MAC3702/QB001/4/2021

QB001/4/2021
Question Bank

Application of Financial Management

Techniques
MAC3702

Semesters 1 and 2

Department of Management Accounting

This question bank is only available in English.

These questions must be used to improve examination technique and topic

understanding.

Open Rubric
 MAC3702/QB001

INTRODUCTION

Dear Student,

Attached please find practice questions with their suggested solutions. We suggest that you
do work through these questions as if under exam conditions, making use of the allocated
marks and time as guidelines. Only once you have completed the integrated questions, you
should compare your answer to the suggested solutions. Your answers to these practice
questions must not be submitted to Unisa, it is purely for self-assessment purposes.
These integrated questions will indicate to you the standard required of you in the exam and
will help you to identify areas of weaknesses that you must pay attention to. Please note that
the questions in the exam will never look exactly the same as any other question, however,
the principles always stay the same.

Please refer to additional practice questions and the question bank posted on myUnisa under
“Additional resources” for more practice questions. Below we have also provided frequently
asked questions (FAQs), especially concerning the exam.

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FREQUENTLY ASKED QUESTIONS

1. Can I expect to see identical examination questions as included in previous exam papers or
other questions included in the assignment questions or in other tutorial letters?

No. You will not get questions that you have seen before, although the exam paper will test the
same principles as the questions included in past papers, practice case studies, assignment
questions and the study guide. The principles will be tested on a level that is acceptable for
third year students. Please work through all the examples and questions referenced in the
tutorial letters, assignment questions and the solutions, case studies, additional practice
questions and the question bank (all available on myUnisa). Once working through all these
different examples you will get an understanding of the different methods as to how the
principles can be tested.

2. Which topics are examinable?

All topics are examinable and you should refer to your tutorial letters as well as the MAC3702
Managerial Finance 8th Edition Study Outline file (under Additional Resources/Managerial
Finance 8th Edition FAQ and Explanation) which highlight key areas to focus on and sections
that are excluded from the MAC3702. You are encouraged to attempt all the assignments on
your own and well in advance to prepare you for the examination.

3. Do I only need to focus on the information included in the MAC3702 study guides and tutorial
letters or do I also need to have knowledge of MAC2602?

In your tutorial letters of MAC3702, we refer to assumed prior knowledge and we refer you to
the study guide of MAC2602. If you have not done this specific module (MAC2602) but an
equivalent one, please make sure that you make use of the study material available on the
website relating to MAC2602.

4. Will I receive a formula sheet or do I need to know my formulas?

Only certain formulas may be provided to you should they be tested in the exam.

These formulas include the following:

1. Formulas to calculate the beta coefficient

2. Covariance and standard deviation
3. Portfolio variance based on the correlation coefficient
4. Correlation coefficient
NB. You still need to know all other formulas by heart.

5. What is the examination format of the tests and year end examination for MAC3702?

The MAC3702 examination will be out of 100 marks (3-hour duration). The paper may consist
of two questions or just one question, and in both instances the paper will comprise of all the
topics covered in the MAC3702 syllabus.

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6. Do I need to write out the formula (for ratio calculation) or can I substitute my amounts directly
into the formula to save time?

Writing down the formula and substituting the components / elements will enable the marker to
follow your thought process and may lead to conceptual / principle marks when applicable.
However, it should be noted that no marks are awarded for simply providing the formula.

7. When computing ratios, should we use the average or closing balances if using balance
sheet accounts?

ONLY when the question specifically states that average balances should be used. In all other
instances use the CLOSING BALANCES. You are encouraged to know how to apply both
methods. It should also be noted that when computing ratios, book values must be used instead
of market values, unless specifically instructed to or if the ratio formula requires a market value.

8. In the examination, will we be given specific ratios to compute or will we be required to

compute all ratios under a particular category (e.g. Profitability, Capital Structure/Solvency or
Liquidity)?

You will be asked specific ratios that you need to compute and these will cover different
categories as outlined in your textbook. However, students may be required to compute ratios
under a particular category in an assignment or an FI concession assessment. You are advised
to study all ratios covered in the textbook and know the formulas off by heart. Cash flow related
ratios are not covered in MAC3702 syllabus.

9. When commenting on ratios, are there marks allocated for stating that there was an
increase/decrease between two different periods?

No. Marks are only awarded if relevant comment is provided over and above simply stating
there was an increase or decrease. You are advised to study the REQUIRED carefully to
understand whether you need to provide reasons for the increase or if you are required to
generally comment on the ratios. Remember to apply your comment to the scenario and not to
simply “dump” generic statements.

10. What should be included in the debt balance of the debt : equity ratio?

The debt (or interest bearing debt) balance should include all the interest bearing debt
balances (this includes both the long- and short term portions of long term loans). Bank
overdraft is usually not included in the debt balance as the bank overdraft is normally used to
finance working capital shortfalls, unless the scenario / information depicts the overdraft to be
of a permanent nature.

11. Are preference shares to be classified as equity or liability?

For simplicity, in MAC3702 the distinguishing factor is whether the preference shares are
redeemable or irredeemable. Redeemable preference shares are classified as a long-term
liability and irredeemable (or non-redeemable) preference shares fall under equity.

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12. Can I make use of my calculator when calculating the Internal Rate of Return (IRR)?

If the question does not specify that you need to use the formula, you may use your calculator.

HOWEVER:

You need to write down the amounts and steps entered into your calculator and the type of
calculator (CASIO, SHARP or HP) used. Marks will be allocated to these amounts and steps.

13. When calculating the Net Present Value, should I use the factors included in the table or can
I use my calculator?

No tables will be provided in the exams. However, you will be allowed to use a calculator. You
need to write down the amounts and steps entered into your calculator and the type of calculator
(CASIO, SHARP or HP) used. Marks will be allocated to these amounts and steps. There is no
need for writing discount factors when a financial calculator is used. If you do not have a
financial calculator, please make sure that you know the TVM formulas as they will not be
provided in the exam.

14. Will the valuation methods only be tested as part of Mergers and Acquisitions or will it be tested
separately?

You may be tested on both of the above. If an exam includes a valuation question, only one of
the two options will be tested (that is to say either as part of a Mergers and Acquisition question
or as a standalone valuation question).

15. In the examination, are we told which valuation method we should use?

The question will provide guidance as to which method you should use to carry out the
valuation. This information at times may not be clear and you are advised to always know which
methods are applicable.

16. When using the free cash flow method for valuation purposes, the non-operating assets of
the entity will not form part of the free cash flow valuation and should be valued separately.
What is the implication thereof?

It means that you will only include cash flow that represents the operational cash flow that is
“free” for distribution to all providers of capital independent of the way the business is financed.

Therefore, you need to EXCLUDE:

 Non-operational cash flow as non-operating assets should be valued separately

 Non-cash charges (depreciation and amortisation)
 Finance related cash flows

Therefore, you need to INCLUDE:

 The effect of capital expenditure and working capital investment that are necessary to
sustain the projected future free cash flow
 The taxation effect of the cash flows included

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Once you have determined the value by making use of the free cash flow method you will also
value the non-operating assets and the combined value is the value of the entity.

You may be tested on the free cash flow method where you need to exclude and include the
relevant cash flows but we will not examine you on the principle of the combined value. This is
only tested in later MAC modules.

17. When calculating WACC, should I use market values or book values?

Always make use of your market values unless the question specifically states that you need
to use the book values or if the only information available is the book values and there is no
information with relation to the market values. Note that the target capital structure should
always be used first if given in the scenario.

18. How do I take tradability (marketability) discounts into consideration when I value a company?

A scenario may be provided with a tradability discount information – in this case, you should
apply the tradability discount given. In the event that no tradability discount information is
provided and there are clear indications that tradability is an issue (very likely to be so in an
unlisted company), take it into account using your own discretion to decide on %. As a guideline
a discount of between 0% and 15% would be deemed reasonable – however, cue should
always be taken from the information provided.

19. How do I take minority interest discount and control premium into consideration when I value
a company?

Similar to the point above on marketability discount, the scenario may provide you with the
minority interest discount (decrease valuation) or control premium (increase valuation) to be
applied in the valuation. Where this is not given, yet the scenario indicates that there is
underlying control of the business or the stake being valued is for a minority interest, discretion
should be used to establish the fair discount % or premium %. An adjustment ranging from 0%
to 15% should be considered.

20. How do I know by how much the given P/E ratio in valuation calculation needs to be adjusted?

This relates to where a scenario provides an industry (or similar) P/E ratio and risk factors
need to be taken into account to determine a company’s adjusted P/E ratio (+/-). It should be
noted that students can discretionally adjust the P/E ratios as long as they are able to
substantiate why factors increase or decrease the P/E ratio given. An adjustment of more
than 3 points may be deemed less appropriate. NB: When marketability or control premium
is included in your adjusting factors for the P/E ratio then it is not necessary to further
add/deduct from the value.

