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    Unit 2 - Activity 4

    Uploaded by

    Mia Khumo

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    © All Rights Reserved
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    Unit 2 - Activity 4

    Uploaded by

    Mia Khumo
    3 views3 pages

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    Copyright:

    © All Rights Reserved
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    Download as pdf or txt
    3 views3 pages

    Unit 2 - Activity 4

    Uploaded by

    Mia Khumo

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
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    UNIT 2 – CAPITAL BUDGETING – ACTIVITY 4

    Test type: File response


    Time: 45 minutes
    Attempts: 2

    Instructions:

    • This assignment is designed to assist students with exam technique for long questions
    and students are requested to attempt it under assessment conditions.

    • Activity 4: Attempting the long question under assessment conditions.


    • Students must download the question, attempt it withing the given time and upload
    their attempt on Blackboard (Word/Excel/Handwritten).
    • Students will receive 10 marks for attempting the question and uploading their
    attempts.

    • Activity 5: Marking your own attempt.


    • The solution will be uploaded after the deadline and students must download this
    solution and mark their attempts comprehensively – commenting on where they were
    wrong and which principles they did not master.
    • Students will receive 10 marks for comprehensive marking their attempts and
    uploading the marked scripts with comments.
    QUESTION 1 (25 marks)

    Siyahamba Ltd is a company listed on the Johannesburg Securities Exchange. The company
    was established 15 years ago aimed at addressing the public transport shortages in South Africa.
    Siyahamba owns buses and shuttles that are used on a daily basis by commuters across the
    country. A recent spate of increased economic conditions and increased competition have
    resulted in a decrease in profits over the previous 5 years. As a result, the directors are of the
    opinion that a different revenue stream should be considered in order to increase profits.

    The CEO of Siyahamba suggested that the company should diversify and consider investing in a
    tyre manufacturing project. If successful, the tyre project will be housed in one of Siyahamba’s
    premises currently occupied by a tenant. The tenant’s lease agreement will have to be
    terminated. The tenant currently pays rentals of R300 000 per annum.

    You are the executive assistant to the CEO, and he has requested you to provide a detailed
    analysis of the project over four years. He provided you with the following information:

    1. A year ago, market research was conducted at a total cost of R275 000. The following was
    revealed relating to demand of tyres from external parties:

    Annual Demand (Units) Probability


    95 000 60%
    70 000 25%
    40 000 15%

    2. The project will require an initial investment of R 15 000 000 on specialized machinery. SARS
    allows wear and tear of 15% per annum on machinery. The machinery will be sold for R7 000
    000 at the end of the project.

    3. Siyahamba will use some of the tyres for its bus fleet and avoid paying external suppliers. It
    is expected that the company will save R2 500 per tyre over the next four years. The company
    utilizes 300 bus tyres annually.

    4. Siyahamba will provide managerial services for the project from its head office. The cost of
    the services will be as follows:

    Year 1 Year 2 Year 3 Year 4


    Incremental head office costs R150 000 R150 000 R150 000 R150 000
    Recovery of head overheads R50 000 R50 000 R50 000 R50 000

    5. It is expected that each tyre will be sold for R2 400 over the life of the project. The company
    will incur variable cost of R2 250 per tyre over the life of the project. Siyahamba will have to
    hire a trained machine operator for the project. The operator will earn R830 000 per annum
    over the life of the project.
    6. Assume capital providers require a 16% return and a tax rate of 28%.

    REQUIRED:

    1.1 Calculate the net present value (NPV) and internal rate of return (IRR) of the project.
    (20)

    1.2 Based on your calculations above, recommend whether Siyahamba should invest in
    the project. (Provide reasons for your answer)
    (2)

    1.3 Briefly explain why NPV method is superior that payback period method.
    (3)

    END OF ACTIVITY 4

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