UNIVERSITY OF ZIMBABWE

DEPARTMENT OF FINANCE AND ACCOUNTING

FINANCIAL MANAGEMENT ASSIGNMENT

DUE DATE: 16 OCTOBER, 2023

ANSWER BOTH QUESTIONS

QUESTION ONE

You are the financial manager at Gamma Investments, a grocery retailing company operating
several branches in Harare and surrounding cities. The company wants to open a new retail
branch in Mutare. The new branch is expected to operate for five years before competition
intensifies and make the branch less profitable.

The following cash flows will be generated by the branch.

Year 0 1 2 3 4 5
Cash (USD30,000) USD13,500 USD12,500 USD15,000 USD10,000 USD15,000

flow

Before financial resources are sought and committed to the project, you have been asked to
evaluate whether the project is feasible. In addition to the above cash flows, the following
information is also made available to you from the company’s head office in Harare.

The capital to finance the opening of the branch will be raised through a combination of debt,
preference shares and ordinary equity (retained earnings) using current market values as the
weights.

The company has 50 debentures outstanding. The debentures have 10 years remaining to
maturity and carry 10% annual coupon paid semi-annually. The current yield to maturity of
the bonds is 12%.

The grocery company has 200, 8% $100 par outstanding preference shares that pay annual
dividends. The preference shares are non-redeemable. Each preference share is currently
trading at $108. If new preference shares are issued, flotation costs will be $2 per share.
The grocery company also has 2 000, $20 par value ordinary shares outstanding. The current
Treasury bill rate is 6%, the company has a stock beta of 1.20 and the average return on the
market is 18%. The ordinary dividend for the current period is $1.00 per share. If new
ordinary dividends are issued flotation costs will be 10% per share. Dividends are expected to
increase by 10% every year indefinitely.

The grocery company finances all its branches using the same capital structure and belongs to
the 40% corporate tax bracket.

Required:

a. Using the above information, compute the appropriate cost of capital for the grocery
company [10 marks]
b. Use the NPV and the payback period methods to evaluate the feasibility of the Mutare
branch and advise management accordingly [10 marks]
c. Explain why companies prefer to exhaust all the retained earnings before resorting to the
issuing of new ordinary equity [5 marks]

QUESTION TWO
Mr Basera decides to save for his son’s 4 year university education and other future family
financial obligations by saving $1,500 every quarter in sinking fund that earns 11% interest
annually compounded monthly. He will commence such deposits at his son’s first birthday
which will be celebrated exactly one year from now until his 24 th birthday. He expects to
make withdrawals each of $6,000 at the son’s 10 th, 15th and 20th birthdays to meet other
family commitments. The son will commence his first year university education at his 20 th
birthday and will graduate at his 24th birthday. A fixed university annual tuition fee will be
paid in arrears at the end of each academic year. Mr Basera has structured the sinking fund so
that the value of the fund will be equal to the value of the above financial obligations.

Required
i) Illustrate the above financial arrangement on a timeline [4 marks]
ii) Calculate the fixed annual university tuition fee such that the inflows into the fund will be
equal to the outflows from the fund [10 marks]
iii) Calculate the future value of the fund at the son’s 20th birthday [8 marks]
iv) Outline any 3 benefits to Mr Basera of using a sinking fund [3 marks]