Question 1 15 Marks

MSC Devine is launching a maritime project by purchasing a small, previously owned cargo ship

for R2.5 million which will be used to ferry iron ore across the Great Lakes. The ship will be

depreciated over four years straight-line. Freight revenues and expenses from the venture are

forecast as follows:

Year Revenue R Cash Expenses R

1 500,000 800,000

2 1,000,000 800,000

3 1,500,000 900,000

4 2,000,000 1,000,000

Required:

Calculate the project's ARR and comment on its likelihood of acceptance by management. Also

estimate project cash flows and calculate its NPV and IRR at 9% cost of capital.

Question 2 15 Marks

MSC is evaluating the following projects for next year's capital program:

Project Initial Investment (Rands)

Length in

Years Annual Cash Flow (Rands)

A 3,000,000.00 6 720,000.00

B 3,500,000.00 5 980,000.00

C 4,000,000.00 7 905,000.00

D 5,000,000.00 4 1,720,000.00

E 6,000,000.00 6 1,510,000.00

F 7,000,000.00 5 1,950,000.00

G 8,000,000.00 7 1,730,000.00

Projects A and B are mutually exclusive and so are Projects D and E. MSC has a 12% cost of

capital and a maximum of R15 million to spend on capital projects next year.

Required:

Use capital rationing to determine which projects should be included in MSC's capital program.

Question 3 20 Marks

General Motors (GM) is evaluating a maintenance contract for its heavy equipment. One

company has offered GM a four-year contract for R100,000 to be paid in advance. Another

company has offered an eight-year contract for R165,000, also to be paid in advance. GM will be

able to save R34,000 per year under either contract because its employees will no longer have to

do the work themselves.

Required:

3.1. If GM's cost of capital is 10%, which project should be selected? Use both the replacement

chain and the equivalent annuity (EAA) method to justify your answer. [12]

3.2. If GM's cost of capital is 12%, does it change the decision? What about 14%? [8]

Question 4 15 Marks

Brook is reviewing a project with an initial cash outflow of R250,000. An additional R100,000

will have to be invested after the first year, followed by an additional investment of R50,000 at

the end of the second year. Beginning at the end of year 3, the project is expected to generate

cash flows of R90,000 per year for the next eight years.

Required:

4.1. Calculate the project's payback period, IRR, and its NPV and PI at a cost of capital of 8%.

[12]

4.2. If Brook's cost of capital is 12%, does it change the decision? What about 14%? [3]

Question 5 12 Marks

Broken just paid annual dividends of R2, has beta of 1.3, and a growth rate of 6% for the

foreseeable future. The current return on the market is 10%, and Treasury bills earn 4%.

Required:

If the rate on Treasury bills drops by 0.50% and market premium increases by 1.0%, what

growth rate would keep Broken's stock price constant?

Question 6 10 Marks

The probability distribution of the return on an investment in Omega's common stock is as

follows:

Return (%) Probability

5 0.05

8 0.25

10 0.4

12 0.25

15 0.05

Required:

6.1. Draw a probability distribution curve and comment on its shape. [2]

6.2. Calculate the expected return, standard deviation of the return, and the coefficient of

variation. [8]

Question 7 13 Marks

Goble has been going through a difficult financial period. Over the past three years, its stock

price has dropped from R50 to R18 per share. Throughout this downturn, Goble has managed to

pay a R1 dividend each year. Management feels the worst is over but intends to maintain the R1

dividend for three more years, after which they plan to increase it by 6% per year indefinitely.

Comparable stocks are returning 11%.

7.1. If these projections are accurate, is Goble stock a good buy at R18? [10]

7.2. How do you think the market feels about Goble's management? [3]