 000. The generator can be leased or owned and the terms are as follows:
Cost of leasing:
The lease would require annual end-of-year payments of R39 200 over the four years. Service and insurance costs of R10 000 per annum will be borne by the lessee. The P.L.U.S City will purchase the asset for R15 000 at the termination of the lease in four years.
Cost of owning:
The cost could be financed with XYZ Financers Limited. It would require a four-year 16% loan, with annual year-end payments of R42 890. P.L.U.S City will pay maintenance cost of R9 000 per annum. Depreciation charges are based on the straight-line method. At the end of the period the generator will be sold at its residual value of R20 000. Interest payments included in the year-end payments are R19 200; R15 410; R10 020; and R5 920 respectively.
Additional Information:
the company is in the 30% tax bracket
the after-tax cost of the debt is 11% Required:
Question 3 Questions:
3.1 Calculate the after-tax cash outflows and the net present value of the cash outflows under each alternative. (22 marks)
3.2 Which alternative would you recommend? Why? (3 marks)
QUESTION 4 (25 Marks)
Shafi Limited is an American based manufacturer of heavy duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with.
Project A:
Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of $49 million. This would result in an additional $650 000 profit being earned in each of the 10 years that the project would last. The new plant to be fully depreciated over the 10 years, on a straight-line basis, in accordance with the company's accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to $200 000 per annum. These expenses were also included in the profit calculation. Consultant fees cost R500 000.
Project B:
Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of Three Hundred million Rands. Annual sales for the 10-year period is expected to be Eighty million Rands annually, and fixed and variable cost of R23 million and R4 million respectively. The fixed cost includes depreciation of R20 million per annum. Consultants fees is expected to be R1.1 million.
Additional information:
The South African inflation is expected to exceed the American inflation by 2% throughout the life of the project.
Shafi Limited cost of capital is currently 12%.
The current spot exchange rate is R15.23/$.
Question 4 Questions:
4.1 Make all the necessary calculations for the two options. (22 marks)
4.2 Advise Shafi Limited if it is worth investing in neither, in one or in both of these projects
