MAC3702/Exam Practise Questions

MAC3702/Exam Practise Questions 1 Exam Practise Questions: Extract from Managerial Finance (Sixth edition) The following questions were extracted - with permission from the publishers (© LexisNexis) - from the Sixth edition of Managerial Finance. These questions will assist you in your preparation for the exams; therefore it is important to work through them as indicated in your (amended) study guide. These questions are only available in English. Question 7–2 40 marks 60 minutes Optical Illusion Ltd has until recently imported glass optical lenses and mirrors which it sells on the South African market. Management is of the opinion that the company should manufacture its own brand of lenses and has decided to invest in a new, state-of-the-art spectrophotometer. The new investment by the company is considered to be a very high risk, as success is dependent on the ability to export a high proportion of manufactured lenses. The spectrophotometer costs R2 400 000 and has an expected useful life of six years and nil scrap value. The machine will be written off in equal annual instalments, as allowed by the SARS, over three years. The maintenance costs are expected to be nil in the first year and R25 000 in the second year, rising by R25 000 in each of the subsequent years. These costs can be assumed to be paid at the end of the year in which they are incurred. The following purchase options have been identified by management: 1 A six-year bank loan at a before tax cost of 20%. 2 Issue 10% preference shares that will be converted to ordinary shares at the end of six years. 3 As an alternative to purchasing the spectrophotometer, the company could lease it. Two types of leasing agreements have been proposed: Type 1 This lease would run for six years at a cost of R550 000 per annum, payable at the beginning of each year. After six years, Optical Illusion Ltd could purchase the asset for a nominal amount. Optical Illusion Ltd would not be responsible for the maintenance of the machine and the lease would not be cancellable. Type 2 This lease would run initially for three years at a cost of R750 000 per annum, payable at the start of the year. At the end of the three years, the lease could be renewed for a further three years at a cost of R450 000 per annum, payable at the start of the year. The leasing company would be responsible for the maintenance of the machine. The lease would be cancellable by Optical Illusion Ltd at any time after the first twelve months. There would be no cancellation charges. The current company tax rate is 40%. The asset is to be purchased or leased on 1 October 20X0. The company’s year-end is 31 December and company tax is paid nine months after the end of the accounting period to which it relates