QUESTION 2
2.1 As the director of a firm's capital budgeting department,you have been asked to evaluate a project. After collectinginformation from various sources, you have determined thefollowing:
The firm's preference share pays a constant annual dividend ofR2.25 and is currently selling for R20. The firm is expected to payan ordinary share dividend of R3 in one year, with anticipatedgrowth of 2% each year thereafter. Currently, the ordinary share isselling at a price of R23.75. The firm has 8-year bonds outstandingwith a coupon rate of 8.75%, paid annually. The bonds are currentlyselling at par. The firm is currently being financed with R10 000000 debt, R20 000 000 of ordinary equity, and R5 000 000 preferenceshares. The project requires the use of equipment valued at R6 200000. The equipment currently has a book value of R3 000 000 withtwo years of straight-line depreciation (to zero) remaining (R1 500000 each year). You anticipate that the equipment can be sold inthree years for R2 100 000. Anticipated sales are 1 000 000 unitsper year based on a sale price of R11 per unit. The cost ofproducing each unit is R8.50. If the project is accepted, the firmwill need to hire an additional manager with an annual salary ofR80 000. Total research (information gathering for projectanalysis) expenses to date are R26 000. The firm's marginal taxrate is 40%.
2.1.1 Calculate the net present value of this project and theinternal rate of return. Should the project be accepted? (25)
2.2 In the context of capital budgeting, what is an opportunitycost? Provide an example of an opportunity cost. (2)
2.3 ‘Since depreciation is a non-cash expense, we should ignoreits effects when evaluating projects.’
Is this statement true? Please elaborate. (3)