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Table of contents – QUESTIONS

ANALYSIS OF FINANCIAL INFORMATION, STRATEGY AND RISK MANAGEMENT
Question 01: EDCARS ..................................................................................................... 11
Question 02: CARLO TITO MARIO AFRICA ..................................................................... 17
Question 03: DRESSED FOR SUCCESS ......................................................................... 22
Question 04: SPLITZ STORES ......................................................................................... 25
Question 05: NEW MUTUAL ............................................................................................ 26

WORKING CAPITAL MANAGEMENT

Question 06: TOY STARS ................................................................................................ 29
Question 07: A GREYS .................................................................................................... 31
Question 08: ZENZEL ....................................................................................................... 33

CAPITAL STRUCTURE AND COST OF CAPITAL

Question 09: KINGSTON .................................................................................................. 34
Question 10: QUEEN POWER ......................................................................................... 36
Question 11: CHAPTERS & NOVELS ............................................................................... 39
Question 12: SIMON & SON ............................................................................................. 42
Question 13: S & S ........................................................................................................... 45
Question 14: SIMUNYE GOLD ......................................................................................... 46

CAPITAL BUDGETING
Question 15: SANRAL ...................................................................................................... 49
Question 16: MASHESHA ................................................................................................ 51
Question 17: PICTURE PERFECT .................................................................................... 53
Question 18: CITY OF NKANDLA ..................................................................................... 54

Question 19: PURIFIED H2O ............................................................................................ 56

Question 20: AFRICAN FISH & CHIPS ............................................................................. 58

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VALUATIONS AND MERGERS & ACQUISITIONS

Question 21: KGORONG .................................................................................................. 65
Question 22: AFRICAN BAG ............................................................................................ 66
Question 23: FAST AND QUICK........................................................................................ 67
Question 24: FAZEBOOK ................................................................................................. 68

Question 25: BOXER CASH & CARRY ............................................................................ 71

Question 26: LION BRANDS ............................................................................................ 74

INTEGRATED QUESTIONS
Question 27: PBC LIMITED .............................................................................................. 78
Question 28: umfula.co.za ................................................................................................ 83
Question 29: HEALTH MATTERS .................................................................................... 87
Question 30: DISTELL ...................................................................................................... 94
Question 31: TILES & STYLES OF AFRICA ................................................................... 103
Question 32: MAGNUS ORANGE .................................................................................. 112
Question 33: MBOWENI TRADING ................................................................................ 117

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Table of contents – SOLUTIONS

ANALYSIS OF FINANCIAL INFORMATION, STRATEGY AND RISK MANAGEMENT
Solution 01: EDCARS ..................................................................................................... 125
Solution 02: CTMA ......................................................................................................... 131
Solution 03: DRESSED FOR SUCCESS ........................................................................ 148
Solution 04: SPLITZ STORES ........................................................................................ 152
Solution 05: NEW MUTUAL ............................................................................................ 154

WORKING CAPITAL MANAGEMENT

Solution 06: TOY STARS ............................................................................................... 156
Solution 07: A GREYS .................................................................................................... 159
Solution 08: ZENZEL ...................................................................................................... 161

CAPITAL STRUCTURE AND COST OF CAPITAL

Solution 09: KINGSTON ................................................................................................. 165
Solution 10: QUEEN POWER ........................................................................................ 167
Solution 11: CHAPTERS & NOVELS .............................................................................. 170
Solution 12: SIMON & SON ............................................................................................ 175
Solution 13: S & S .......................................................................................................... 180
Solution 14: SIMUNYE GOLD ........................................................................................ 182

CAPITAL BUDGETING
Solution 15: SANRAL ..................................................................................................... 188
Solution 16: MASHESHA ................................................................................................ 192
Solution 17: PICTURE PERFECT ................................................................................... 196
Solution 18: CITY OF NKANDLA .................................................................................... 199

Solution 19: PURIFIED H2O ........................................................................................... 202

Solution 20: AFRICAN FISH & CHIPS ............................................................................ 204

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VALUATIONS AND MERGERS & ACQUISITIONS

Solution 21: KGORONG ................................................................................................. 216
Solution 22: AFRICAN BAG ........................................................................................... 219
Solution 23: FAST AND QUICK ....................................................................................... 220
Solution 24: FAZEBOOK ................................................................................................ 223

Solution 25: BOXER CASH & CARRY ............................................................................ 227

Solution 26: LION BRANDS ........................................................................................... 230

INTEGRATED QUESTIONS
Solution 27: PBC LIMITED ............................................................................................. 235
Solution 28: umfula.co.za ............................................................................................... 238
Solution 29: HEALTH MATTERS .................................................................................... 244
Solution 30: DISTELL ..................................................................................................... 260
Solution 31: TILES & STYLES OF AFRICA .................................................................... 269
Solution 32: MAGNUS ORANGE .................................................................................... 277
Solution 33: MBOWENI TRADING ................................................................................. 289

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 MAC3702/QB001

QUESTION 01: EDCARS (120 marks; 3½ hours)

Edcars Group Limited (also known as “Edcars”) is the largest non-food retailer in South Africa
and is listed on the Johannesburg Stock Exchange (JSE). The company is the leading retailer
of clothing, home appliances, stationery, cosmetics, accessories and cellular products in
Southern Africa with more than 3 000 retail stores, the majority of which are in South Africa.
Edcars caters for different LSM groups and also has become one of South Africa’s most
trusted brands.
The company’s main rivals are clothing retailers with less exposure in home appliances and
cellular products retail market than Edcars. Home appliances and related cellular products
tend to have quite higher margins than the clothing segment and these items are generally
sold on credit due to their high value.
The influx of discounted Chinese imports, coupled with high unemployment rates, has put the
company’s profit margins under pressure. The recent depreciation of the rand against world’s
major currencies (exacerbated by local politics) has sent the JSE share index into a downward
spiral and the shareholders of Edcars Group Limited have also seen a sharp decline in their
investment value in the company.
Edcars managed to increase its sales in the current year by almost a double digit figure,
despite strict lending guidelines by the National Credit Regulator (NCR). This increase is partly
as the result of a more robust marketing campaign the company embarked on during the
financial year. Fifteen new stores opened in November 2015 and have performed above
expectations. Management of Edcars has invested a significant amount of capital in getting
these stores fully functioning.
The prime lending rate during the current financial year was 11,25% per annum and there are
365 days in a year. The target capital structure of Edcars Group Limited is 40: 60.
The statement of comprehensive income and the statement of financial position of Edcars
Group Limited are provided below:

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Statement of comprehensive income

For the year ended 30 September 2016

R million Notes 2016

Revenue 1 23 700
Cost of merchandise (13 300)
Gross profit 10 400
Other operating income 1 500
Other income 2 1 100
Trading expenses 3 (9 000)
Net finance costs 4 (1 000)
Profit before taxation 3 000
Taxation 5 ( 900)
Profit for the year 2 100
Dividends - Interim (600)
Dividends - Final (700)
Retained income for the year 800

Weighted average number of shares (million) 200

Number of outlets 3 100
Staff complement 22 200
Share price – closing (cents) 14 000

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Statement of financial position

At 30 September 2016

R million Notes 2016

Non-current assets
Property, plant and equipment 3 300
Other Investments 2 4 700
Goodwill 500

Current assets
Inventory 5 100
Trade and other receivables – retail 6 700
Prepayments 900
Cash and cash equivalents 800
Total assets 22 000

Capital and reserves

Stated capital 700
Other reserves 400
Retained income 8 800
Total equity 9 900

Non-current liabilities
Long-term portion of interest-bearing debt 4 5 300
Deferred taxation 300
Post-retirement medical benefits 200

Current liabilities
Short-term portion of interest-bearing debt 4 3 000
Trade and other payables 3 200
Operating lease liability 100
Total equity and liabilities 22 000

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NOTES
1. Of the R23,7 billion sales made during the year, about R16,6 billion were on credit.
Over the years, Edcars has maintained healthy relations with its suppliers resulting in
discounts received and flexible terms of payment. Purchases for the year amounted to
R12,1 billion of which 90% was secured on credit. The company also maintains a gross
profit percentage of 32% on clothing brands (viz. excluding homeware and cellular
products).

2. Other income relates to dividends received from investments (marketable securities)

in listed retail companies outside the country.

3. Trading expenses comprise of:

R million
Trading expenses
Depreciation and amortisation 500
Employee costs 3 200
Occupancy costs 2 000
Net bad debts 1 000
Other operating costs 2 300
9 000

4. Finance costs for the year amounted to R1,2 billion and interest income received on
credit bank balance was R200 million. Interest-bearing debt at 30 September 2015
was R11 billion.

5. The corporate taxation rate is 28%.

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REQUIRED
a) Calculate the following profitability ratios for Edcars Group Limited for the year ended
30 September 2016 and provide possible explanation for any changes in these ratios
from 2015 (2015 ratios are provided below in brackets).
[Round answers to two decimal places]
a. Gross profit margin (41,85%)
b. EBIT margin (13,66%)
c. EBITDA margin (15,06%)
d. Net profit margin (7,07%)
e. Effective tax rate (27,79%)
f. Bad debt as % of sales (6,52%)
g. Total operating costs per store (R2,42m)
h. Revenue per employee (R0,88m)

(Calculations 16 marks & comments 8 marks)

(24)
b) Calculate the following return on capital ratios for Edcars Group Limited for the year
ended 30 September 2016 and provide possible explanation for any changes in these
ratios from 2015 (2015 ratios are provided below in brackets).
[Round answers to two decimal places]
a. Return on other investment (27,19%)
b. Return on assets (12,37%)
c. Return on equity (20,94%)
d. Return capital employed (15,70%)
e. Non-current asset turnover (2,22 times)

(Calculations 10 marks & comments 5 marks)

(15)
c) Calculate the following liquidity ratios for Edcars Group Limited for the year ended 30
September 2016 and provide possible explanation for any changes in these ratios
from 2015 (2015 ratios are provided below in brackets).
[Round answers to two decimal places]
a. Current ratio (2,01: 1)
b. Acid-test ratio (1,30: 1)
c. Cash ratio (0,31: 1)
d. Debtors’ days (180 days)
e. Creditors’ days (89 days)
f. Inventory days (129 days)
g. Business days (220 days)
h. Inventory turnover (2,83 times)

