FIN4801 Jan/Feb 2017

1.1.

Re(Nominal) = 7% + 2 (6%)

= 19%

Nominal re = (1 + rreal ) (1 + i) – 1

Rreal = (1+ rnominal)/(1+i) - 1

= (1 +0.19)/(1+ 0.06) - 1

= (1.19/1.06) - 1

=1.1226 – 1

= 12.26%

Real sales

Year 0 1 2 3 4
Initial investment -4 000 000

Sales 3 000 000 2 500 000 3 000 000 2 800 000

Salvage 500 000
Variable costs 1 200 000 1 000 000 1 200 000 1 120 000
Fixed costs 400 000 400 000 400 000 400 000
Depreciation 1000 000 1 000 000 1 000 000 1 000 000
EBIT 400 000 100 000 400 000 780 000
NOPAT 280 000 70 000 280 000 546 000
Add depreciation 1 000 000 1 000 000 1 000 000 1 000 000
NOWC -1 000 000 0 0 0 1 000 000
Net cash flow -5 000 000 1 280 000 1 070 000 1 280 000 2 546 000

Depreciation = 4 000 000 / 4 = 1 000 000

NPV for 6% inflation

NPV = - 5000000 + (1280000/1.1226) + [1070000/(1.1226)2] + [1280000/(1.1226)3] +

[2546000/(1.1226)4]

= -5000000 + 1140210 + 849051 + 904763 + 1603091

= -R502 885
NPV for 8% inflation

Rreal = (1+ rnominal)/(1+i) - 1

= (1 +0.19)/(1+ 0.08) – 1

= 10.19%

NPV = - 5000000 + (1280000/1.1019) + [1070000/(1.1019)2] + [1280000/(1.1019)3] +

[2546000/(1.1019)4]

= - 5000000 + 1161630 + 881251 + 956717 + 1726989

= -R273 413

The project should be rejected because all the NPVs are negative.

Inflation has a direct relationship with NPV, the higher inflation leads to a better NPV.

1.2.

a)

re = rf + b (MRP)

= 9.4% + 0.8 (6%)

= 14.2%

Total value of equity and debt = 15000/0.2

=R75000

If Zet Ltd issues R10000 worth of new debt then the total debt will be 15000 + 10000 = R25000

So:

Wd =25000/75000

= 33.33%

We = 66.67%

WACC = WdRd (1-T) + WeRe

= 0.3333 (1 – 0.28) 10% + 0.6667 (14.2%)

 = 2.4% + 9.46714

= 11.87%

b)

The use of more debt at this point will lead to an increase in the cost of debt and ultimately increases
the WACC as investors will perceive the company as riskier than it was before.

2.1.

Current value

Vop (current) = FCF/WACC

=3000000/0.15

= N$20 000 000

Issue vs expected price

D0 = D1/1 + g

= 6/1.02

= N$5.88

Rs = (D1/P0) + g

P0 =D1/( Rs – g)

= 6/0.18 – 0.02

= N$37.5

Value of issue = 30 000 000/0.9

= 33 333 333

Issue price = 33 333 333 / 1 000 000

= 33.33

Value, if IPO is carried out

Firm value = 20 000 000 + 30 000 000

= 50 000 000
Value, if bonds are issued

V = 6000000 (1.02)/(0.15 -0.02)

= 6120000/0.13

= N$47 076 923

IPO carried out

The issue price of 33.33 is less than the intrinsic price of the share using the dividend discounted model
of 37.50. this means at the IPO the share will be undervalued, hence an attractive buy recommendation
to investors. If the IPO is carried out, the value of the firm will be 50 000 000.

Advantages

 The IPO will reduce the debt ratio of the firm

 The cost of financing for future projects will likely be lower
 The IPO will increase the value of the firm to 50 000 000 compare to 47 076 923 for issuing
bonds.

Drawbacks

 The IPO will dilute shares of existing shareholders

 Bond issue will increase the value of the firm to only 47 076 923

2.2.

The minimum return on the project is 23% which is greater than WACC of 15%, hence the company
should prioritize investment in projects.

Total investment need is 100 000 000 which is greater than retained earnings of 50 000 000, hence no
dividend should be payout.

3.1.

