QUESTION 1:

Rollgo (Ltd), South Africa, is a specialist manufacturer of security doors and gates. In seeking to expand its operations, it has the opportunity to acquire a German subsidiary company, Dusseldorf Guard, or set up a new division in its home market.

The relevant figures for these two options are:

Set up new division at home Rand

Cost of setting up premises                                            28 000 000

Cost of machinery                                                        18 000 000

Annual sales                                                                23 000 000

Annual variable cost                                                      6 000 000

Additional head office expenses                                       1 000 000

Existing head office expenses                                          800 000

Depreciation: machinery 10% on cost annually                   3 000 000

Acquisition Euro 

Acquire shares from existing shareholders                           11 000 000

Redundancy costs                                                          3 500 000

Annual sales                                                                  18000 000

Annual variable costs                                                      9 500 000

Annual fixed costs                                                          3 500 000

Consultants fees                                                            6 000 000

Additional information:

- The project is expected to last for 10 years.

- Rollgo (Ltd), current cost of capital is 12%.

- The German inflation is expected to be below the South African inflation by 1% per year, throughout the life of this investment.

- The current exchange spot rate is R13 to the Euro (€).

Required:

1.1 Make all necessary calculations for the two options.

1.2 Advise Rollgo (Ltd) on the viability of these two opportunities.

QUESTION 2:

2.1 Orkney Limited has the choice of purchasing one of two machines viz. machine P and machine Q. Both machines have a five-year life with no residual value. The annual volume of production for both machines is estimated at 300 000 units, which can be sold at R12 per unit.

Depreciation is calculated on the machine using the straight-line method.

Machine P costs R4 500 000. Its annual operating costs are estimated at R400 000 (excluding depreciation). Fixed costs are estimated at R1 800 000.

Machine Q costs R4 800 000. Its annual operating costs are estimated at R360 000 (excluding depreciation).

Fixed costs are the same as machine P.

The cost of capital may be assumed at 14%.

Required:

2.1.1 Use the net present value method to determine and justify which machine should be selected by the company.

2.1.2 Calculate the accounting rate of return for machine P.

2.2 Riaad Hendricks, owner of Ozworld Enterprises, was approached by a local dealer in the air conditioning units. The dealer proposed replacing the old cooling system of Ozworld Enterprises with a modern, more efficient system. The cost of the new system was quoted at R140 000, but it would save R30 000 per year in energy costs. The estimated life of the new system is 10 years, with no salvage value expected. All capital projects are required to earn at least the firm's cost of capital, which is 10%.

Required:

Calculate the project's Internal Rate of Return (IRR). (Round off your answer to two decimal places)

QUESTION 3

Mr. Khuswayo has just been appointed as a chief financial officer of Nongoma Ltd. His first priority is to review the capital structure and the cost of capital situation of the company, since he has to decide how to finance a new project. The new project is an expansion of the company's production facilities and requires that R1.2 million new capital be raised.

- Nongoma Ltd. has 120 000 ordinary shares in issue. Over the past five years the company has maintained a stable dividend policy and a relatively constant growth rate in dividends. This policy is not expected to change significantly in the foreseeable future. The following historical information is available about the dividend payments during the period 2009-2014:

• The company currently uses convertible preference shares in its capital structure. The company currently has 50 000 preference shares in issue. The preference shares do not have a redemption proviso, but in 3 years' time each preference share can be converted into one ordinary share. The preference dividend is fixed at R17.00 per share, and the current required rate of return on such shares is 18%.

- The company uses long-term debt in its capital structure. The company currently has 3 000 redeemable debentures in issue. Each debenture has a face value of R1 000 and pays an interest of 20% per annum. The debentures mature in 5 years' time. The current yield-to-maturity of these debentures is 16%.

- The company has a beta of 1.3, a risk free rate of 13% and the expected return on the market will be 20%. The corporate tax rate is 30%.

Required:

3.1 Calculate the total current market values of Nongoma Ltd.'s:

3.1.1 ordinary shares

3.1.2 convertible preference shares, and

3.1.3 redeemable debentures. (24)

3.2 Determine Nongoma Ltd.'s after-tax weighted average cost of capital, based on the current market values of its sources of capital.

3.3 Advise Nongoma Ltd.'s whether the new project should be financed with debt or ordinary equity, if the firm's long-term target debt-to-equity ratio is 25:75.

Support your recommendation with an appropriation calculation.