(Calculations 16 marks & comments 8 marks)

(24)

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d) Calculate the following capital structure/solvency ratios for Edcars Group Limited for
the year ended 30 September 2016; and where possible provide explanation for any
changes in these ratios from 2015 (2015 ratios are provided below in brackets).
[Round answers to two decimal places]
a. Interest cover (2,75: 1)
b. Net interest cover (2,78: 1)
c. Effective interest rate (11,28%)
d. Interest-bearing debt to EBITDA (2,99: 1)
e. Interest-bearing debt to equity (86,32%)
f. Net interest-bearing debt to equity (77,34%)
g. Total debt ratio (56,21%)
h. Capital gearing ratio (46,95%)
i. Existing capital structure vs target capital structure

(Calculations 18 marks & comments 8 marks)

(26)
e) Calculate the following financial market/investor ratios for Edcars Group Limited for
the year ended 30 September 2016; and where possible provide explanation for any
changes in these ratios from 2015 (2015 ratios are provided below in brackets).
[Round answers to two decimal places]
a. Earnings per share
b. Dividend per share
c. P/E ratio (14,2)
d. Earnings yield (7,04%)
e. Dividend yield (3,8%)
f. Dividend cover (2,0 times)
g. Dividend pay-out ratio (50,14%)
h. Price / book value multiple (3,18: 1)
i. Price / sales multiple (1,44: 1)

(Calculations 18 marks & comments 7 marks)

(25)
f) Describe key risks faced by Edcars Group Limited.
(6)
TOTAL: 120 MARKS

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QUESTION 02: CARLO TITO MARIO AFRICA (160 marks; 4¾ hours)

Carlo Tito Mario Africa (“CTMA”) is South Africa’s leading retailer of tiles, bathroom fixtures
and related products. The company provides superior ceramic tile flooring and walling at
competitive prices to a growing market. Listed on the JSE in 2013, today CTMA has a network
of 162 retail stores (excluding the online platform) in the Southern African Development
Economic region (SADEC) and the east coast of Australia.

As the company continues to enjoy strong brand affinity based on its reputation for a high
quality year-round value offering, the market capitalisation of CTMA at the end of its 2017
financial year was R9,457 billion (market value of equity), a jump of 12,75% from the previous
year. This was despite constrained discretionary disposable income of its customers and the
Rand plunging to its lowest levels in more than 15 years against major currencies.

The Competition Tribunal has just approved the company’s offer to acquire 51% of Ceramic
Industries (Pty) Ltd (“Ceramic Industries”), one of its suppliers in an effort to ensure that the
company continues to attain its growth targets. CTMA has offered R5 billion in cash to the
existing shareholders of Ceramic Industries. This strategic acquisition has been well received
by the market, as it will likely lead to cost reduction and other synergistic benefits. CTMA also
continues to invest substantially in information technology and e-commerce to keep abreast
of opportunities in the rapidly changing environment. For ratio computation, CTMA uses
closing balances and book values except for effective interest rate and financial/investor ratios
where specific balances and values must be used in line with the formula.

The statements of comprehensive income and of financial position of Carlo Tito Mario Africa,
including salient information, are presented below.

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Statement of comprehensive income of Carlo Tito Mario Africa

For the year ended 31 December 2017
2017 2016
Notes Rm Rm
Revenue 6 662 6 819
In-store sales 6 058 6 585
Online sales 604 234
Cost of sales (3 748) (3 925)
Gross profit 2 914 2 894
Maintenance and other indirect expenses (301) (308)
Personnel costs (1 003) (1 031)
Depreciation, amortisation and impairments (410) (372)
Other operating expenses (256) (283)
Profit before interest and taxation 944 900
Finance costs (125) (113)
Finance income 24 8
Profit before taxation 843 795
Taxation (157) (150)
Net profit for the year 686 645
Interim dividend (70) (70)
Final dividend (134) (110)
Retained income for the year 482 465

SALIENT INFORMATION 2017 2016

Trading days 365 366
Number of retail stores 162 182
Number of employees (000) 25,4 26,1
Prime rate (%) 10,3 10,5
Corporate taxation rate (%) 28,0 28,0
Inflation rate (%) 4,8 6,4

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Statement of financial position of Carlo Tito Mario Africa

For the year ended 31 December 2017
2017 2016
Notes Rm Rm
ASSETS
Property, plant and equipment 3 788 3 659
Goodwill 681 590
Intangible assets 334 151
Deferred tax 61 58
Other non-current assets 102 68
Total non-currents assets 4 966 4 526

Inventories 850 838

Trade and other receivables 1 049 994
Marketable securities 41 47
Cash and cash equivalents 404 64
Total current assets 2 344 1 943
TOTAL ASSETS 7 310 6 469

EQUITY AND LIABILITIES

Stated capital 542 542
Retained income and other reserves 3 154 2 645
Total equity 3 696 3 187

LIABILITIES
Medium and long-term borrowings 1 912 2 077
Net retirement benefits liability 240 212
Provisions 44 40
Total non-current liabilities 2 196 2 329

Short-term borrowings (bank overdraft) 651 250

Trade and other payables 600 538
Current tax liability 167 165
Total current liabilities 1 418 953
TOTAL EQUITY AND LIABILITIES 7 310 6 469

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REQUIRED
a) Calculate the following ratios for both the 2016 and 2017 financial years, and provide
possible reasons and ways to improve these ratios going forward.
i). Gross profit margin
ii). Change in online sales (2016 already calculated: 18,1%)
iii). Average salary
iv). Return on capital employed
v). Inventory turnover
vi). Debt: equity ratio
vii). Price-earnings ratio

(Calculation 14 marks, Comment 14 marks, presentation 2 marks)

(30)

b) Calculate the following ratios for both the 2016 and 2017 financial years, and provide
possible reasons and ways to improve these ratios going forward.
i). EBIT margin
ii). Change in personnel cost (2016 already calculated: 7,3%)
iii). Average sales generated by a store
iv). Return on equity
v). Cash ratio
vi). Capital gearing ratio
vii). Earnings yield

(Calculation 14 marks, comment 14 marks, presentation 2 marks)

(30)

c) Calculate the following ratios for both the 2016 and 2017 financial years, and provide
possible reasons and ways to improve these ratios going forward.
i). EBITDA margin
ii). Change in cost of sales (2016 already calculated: 3,7%)
iii). Online sales as % of revenue
iv). Return on assets
v). Acid-test ratio
vi). Interest-bearing debt: equity (net)
vii). Dividend cover

(Calculation 14 marks, comment 14 marks, presentation 2 marks)

(30)

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d) Calculate the following ratios for both the 2016 and 2017 financial years, and provide
possible reasons and ways to improve these ratios going forward.
i). Net profit margin
ii). Change in net finance costs (2016 already calculated: 4,0%)
iii). Operating profit per store
iv). Non-current asset turnover
v). Current ratio
vi). Total debt ratio
vii). Creditors' payment period
viii). Times interest earned
ix). Dividend yield
x). Price/book value multiple

(Calculation 20 marks, comment 20 marks, presentation 2 marks)

(42)

e) Calculate the following ratios for both the 2016 and 2017 financial years, and provide
possible reasons and ways to improve these ratios going forward.
i). Asset turnover
ii). Inventory days
iii). Debt: EBITDA
iv). Price/sales multiple
v). Debtors' collection period
vi). Times interest earned (net)
vii). Dividend pay-out ratio

(Calculation 14 marks, comment 14 marks)

(28)

TOTAL: 160 MARKS

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QUESTION 03: DRESSED FOR SUCCESS (30 marks; 54 minutes)

Dressed For Success Limited trades in the retail clothing sector and is listed on the general
retail sector of the Johannesburg Securities Exchange (JSE). The company focuses on young
buyers. Their unaudited results for 31 December 2X14 are shown below:

Statement of comprehensive income for the year ended 31 December 2X14

2X14 2X13
R’000 R’000

Turnover 908 191 814 521

Cost of sales (563 078) (553 874)

Opening inventory 120 000 198 000
Purchases 657 078 475 874
Less: Closing inventory (214 000) (120 000)

Gross profit 345 113 260 647

Operating expenses (187 634) (125 340)
Operating profit before other income, interest and tax 157 479 135 307
Finance charges (net) (23 547) (18 712)
Profit after interest before tax 133 932 116 595
Tax (37 500) (32 647)
Profit after tax 96 432 83 948

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Statement of financial position at 31 December 2X14

2X14 2X13
R’000 R’000
ASSETS
Non- current assets 330 187 314 124
Current assets 462 434 261 033
Inventory 214 000 120 000
Trade receivables 89 669 45 421
Cash balances and investments 158 765 95 612

Total Assets 792 621 575 157

EQUITY AND LIABILITIES

Equity 343 876 294 876
Ordinary share capital 82 000 82 000
(82 million ordinary shares at R1 each)
Accumulated reserves 261 876 212 876

Non-current liabilities 188 386 111 579

Long term loan 188 386 111 579
Current liabilities 260 359 168 702
Trade payables 185 269 140 174
Accruals and provisions 75 090 28 528

Total equity and liabilities 792 621 575 157

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Financial ratios of Dressed For Success Limited

Ratio 2X13 2X14

(i) Gross profit percentage 32% ?

