- 25 Marks
FM – MAY 2018 – L2 – Q3 – Cost of capital | Introduction to Investment Appraisal
Involves the calculation of the cost of various sources of capital, the weighted average cost of capital (WACC), and the net present value (NPV) of a proposed project, as well as an explanation of transaction and economic exposures and methods of mitigating transaction exposure.
Question
a) Okechukwu Ltd is financed by three types of capital:
- i) 1 million 50p ordinary shares each having a current market value of GH¢5.20 cum div. The current dividend, which is due to be paid shortly, is 20p per share. The dividend has grown steadily in the past at a compound annual rate of 15% and is generally expected to continue doing so indefinitely.
- ii) 200,000 GH¢1 irredeemable 8% preference shares, each having a current market value of 50p ex div.
- iii) GH¢2 million 10% debentures, redeemable in 20 years at a price of 110. The current market value is 80 ex int.
Okechukwu is considering a new project having the same risk characteristics as existing projects, which would require an immediate outlay of GH¢150,000 and would produce annual net cash inflow of GH¢30,000 indefinitely.
Required:
Evaluate the viability of the new project using appropriate computations.
(15 marks)
b) Foreign currency risk can be managed to reduce or eliminate the risk. Measures to reduce currency risk are known as hedging.
Required:
i) Explain Transaction and Economic Exposure.
(5 marks)
ii) Explain FIVE ways of mitigating transaction exposure.
(5 marks)
Find Related Questions by Tags, levels, etc.
- Tags: Cost of Equity, Debentures, Economic Exposure, NPV, Preference shares, Transaction Exposure, WACC
- Level: Level 2
- Topic: Cost of capital, Introduction to Investment Appraisal
- Series: MAY 2018
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