Minks (Ltd) is a listed company that has been successful in the past decade. In 2021, the
company’s board has decided to expand its operations by embarking on a new project to gain more
market share. Minks (Ltd) would need to invest R30-million, payable at the beginning of the first
year of the project. The project is expected to have a four-year life span. The forecast financial are
as follows:
Year 1 2 3 4
Units sold per year 320 000 350 000 475 000 500 000
Price per unit sold (R/unit) 140 145 150 150
Variable cost per unit (R/Unit) 70 70 70 70
Fixed costs per annum (R) 2 500 000 2 500 000 2 700 000 2 700 000
Additional project information:
• Price and costing information are in current terms before the application of selling price
inflation of 7% per annum, variable cost inflation of 4% and fixed cost inflation of 5%;
• Current corporate tax is at 28% and the tax liability is payable in the year it arises. Assume
profit from the project is similar to its cash flow;
• Minks (Ltd) has a cost of debt of 10%;
• The risk-free rate is 7%, the return on the market where Minks (Ltd) is listed is 15% and it has
a beta coefficient of 1.1;
• It is the company’s policy to maintain a 40/60 debt/equity financing; and
• Minks (Ltd) uses its weighted cost of capital in all project appraisals.
Required:
Recommend whether Minks (Ltd) should embark on this expansion project or not. Show all your
calculations to justify your recommendation.

Dalton Ltd – a manufacturer of high quality JoJo tanks – has maintained stable annual sales of $500 000 for the past two years and is expected to remain stable for the next 5 years. Although the market for JoJo tanks has been expanding, Dalton Ltd could not share in this growth due to the technical problems experienced with the current machine. To increase its production and sales, the company is considering replacing the current injection moulding machine with a more technically advanced model which will cost the company $3 000 000.The outlay would be offset partially by the sale of the old machine. The old machine cost $1 500 000 two years ago and can be sold currently for $500 000 before tax. The lifespan of the old machine was originally six years and depreciation is calculated on a straight line basis. The total fixed operating costs for the old machine is $80 000 (excluding depreciation) and will be constant for the next five years.As a result of the acquisition of the new machine, sales are expected to increase by 5 000 units in each of the next three years and to stabilise in the following two years. The new injection moulding machine will be depreciated on a straight-line basis over five years and will be terminated and sold at end of the fifth year for a scrap value of $600 000.The company is currently selling 25 000 tanks annually. The total fixed operating costs of $120 000 (including depreciation) will be constant for the next five years. Variable cost per unit per year total R5.As a result of switching to the new machine management expects cash to increase by $20 000, accounts receivable by $40 000 and inventory by $60 000. At the same time, accounts payable will increase by $50 000, accruals by $10 000 and long-term debt by $100 000.Dalton Ltd's cost of capital is 11%. Assume a tax rate of 29%.

1. The internal rate of return for the project would be closest to … .

1. 8%

2. 11%

3. 14%

4. 17%

2. The net present value for the project is closest to ….

1. R876.91

2. R906.91

3. R930.91

4. R970.91

3. Calculate the number of units which must be sold in order to achieve a net profit before tax of R148 800 in the first year.

1. 14 920 units

2. 15 920 units

3. 16 920 units

4. 17 920 units

Exxaro’s managers are ambitious and wish to expand their range of activities. They have produced a report for the head office detailing five projects requiring large initial investments. After reading the report the head office say they have a policy allowing unit managers to select investment projects without interference from their office. However, they do set a limit on the amount spent in any one period. In the case of Exxaro this limit is to be R110 000 at Time 0 for these projects, which if accepted will commence immediately. The five projects are mutually exclusive (that is, taking one does not exclude the possibility of taking on another), each one can only be undertaken once and they are all divisible.

None of the projects lasts more than four years and cash flows are confined to within the four-year horizon.

Assume:

 The cost of capital is 10 per cent

 No inflation

 No tax

 All cash flows occur on anniversary dates

5.1. What is the optimal allocation of the R110 000 and the resulting net present value? (15)

5.2. How would your answer above (5.1) change if the cost of capital is decreased by 2 per cent? (5)

5.3. Distinguish between ‘soft’ and ‘hard’ capital rationing and explain why these forms of rationing occur. (5)

PLEASE ONLY ANSWER QUESTION 1.6 - 1.11

Merafe Mining is evaluating the possibility of adding a new product line to its product mix. Because the exercise requires a detailed analysis of all possible risk scenarios or cases, EY was contracted to perform capital budgeting analysis for Merafe. The new machinery would cost Merafe an estimated amount of R200 000. A further R10 000 would be required for shipping charges and additional amount of R30 000 is estimated for installation of the new equipment.
Assume an economic life of 4 year for the machinery and the depreciation is based on MACRS 3-year class. Assume the following MACRS 3-year class depreciate rates:

year 1: 33.33%,

year 2: 44.45%,

year 3: 14.81%,

year 4: 7.41%.
The machinery is expected to have a salvage value of R25 000 after 4 years of use.
The new product line would generate incremental sales of 1 250 units per year for 4 years at an incremental cost of R100 per unit in the first year, excluding depreciation. Each unit can be sold for R200 in the first year. The sales price and cost are both expected to increase by 3% per year. Further, to handle the new line, the company’s net working capital would have to increase by an amount equal to 12% of sales revenues. Assume company’s tax rate of 40%, and its overall weighted average cost of capital, which is the risk-adjusted cost of capital for an average project (r), is 10%.
1.2. What is Merafe’s depreciable basis? What are the annual depreciation expenses? (5)
1.3. Calculate the annual sales revenues and costs (other than depreciation). Why is it important to include inflation when estimating cash flows? (5)
1.4. Construct annual incremental operating cash flow statements. (5)
1.5. Estimate the required net working capital for each year, and the cash flow due to investments in net working capital. (3)
1.6. Calculate the after-tax salvage cash flow. (3)
1.7. Calculate the net cash flows for each year. Based on these cash flows and the average project cost of capital, what are the project’s NPV, IRR, PI, payback, and discounted payback? Do these indicators suggest that the project should be undertaken? (10)
1.8. Perform a sensitivity analysis on the unit sales, salvage value, and cost of capital for the project. Assume each of these variables can vary from its base-case, or expected, value by +-10%, +-20%, and +-30%. Discuss the results. (8)
1.9. Assume that EY is confident of its estimates of all the variables that affect the project’s cash flows except unit sales and sales price. If product acceptance is poor, unit sales would be only 900 units a year and the unit price would only be R160; a strong consumer response would produce sales of 1 600 units and a unit price of R240. EY believes that there is a 25% chance of poor acceptance, a 25% chance of excellent acceptance, and a 50% chance of average acceptance (the base case).
Use the worst-, base-, and best-case NPVs and probabilities of occurrence to find the project’s expected NPV, standard deviation, and coefficient of variation. (5)
1.10. Assume that Merafe’s average project has a coefficient of variation in the range of 0.2 to 0.4. Would the new line be classified as high risk, average risk, or low risk? What type of risk is being measured here? (3)
1.11. Merafe typically adds or subtracts 3 percentage points to the overall cost of capital to adjust for risk. Should the new line be accepted? (3)