Joebel Limited is a diversified company operating in different industries on the African Continent. The shares of the company are widely traded on the stock exchange and currently has a market of GH¢3.20 per share. The company’s dividend payment over the last five years are as follows:
Year Dividend Per Share (DPS)
. (GH¢)
2015 0.35
2014 0.32
2013 0.30
2012 0.29
2011 0.28
The Board of Directors of Joebel Limited are currently considering two main investment opportunities: one in Oil and Gas sector and the other in the Hotel and Tourism Sector. Both projects have short lives and their associated cash flows are as follows;
Year Oil & Gas Hotel & Tourism
. GH¢’000 GH¢’000
1 85 180
2 175 195
3 160 150
The investment in Oil and Gas would cost GH¢400,000 while that in Hotel and Tourism would cost GH¢405,000.
The Management of the Company has identified the industry beta of Oil and Gas and Hotel and Tourism as 1.2 and 1.6 respectively. However, a research conducted by management revealed that Joebel Limited’s beta is 1.5. The average return on the companies listed on the stock exchange is 25% and the yield on Treasury bill is 20%.
Required:
i) Compute the Net Present Values (NPV) of both projects using the company’s weighted average cost of capital as a discount rate. (5 marks)
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Computation of NPV for both projects Using WACC
WORKINGS:
Cost of Capital Using WACC
ii) Compute the NPV using a discount rate which take into account the risk associated with the individual projects. (5 marks)
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Computation of NPV for both projects Using CAPM
WORKINGS:
iii) Advise Management regarding the suitability and acceptability of the projects (1 mark)
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In view of the high risk inherent in the Oil and Gas Project, the Hotel and Tourism project should be selected.