(ii) Net operating profit percentage 16,6% ?
(iii) Change in turnover 10,3% ?
(iv) Return on assets 23,5% ?
(v) Return on equity 28,5% ?
(vi) Debtors collection period 29,1 days ?
(vii) Inventory turnover 4,6 times ?
(viii) Debt equity ratio 37,8 : 1 ?
(ix) Cash ratio 0,57 : 1 ?

Additional information:
 The company launched a new exclusive clothing brand at the beginning of 2X14 which
is very popular amongst most teenagers.

 The annual sales occurred evenly throughout the year. Of the turnover in 2014, 65%
was credit sales. This represents a slight decrease from the 70% credit sales in 2X13.
The financial manager has reviewed the company’s credit sales policy and intends to
decrease credit sales to 55% of turnover from 2X15 onwards.

 All inventories are purchased on credit. A substantial part of the new clothing brand is
imported from China. This inventory is ordered in large quantities to save on shipping
costs. The budgeted turnover of the company is R1 089 829 000 for 2X15.

 There are 365 days in a year and the company tax rate is 28%.

 You may ignore the impact of VAT.

REQUIRED

a) Calculate ratios (i) to (ix) for 2X14 in the table above, and provide possible reasons for
the deterioration or improvement thereof from 2X13 to 2X14. Take the additional
information into account for providing these reasons. Round your final answer to the
nearest decimal place.
TOTAL: 30 MARKS

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QUESTION 04: SPLITZ STORES (18 marks; 32 minutes)

Splitz Stores (Pty) Ltd (“Splitz Stores”) was founded 20 years ago by its current chairman,
Shaun Spielberg and the incumbent chief executive officer, Zelda Zara. The shareholders of
Splitz Stores are The Spielberg Family Trust (50%), Ms Zelda Zara (25%), Ms Geraldine
Ackerman, the chief financial officer (10%) and Splitz Stores Employee Share Trust (15%).

The company has over 150 retail stores throughout South Africa, which all sell shoes and
accessories. Splitz Stores prides itself on offering high quality fashion apparel at exceptional
prices, aimed predominantly at 18 to 30-year-old customers. International fashion trends are
closely monitored to ensure that Splitz Stores is abreast of the latest trends.

The National Credit Regulator (NCR) has recently given Splitz Stores a clean audit report for
its credit process when it comes to customers that buy on credit (50% of total sales are on
credit), while hefty penalties have been imposed on a number of its competitors. Generally,
consumer spending in South Africa has been depressed over the past two years as a result
of the knock-on effect of the global financial crisis. However, Splitz Stores has managed to
increase revenue despite the prevailing economic conditions. Ms Zara attributes this to Splitz
Stores’ retention of loyal customers and its ability to attract new customers. Shoes are sourced
both locally and internationally from suppliers who manufacture major shoe brands.

Splitz Stores generates positive cash flows annually. The board of directors of the company
has been exploring various options to utilise cash resources more effectively. Current deposit
rates in the money market are low and Mr Spielberg is of the firm opinion that surplus cash
should be paid out to shareholders and external debt should be considered if funds are needed
at a later stage. However, Ms Zara believes that Splitz Stores should always have a
reasonable level of cash on its balance sheet as a buffer.

REQUIRED
a) Critically discuss the arguments raised by Mr Spielberg and Ms Zara.
(8)

b) Identify and explain the risks that Splitz Stores is exposed to, using the
classification below:
 Business (4 marks)
 Financial (credit, interest & currency) (3 marks)
 Regulatory/legal (3 marks)
(10)

TOTAL: 18 MARKS

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QUESTION 05: NEW MUTUAL (30 marks; 54 minutes)

You have just been appointed the Head: Telecommunications Equity Fund at one of the
leading investment houses in South Africa, New Mutual Investment Group (“New Mutual”).
Your team’s mandate is to keep abreast of developments in the telecommunications industry
and advise the investment committee whether to buy, sell or hold shares in the relevant
companies. New Mutual already has exposure in this industry through an 8,75% shareholding
in MTM Group Limited (“MTM”), a leading emerging markets mobile operator. MTM’s share
price has come under a lot of pressure lately due to hefty fines imposed on its subsidiaries, as
well as growing competition in the sector. However, MTM continues to deliver solid results
mainly due to its robust cost control measures and the weakening rand (for its foreign
subsidiaries). The junior analyst in your team has already provided you with MTM’s key ratios
for the year ended 30 September 2016 (see below).

You have been tracking Hola Limited (“Hola”) share performance for a while now, and you are
convinced the company has got the right strategy to grow its business to rival MTM locally and
in the other parts of Africa. Hola is the sixth biggest network provider in the SADC region and,
just like MTM, is listed on the Johannesburg Stock Exchange. The company offers fixed line,
mobile, ICT and data services to business and consumer markets. Hola has just won a R2
billion tender to supply qualifying government employees with contract packages and this is
expected to increase its clientele of 2,8 million active customers by at least 15%. Looking at
its primary performance indicators, you are convinced that buying Hola shares would be a
great investment for New Mutual. MTM has also given its shareholders (including New Mutual)
a good return over the years and you are also considering increasing New Mutual’s exposure
in MTM.

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An extract from the annual report of Hola Limited at 30 September 2016 shows the
following:

Statement of comprehensive income R million

Net revenue 37 325
EBITDA 8 761
Finance charges 1 060
Profit before taxation 2 900
Profit for the year 2 043

Statement of financial position R million

Non-current assets 33 875
Cash and cash equivalents 2 548
Trade and other receivables 7 375
Other current assets 2 989
Share capital 6 888
Long-term loan 7 104
Trade and other payables 12 259
Current portion of the long-term loan 817
Retained income 19 179

The information below relates to the share history and dividends declared by Hola
Limited:
Performance 2016
Weighted average number of shares (million) 505
Share price - low (cents) 5 141
Share price - high (cents) 6 007
Share price - opening (cents) 5 283
Share price - closing (cents) 5 885
Share price - average (cents) 5 529
Dividends declared - interim (R million) 280
Dividends declared - final (R million) 640

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Below are the ratios for MTM Group Limited calculated for the year ended 30 September
2016:
Ratios
(a) Dividend yield (%) 2,79

(b) Price-earnings ratio (times) 13,06

(c) Net interest-bearing debt to equity ratio (x: 1) 0,16: 1

(d) Return on assets (%) 12

(e) Effective taxation rate (%) 35,79

(f) EBITDA per customer (R) 3 680

(g) Change in share price (%) (2,27)

Additional information
 In computing ratios, New Mutual uses closing balances and book values, unless where
stated otherwise.
 The South African corporate tax rate is 28%.

REQUIRED

(a) Draft a memorandum to the investment committee of New Mutual advising whether to
invest in Hola Limited or to increase its investment in MTM Group Limited, by comparing
the two companies’ ratios computed.

[Round all calculations to the nearest two decimal places]

(Calculations 15 marks; comments 7 marks; and presentation 2 marks)

(24)

(b) Identify key risks faced by the South African telecommunications companies that the
investment committee of New Mutual should be aware of.
(6)

TOTAL: 30 MARKS

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QUESTION 06: TOY STARS (10 marks; 18 minutes)

Toy Stars Limited is a retail company that trades in the toy industry. The following information
is available on 31 December 2X13:

Statement of comprehensive income for the year ending 31 December 2X13

2X13 2X12
Rand Rand

Turnover 4 400 000 4 120 000

Cost of sales 3 300 000 3 200 000
Opening inventory 396 000 342 000
Purchases 3 530 000 3 254 000
Less: Closing inventory (626 000) (396 000)

Gross profit 1 100 000 920 000

Operating expense (820 000) (680 000)
Operating profit 280 000 240 000
Dividends received 5 000 5 000
Finance charges (net) (18 000) (8 000)
Profit before taxation 267 000 237 000
Taxation expense (75 000) (71 000)
Profit after taxation 192 000 166 000

Number of issued shares 700 000 700 000

Dividend (per share) 12 cents 10 cents

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Statement of financial position at 31 December 2X13

2X13 2X12
Rand Rand
Assets
Non-current assets 806 000 600 000
Current assets 1 468 000 1 133 000
Inventory 626 000 396 000
Trade receivables 647 000 454 000
Cash balances and investments 195 000 283 000

Total assets 2 274 000 1 733 000

Equity and liabilities

Equity 1 015 000 865 000
Share capital and share premium 140 000 140 000
Accumulated reserves 875 000 725 000

Non-current liabilities 107 000 60 000

Long-term loan 107 000 60 000

Current liabilities 1 152 000 808 000

Trade payables 800 000 590 000
Other payables and provisions 352 000 218 000

Total equity and liabilities 2 274 000 1 733 000

Additional information:
 50% of the sales in 2X13 were cash sales (in 2X12 it was 60%). Management decided to
extend their credit facilities and believe that it would result in future growth. The intention
is to bring the percentage of cash sales down to 35% in 2X14 and to retain this percentage
split between cash and credit sales in future. The budgeted turnover for 2X14 is R5 120
000. All inventory purchases are done on credit.

REQUIRED
Calculate the working capital required to support the increase in sales budgeted for 2X14.
Show all your calculations.

TOTAL: 10 MARKS

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QUESTION 07: A GREYS (20 marks; 36 minutes)

A Greys (Pty) Limited has been operating an acute care facility in Gauteng. The hospital has
been operating for approximately 19 months.

“At A Greys (Pty) Ltd, our priority is to focus on the delivery of a special brand of health and
care to patients. Within a world class hospital, this unique approach is what makes the
difference and helps us to maintain our position as one of the top hospitals in the country,”
says the hospital director.

