FIN3701 Assignment 2 (DETAILED ANSWERS) Semester 1 2025 - DISTINCTION GUARANTEED

FIN3701 Assignment 2 (DETAILED ANSWERS) Semester 1 2025 - DISTINCTION GUARANTEED - DISTINCTION GUARANTEED - DISTINCTION GUARANTEED Answers, guidelines, workings and references ,. QUESTION 1 [20 marks] MathethePharm Ltd has optimal capital structure weights of 40% debt and 60% equity. MathethePharm is in the 30% tax bracket and is evaluating four independent investment proposals. Project Initial investment (R) Internal rate of return (IRR) (%) A 100 000 18 B 200 000 15 C 125 000 13 D 100 000 12 MathethePharm’s senior financial analyst has gathered the following information: MathethePharm can raise R160 000 through the sale of a R1 000 par value, 8% annual coupon rate and a ten-year debenture. The debenture will be issued at 5% discount and R20 flotation cost per debenture. Additional funds will be raised through the bank loan with an after-tax cost of 10%. R425 000 is available through retained earnings. Additional funds will be raised through the issue of new ordinary shares. The company pays a regular dividend of R10, has a growth rate of 3% and nets R87.30 after flotation costs. The flotation costs are calculated at 3% of the par value (R90) of a share. KINDLY NOTE THAT THERE ARE TWO COMPULSORY ASSIGNMENTS FOR THE SECOND SEMESTER. The purpose of this assignment is to evaluate your knowledge of some of the fundamental issues in the long-term financing decisions of a company. To complete this assessment, you must study chapters 13, 14 and 17 of the prescribed book and the relevant learning units. 12 FIN3701/101/2/2023 REQUIRED: 1.1 Calculate the WACC associated with each range of financing/break-point. (18 marks) 1.2 In which project do you recommend that the company invest its funds? Motivate your choice. (2 marks) QUESTION 2 [18 marks] A totally equity financed company with 10 000 outstanding ordinary shares, each with a book and market value of R40, is in the process of introducing debt into its capital structure. Funds raised through debt will be used to retire some of the shares and the company’s aim is to maintain the same total amount of financing required. The company pays all its earnings as dividends and is subject to a 30% tax rate. The expected sales are R600 000, the fixed costs are estimated at R300 000 and the variable cost are estimated at 30%. The following capital structures are being considered: Capital structure A at 40% debt ratio A loan provided by Standard Bank at 20% per annum interest rate. Capital structure B at 60% debt ratio A loan provided by Capitec Bank at 18% per annum interest rate. REQUIRED: 2.1 Which capital structure would you advise the company to choose if its objective is to maximise earnings per share (EPS)? (9 marks) 2.2 Calculate the weighted average cost of capital (WACC) for both equity and debt structure at 40% and 60%, respectively. (4 marks) 2.3 Which capital structure would you advise the company to choose if the aim is to maximise shareholder wealth? (3 marks) 2.4 Calculate the company’s dividend per share (for both 40% and 60% debt structures) if the company has a 45% dividend pay-out ratio. (2 marks) 13 QUESTION 3 [6 marks] Consider the following pre-merger information about a bidding company (Tiger Gold Mining) and a target company (Silver Enterprises) at the end of the year 2020: Tiger Gold Mining had 600 000 ordinary shares outstanding and had earnings of R. Tiger Gold Mining’s earnings are expected to grow at an annual rate of 5%. Silver Enterprises had 100 000 ordinary shares outstanding and had earnings of R200 000. Silver Enterprises’ earnings are expected to grow at an annual rate of 10%. REQUIRED: 3.1 Calculate the next five years’ (2020 to 2024) earnings per share (EPS) for Tiger Gold Mining before the merger. (3 marks) 3.2 Calculate the next five years’ (2020 to 2024) earnings per share (EPS) for Silver Enterprises before the merger. (3 marks) QUESTION 4 [6 marks] Homza 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, a number of profitable investments under consideration for Homza. 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. Homza’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 R900 million. The company has the following investment opportunities: Project Cost (Rm) IRR (%) A 180 16 B 420 14 C 240 13 D 210 12 E 270 10 The CFO has determined the WACC of Homza to be 11.28%.