QUESTION 1
A company issued R100-million in 14% debentures of R100 each, redeemable at par after five years. Calculate the cost of debt if the debentures are issued at 10% premium with 5% flotation cost. Assume 30% corporate tax.
QUESTION 2
CT Ltd. has R1,000,000 allocated for capital rationing purposes. The following proposals and associated profitability indexes have been determined.
| Project | Investment required ® | Present value of cash inflow |
| 1 | R350,000 | R420,000 |
| 2 | R450,000 | R531,000 |
| 3 | R200,000 | R240,000 |
| 4 | R150,000 | R142,500 |
| 5 | R300,000 | R366,000 |
| 6 | R400,000 | R420,000 |
Assume that projects are indivisible and there is no alternative use of the money allocated for capital rationing.
- What is the relation between NPV and the profitability index? (5 marks)
- Find out the value of NPV for each project. (6 marks)
- Which of the above investments, with a given amount of R1-million, should be undertaken? (4 marks)
- What are the steps involved in the selection process under capital rationing? (3 marks)
QUESTION 3
The par value of a 10% bond is R1,000 with a maturity of five years. What would be the price of the bond if the discounting rate is 12%?
Justify the bond price in terms of coupon rate and discounting rate.
QUESTION 4
The Defy appliances company has net earnings available for ordinary shareholders of R4-million and has 1-million ordinary shares selling at R60 per share in the market.
The firm is currently contemplating the payment of R2 per share in cash dividends.
Tasks:
- Calculate the firm’s current earnings per share (EPS). (3 marks)
- Calculate the firm’s current price/earnings (P/E) ratio. (3 marks)
- If the firm can repurchase the shares at R62 per share, how many shares can be purchased in lieu of making the proposed cash dividend payment? (2 marks)
- How much will the EPS be after the proposed repurchase? (3 marks)
- If the share sells at the old P/E ratio, what will the market price be after the repurchase? (2 marks)
- Compare and contrast the earnings per share before and after the proposed repurchase. (2 marks)
QUESTION 5
S Ltd has R1-million allocated for capital rationing purposes. The following proposals and associated profitability indexes have been determined.
| Project | Investment required ® | Present value of cash inflow |
| 1 | R300,000 | R366,000 |
| 2 | R150,000 | R142,500 |
| 3 | R350,000 | R420,000 |
| 4 | R450,000 | R531,000 |
| 5 | R200,000 | R240,000 |
| 6 | R400,000 | R420,000 |
Assume that projects are indivisible and there is no alternative use of the money allocated for capital rationing.
- What is the relation between NPV and the profitability index? (5 marks)
- Find out the value of NPV for each project. (6 marks)
- Which of the above investments should be undertaken, with R1-million available? (4 marks)
QUESTION 6
The following are the cash inflows of a money back policy:
| Year | Cash inflows (R) |
| 1 | 25,000 |
| 2 | 30,000 |
| 3 | 30,000 |
| 4 | 35,000 |
Task:
The required rate of return is expected to be 10%. Find the value of the policy over the next five years.
Answers to Above Questions
Answer 1:
| Coupon rate | 14% |
| Face value | 100 |
| Coupon amount (100*14%) | 14 |
| Issue at 10%, premium so gross value | 110 |
| Less: Floating cost 5% | -5.5 |
| Net proceeds received | 115.5 |
| Tax rate | 30% |
| Cost of debt (14/115.5*(1-30%) | 8.48% |
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