The hospital has recently experienced serious cash flow problems, amongst other things due
to the high start-up costs. The cash flow problems have reached critical proportions and
management are desperately seeking a solution to the problems. They have approached the
management consulting services division of their audit firm, where you work as a consultant,
to give them plausible ways by which to resolve their problems.

The following details were discussed during a meeting with the consultants from the audit firm:

Inventory
The value of the hospital's inventory is R750 000. This represents two and a half months’
worth of inventory. The hospital purchases their inventory from various suppliers based
throughout the country. Not all suppliers are reliable with lead times ranging from anything
from 1 to 15 days. Management suggests ceasing all purchases and using up the current
inventory. Thereafter they propose implementing a Just-In-Time inventory system.

Accounts receivable
Approximately 50% of the patients (based on value) are private patients and the remaining
50% are medical aid patients. The accounts department has a very relaxed atmosphere. In
fact, many of the personnel working in this department have on occasions been heard saying,
"I would not exchange this job for anything in the world".

The current amount outstanding from private and medical aid patients is R3 500 000.
Management informs you that medical aids can take up to 150 days to pay. "How long does it
take for you to do the billings for the hospital?” you ask. The reply astonishes you. "Sometimes
up to 90 days".

Approximately 20% of all private patient accounts and the private portions of the medical aid
accounts are irrecoverable. On further investigation you determine that all patients are
admitted, without asking for any deposit or checking validity of medical aid cards. No follow-
ups are done on outstanding amounts.

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Accounts payable
All purchases are done on a 3/10 net 30 basis. The suppliers are very strict regarding this.

Cash resources
The balance on the current account is R1 million (overdraft). The bank has intimated that they
would be willing to increase this facility. The effective interest rate applicable is prime + 5%
per annum. Currently prime is 10%. Further investigation has shown that most medical aids
pay by cheque and that it can take up to five days before the company banks the cheques.

REQUIRED
a) Draft a memorandum to management, in which you critically assess the working
capital management situation of the company. Where necessary, make
recommendations as to how to improve the management thereof as well as ways to
resolve the current cash flow crisis.
TOTAL: 20 MARKS

Comments:

3/10 net 30 - this means the buyer must pay within 30 days of the invoice date, but will receive
a 3% discount if they pay within 10 days of the invoice date.

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QUESTION 08: ZENZEL (20 marks; 36 minutes)

Zenzel (Pty) Ltd is a computer company that distributes computer hardware to smaller retail
companies. The following information relates to the current credit terms and other aspects of
the company's business:

i. Credit sales for the year amounted to R25 750 000.

ii. A 3% discount was offered to debtors that paid within 10 days.
iii. Bad debt provision for the current year amounted to R2 300 000.
iv. Currently, 20% of debtors pay within 10 days, while the remaining debtors take 45 days
on average to settle their accounts.

As many of the clients cannot afford to pay in cash or within the credit terms due to the current
economic circumstances, the company decided to make changes to the current credit policy.
The financial manager proposes to grant credit on 5/10 (5% discount for payment within 10
days) net 45 basis in future. The financial manager anticipates that 55% of current debtors will
now make use of this option, whilst the remaining current debtors will pay within 50 days on
average. Bad debt provision for existing customers will remain the same.

The following assumptions were also included in the proposal:

 Credit sales to new customers will increase with R2 500 000.

 60% of new customers will pay within the discount period, while the remaining new
customers will pay within 65 days.
 The increase in sales is expected to result in a R1 250 000 increase in inventory, and
trade payables are likely to increase with R850 000.
 Bad debt will increase to R2 345 000 in total as a result of the new sales.

The contribution ratio is determined at 32%. The applicable tax rate is 28%, and WACC is
equal to 20%.

REQUIRED

a) Determine the impact of the new credit policy on the company's profitability and
comment if the company should accept the new credit policy by means of the annual
after-tax cash flow calculations.
TOTAL: 20 MARKS

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QUESTION 09: KINGSTON (25 marks; 45 minutes)

Kingston Ltd is a medium size manufacturing business that is highly dependent on electricity
for production. Due to the recent load shedding, the production and profit of the company is
under massive strain. The directors have decided to invest in a solar power system as an
alternative energy source, to minimise the impact of load shedding on the business as there
is no other short to medium-term solution to the national electricity crisis. The project cost is
estimated at R13 000 000 and will commence as soon as the funding of the project is
confirmed. In order to evaluate the feasibility of the project, the company needs to establish
the company’s weighted average cost of capital.
The following is an extract from the statement of financial position at 31 March 2016.
Notes Rand
Equity and Liabilities
Total equity 65 000 000
Ordinary share capital 1 40 000 000
Non-distributable reserves 15 000 000
Retained income 10 000 000

Non-current liabilities 26 500 000

12% Debentures 2 16 000 000
Long-term loan 3 10 000 000
Deferred tax 500 000

Current liabilities 2 500 000

Trade payables 1 900 000
Provisions 600 000

Total equity and liabilities 94 000 000

Notes
1. The historical average issue price of ordinary shares is 250 cents. The latest known
share price is 625 cents. Kingston Ltd has just declared and paid a dividend of 25 cents.
In line with its stable annual growth, the company is expecting to declare a dividend of
28 cents for the year ended 31 March 2017.
The government bonds (risk-free rate) currently yield 7%, and the company’s beta is
estimated at 1,2 while the market risk premium 7,9%.
2. Similar debentures are trading at 10% per annum. The interest is payable annually in
arrears and redemption date of these debentures is 31 March 2021.
3. The long-term loan is repayable in three years’ time and carries an interest rate of prime
rate-1%. The current prime rate is 10,5%. Similar loans trade at prime rate+2%.

Additional information
 The current effective tax rate is 28%. All percentages given are before tax, unless
where otherwise stated.

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REQUIRED

a) Calculate the cost of debt (loan). (2)

b) Calculate the cost of debt (debentures). (2)

c) Calculate the cost of equity, using both the Gordon’s Dividend Growth and Capital
Asset Pricing models. (6)

d) Calculate the market value of a loan (4)

e) Calculate the market value of debentures. (4)

f) Calculate the market value of equity. (4)

g) Calculate the weighted average cost of capital. (3)

TOTAL: 25 MARKS

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QUESTION 10: QUEEN POWER (45 marks; 1󠄧⅓ hours)

Queen Power Ltd is a medium size manufacturing business that is highly dependent on
electricity for production. Due to the recent load shedding, the production and profit of the
company is under massive strain. The directors have decided to invest in a solar power system
as an alternative energy source, to minimise the impact of load shedding on the business as
there is no other short to medium-term solution to the national electricity crisis. The project
cost is estimated at R25 000 000 and will commence as soon as the funding of the project is
confirmed.

The following is an extract from the statement of financial position at 31 March 2016:

Notes Rand

Equity and Liabilities

Total equity 65 000 000

Ordinary share capital 1 40 000 000

Retained income 2 10 000 000

10% Preference share capital 3 15 000 000

Non-current liabilities 16 500 000

12% Debentures 4 16 000 000

Deferred tax 500 000

Current liabilities 2 550 000

Trade payables 950 000

Bank overdraft 5 1 000 000

Provisions 600 000

Total equity and liabilities 84 050 000

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Notes

1. The historical average issue price of ordinary shares is 160 cents. The latest known
share price is 225 cents (cum dividend of 25 cents). In line with its stable annual growth,
the company is expecting to declare a dividend of 26 cents for the year ended 31 March
2017.

2. The company’s post-tax net profit margin for the year was 20%, while the operating profit
margin was 38%. Despite the slow economic growth and electricity supply disruptions,
the company managed to increase its sales by 11% to R30 000 000. Retained earnings
are not available for future projects.

3. The market value of these irredeemable preference shares is R20 000 000. Preference
shareholders have indicated their willingness to convert their shares into ordinary shares
should a need arise.

4. The 10-year debentures with a redemption discount of R757 574 were issued on 5 April
2010. The yield on similar debentures in the market approximates 8%. Interest is paid
annually in arrears.

5. The bank overdraft bears an average interest rate of 8% per annum. The overdraft is
used to bridge the working capital requirements when the need arises, and the balance
fluctuates monthly.

Additional information:
 The current effective tax rate is 28%. All percentages given are before tax, unless where
otherwise stated.

 The company has a target capital structure of 80% equity and 20% debt. Under the
target capital structure, ordinary share capital is to be maintained at 75% of total equity.

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REQUIRED

a) Calculate the weighted average cost of capital of Queen Power Ltd based on both the
current- and target capital structure, for the purpose of evaluating the proposed project
and comment on the differences between these calculations.

[Round rand amounts to the nearest rand and other numbers to the nearest two decimal
places]

(Calculations 22 marks; comments 3 marks)

(25)

b) Calculate the following ratios for the year ended 31 March 2016 using book
values:

[Round your answers to two decimal places]

i). Return on assets

ii). Return on equity
iii). Capital gearing ratio
iv). Asset turnover
v). Price / book value multiple
vi). Interest-bearing debt to equity ratio
vii). Earnings yield

(Calculations 13 marks; comments 7 marks)

(20)

TOTAL: 45 MARKS

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QUESTION 11: CHAPTERS & NOVELS (50 marks; 1½ hours)

Chapters & Novels for Africa (trading as “CNA”) is Africa’s largest book and stationery outlet
and is listed on the JSE Limited. CNA has stores only in the major cities on the African
continent but the company, together with its sector peers, has faced tough competition from
online paperless book (e-book) retailers. The project steering committee of CNA has been
tasked with the running of two mutually exclusive initiatives to help boost the financial
performance of the company. Regarding one of the projects, Project Thewuka, the company
is looking at investing R76 253 745 into the business of transporting books and stationery to
different government schools throughout the continent. CNA already has a very credible and
reliable distribution system that covers most parts of Africa, from Cape to Cairo.

