FINANCIAL MANAGEMENT

TUTORIALS
WITH MR PINEAS IKECHUKWU SHEFIKA
CATCH US: +2645608712
 CHAPTER 3: RISK AND RETURN

• CONCEPT OF RISK ~WHAT IS RISK

• BUSINESS RISK: DEGREE OF OPERATING LEVERAGE
DOL=(S-VC)/(S-VC-F)
• FINANCIAL RISK
. DEGREE OF FINANCIAL LEVERAGE
DFL=EBIT/EBIT-I
• DEGREE OF COMBINED LEVERAGE DCF=DOL×DFL
• LET’S NOW LOOK AT TWO EXAMPLES
BUSINESS AND FINANCIAL RISKS
 REQUIRED

• FIND THE DEGREE OF OPERATING LEVERAGE, THE DEGREE OF FINANCIAL LEVERAGE, AND THE
DEGREE OF TOTAL LEVERAGE FOR EACH COMPANY. RECOMMEND ON THE TWO COMPANIES.
 RETURN AND RISKS

QUESTION 3
EMMA DLAMINI IS CONSIDERING TWO INVESTMENTS AND CAN ONLY INVEST IN EITHER THE
SHARES OF COMPANY X OR IN THE SHARES OF COMPANY Y. THE FOLLOWING INFORMATION
REGARDING RETURNS AND PROBABILITY DISTRIBUTIONS OF RETURNS IS RELEVANT:
QUESTION 3 CONTINUED
 CHAPTER 7 COST OF CAPITAL
LEARNING OBJECTIVES

AFTER WORKING THROUGH THIS CHAPTER, YOU SHOULD BE ABLE TO:

■■ UNDERSTAND THE CONCEPT OF THE WEIGHTED-AVERAGE COST OF CAPITAL (WACC).

■■ DETERMINE THE COST OF DEBT.

■■ DETERMINE THE COST OF PREFERENCE SHARE CAPITAL.
■■ CALCULATE THE COST OF EQUITY USING THE DIVIDEND GROWTH MODEL AND THE CAPM APPROACH.
■■ UNDERSTAND THE PRACTICAL ISSUES OF ESTIMATING THE CAPM PARAMETERS.
■■ UNDERSTAND HOW A FIRM’S CAPITAL STRUCTURE AFFECTS A FIRM’S WACC.

■■ CALCULATE A FIRM’S WACC.

■■ UNDERSTAND THE USE OF THE WACC IN DETERMINING A FIRM’S ECONOMIC VALUE ADDED (EVA).

■■ UNDERSTAND ALTERNATIVE METHODS OF DETERMINING THE COST OF EQUITY.

■■ DETERMINE THE COST OF CAPITAL OF DIVISIONS, INCLUDING UNLEVERING AND RELEVERING BETAS.

■■ REFLECT ON ADJUSTMENTS MADE IN PRACTICE TO THE COST OF EQUITY.

■■ COMPREHEND THE EVIDENCE OF THE MARKET RISK PREMIUM BASED ON SURVEYS AND HISTORICAL
WHAT’S EARNED IN THE ENTITY BELONGS TO
INVESTORS
HOW TO FIND THE COST OF CAPITAL
CAPITAL ASSET PRICING MODEL METHOD (CAPM)
 ILLUSTRATIVE QUESTION

• QUESTION 2 : TEST 3 18.05.22

CHAPTER 8: CAPITAL BUDGETING
PROFITABILITY INDEX
 PAY BACK PERIODS

• DISCOUNTED
• UNDISCOUNTED
INTERNAL RATE OF RETURN
NET PRESENT VALUE
ILLUSTRATIVE QUESTION
 REQUIRED

• EVALUATE PROJECTS USING:

1. PAYBACK METHOD
2. DISCOUNTED PAYBACK
3. NPV
4. IRR
5. PI
CHAPTER 9: FURTHER ISSUES OF CAPITAL BUDGETING

• CAPITAL RATIONING:
1. DIVISIBLE PROJECTS – USE PROFITABILITY INDEX TO RANK PROJECTS
2. INDIVISIBLE PROJECTS – GROUP PROJECTS BASED ON AVAILABLE CAPITAL, AND SELECT THE
GROUP THAT IS LIKELY TO MAXIMIZE SHAREHOLDERS WEALTHY.
3. ILLUSTRATIVE QUESTION: QUESTION 1 TEST 3 18/05/22
4. PROJECTS WITH UNEQUAL LIVES
 PROJECTS WITH UNEQUAL LIVES

• CHIOMA HAS N$12,000 TO INVEST EITHER IN PROJECT A OR B. THE FOLLOWING

INFORMATION IS GIVEN
• COST OF CAPITAL 12%

YR 0 1 2 3 4
A -12,000 6,200 6,200 6,200
B -12,000 5,000 5,000 5,000 5,000
 REQUIRED

• WITH THE AID OF EQUIVALENT ANNUAL ANNUITY (EAA), ADVISE CHIOMA ON WHICH PROJECT
TO INVEST HER MONEY.
 CHAPTER 2: TIME VALUE OF MONEY

IS COMPOUND INTERESTTHE MOST POWERFUL FORCE INTHE UNIVERSE?

