FINANCIAL MANAGEMENT 3B

BSR3B01/FNM03B3

ASSESSMENT OPPORTUNITY 1
Suggested solution

SECTION A (30 marks)

Calculation
1.1 B √
1.2 D √
1.3 A √
1.4 A √
1.5 B √
1.6 C √
1.7 D √
1.8 B √
1.9 A √
1.10 C √
1.11 A √√ 0,07x100= R7/R36 = 19,44%
1.12 C √√ 100(0,8/22,40) + 5% = 8,5714%
1.13 D √√ 2/3(15%) + 1/3(11%x0,69) = 12,53%
1.14 B √√ PMT = -40
N = 20
PV = 980,75
FV = 1 000
I/YR = 8,2869
8.2869 x 0,73 = 6,0494
1.15 D √√ (37x28 000) / ((990x1 200)+(28x2 500)+(37x28 000)) = 0,4516
or 45,16%
1.16 B √√ (10x0.91)/(0,15+0,09) = R37,92
1.17 B √√ (1,15x1,026)/(0,12-0,026) = R12,55
1.18 D √√ 6 + 10,5 = 16,50%
1.19 A √√ (1+0,1718)/(1+0,0731) – 1 = 9,1976 or 9,20
1.20 A √√ 32,35 = (1,1 + 1,1g) / 0,107-g
2,3614g = 33,45
g = 0,7059 or 7.06%
SECTION B [25 MARKS]
QUESTION 2 (15 marks)

2.1 Limited to 13 Marks

2023 2024 2025 2026

(1) (2) (3) (4)
(5%) (5%) (3%)
FCF 860 000 √
Dividend (80 000) √
income
Interest 54 750 √P
expense
(75000*73%)
Total 834 750 876 487.50 920 311.88 947 921.23 √P
Terminal value 6 319 475.88 √√(1P)
((947 921/(0.18-
0.03))
Total 834 750876 487.50 7 239 786.75 √P
WACC 18% √
NPV 5 743 252,66√
Value of investment 800 000√√ (1P)
MV of debt (2 650 000,00)√
Value of equity 3 893 252,66 √P

Value of 60% equity 2 335 951,59 √P

2.2 Limited to 2 Marks

Dividend income is not related to the core business of the entity√√

The investment carries a different risk profile to the business√√
QUESTION 3 (10 marks)

3.1 Limited to 1 Mark

M&M Proposition 1√ (Without taxes)

3.2 Limited to 2 Marks

No optimal capital structure. √√

Capital structure decision do not affect firm value. √√

3.3 Limited to 3 Marks

No target capital structure. √

Profitable firms use less debt. √
Companies will want financial slack. √

3.4 Limited to 4 Marks

Taxes √
Interest carries a tax benefit/ tax shield. √
The higher the effective tax rate, the greater the incentive to borrow. √

Financial distress costs √

Financial distress costs are the direct and indirect costs associated with going bankrupt
or experiencing financial distress. √
Firms with a greater risk of experiencing financial distress will borrow less than firms
with a lower risk of financial distress. √
QUESTION 4 (25 marks)

4.1 Limited to 12 Marks

Cost of share capital.

Growth=(5.5-5)/5=0.10√

Re=(5.5*1.10) √/100) +0.10

Re=0.1605=16.05%√

Cost of debt.

N=8 √
PV=1 250
PMT=(1000*10%)=100 √
FV=1050 √
I=6.41% √
After tax= (6.41%*73%) = 4.68% √P

WACC

Target Capital Cost WACC

Structure√ √P
Share Capital 30% 16.05%√P 4.82%
Preference shares 10% 9%√ 0.90%
Debentures 60% 4.68% √P 2.81%
8.53%√P

4.2 Limited to 3 Marks

• If the different operating divisions are in much different risk classes, then separate cost
of capital figures should be used for the different divisions. √
• The use of a single, overall cost of capital would be inappropriate. √
• If the single hurdle rate were used, riskier divisions would tend to receive more funds for
investment projects, since their expected return would exceed the hurdle rate/WACC.
√√
• Despite the fact that such investment projects may be unprofitable projects on a risk-
adjusted basis. √

4.3 Limited to 4 Marks

Two typical ways around this are to use a:

• Pure play approach √: the use of WACC that is unique to a particular project, based on
companies in similar lines of business. √
• Subjective approach √: to use subjective adjustments of the overall firm WACC based on
the perceived risk of the division. √
4.4 Limited to 3 Marks

• Decision is incorrect. √
• Project should not be evaluated based on the cost of debt. √
• Project should be evaluated using a risk-adjusted hurdle rate. √
• Managing director should not look at the flotation costs of debt only. √
• Managing director should look at the weighted average flotation costs. √

4.5 Limited to 2 Marks

50million/(1-0.05)= 52 631 579 (52,63million) √√ (1P)

4.6 Limited to 1 Mark

Flotation costs of equity will be nil when calculating WAFC. √