MAN704 - Advanced Financial Management Assignment - University of Western Cape

Assignment Task

Question

1. Firm Valuation- Harley Davidson

Harley Davidson is American motorcycle manufacturer headquartered in Milwaukee, Wisconsin, United States. Founded in 1903, it is one of two major American motorcycle manufacturers to survive the Great Depression along with its historical rival, Indian Motorcycles.

One of the major revenues producing items manufactured by Harley Davidson is a cruiser bike called Iron 883. Harley Davidson currently has one model on the market and sales have been excellent. However, as with any motorcycle, technology changes rapidly, and the current IRON 883 has limited features in comparison with newer models.

Harley Davidson spent R750 000 to develop a prototype for a new model that has all the features of the existing board but has spent a further R200 000 for a marketing study to determine the expected sales figures for the new model.

Harley Davidson can manufacture the new model for R86 each at variable costs. Fixed costs for the operation are estimated to run R3 million per year. The estimated sales volume is 70 000, 80 000, 100 000, 85 000 and 75 000 per each year for the next five years, respectively. The unit price of the new model will be R250. The necessary equipment can be purchased for R15 million and will be depreciated on a three-year 50:30:20 schedule. It is believed the value of the equipment in five years will be R3 million.

As previously stated, Harley Davidson currently manufactures IRON 883. Production of the existing model is expected to be terminated in two years. If Harley Davidson does not introduce the new model, sales will be 80 000 units and 60 000 units for the next two years, respectively. The price of the existing model is R240 per unit, with variable costs of R68 each and fixed costs of R1 800 000 per year. If Harley Davidson does introduce the new IRON 883, sales of the existing model will fall by 15 000 units per year, and the price of the existing units will have to be lowered to R220 each. Net working capital for the IRON 883’s will be 20 per cent of sales and will occur with the timing of the cash flows for the year; for example, there is no initial outlay for NWC, but changes in NWC will first occur in Year 1 with the first year’s sales. Harley Davidson has a 29 per cent corporate tax rate and a 12 per cent required return. The CEO has asked you as finance graduate to prepare a report that answers the following questions:

• What is the IRR of the project?
• What is the NPV of the project?
• What is the payback period of the project?
• What is the profitability index of the project?

2. Bond Valuation

1. RMB which is a subsidiary of the FNB group issues a R1,000 000 bond with a 10% coupon rate and a 3-year life. Similarly, firms within the financial services industries are paying 10% for their 3-year bonds. What would you pay for this bond?

2. Considering their strategy to expand into renewable energy transition, RMB further issued another two-year bond with a face value of R100, a coupon rate of 10% and a yield to maturity of 5%. What is the bond’s duration?

3. Share valuation & Cost of equity and debt

a. Thungela had a successful year at the backdrop of high commodity prices as such they paid a dividend of R0.50. It is expected to increase its dividend by 2% per year. If the market requires a return of 15% on assets of this risk, how much should the share be selling for?

b. Exxaro holdings which is a direct competitor to Thungela, shares are selling for R10.50. just like their competitor, they just paid a R1 dividend, and dividends are expected to grow at 5% per year considering that there is high demand for coal. As an analyst covering resource stocks, find the following:

• Dividend yield
• Capital gains yield
• Required return 

c. Given the volatility of the precious gold metal stocks, Impala platinum has a beta of 1.25. The risk-free rate proxied by the R186 Government Bond is 4% and the expected return on the market as proxied by the FTSE/JSE SWIX index is 11.2%. What is impala platinum cost of equity?

d. ABC Ltd has a 15-year, 12% semi-annual coupon bond, which is currently selling for R1,153.72. What is the cost of debt? Assume a 30% marginal tax rate.

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