REQUIRED

(a) Calculate the optimal replacement policy for the cars in a choice between a two year or th
Two years replacing cycle
time - 1 2
purchase replacement cost - 23,000
maintenance cost - 756 - 1,050
resale value 17,187
total cash flows - 23,000 - 756 16,137
discounting factor(13%) 1.000 0.885 0.783
present value - 23,000 - 669 12,637
net present value - 11,032
Equivalent cost - 6,614

The optimal replacmenet policy will be the two year replacement cycle as it has the lower equ

(b) Discuss THREE ways a company can incorporate risk and uncertainty into its investment appraisal process. (6 mark

Sensitivity analysis

Sensitivity analysis is whereby the company assess the variability of casflows, the company could asse
change in order to result in a nagative net present value. sensitivity analysis assess one variable at the
sensitive it is toward the NPV of the project.
It does not involve the use of probabilities of the cash flows.
Simulation

simulation also assess how the variables may have to change in order for the project to give the nagati
assess the change of more than one vairiables at the same time. However it does not tell the manage
taken, it only provides the information that the management could use to make the decisions.

(c) Discuss the strengths and weaknesses of internal rate of return in appraising capital investments. (5 marks)

Internal rate of return incorporate the use of relevant cash flows rather than profits. this make it diffic
company to manipulate the results.
It is helpful for the management to make the investment decisions on whether to accept the investme
making the comparision between the cost of capital and the internl rate of return. if the cost of capita
return the the project should not be accepted and should be accepted if it is lower since the internal r
at which the net present value of the investment is at breakeven.
It is possible for one investment project to have more than one internal rate of return, therfore it may
lead to the company making wrong decisions.
Since it is possible for the cost of capital used to be wrong, it may also provide the wrong output infor
incorrent dicisions provided the dicsounting rate calculated is incorrent.
at which the net present value of the investment is at breakeven.
It is possible for one investment project to have more than one internal rate of return, therfore it may
lead to the company making wrong decisions.
Since it is possible for the cost of capital used to be wrong, it may also provide the wrong output infor
incorrent dicisions provided the dicsounting rate calculated is incorrent.
etween a two year or three-year replacement cycle. (9 marks)
Three year replacing cycle
time - 1 2
purchase replacement cost - 23,000
maintenance cost - 756 - 1,050
resale value
total cash flows - 23,000 - 756 - 1,050
discounting factor(13%) 1.000 0.885 0.783
present value - 23,000 - 669 - 822
net present value - 16,995
Equivalent cost - 7,198

e as it has the lower equivalent cost.

ment appraisal process. (6 marks)

ws, the company could assess how much each cashflow could
s assess one variable at the same time and indicate how

he project to give the nagative net present value. It is able to

t does not tell the management the decision that should be
make the decisions.

investments. (5 marks)

n profits. this make it difficult for the management of the

her to accept the investment project proposed or not, by

return. if the cost of capital is more than the internal rate of
s lower since the internal rate of return represents the rate
e of return, therfore it may sometimes be missleading and

ide the wrong output information therefore leading to

e of return, therfore it may sometimes be missleading and

ide the wrong output information therefore leading to

 3

- 2,079
12,894
10,816
0.693
7,496
(a) Explain th
companies m
The rights iss
share.
The Scrip issu
reserve and i
The company
The scrip issu
reduced ther
Making the r
company ma
company.
(d) Renpec Co
term investme
on short-term
Determine th
relevance of t
 REQUIRED
(a) Explain the difference between a rights issue and a scrip issue. Your answer should include comment on the
companies make such issues and the effect of the issues on private investors. (6 mark)
The rights issue is the issue of shares to the existing shareholders at the price lower than the current markent pric
share.
The Scrip issue it the issue of the bonus shares to the existing shareholders. the opmay make the scip issue from t
reserve and isses new share to the shareholders for free since there is no considerration from the shareholder to
The company may make the rights issue to raise finance while when making the scrip issue there is no finace that
The scrip issue may dialute the earning per share of the company and this means that the market share price of t
reduced therefore indicating the reduction is the investor's weath.
Making the rights issue to the existing shareholder of the company does not make the change in the shareholder
company may also make them to make the share price of the company more attractive in the market arpat from
company.

(b) Calculate the theoretical value of:

(i) James Brown’s shareholding if he takes up his rights; and

Existing price of shares 8.00

Rights issue price 1.30

9.30

Theoritical value 1.55

(ii) James Brown’s rights if he chooses to sell them. (4 marks)

Theoritical value 1.55

Rights issue price 1.30

value of rights issue 0.25

(c) Using only the information given below, calculate Jeronimo Co’s cost of equity.

Current share price: $1.60 per share

Dividend paid (cents per share):

20X2: 8 dividends growth rate 10.67%

20X3: 9

20X4: 11 cost of equity 8.30%

20X5: 11

20X6: 12
(d) Renpec Co, a subsidiary of Jeronimo Co, has set a minimum cash account balance of $7,500. The cost to the company of
term investments is $18 per transaction and the standard deviation of its cash flows was $1,000 per day during the last yea
on short-term investments is 5.11%.
Determine the spread, the upper limit and the return point for the cash account of Renpec Co using the Miller-Orr mode
relevance of these values for the cash management of the company. (6 marks)

varience of cashflow 1,000,000

interest rate per day 0.00014

spread 13,757

lower limit 7,500

the upper limit 6,257

the return point 12,086

hould include comment on the reasons why
mark)
er than the current markent price of the company
pmay make the scip issue from the share premium
ration from the shareholder to acquire those share.
rip issue there is no finace that is being raised.
that the market share price of the company may be

the change in the shareholder's wealth and the

ctive in the market arpat from raising funds for the

ty.
 (4 marks)
7,500. The cost to the company of making or selling short-
$1,000 per day during the last year. The annual interest rate

pec Co using the Miller-Orr model and explain the