Question

Question 1

(Show workings)

1.1 A firm’s capital structure comprises: R600 000 Equity and R400 000 long term debt. The cost of equity is 12% and the before tax cost of debt is 12%. If the firm’s tax rate is 30%, determine the firm’s weighted average cost of capital(WACC) and comment if the firm should accept a project if the internal rate of return is 12%.

1.2 Complete table attached

As a newly appointed store manager you are required to draw up a 3 month cash budget to present to your senior manager. The following information are provided: Use 800K, instead of 800 000.     

1. Total sales are projected to be R800 000 for month1 and increasing by 10% each month. 70% of the total sales are cash sales and the remaining 30% is collected the following month from debtors.(there was no amount owing prior to month 1)
2. Purchases are 60% of the total monthly sales, paid in the same month.
3. Rent to be paid will be R36 000 per month.
4. Salaries are expected to be R150 000 per month.
5. A machine will be bought for R50 000 cash in month 2.
6. The opening cash balance was R 56 000 in month 1.

CASH BUDGET
	Month 1	Month 2	Month 3
Sales	800K
Cash sales (70%)
Collections(30%)
Total Receipts(a)
Payments
Purchases
Rent
Salaries
Machine
Total payments(b)
Net surplus/deficit(a-b)
Balance
Surplus/(deficit)

Answer 1

SOLUTION 1.1

WACC = COST OF EQUITY(%) X (EQUITY/TOTAL CAPITAL) + COST OF DEBT(%) (1-TAX%) X (DEBT/TOTAL CAPITAL)

Where,

COST OF EQUITY(%) = 12%

EQUITY = R600000

COST OF DEBT(%) = 12%

TAX% = 30%

DEBT = R400000

TOTAL CAPITAL = R1000000 (R600000 + R400000)

=12% X (600000/1000000) + 12%(1-30%) X (400000/1000000)

=0.072 + 0.0336

=0.1056

=10.56%

WACC is the expected average future costs of funds whereas Internal Rate of return shows the return rate which a firm will get if it invests in a particular project. The firm should accept a project if the IRR is greater than WACC. Here the WACC is 10.56 % and IRR is 12%.

Therefore, the firm should accept the project.

SOLUTION 1.2

	CASH BUDGET
	Month 1	Month 2	Month 3
Sales	800K	880K	968K
Cash sales (70%)	560K	616K	677.6K
Collections(30%)	-	240K	264K
Total Receipts(a)	560K	856K	941.6K
Payments
Purchases	480K	528K	580.8K
Rent	36K	36K	36K
Salaries	150K	150K	150K
Machine	-	50K	-
Total payments(b)	666K	764K	766.8K
Net surplus/deficit(a-b)	(106K)	92K	174.8K
Balance	56K	(50K)	42K
Surplus/(deficit)	(50K)	42K	216.8K

WORKINGS:

SALES

MONTH 1 : 800000 (GIVEN)

MONTH 2 : 800000 + 10% = 880000

MONTH 3 : 880000 + 10% = 968000

CASH SALES ( 70%)

MONTH 1 : 800000 * 70% = 560000

MONTH 2 : 880000*70% = 616000

MONTH 3 : 968000*70% = 677600

COLLECTIONS(30%)

MONTH 1 : NO COLLECTIONS AS NO AMOUNT WAS PENDING BEFORE MONTH 1

MONTH 2 : 800000*30% = 240000

MONTH 3 : 880000*30% = 264000

PURCHASES (60% OF SALES)

MONTH 1 : 800000*60% = 480000

MONTH 2 : 880000 + 60% = 528000

MONTH 3 : 968000 + 60% =580800

RENT, SALARIES, MACHINE (GIVEN)

OPENING BALANCE OF CASH = 56000 (GIVEN)