Variable costs under current policy (100000 x 70%) = R70000

Variable costs under new policy (120000 x 70%) = R84000

Costs of carrying receivables

Current policy = 120 x 100000/365 x 0.70x 0.06 = R1381

New policy = 150 x 120000/365 x 0.70 x 0.06 = R2071

Bad debts (current policy) = 3% x 100000 = R3000

Bad debts (new policy) = 4% x 120000 = R4800

Income statement Effect of credit Income statement

Current policy policy New policy
Net sales R100000 R20000 R120000
Variable costs R70000 (R14000) R84000
Profit before tax/credit R30000 R6000 R36000
Credit costs
Costs of carrying receivables R1381 R690 R2071
Collection expenses R0 R0 R0
Bad debts R3000 (R1800) R4800
Profit before taxes R25619 R3510 R29129
Taxes R0 R0 R0
Net income R25619 R3510 R29129
The company should relax its credit policy since the overall effect of this new change will lead to profit.
3.2. Cash budget in R000

May Jun Jul Aug

COLLECTIONS AND PURCHASES
Sales 400 300 400 800
Collections

During month of sales

(40% of month sales) 120 160 320
One month later (60% of previous sales) 240 180 240

Total collection 360 340 560

Purchases 150 200 400

CASH LOSS OR GAIN FOR MONTH

Collections 360 340 560
Payments for purchase 150 200 400

Other expenses 200 200 200

Total payments 350 400 600

Net cash gain (loss) during month 10 -60 -40

Short-term financing cost (July) = R60 000 (12%/12)

= 600

Short-term financing cost (August) = 40 000 (12%/12)

= 400

Total short-term financing cost = 600 + 400

= 1000

3.3.

RR = 1 – (dividends per share/EPS)

 = 1 – (59.50/119)

= 1 – 0.5

= 0.5

AFN = (A*/S0)∆S – (L*/S0) ∆S – MS1 (RR)

= (5000000/850000)(980000 – 850000) – (3000000/850000)(980000 – 850000) – 0.07(980000)0.5

= 764706 – 458824 – 34300

=R 271582

4.1.

Fishcakes Ltd : Rand cost analysis (000)

Y0 Y1 Y2 Y3 Y4 Y5
A. Cost of owning(borrowing)
After tax loan payment (40) (40) (40) (40) (540)
Maintenance cost (20) (20) (20) (20) (20)
Maintenance Tax-savings 5.6 5.6 5.6 5.6 5.6
Depreciation Tax-savings 28 28 28 28 28
Residual value 50
Tax on residual value (14)
Net Cash flow (26.4) (26.4) (26.4) (26.4) (490.4)
PV of cost of owning @ 8% (421)
B. Cost of Lease
Lease payment (120) (120) (120) (120) (120)
Payment Tax-savings 33.6 33.6 33.6 33.6 33.6
Net cash flow (86.4) (86.4) (86.4) (86.4) (86.4)
PV of cost of leasing@ 8% (345)
C. Cost comparison
Net advantage of leasing (NAL)= |PV of cost of owning| - |PV of cost of leasing|= R421 - R345
= R76

The PV cost of owning exceeds the PV cost of leasing, so the NAL is positive. Therefore, Fishcakes Ltd
should lease the equipment.

4.2.

Total assets (2016) = fixed assets + current assets

= 7000 + 1800

= R8800

Total liabilities (2016) = long-term debt + current liabilities

 = 4000 + 1000

= R5000

Equity (2016) = Assets – liabilities

= 8800 – 5000

= R3800

2016 2015
Liquidity
Current ratio = current assets/current liabilities 1800/1000 =1.8 times 1200/100 = 12times
Asset management
Fixed assets turnover ratio = sales/fixed assets 20000/7000 = 2.86times 18000/4000 = 4.5times
Total assets turnover ratio = sales/Total assets 20000/8800 = 2.27times 18000/5200 = 3.46times
Debt management
Debt ratio = total liabilities/total assets 5000/8800 = 56.8% 1100/5200 = 21.15%
Profitability
Profit margin = net income available to shareholders/sales 1500/20000 = 7.5% 1300/18000 = 7.2%
ROA = net income available to shareholders/Total assets 1500/8800 = 17% 1300/5200 =25%
ROE = net income available to shareholders/equity 1500/3800 = 39.5% 1300/4100 = 31.7%

As far as the liquidity of Chemicals Ltd is concern, the company will have difficulty servicing its short-
term obligations going forward as it is experience a decrease in its current ratio from 12 times in 2015 to
1.8 times in 2016. This should be a warning signal to Phosphors Pty (Ltd) as a supplier to Chemicals Ltd.

The asset management aspect of Chemicals Ltd doesn’t look great as its Total assets turnover ratio has
been decreasing too which signals the company is not managing its assets effectively.

The debt management and profitability of Chemicals Ltd have been increasing. The debt ratio increased
from 21.15% in 2015 to 56.8% in 2016 which indicates overleveraging and could lead to financial
distress.