Exam (elaborations)
FIN4801 EXAM PACK 2023
- Course
- FIN4801 EXAM PACK 2023
- Institution
- University Of South Africa
FIN4801 EXAM PACK 2023
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FIN4801 EXAMPACK 2023
[School]
[Course title]
,Advanced Financial Management
100 Marks
Duration: 4 Hours
This paper consists of 29 pages.
Instructions:
The examination is open book.
As the examination is an assessment, it should still be your own work and you
should
remember to sign the Honesty Declaration.
Plagiarism checks may be run on your submission.
You can either fill in the template provided in MS Word, or you can print out the
paper,
answer on the paper, and scan and submit your filled in paper, or you can answer
on blank
paper and scan and submit your answers.
This paper consists of 29 pages, including five pages for rough work, plus
appendix A
(financial tables) on pages 26 to 29. Answer all FOUR questions. Each question
counts 25
marks. Show all your calculations clearly.
Please note that rough work will not be marked
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Question 1 [25 marks]
Question 1.1 (18 Marks)
Rotary Ltd is a manufacturer of aircraft engines which is considered to be a contracting
industry at the moment. There is a need for more environmentally friendly engines in the
industry. To this end, the management of Rotary Ltd is investing in a low emission engine
programme consisting of a two-year long research and development (R&D) programme
followed by the manufacture, marketing and sale of a new engine over a period of two years.
The management of the company is confident that the R&D phase will be a success. It is
expected that machinery related to the manufacture of the engines will be bought at the end
of the second year of the project. At the end of the project, the company will sell off the
machinery related to the project at half of the original cost of the machinery. The project was
adjudicated by the South African Revenue Service (SARS) to be an R&D project, with the
deduction equal to 150% of directly related expenses. The machinery related to the
manufacture of the engines are machines that qualify for depreciation over three years
according to the following schedule: Year 1: 50%; Year 2: 30%; Year 3:20%. Over the first two
years of the project, it is expected that only R&D expenses will be incurred and that all other
cash flows as given below the R&D expenses, will be incurred after concluding the R&D phase
at the end of year 2 of the project. Assume that any tax credits in a given year can be written
off against other obligations of the company in the same year (negative tax payments should
be treated as an inflow in the same year).
Other relevant information is presented below:
Sales generated annually R3000 000
Expenses
R&D (each year for the first two years) R1000 000
Machinery cost (expense at end of year two of the project) R1000 000
Cost of sales (annual) R750 000
Fixed costs (annual) R250 000
,The machine is expected to be sold for 50% of its purchase price at the end of the project and
a tax rate of 28% is applicable, while capital gains are taxed on 67% of the gain at the normal
tax rate. The company is wholly funded by equity and has a beta of 1.8 while the risk-free rate
is 10% and the market risk premium is 7%. All cash flows provided are in nominal terms. For
risky projects, the company multiplies its WACC by 1.5. Due to the project being strategic to
the future aspirations of the company, it will not stop the project at any time if it is found to be
financially acceptable in its totality.
Required:
(i) Determine two NPV’s of the proposed project using both the company’s WACC for
one and risk adjusted WACC for the other. (10)
(ii) Comment on the acceptability and profitability of the project. (2)
(iii) Discuss the influence of the tax concessions on R&D expenditure and on the NPV.
(4)
(iv) Discuss how the NPV is influenced by the company considering the project to be
risky. (2)
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Question 1.2 (7 Marks)
Oranges Ltd is a manufacturer of orange juice. The company is considering purchasing a new
juicing machine that has a limited life-span. The machine will cost R80m.
In the first year of operation, it is expected that there is a 50% chance of the project generating
net cash flows of R60m and a 50% chance of it generating net cash flows of R40m.
If the machine generated R60m in year 1, there is a 70% chance of it generating R50m in year
two and a 30% chance of it generating R40m in year two.
If the machine generated R40m in year one, there is a 100% chance of it generating R40m in
year two.
In any scenario, in the third year, the machine will be scrapped, a process that takes a full
year and therefore occurs in year 3. In all cases, there is a 100% chance that the machine will
be scrapped for a net R20m in year three.
The company has a WACC of 10%.
Required:
Use a decision tree to determine the expected NPV of the project.
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Question 2 [25 Marks]
Question 2.1 (7 Marks)
Sardine Canneries Ltd wants to estimate the amount of funds they will require to fund their
, operations in 2020. The company has total assets of R70m, liabilities of R10m and a net profit
margin of 10% on sales of R60m with a dividend pay-out ratio of 10%. All assets and liabilities
are considered spontaneous and increase in line with increases in sales. The company plans
to pay an extraordinary dividend of R1m in the coming year. It is expected that sales will grow
by 20% in the coming year. Estimate the funds the firm will require in 2020.
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Question 2.2 (9 Marks)
Clothing Ltd. sells apparel and accessories in retail outlets with all of their clients utilising store
credit due to the favourable terms offered. Currently, the company has sales of R90m per
annum with a gross profit margin of 50% while offering favourable repayment terms of 120
days to make payment with no interest charged and bad debts amounting to 8% of sales
leading to a current days sales outstanding (DSO or ACP) of 150 days. The financial manager
of the company wants to change the terms to 10/30 net 60, which she expects will drive the
DSO down to 70 days but increase bad debts to 10% of sales. It is also expected that the
discount on offer for early payment will lead to sales increasing to R100m if the terms were
adopted. The company can invest excess funds in short term securities at a rate of 10% per
annum. Assume a 365-day year.
Determine the effect of the change in credit terms and advise Clothing Ltd on the feasibility of
the new terms.
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Question 2.3 (9 Marks)
Flour Pty (Ltd) is currently planning their cash requirements for the next quarter, June 2020 to
August 2020. The company sells baking supplies on credit, leading to a constant flow of sales
and payments from debtors, with occasional large inflows when goods are supplied for large
contracts. The aging report on the accounting system of the company gives the following
breakdown of collection from debtors:
20% one month after the sales have taken place
80% two months after the sales have taken place
The sales recorded for both April and May are R400 000 respectively. Sales are
expected to remain unchanged until at least August 2020.
Further to this, e-mails from other branches and sales personnel indicate that the company
can expect payments from large contracts worth R100 000 in June, R30 000 in July and
R200 000 in August.
Variable costs related to sales equal 70% of the selling price; and the company has fixed
expenses estimated at R400 000 every month. The company had a cash balance of R200 000
at the end of May 2020.
The company uses a R20 000 000 revolving credit facility to finance cash shortfalls which
costs 1% per month and on which interest is paid on the opening balance every month.
Required:
Compile a cash budget for Flour Pty (Ltd) for June to August 2020.
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Question 3 [25 Marks]
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