Question 1: Rand Water is evaluating five possible projects to enhance the efficiency of its water treatment plant. It is permitted to spend R5 million on investment projects at Time 0. The cash flows for five proposed projects are:
|
Project (R Million)
|
0
|
1
|
2
|
3
|
4
|
|
A
|
-1.5
|
0.5
|
0.5
|
1
|
1
|
|
B
|
-2
|
0
|
0
|
0
|
4
|
|
C
|
-1.8
|
0
|
0
|
1.2
|
1.2
|
|
D
|
-3
|
1.2
|
1.2
|
1.2
|
1.2
|
|
E
|
-0.5
|
0.3
|
0.3
|
0.3
|
0.3
|
The cost of capital is 12 per cent, all projects are divisible and none may be repeated. The projects are not mutually exclusive.
Required: I. Which projects should be undertaken to maximise NPV in the presence of the capital constraint?
II. If the division was able to undertake all positive NPV projects, what level of NPV could be achieved?
III. If you now assume that these projects are indivisible, how would you allocate the available R5 million?
Question 2: A project requires an immediate outflow of cash of R400 000 in return for the following probable cash flows:
|
State of Economy
|
Probability
|
End of year 1 (Rands)
|
End of year 2 (Rands)
|
|
Recession
|
0.3
|
100 000
|
150 000
|
|
Growth
|
0.5
|
300 000
|
350 000
|
|
Boom
|
0.2
|
500 000
|
550 000
|
Assume that the state of the economy will be the same in the second year as in the first. The required rate of return is 8 per cent. There is no tax or inflation.
Required: I. Calculate the expected NPV.
II. Calculate the standard deviation of NPV and the coefficient of variance of the NPV. Interpret these results taking into consideration of the state of economy.
Question 3: Mr Patel has approached you for an advice on how best to invest his savings. You have proposed that he can invest all his savings in shares of Sanlam, or all his savings in Sasol. Alternatively, he could diversify his investment between these two (share companies). There are three possible states of the economy, boom, growth or recession, and the returns on Sanlam and Sasol depend on which state will occur.
|
State of Economy
|
Probability of growth occurring
|
Sanlam return (%)
|
Sasol return (%)
|
|
Recession
|
0.3
|
40
|
10
|
|
Growth
|
0.4
|
30
|
15
|
|
Boom
|
0.3
|
-10
|
20
|
Required: I. Calculate the expected return, variance and standard deviation for each share.
II. Calculate the expected return, variance and standard deviation for the following diversifying allocations of Mr Patel's savings:
a) 50% in Sanlam, 50% in Sasol.
b) 10% in Sanlam, 90% in Sasol.
III. Explain the relationship between risk reduction and the correlation between individual financial security returns.
Question 4: Santam wants to determine its cost of capital. The company is financed through bonds and ordinary shares. The bonds were issued five years ago at a par value of R100 (total funds raised R5 million). They carry an annual coupon of 12 per cent, are due to be redeemed in four years and are currently trading at R110. The company's shares have a market value of R4 million, the return on risk-free government securities is 9 per cent and the risk premium for an average-risk share has been 6 per cent. Santam's shares have a lower than average risk and its historic beta, as measured by the co-movement of its shares and the market index, correctly reflects the risk adjustment necessary to the average risk premium - this is 0.90. The corporate tax rate is 30 per cent. Santam has a net asset figure of R3.5 million showing in its statement of financial position.
Required: I. Calculate the cost of debt capital.
II. Calculate the cost of equity capital.
III. Calculate the weighted average cost of capital.
IV. Should Santam use the WACC for all future projects and SBUs? Explain your answer.
Question 5: The directors of the Shell Group of Companies have decided to expand rapidly through mergers. You have been appointed to run with this task.
Required: Briefly explain the process itself, from appointing an advisor to the offer going unconditional.
- Do this in the form of a structured essay addressing the essential elements required.