The following is an extract from the statement of financial position at 31 March 2017.

Notes Rand
Equity and liabilities
Total equity 80 000 000
Ordinary share capital 1 40 000 000
Retained income 10 000 000
Preference share capital 2 30 000 000

Non-current liabilities 30 500 000

Debentures 3 30 000 000
Deferred tax 500 000

Current liabilities 2 500 000

Trade payables 900 000
Bank overdraft 4 1 000 000
Provisions 600 000

Total equity and liabilities 113 000 000

Notes
1. The historical average issue price of ordinary shares is R2,50. The latest share price is
R6,50. CNA has recently declared and paid an ordinary dividend of R3 000 000 (from
R2 666 667 declared and paid a year ago) in line with its profit growth. The share issue
costs approximate 25 cents per share (only for the purpose of calculating cost of equity).
2. The company pays a total annual dividend of R3 450 000 on the preference shares.
Similar shares are trading at an average of 300 basis points below the prime rate.
3. The pre-tax annual interest payment on debentures is R3 450 000. The debentures will
be redeemed on 28 March 2020 at a premium of 10% of the capital amount borrowed.
The capital will be repaid on 31 March 2020, while the premium will be paid a year later
(on 31 March 2021). The going rate in the market for similar debentures is 9%.

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4. The bank overdraft bears an average interest rate of 8% per annum. The overdraft is
used to bridge the working capital requirements when the need arises, and the balance
fluctuates monthly.
5. The company has a target capital structure of 50% equity and 50% debt. Under the
target capital structure, ordinary share capital is to be maintained at 80% of total equity.

The second initiative is the reviewing of the working capital management strategy of the
company, particularly the credit policy. The following information relates to the current credit
terms of the company's business:

i). Sales for the year amounted to R30 000 000 and were all made on credit.
ii). A standard discount of 2,5% is currently offered to debtors paying within 8 days.
iii). Bad debt expense for the current year was R1 750 000.
iv). Currently, one-fourth of debtors pay within 8 days, while the remaining debtors take 50
days on average to settle their accounts.

The responsibility of the project steering committee is to advise the senior management
whether implementing a new credit policy would be of any benefit to CNA. The proposed
credit policy entails the following:

i. Credit is granted to customers on 3/10 (3% discount on payments made within 10

days) net 40 basis in future. 30% of existing customers will make use of this option,
whilst the remaining current debtors will pay on average within credit terms.
ii. Bad debt expense ratio (based on total credit sales) is expected to be 5,5%.

Additional information
 The prime interest rate is 10,5%.
 Gross profit margin is maintained at 40% throughout the year.
 There are 365 days in the 2017 financial year.
 The corporate taxation rate is 28%.

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REQUIRED

a) Calculate the weighted average cost of capital of Chapters & Novels for Africa
based on both the current and target capital structure, for the purpose of evaluating
the proposed project and comment on the differences between these calculations.
[Round rand amounts to the nearest rand and other numbers to the nearest one
decimal place.]
(Calculations 22 marks; comments 3 marks) (25)

b) With supporting calculations, determine how Project Thewuka should be

financed, if the company is working towards the target capital structure.
(Calculations 6 marks; comments 4 marks) (10)

c) Advise the project steering committee whether company should adopt the
proposed credit policy or continue with the current one.
[Show all workings starting with the gross profit. Use the weighted average cost
of capital based on the current capital structure, where applicable.]
(10)

d) Describe some of the risks faced by Chapters & Novels for Africa.
(5)

TOTAL: 50 MARKS

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QUESTION 12: SIMON & SON (40 marks; 72 minutes)

Simon & Son Ltd is a medium size manufacturing business that is highly dependent on
electricity for production.

Due to the recent load shedding, the production and profit of the company is under massive
strain. The directors have decided to invest in a solar power system as an alternative energy
source, to minimise the impact of load shedding on the business as there is no other short to
medium-term solution to the national electricity crisis. The project cost is estimated at R16 250
000 and will commence as soon as the funding of the project is confirmed.

The three directors of the company are still not in agreement on how to fund the project and
have tasked your consulting team to investigate the three options on the table as possibilities
of funding the project. They will then make a final decision based on the information provided
by your consulting team.

From the minutes of the last board meeting you gathered that the views of the three directors
are as follows:

Managing director
He is of the opinion that the project should be financed through the issuing of new shares as
debt finance is riskier than equity finance.

Chief operating officer

He is of the opinion that the project should be financed through the issuing of cumulative
redeemable preference shares. He believes that this instrument is cheaper than other debt
instruments available to the company.

Financial director
She is of the opinion that the company should use a mix of debt and equity. Unfortunately,
she was not able to support her recommendation with proper reasons as the meeting had to
be adjourned due to time constraints and other meetings.

Your management consulting team was tasked by the financial director to

 critically evaluate each of the director’s views

 calculate the cost of capital for the proposed project

 establish the capacity of the company to raise debt, equity or both

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The following is an extract of the statement of financial position at 28 February 2016.

Notes Rand

Equity and Liabilities

Total equity 50 000 000

Ordinary share capital 1 40 000 000

Retained income 2 10 000 000

Total liabilities 34 050 000

Non-current liabilities 27 500 000

Debentures 3 15 000 000

Preference shares 4 12 000 000

Deferred tax 500 000

Current liabilities 6 550 000

Trade payables 950 000

Bank overdraft 5 5 000 000

Provisions 600 000

Total equity and liabilities 84 050 000

Notes

1. The issued ordinary share capital is made up of 1 million shares. The latest known share
price was R66 cum div and the company has just declared a dividend of R6 per share.
The dividends are expected to grow at a rate of 8% per annum.

2. The retained earnings are not available for future projects.

3. The debentures were issued at an annual pre-tax coupon rate of 11,11% redeemable at
the end of eight years. Three of the eight years have already expired and similar
debentures are currently yielding at an annual pre-tax coupon rate of 13,89% in the market.

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4. The 9% preference shares are redeemable at a premium of 5% in 10 years’ time.

Dividends for the current year have been paid and the preference shares in a similar risk
class are currently yielding 12% per annum.

5. The bank overdraft bears an average interest rate of 12,5% (after tax) per annum. The
overdraft is used to bridge the working capital requirements when the need arises, and the
balance fluctuates monthly.

6. The current effective tax rate is 28%.

7. The company has a target capital structure of 60% equity and 40% debt. The 40% target
debt consists of 20% debentures and 20% preference shares.

REQUIRED

a) Calculate the cost of capital for evaluating proposed project and indicate briefly what
assumptions underlie the use of this cost for the new project.

(Calculation 8 marks; comment 3 marks)

(11)

b) Prepare a memorandum to the board of directors where you critically evaluate each of
the director’s views on the appropriate funding instrument.
(10)

c) With supporting calculations, demonstrate the company’s ability / capacity to raise debt,
equity or both, if working towards the target capital structure.
(14)

d) Discuss five (5) qualitative factors that the directors should consider in the planning of the
implementation of the project.
(5)

TOTAL: 40 MARKS

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QUESTION 13: S&S (10 marks; 18 minutes)

Simphiwe is the financial manager of S&S Ltd and has been instructed to find a suitable
funding instrument for new equipment that needs to be purchased at a cost of R375 000. He
has identified two possible funding instruments, namely a loan from CapC Bank and the issue
of new shares. He has discussed the loan option with the bank manager from CapC Bank and
also had discussions with a few investors that are interested in taking up some shares in S&S
Ltd.

The following information is available based on the outcome of his discussions:

CapC Bank

1. The bank manager of CapC Bank has agreed to grant a loan of up to 100% of the total
purchase value.

2. The loan will be granted in multiples of R75 000, and S&S Ltd can decide how many
multiples they would like to borrow from the bank.

3. For a 100% loan, the risk is higher and therefore the interest rate charged for a 100%
loan is 17,5% before tax.

4. For every R75 000 not taken up by S&S, the interest rate will decrease by 1,25% as the
risk to the bank reduces.

Issue of new shares to prospective investors

1. Investors are very keen to invest in S&S Ltd and after discussions; Simphiwe identified
enough interested parties to take up 100% of the investment amount needed.

2. If everything is financed through equity the equity holders will require a return of 15%
per annum on their investment.

3. If a portion of the funds are generated through the loan the investors are of the opinion
that it will increase their risk and they will therefore require a greater return on their
investment. They have agreed that they will require an additional return of 0,25% for
every R75 000 that is borrowed from CapC Bank.

REQUIRED

a) Determine the optimal capital structure of S&S Ltd to finance the new equipment.
Assume a corporate taxation rate of 28%.

TOTAL: 10 MARKS

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QUESTION 14: SIMUNYE GOLD (50 marks; 1½ hour)

Simunye Gold (“Simunye”) is an independent, South African domiciled and focused mining
group, which currently owns and operates three underground and surface gold operations in
the southern Free State. Simunye owns and operates high quality gold operations in South
Africa – consolidated into one group with one vision and strategy. In addition to its mining
activities, the group owns and manages significant extraction and processing facilities at its
operations, which beneficiate the gold bearing ore mined. Listed on the Johannesburg Stock
Exchange, Simunye is the largest individual producer of gold from South Africa and is one of
the world’s 10 largest gold producers.