HOW DO YOU GROW AN INVESTMENT OF $1 INTO $8 571 OVER 49 YEARS? YET, THIS IS WHAT WARREN BUFFETT
MANAGED TO ACHIEVE FOR HIS SHAREHOLDERS. NEARER TO HOME, ALLAN GRAY MANAGED TO DO EVEN BETTER
BY GROWING R10 INTO R142 100 OVER 39.5 YEARS FOR ALLAN GRAY’S INVESTORS. WHAT IS THE COMPOUND
RETURN THAT WARREN BUFFETT AND ALLAN GRAY ACHIEVED FOR THEIR SHAREHOLDERS AND HOW DO THEIR RETURNS
COMPARE TO INVESTING IN THE MARKET INDEX? WE WILL ANSWER THIS QUESTION AND ANALYSE THE FORMULAE AND
APPLICATION OF TIME VALUE OF MONEY PRINCIPLES TO REAL WORLD PROBLEMS. WE WILL ALSO ANALYSE THE ROLE OF
INTEREST RATES AND DETERMINE HOW TO VALUE BONDS.
 CONTENTS

• UNDERSTAND THE ROLE OF TIME VALUE OF MONEY IN FINANCE AND UNDERSTAND THE CONCEPT OF COMPOUND INTEREST.

• ■ USE FORMULAE, TABLES, FINANCIAL CALCULATORS AND SPREADSHEETS TO DETERMINE:

• – THE FUTURE VALUE OF A SINGLE AMOUNT INVESTED TODAY;

• – THE FUTURE VALUE OF AN ANNUITY;

• – THE PRESENT VALUE OF A SINGLE FUTURE AMOUNT;

• – THE PRESENT VALUE OF AN ANNUITY;

• – THE PRESENT VALUE OF A PERPETUITY;

• – THE PRESENT VALUE OF A GROWING PERPETUITY;

• – THE PRESENT VALUE OF A CASH FLOW GROWING AT A CONSTANT RATE OVER A PERIOD OF TIME;

• – THE PRESENT VALUE OF UNEVEN CASH FLOW STREAMS.

• ■ DEFINE AND CALCULATE AN ANNUAL EFFECTIVE RATE.

 FUTURE VALUE

1 FUTURE VALUE

INVESTORS EXPECT TO RECEIVE A RETURN ON THEIR INVESTMENTS IN THE FORM OF INTEREST OR OTHER RETURNS.

WE NEED TO INCREASE THE ORIGINAL AMOUNT INVESTED BY ADDING THE INTEREST THAT ACCRUED DURING THE

TIME OF THE INVESTMENT. FUTURE VALUE IS THE VALUE IN RANDS THAT AN INVESTMENT OR SERIES OF INVESTMENTS

WILL GROW TO OVER A STATED TIME PERIOD AT A SPECIFIED INTEREST RATE. THE FOLLOWING NOTATION WILL FORM THE

BASIS OF THE FORMULAE TO BE APPLIED IN THIS CHAPTER:

FV: THE AMOUNT OF CASH WHICH WILL HAVE ACCRUED BY A GIVEN DATE RESULTING FROM

EARLIER SINGLE SUM OR PERIODIC INVESTMENTS.

PV: THE VALUE OF AN INVESTMENT AT THE BEGINNING OF A PERIOD, SOMETIMES REFERRED TO AS

THE PRINCIPAL SUM.

R: THE INTEREST RATE.

PMT: THE PERIODIC INVESTMENTS OR INSTALMENTS MADE, EXCLUDING SINGLE LUMP-SUM

INVESTMENTS. THIS MAY OCCUR AT THE END OR BEGINNING OF EACH PERIOD.

N: THE NUMBER OF PERIODS FOR WHICH THE INVESTMENT IS TO RECEIVE INTEREST.

 SINGLE AMOUNT
1.Finding the future value

2.Finding the present value

3. Finding the number of years

4. Future value for compounded interests
5. Effective interest rate
EXAMPLE
ANNUITY
1. Find the future value of ordinary annuity

2. Finding the future value of annuity due

3. PV ordinary annuity

4. PV annuity due
PERPETUITY

All annuities discussed so far have a

finite life. The cash flows take place
over a specific
time and then cease. There are cases of
annuities which provide cash flows for
an infinite
period. Such cash flows are called
perpetuities. An example of perpetuity
would be a non-
redeemable preference share paying
a fixed dividend.
 LETS NOW GRASP THE CONCEPT
S2.1
You deposit R10 000 in a bank account which is paying 4.8% per year, interest compounded
annually. How much will you have accumulated in the account in 5 years time? What will
you have accumulated if interest is compounded monthly?
S2.2
You have purchased a motor car for R120 000 and you have obtained a car loan for the total
amount, which requires you to pay this amount over 5 years at an interest rate of 7.2%. If
interest is compounded monthly, determine the monthly payment required over the 5 years
if the first payment is due immediately.

S2.3
What is the present value of a zero coupon bond, with a par value of R100, which is due to
be redeemed in 10 years’ time, when the current market interest rate for such bonds is 6%,
interest compounded semi-annually?
S2.4
You wish to purchase an apartment in Port Elizabeth which is situated in a tree-lined
avenue. The purchase price, with costs, is R710 000 and you are able to obtain a 100%
mortgage loan at an interest rate of 6%, interest compounded monthly. The term of the
loan is 20 years. Assume that property values are expected to rise at a rate of 9% per
year (0.75% per month). You will be able to rent out the apartment after costs at a rate
of R4 000 per month for the first year. Interest and rent are payable at the beginning of
each month.
Required:
What is the expected value of the apartment in 20 years time? What is the mortgage loan
repayment at the beginning of each month? What is the net amount you have to pay in each
month?
 CHAPTER 5 FINANCIAL STATEMENTS ANALYSIS

Dome
• Limited is an industrial holding company. Extracts from the company’s latest annual
Financial Statements as at 30 June 2021 & 2022 are as follows:
 YOU ARE REQUIRED TO:

Calculate all the relevant ratios for Dome Limited as at 30 June 20.2 and
20.1.
 GOOD LUCK

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