Fincom Limited is currently considering the purchase of a new manufacturing machine at a cost of...

 

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Fincom Limited is currently considering the purchase of a new manufacturing machine at a cost of R800 000. Transportation cost of R50 000 and installation cost of R100 000 have to be incurred before production can start. The machine will require recoupable working capital of R80 000. The expected useful life of the machine is four years and it can be sold for R60 000 after taxes (the company's tax rate is 30%) at the end of the four years. The machine will reach full production capacity of 150 000 units per year, in year one. Thereafter the capacity of the machine will increase by 5% per year on the previous year's sales. All units manufactured can be sold at a price of R5 per unit. Variable cost is R3 per unit manufactured. Annual maintenance cost will amount to R10 000. The South African Revenue Service will allow wear and tear to be deducted on the new machine on a straight-line basis over a five year period. The current capital structure consists of 150 000 issued ordinary shares and long-term debt amounting to R18 million. The current market price for the ordinary shares is R40 per share. The company plans to keep its existing capital structure weights for the future. A current dividend of R4 was declared. The expected dividend growth rate is 12% per annum. Furthermore, the company will be able to obtain new external capital on the local capital market on the following conditions: Debentures with a time to maturity of five years and a coupon rate of 10% per year. Coupon payments will be made semi-annually. Due to the current high levels of interest rates the debentures can be issued at a discount of 21% on the par value of R1 000, but will be redeemed at a premium of 15%. Required: (a) Calculate the weighted average cost of capital for Fincom Limited. (b) Use the cost of capital calculated above as well as the relevant Fincom Limited is currently considering the purchase of a new manufacturing machine at a cost of R800 000. Transportation cost of R50 000 and installation cost of R100 000 have to be incurred before production can start. The machine will require recoupable working capital of R80 000. The expected useful life of the machine is four years and it can be sold for R60 000 after taxes (the company's tax rate is 30%) at the end of the four years. The machine will reach full production capacity of 150 000 units per year, in year one. Thereafter the capacity of the machine will increase by 5% per year on the previous year's sales. All units manufactured can be sold at a price of R5 per unit. Variable cost is R3 per unit manufactured. Annual maintenance cost will amount to R10 000. The South African Revenue Service will allow wear and tear to be deducted on the new machine on a straight-line basis over a five year period. The current capital structure consists of 150 000 issued ordinary shares and long-term debt amounting to R18 million. The current market price for the ordinary shares is R40 per share. The company plans to keep its existing capital structure weights for the future. A current dividend of R4 was declared. The expected dividend growth rate is 12% per annum. Furthermore, the company will be able to obtain new external capital on the local capital market on the following conditions: Debentures with a time to maturity of five years and a coupon rate of 10% per year. Coupon payments will be made semi-annually. Due to the current high levels of interest rates the debentures can be issued at a discount of 21% on the par value of R1 000, but will be redeemed at a premium of 15%. Required: (a) Calculate the weighted average cost of capital for Fincom Limited. (b) Use the cost of capital calculated above as well as the relevant

Answer rating: 100% (QA)

Answer a To calculate the weighted average cost of capital WACC for Fincom Limited we need to consid... View the full answer