Posted: June 7th, 2022

Question 1 Zaha Ltd has an equity beta of 1.10.

Question 1
Zaha Ltd has an equity beta of 1.10. The market risk premium in South Africa is expected to be 5% and the yield on government bonds is currently 7.5%. Zaha has issued bonds and its R100 par-value bond is currently trading at R94.50. The coupon rate is 8%. The maturity date is in 5 years’ time and the corporate tax rate is 29%. Interest is payable annually in arrears. The company has just paid the coupon interest for the current year.
What is Zaha’s cost of equity, based on CAPM?
What is the after-tax cost of debt?
Zaha paid a dividend of R0.12 per share and the dividend per share is expected to grow at 7% indefinitely. The company’s share price is R2.30. What is the company’s cost of equity if we use the dividend growth model?
What is the weighted-average cost of capital (WACC) if the target debt-equity ratio is 50%? (Use cost of equity as per CAPM)
Question 2
Afroflights wishes to make a takeover bid for Mayfly. Mayfly makes after-tax profits of R40 000 per year. Afroflights believes that if further money is spent on additional investments, the after-tax cash flows (ignoring the purchase consideration) could be as follows.
Cash flow (net of tax)
(100 000)
(80 000)
60 000
100 000
150 000
150 000
The after-tax cost of capital of Afroflights is 15% and the company expects all the investments to payback, in discounted terms, within five years.
What is the maximum price that the company should be willing to pay for the shares of Mayfly?
What is the maximum price that the company should be willing to pay for the shares of Mayfly if it decides to value the business on the basis of cash flows in perpetuity, and annual cash flows from year 6 onwards are expected to be R120 000 with a sustainable growth rate of 6% per year?
Question 3
Amandla Pty is considering an investment in new technology that will reduce operating costs through increasing energy efficiency and decreasing pollution. The new technology will cost R1 million and have a four year life, at the end of which it will have a scrap value of R100 000.
A licence fee of R104 000 is payable at the end of the first year. This licence fee will increase by 4% per year in each subsequent year.
The new technology is expected to reduce operating costs by R5.80 per unit in current price terms.
Forecast production volumes over the life of the new technology are expected to be as follows:
Production (units per year)
60 000
75 000
95 000
80 000
If Amandla bought the new technology, it would finance the purchase through a four-year loan paying interest at an annual before-tax rate of 8.6% per year. The loan repayment schedule is as shown in the table below:
Alternatively, Amandla could lease the new technology. The company would pay four annual lease rentals of R380 000 per year, payable in advance at the start of each year. The annual lease rentals include the cost of the licence fee.
If Amandla buys the new technology it can claim tax allowance depreciation on the investment on a 25% reducing balance basis. The company pays taxation one year in arrears at an annual rate of 30%. Amandla has an after-tax weighted average cost of capital of 11% per year.
Calculate and determine whether Amandla should lease or buy (using the loan facility) the new technology. (Round the discount rate and cash flows to zero decimal places)
Using a nominal terms approach, calculate the net present value of buying (paying the full cost immediately) the new technology and advise whether Amandla should undertake the proposed investment.

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