The group is currently under negotiations with a Toronto Stock Exchange listed company One
Gold International to acquire its underground and surface operation just 50 kilometres south
of Johannesburg. This will increase Simunye’s annual gold production, enhancing existing
operational flexibility and providing the group with the potential to significantly extend its
operating life. Below are three expected outcomes of purchase price (in Canadian dollars –
CAD) from the negotiations.
Probability Bid price (CAD)
20% 25 000 000
50% 60 000 000
30% 50 000 000

Simunye has a target capital structure of 40%: 60% (debt: equity ratio). Ordinary share capital
must not exceed 80% of total equity. The debt portion is split 50: 50 between loans and
debentures. Loans are to be maintained at the same ratio as they currently are at their carrying
values (Ifafa Bank: Netbank). The capital structure as extracted from the company’s latest
statement of financial position (28 February 2017) is provided below.

Financing instrument Notes Rand (‘000)

Ordinary share capital (96 000 000 shares
1 1 200 000
issued)
8,5% Preference share capital 2 240 000
Loan: Ifafa Bank 3 570 000
Loan: Netbank 4 380 000
Debentures: JP Mogano Bank 5 135 000

Total capital employed 2 525 000

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Notes
1. Only 96% of the authorised share capital has been issued. A Simunye share is
currently trading on the Johannesburg Stock Exchange at R25 (issue costs are
estimated at 20 cents). The expected dividend to be declared on 28 February 2018 is
186 cents in line with company’s annual growth (recent dividend declared in February
2017 was 169 cents).
2. These irredeemable preference shares pay out a dividend of R20,4m annually and
their market value is estimated at R255m.
3. The long-term loan from Ifafa Bank was received on 4 March 2016 (a year ago) at
JIBAR + 1% and it will be repaid in two years’ time. Loans bearing similar terms are
trading at JIBAR + 0,75%.
4. The Netbank loan was issued 3 years ago at JIBAR + 1,25% and the going interest
rate for similar loans averages JIBAR + 0,5%.
5. The JP Mogano Bank debentures were issued at the beginning of this current financial
year (1 March 2016) and will be redeemed at a premium of 5% on 28 February 2020.
The coupon rate on these debentures is 9%, whereas the market rate for similar
debentures is 8,5%.

Additional information
 The banks have indicated their willingness to avail their facilities for the funding of One
Gold International acquisition. The banks and shareholders will also accept any
reduction in capital (through share buyback and loan repayment) if necessary.
 Simunye aims to operate at its maximum ordinary share capital: total equity ratio of
80% where feasible.
 One Canadian dollar (CAD) buys 9,50 South African rand (ZAR) and this exchange
rate is expected to remain at these levels for the foreseeable future.
 The relevant JIBAR (Johannesburg Interbank Average Rate) is quoted at 8,25%. All
the above loans are referenced to this JIBAR.
 The corporate taxation rate is 28%.

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REQUIRED
a) Calculate or determine the relevant cost of capital for each of the financing instruments
used by Simunye to finance the new acquisition.
(10 marks)

b) Calculate the weighted average cost of capital of Simunye based on its target capital
structure.
(7 marks)

c) Calculate the weighted average cost of capital of Simunye based on its existing capital
structure (before the new acquisition) using book values.
(4 marks)

d) Calculate the probable bid price (R) for One Gold International business to be acquired
by Simunye.
(2 marks)

e) Determine how the new acquisition of One Gold International operations should be
financed based on book values, using where possible available loan facilities and/or a
fresh issue of shares.
(11 marks)

f) Calculate the market values for the capital employed by Simunye.

(12 marks)

g) Calculate the weighted average cost of capital of Simunye based on its existing capital
structure (before the new acquisition) using market values.
(4 marks)

TOTAL: 50 MARKS

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QUESTION 15: SANRAL (20 marks; 36 minutes)

After the successful hosting of the 2010 FIFA World Cup® and successful launching of the e-
toll system in Gauteng, the Western Cape Provincial Government (WCG) is following suit. The
City of Cape Town has won a bid to host Olympics 2024 and the WCG has started reviewing
its infrastructure with the view of making necessary upgrades.
South African National Roads Agency Limited (SANRAL) is responsible for the road
infrastructure throughout the country and has been given a mandate to improve major road
networks in the Western Cape in preparation for the Olympics games in 2024. The Department
of Transport and Public Works has made it clear that it would not allocate any funds to the
upgrade.
SANRAL is considering two alternatives for recovering the capital outlay on the road
infrastructure over the next five years. SANRAL can either use the e-toll system or the fuel
levy system.

Alternative 1: e-toll system

How it works: Gantries are constructed at different points on major roads around the Western
Cape. As a motor vehicle passes through a gantry, the car registration details are read
electronically and the information is passed directly to the control centre in Paarl where the
amount owed (toll fee) for passing that gantry is established. This is immediately sent to the
motor vehicle owner’s bank, instructing the bank to debit the owner’s account with the toll fee.
All Western Cape car owners are required to register with SANRAL. Visitors to the Western
Cape Province also need to register at any of the leading retailers in the province. A customer
centre will be established to attend to general road user queries, unpaid toll fees, unregistered
motor vehicles.

Alternative 2: Fuel levy system

How it works: No e-toll infrastructure will be put in place but a special levy will be charged to
the fuel price, meaning that the retail price of fuel (across all grades) will be increased at all
fuel stations across the country. This levy is then electronically transferred to SANRAL’s
account as fuel is purchased. Only the levy collected in the Western Cape will be used for the
Western Cape infrastructure development.

SANRAL has estimated capital expenditure (CAPEX) at the start of the project, where
applicable to be as follows:

CAPEX R
Roads 17 884 002
Gantries (civil works) 393 867
e-toll IT systems 1 837 480
Control centre – Paarl 229 756
Customer centre 217 217
IT Systems - fuel levy 5 545 682

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Running of the e-toll system

SANRAL expects 2 300 000 cars to go through the gantries per annum at an average toll fee
of R3,60 (which will not change) per car. About 30% of the cars passing the gantries will not
register for e-toll, making it impossible to recover amount owed by the unregistered users. The
toll revenue is expected to grow in line with inflation and increase in number of cars annually.
Electronic Tolling Collection Company has provisionally been awarded R6 500 000 tender to
manage the collection of toll fees and this is paid annually in arrears in equal instalments over
the next five years. Working capital of R1 677 123 is required at the start of the project.

Running of the fuel levy system

SANRAL will charge a fixed fuel levy of 55c per litre for the next five years. South African road
users currently consume 35 000 000 litres of fuel per annum, of which the Western Cape will
consume 30% (this ratio will apply for the duration of the project). Annual consumption of fuel
will increase in line with increase in number of road users.
SANRAL has estimated the initial working capital of R234 187. Operating costs are budgeted
at R650 000 per annum.

Additional information:
National Association of Automobile Manufacturers of South Africa (NAAMSA) expects the
Western Cape road users to increase at a steady annual rate of 6% for the duration of the
project. SANRAL is exempt from Income Tax in terms of s 10(1)(t)(iii) of the Income Tax Act.
The WACC is calculated using the RSA government bond rate of 7% before tax

REQUIRED
a) Using NPV calculation, determine which system SANRAL should use to recover the
capital outlay.
TOTAL: 20 MARKS

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QUESTION 16: MASHESHA (30 marks; 54 minutes)

MASHESHA (Pty) Ltd (“MASHESHA”) is a transport and logistics company, which operates a
national distribution network with a large client base and utilises a rigid dispatch and
prioritisation schedule. MASHESHA is currently in talks with Moya Technology Limited
(“Moya”), a company that distributes prepaid airtime to wholesalers, retailers, petrol stations
and end users throughout South Africa.

Moya’s business model is such that it customises the delivery of prepaid airtime according to
the circumstances and requirements of its clients, some of which are highlighted below:

 Moya supplies a large number of retail chain stores with prepaid airtime by sending
them a file via email or electronic file transfer. The file contains PINs (personal
identification number) which retailers then split and send to their various outlets.
 Prepaid airtime is supplied to smaller businesses such as corner cafes by installing
mobile Point Of Sale (POS) terminals. This allows for encrypted PIN inventory of
frequently used products to be delivered to and stored on the POS device. The devices
are operated by the cashier and are password protected, ensuring transactions are
secure. For the less structured operations mobile solutions are provided.
 Vending machines are supplied to busy supermarkets, 24 hour forecourts and hotels.
These are standalone units which can be operated by the customer.

Moya had previously undertaken the delivery of prepaid airtime in-house. Moya has recently
been experiencing several staffing problems and given the nature of its large, geographically
dispersed customer base, Moya has been finding it difficult to keep up and has made many
late deliveries over the past few months. Moya’s customers are extremely unhappy and have
been inundating them with complaints.

Moya has decided to outsource its distribution operations to MASHESHA in order to focus on
its primary business (technological solutions for the telecommunication industry). For the
delivery of prepaid airtime to its customers, Moya has proposed to pay MASHESHA a fixed
monthly fee of R450 000 and an additional R75 per 100 km travelled (all amounts at today’s
value). In return, MASHESHA will have to pay a once off cancellation fee of R100 000 (payable
immediately) in the event that MASHESHA terminates the contract before the expiration of its
five-year period.

In order to undertake the delivery service MASHESHA will have to purchase a fleet of delivery
trucks, an upfront capital investment of R 4 800 000. These trucks are reliable and fuel efficient
(requiring seven litres of fuel per 100 km for the first 3 years whilst thereafter 9 litres of fuel
are required per 100km). In accordance with the delivery fleet maintenance plan, annual

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maintenance costs (expected to be R 336 000 in year 1) will escalate with increasing multiples
of 2% every year, as the delivery fleet increases with age and usage.

