QUESTION ONE (25 Marks)

Jimny Limited is an American based manufacturer of heavy-duty equipment. The company is currently investigating two projects for expansion. It can only undertake one of them and has asked your advice in deciding which one to proceed with.

Project A:
Production at the existing factory could be expanded. The cost of the new plant for this option would be an initial outlay of
$10 million. This would result in an additional $240 000 profit being earned in each of the 10 years that the project would last. The new plant to be fully depreciated over the 10 years, on a straight-line basis, in accordance with the company’s accounting policy. The financial team has also determined that the new plant must bear its share of the existing overheads and that amounted to 9% of additional profit per annum. Furthermore, additional expenses attributed to the expansion of the existing factory is R25 750. All of these expenses were included in the profit calculation.

Project B:
Production could be increased by purchasing a new manufacturing facility in South Africa. The cost of the facility would be an initial outlay of R8 000 000. In addition, equipment must be purchased and installed for the safety of workers according to the laws and regulations set by the South African government. The cost of this equipment is R600 000 and cost of installation is R150 000. Annual sales for the 10-year period is expected to be R42 000 000 annually, and fixed and variable cost of R12 000 000 and R1 000 000 respectively. Consultant’s fees are expected to be R125 750.

Additional information:
* The South African inflation is expected to exceed the American inflation by 2% throughout the life of the project.
* Jimny’s cost of capital is currently 12%.
* The current spot exchange rate is R18.27/$.

Required:
Make all the necessary calculations for the two options. (22 Marks)
Advise Jimny Limited on which of these two projects would be more profitable (3 Marks)

QUESTION TWO (25 Marks)

Suzuki Limited uses a combination of shares and debt in their capital structure. The details are given below:

• There are 7 million ordinary shares in issue with a par value of R2.20 each and the current market price is R7 per share. The latest dividend paid was R0.84 and a 9.5% average growth for the past six years were maintained.

• The company has 5 200 000 R6, 8% preference shares with a market price of R4.20 per share.

• Suzuki Limited has a public traded debt with a face value of R5 million. The coupon rate of the debenture is 7% and the current yield to maturity of 10%. The debenture has 6 years to maturity.

• They also have a bank overdraft of R0.9 million due in 5 years’ time and interest is charged at 15% per annum.

Additional Information:
• Suzuki Limited has a beta of 1.7, a risk-free rate of 6% and a return on the market of 13%.
• Company tax rate is 28%.

Required:
Calculate the weighted average cost of capital, using the Gordon Growth Model to calculate the cost of equity. (22 Marks)
Calculate the cost of equity, using the Capital Asset Pricing Model. (3 Marks)
QUESTION THREE (25 Marks)
Consider two projects whose cash inflows are not even. Assume that the project costs R205 000. The net cash inflows for each year are as follows:

REQUIRED
Calculate the payback period of each project and recommend the project that should be selected based on the payback period. (6 Marks)

Dunstan Limited has a choice of investing in one of two projects. The following details relate to these:

REQUIRED
Use the net present value method to determine which project Dunstan Ltd should choose. (8 Marks)
Calculate the internal rate of return of Project Y. (6 Marks)
Discuss whether the advantages of using the NPV method outweigh the disadvantages. (5 Marks)

QUESTION FOUR (25 Marks)

Ford Limited needs to acquire equipment costing R2 000 000 to expand their facilities in order to be more competitive. The machine can be purchased or leased. The after-tax cost of the debt is 7 % and the company is in the 28% tax bracket.

The terms of the lease and purchase plans are as follows:
Lease
The leasing agreement would require annual end-of-year payments of R385 600 over the five years. Service and maintenance costs are R90 000 per annum. According to the lease agreement, these costs are shared equally amongst the lessee and the lessor and is not included in the annual lease payment of R385 600. In addition, the lessee will exercise its option to purchase the equipment for R128 000 at the termination of the lease.

Purchase
The cost could be financed with a five-year, 15 % loan, requiring equal annual payments of R650 000. The company will pay R18 000 per year for a service contract that covers All costs. The straight-line method of depreciation is used. They plan to sell the machine for spares after the five years for R50 000.
The interest payments for the respective five years are R97 500; R82 500; R67 800; R59 090 and R35 500.

Required:
Determine the after-tax cash outflows and the net present value of the cash outflows under each alternative. (22 Marks)

Which alternative would you recommend and why? (3 Marks)

Answers to Above Questions on Jimny Case Study

Answer 1: An analysis of the two projects A and B is performed as follows to evaluate which project is profitable.

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