QUESTION

The Stanger Steel Company issued 10 000 000 ordinary shares at R24.00 per share. The before tax borrowing cost of R200 million is 12%. The company paid dividend of R2.40 per share which is expected to grow by 5% annually.

Assume a tax rate of 28%.

The Stanger Steel Company has the following investment opportunities:

Project Sony

Initial investment R30 000

Life Span 3 years

Cash inflow R12 000

WACC ?

IRR ?

Project LG

Initial investment R39 000

Life Span 3 years

Cash inflow R15 000

WACC ?

IRR ?

Project Supersonic

Initial investment R 42 000

Life span 3 years

Cash inflow R20 000

WACC ?

IRR?

Project Hisense

Initial investment R50 000

Life span 3 years

Cash inflow R25 000

WACC ?

IRR?

The Stanger Steel Company expects to have net income of R161 000 and bases its dividend payment on the residual policy.

As a financial analyst, you have been requested by the management of the Stanger Steel Company to advise it on the basis of the residual theory, which projects to select and which to reject given the company's WACC and IRR of the investment opportunity. Also indicate how much to pay-out as dividends if any (pay-out ratio) and the retention ratio.

NB: use the market value to calculate the weights (capital structure). The same weights must be used to calculate the amount of equity and debt to be invested in the chosen projects.

Required:

4.1 Which projects should The Stanger Steel Company choose given their calculated WACC and IRRs? Justify your answer.

4.2 How much would The Stanger Steel Company pay in dividends (after accepting all profitable projects) if it were to follows the residual theory of dividends?

4.3 Calculate the Stanger Steel Company's pay-out ratio and retention ratios.