MBA722 GROUP ASSIGNMENTS SEPTEMBER 2023

GROUP ONE

Amtec Limited is a leading manufacturer of automotive components. It supplies to the

original equipment manufacturers as well as the replacement market. Its projects typically
have a short life as it introduces new models periodically.

You have recently joined Amtec Limited as a financial analyst reporting to Joseph Nyathi,
the CFO of the company. He has provided you the following information about three
projects, A, B, and C that are being considered by the Executive Committee of Amtec
Limited:

• Project A is an extension of an existing line. Its cash flow will decrease over time.
• Project B involves a new product. Building its market will take some time and
hence its cash flow will increase over time.
• Project C is concerned with sponsoring a pavilion at a Trade Fair. It will entail a
cost initially which will be followed by a huge benefit for one year. However, in
the year following that some cost will be incurred to raze the pavilion.

The expected net cash flows of the three projects are as follows:

Year Project A Project B Project C

$ $ $ .

0 (15 000) (15 000) (15 000)

1 11 000 3 500 42 000

2 7 000 8 000 (4 000)

3 4 800 13 000 -

Joseph Nyathi believes that all the three projects have risk characteristics similar to the
average risk of the firm and hence the firm’s cost of capital, viz., 12% will apply to them.

You have been asked to prepare a report for the executive committee, covering the following:

a) The payback period of Projects A and B.

b) The net present value (NPV) of Projects B, and C.
c) The internal rate of return (IRR) for Projects A and B.
d) Discuss the merits and demerits of the accounting rate of return (ARR) as a project
evaluation technique.
GROUP TWO

(a) The following is probability distribution of the rate of return on National Foods Stocks
and Premier Foods Stocks
State of the Economy Probability of Occurrence National Foods (%) Premier (%)
Boom 0,30 16% 40%
Normal 0,50 11% 10%
Recession 0,20 6% -20%

Required: Using the above statistical data compare the performances of the two
firms taking into account the returns and risks that potential investors would be
interested in.

(b) A company is considering two mutually exclusive projects. Both require an initial cash
outlay of $10 000 each, and have a life of five years. The company’s required rate of
return is 10% and pays tax at a 50% rate. The projects will be depreciated on straight-line
basis. The before taxes cash flows expected to be generated by the projects are as
follows:
Before Tax Cash Flows ($) .

Project 1 2 3 4 5

A 4 000 4 000 4 000 4 000 4 000

B 6 000 3 000 2 000 5 000 5000

Required

The company has approached you for advice in deciding which project to undertake. Using
the following techniques: (i) the payback, (ii) the average rate of return, (iii) the net present
value, and (iv) the internal rate of return, advise which project should be accepted and why?

GROUP THREE
a. You are the financial manager of a large indigenous firm. Your Managing Director
does not understand how the firm can come up with a good dividend policy. Advise
your MD on the practical considerations to be taken into account in coming up with a
dividend policy.
b.

Suman Joshi, Managing Director, of Omega Textiles, was reviewing two very different
investment proposals. The first one is for expanding the capacity in the main line of business
and the second one is for diversifying into a new line of business.

Suman Joshi asks for your help in estimating Omega’s weighted average cost of capital
which he believes is relevant for evaluating the expansion proposal. He also wants you to
estimate the hurdle rate for the new line of business. To enable you to carry out your task, he
has provided the following data.

▪ The latest balance sheet of Omega is given below

$’ million
Liabilities Assets
Equity capital 350 Fixed assets 700
Preference capital 100 Investments 100
Reserves & Surplus 200 Current assets 400
Debentures 450
Current liabilities 100 . .
1200 1200
▪ Omega’s target capital structure has 50% equity, 10% preference, and 40% debt.
▪ Omega has $100 par, 10% coupon, annual payment, noncallable debentures with 8
years to maturity. The debentures are selling currently at $112,00
▪ Omega has $100 par, 10% annual dividend, preference shares with residual maturity
of 5 years. The market price of these preference shares is $106,00
▪ Omega’s equity stock is currently selling at $80,00 per share. Its last dividend was
$2,80 and the dividend per share is expected to grow at a rate of 10% in future.
▪ Omega’s tax rate is 30%.
▪ The new business that Omega is considering has different financial characteristics
than Omega’s existing business. Firms engaged purely in such business have, on
average, the following characteristics: (i) Their capital structure has debt and equity
in equal proportions. The cost of debt is 11%.
(a) What sources of capital would you consider relevant for calculating the weighted
average cost of capital?
(b) How would you determine Omega’s post-tax cost of debt?

(c) How would you determine Omega’s cost of preference ?

(d) What is Omega’s estimated cost of equity using the dividend discount model?
(e) Determine the cost which Omega should use to evaluate any prospective projects.
GROUP FOUR
A 7 year $100,00 debenture can be sold for a net price of $97,75. The rate of interest is 15% per year,
and the bond will be redeemed at a premium of 5% on maturity. The firm’s tax rate is 35%. Compute
the after-tax cost of the debenture.

a. A company issues 10% irredeemable preference shares. The face value of the share is
$100,00, but the issue price is $95,00. What is the cost of the preference share? What is the
cost if the issue price is $105,00?
b. The share of a company is currently selling for $100,00. It wants to finance its capital
expenditure of $100 000 000 either by retained earnings, or by issue of new shares. If the
company issues new shares, the issue price will be $95,00. The dividend per share next year
is $4,75 and it is expected to grow at 6%. Calculate (i) the cost of retained earnings, and (ii)
the cost of new issue of shares.
c. Suppose in the year 2002 the risk-free rate is 6 per cent, the market risk premium is 9 per cent
and beta of L&T’s share is 1.54. Calculate the cost of equity for L & T.
d. A firm finances all its investments by 40% debt and 60% equity. The estimated required rate
of return on equity is 20% and that of debt is 8% after taxes. The firm is considering an
investment
e. proposal costing $40 000 with an expected return that will last forever. What amount (in
dollars) must the proposal yield per year so that the market price per share does not change?
(B)

A machine costing $80 000 has a residual value of $10 000. Depreciation is $14 000
annually. The machine will bring in uniform cash flows of $20 000 per year for five years.
Cost of capital is 11%. You are required to calculate:

i. Payback period
ii. Net present value (NPV)
iii. Internal rate of return (IRR)
iv. Profitability index.
Should the company buy this machine? Justify your answer.