FIN3701 Assignment 2 Semester 1 2023 (678669)

FIN3701 Assignment 2 Semester % TRUSTED workings, explanations and solutions. QUESTION 1 [7 marks] Use the information provided below to answer questions 1.1 and 1.2. A company is evaluating three operating and financial structures. The company is in a 30% tax bracket and the Chief Financial Officer (CFO) compiled the following information: Operating structure A B C Units sold 000 Fixed costs (R) 000 Selling price (R) 25.00 17.50 29.00 Variable costs (R) 13.90 10.00 12.00 Expected EPS 0.60 0.18 0.36 Standard deviation of EPS 0.760 1.138 1.560 WACC 11% 11% 11% REQUIRED: 1.1 Calculate the operating break-even point for structures A, B and C. (6 marks) 1.2 Arrange/show the operational risk of the three structures from least to most risky. (1 mark) 12 QUESTION 2 [15 marks] Taco Ltd is a growth-oriented company – 75% is owned by its directors and 25% is owned by an outside financier. The company was formed fours year ago by the directors but after two years, the company could not raise further loans and the directors had no further funds to invest. There were, however, several profitable investments under consideration for Taco Ltd. At that time, the financier agreed to invest in the company but indicated that he would not like the debt ratio to exceed 40% because he believed that the company was exposed to a high degree of business risk and should therefore take a conservative financial position. Taco Ltd’s interest rate on its debt is a constant 10%; its cost of ordinary shares funding from retained earnings is 14%; and its marginal tax rate is 28%. The after-tax profit for the past year amounted to R600 million. The company has the following investment opportunities: Project Cost (Rm) IRR (%) A 180 16 B 420 14 C 240 13 D 210 10 E 270 9 REQUIRED: 2.1 Apply the residual dividend policy and determine the amount (if any) that should be distributed as a dividend. (10 marks) 2.2 Calculate the dividend pay-out and retention ratios. (5 marks) QUESTION 3 [15 marks] T & J Exporters has a total market value of R500 000 is currently evaluating three capital structures (30%, 40% and 50%-debt) without altering the total amount of financing required. T & J Exporters’ ordinary shares have a book value of R60 per share and the company has a dividend retention ratio of 70%. Earnings available for ordinary shareholders are estimated at R35 000, R28 000 and R20 000 for the 30%, 40% and 50%-debt capital structures respectively. The corporate charter of the company authorises the issue of 5 000 ordinary shares internally and intends to use the same corporate charter for the next three years. REQUIRED: 3.1 Calculate the number of ordinary shares issued to existing ordinary shareholders for each of the capital structures under evaluation. (9 marks) 3.2 Calculate T & J Exporters’ earnings per share (EPS) for each of the capital structures under evaluation. (3 marks) FIN3701/101/1/2023 13 3.3 Calculate the dividend per share for each of the capital structures under evaluation. (3 marks) QUESTION 4 [13 marks] QUESTION 4.1 (5 marks) A small storage company is contemplating acquiring new material storage equipment that costs R20 000. The company has no purchase option and can lease the equipment under a 5-year lease requiring annual end-of-year payments of R5 000. All maintenance costs will be paid by the lessor but insurance and other costs will be borne by the lessee. The lessee will exercise its option to purchase the equipment for R4 000 at termination of the lease. Assume that the company is in the 40% tax bracket. REQUIRED: 4.1 Evaluate the lease financing option by determining the annual after-tax cash outflows. QUESTION 4.2 (8 marks) Concor Construction, a black owned consortium recently accepted a stadium development project which will be overseen by Murray & Roberts Construction. The project requires purchasing a new Skid-steer loader. The loader will have a 3-year life and will be depreciated over 3 years. The purchase will be financed by a 3-year, 13% loan requiring annual end-of-year payments of R63 530. Assume that the company is in the 40% tax bracket. The table below depicts total before-tax cash outflows associated with the purchase: End of year Loan payment (1) Maintenance (2) Depreciation (3) Interest (13%) (4) Before-tax cash outflows (2+3+4) (5) 1 R63 530 R3 500 R49 500 R19 500 R72 500 2 R63 530 R3 500 R67 500 R13 776 R84 776 3 R63 530 R3 500 R22 500 R7 308 R33 308 REQUIRED: 4.2 Determine the after-tax cash outflows resulting from the purchase for each of the 3 years and calculate the present value of the cash outflows using 8% discount rate.