For accounting purposes MASHESHA depreciates its trucks over the useful lives determined
to be four years. SARS allows a wear & tear of 20% per annum on a straight line method. The
trucks will have a combined resale value of R1 200 000 at the end of five years. Total monthly
salaries of the truck drivers are expected to amount to R 264 000 in the first year with a 7%
annual increase thereafter. Other costs relating to the delivery fleet is expected to amount to
R 65 000 per year in year one.

Additional information:
 The current tax rate of 28% is expected to be applicable for the next 5 years.
 The fees paid by Moya to MASHESHA and other costs relating to the delivery fleet are
subject to an annual escalation clause of 5,9%.
 The weighted average cost of capital of MASHESHA is 15%.
 The current price of diesel amounts to R11,41/litre and average annual increases per
litre are expected to be as follows:
Year 1 Year 2 Year 3 Year 4 Year 5
50c 70c 75c 80c 90c

 Based on current information and taking into account Moya’s growth plans, the
following represents the kilometres MASHESHA expects its fleet of delivery trucks to
travel over the next 5 years:
Year 1 Year 2 Year 3 Year 4 Year 5
600 000 605 400 612 665 704 565 713 019

REQURED
a) Based on the principles of capital budgeting, advise MASHESHA whether it will be
beneficial to accept the terms of the contract proposed by Moya.
(20)
b) Discuss financial factors that MASHESHA should consider before accepting the terms
of the contract proposed by Moya.
(5)
c) Discuss the qualitative factors that Moya should consider when deciding on whether
to perform the delivery function in- house as opposed to outsourcing.
(5)

TOTAL: 30 MARKS

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QUESTION 17: PICTURE PERFECT (15 marks; 27 minutes)

Picture Perfect Ltd is in the printing industry and makes use of digital litho printers. The
operations manager has brought it to the attention of the financial manager that one of the
litho printers needs to be replaced.

Existing printer New printer

Current tax value R100 000

Cost price R200 000 R250 000

Current realisable value R180 000

Realisable value after 4 years R40 000 R60 000

Working capital R35 000 R50 000

Sales generated by printer per annum R350 000 R450 000

Fixed cost R100 000 R150 000

Variable cost R50 000 R70 000

 Depreciation is not included in the variable cost. SARS allows for wear and tear over
four years.
 The cost of capital is 15%.
 The current tax rate is 28%.

REQUIRED
a) Should Picture Perfect Ltd continue using their existing printer, or should they invest
in a new one? Perform a net present value (NPV) calculation to substantiate your
answer.
[Round your final answer to the nearest rand]
(12)

b) List two qualitative factors that Picture Perfect Ltd needs to consider when
evaluating whether or not to replace the existing printer.

(2)

c) Explain the difference between mutually exclusive and independent projects.

(1)
TOTAL: 15 MARKS

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QUESTION 18: CITY OF NKANDLA (25 marks; 45 minutes)

The City of Nkandla has embarked on a campaign of becoming one of Africa’s top tourist
attractions. The City Council bought a fleet of open-top buses from a Brazilian supplier. An
order of 50 identical buses was placed on 2 January 2015 at a unit cost of US $48 000, and
the buses arrived at the Durban harbour on 29 January 2015. An EFT payment was made on
the 29 January 2015 and a further R5 320 000 was spent on modification of the buses. The
buses were ready for use on 31 January 2015.

These 50-seater buses visit famous sites and attractions around the City of Nkandla and
tourists can hop-on-and-off with a ticket that is valid for the entire day. Ticket costs R30 per
adult, but children (under 12 years of age) pay a third of the ticket cost. Ticket sales are
expected to grow at an average of 4% per annum over the next 5 years. Working capital
requirements were budgeted at R4 000 000 at the start of the project.

The Council estimated that each bus would operate at 80% capacity throughout the year, with
1 trip scheduled per day. For every 3 adult tourists, there will be one child – the adult/child
ratio and the bus capacity are constant for the duration of the project (5 years).

SA Fleet Enterprise (SAFE) was awarded a fixed contract of R20 000 000 to manage the fleet,
with equal payments made annually for the next 5 years (the contract amount is after taking
into account total estimated cost of running the project and spreading these costs equally over
the 5 years). SAFE will be responsible for maintaining the buses, personnel management and
all the operational costs of running the project.

Additional information:
 The City of Nkandla depreciates its buses over 5 years on a straight line basis and the
value of buses at the end of the project is negligible.

 Weighted average cost of capital is 10%.

 The City of Nkandla is exempt from Income Tax in terms of s10(1)(c).

 Assume 250 days in operation per annum.

QUOTATIONS FROM THE BANK – Rand per USD

Date Selling rate Buying rate
02/01/2015 10,000 9,800

29/01/2015 10,450 10,250

31/01/2015 10,500 10,300
Month average 10,250 10,000

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REQUIRED

a) Determine whether you support the decision taken by the Council to invest in the
project.
(16)

b) Based on your answer above, calculate the project’s discounted payback period.
(4)

c) What are the qualitative factors that the Council would have considered before
embarking on the project? List.
(5)

TOTAL: 25 MARKS

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QUESTION 19: PURIFIED H2O (20 marks; 36 minutes)

Purified H2O (Pty) Ltd (“Purified H2O”) is a private company selling purified water to
companies, government departments and individuals mainly in the Gauteng area. The
company sells bottled water ranging from 500 ml to 10 litres. The business is growing faster
than anticipated and as a result the directors have decided to open one more city branch in
either Sandton or Pietermaritzburg. Purified H2O has limited financial resources and can only
invest in one branch. You, as the chief financial officer, have been requested to analyse the
commercial viability of the two cities and recommend which city will be the best for opening
the branch. After much research, the following information is available to you:

THE SANDTON MARKET

1. The new purifying machine will cost the company R600 000 and can be sold for R100
000 in five years’ time. Working capital of R120 000 will be required at the opening of
the branch.

2. The following are prices for different bottle sizes at the Sandton branch for walk-in
customers:

500ml – R5

1l – R7,50

5l – R25

10l – R50

105 000 walk-in customers (“sales volume”) are projected annually for the next five
years. Sales volume is expected to be equal for 500 ml, 1 l and 5 l. The 10l bottle size
has a low demand and it is expected that its sales volume will be half that of 500ml. The
sales mix is estimated to remain the same for the next five years.

3. The Sandton Conference Centre (SCC) is interested in securing a contract with Purified
H2O to be the sole provider of bottled water for their conference facility over a period of
five years. The conference centre has 20 conference rooms that are used for 26 days
in a month, with an average daily consumption of 50 units of 500 ml bottled water per
conference room. A special price of R4 per 500 ml has been agreed with SCC.

4. Good Life Restaurant at Sandton Square has agreed to purchase annually 200 000 500
ml bottles on condition that the price is R4.50 per bottle for the next five years.

5. Variable costs are estimated at R1 019 000 and fixed costs, including depreciation at
R975 000.

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THE PIETERMARITZBURG MARKET

1. Purified H2O will buy a second hand purifying machine at a cost of R500 000. The
working capital of R80 000 at the start of the project.
2. Normal average sales to walk-in customers are estimated at R3 500 000 per annum and
are estimated to remain the same for the next five years.
3. The company has registered on the supplier databases of government departments in
Pietermaritzburg. It is estimated that an average of R200 000 sales per annum will be
generated from the departments. These projections are in line with the actual sales
received by the Pretoria CBD branch.

4. The contribution ratio of the total branch sales is projected at 70% for the duration of
this five-year venture.

5. Cash fixed costs are estimated at R900 000 per annum.

Additional information:

 The current company tax rate is 28%.

 The company uses a weighted average cost of capital of 12%.
 SARS allows a wear and tear of six years for a brand new purifying machine, and five
years for a second-hand machine.
 The depreciation policy of the company is eight years for new machines and five years
for second-hand machines

REQUIRED

a) Advise the management team of Purified H2O whether they should invest in any of
the two branches.
TOTAL: 20 MARKS

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QUESTION 20: AFRICAN FISH & CHIPS (130 marks; 3½ hours)

African Fish & Chips (Pty) Ltd (“AFC”) is a fish and chips retailer and franchiser founded by
the famous British immigrant, Stuart Barker in 2010. Since its establishment, AFC has
achieved rapid growth with 10 of its own outlets opened in 2016 alone and about 2 000 direct
and indirect job opportunities created to date.
As a 100% family-owned business, initially Stuart Barker had to rely heavily on third party
funding, mainly banks and other development finance institutions. However, with increasing
profit levels the company has started to reduce its debt levels and is now working towards its
target capital structure (of 60%: 40% debt-to-equity at book values).
The company exclusively owns and runs all African Fish & Chips outlets that operate in three
coastal provinces. The inland stores are run and owned by licensed franchisees, which in turn
pay a royalty fee of 4% (based on their gross sales).
Despite a 15% increase in revenue for AFC, 2017 has not been a smooth ride for the company
and its peers as the country continues to be under a cloud of political uncertainty, the recent
credit downgrades, high levels of unemployment and abrupt climate changes. Because of
these challenging market conditions, AFC also had to restructure its business and revise its
growth strategy.
The financial statements for the year ended 30 June 2017 are provided below.

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Statement of comprehensive income

For the year ended 30 June 2017

R 000 Notes 2017

Revenue 242 455
Cost of sales (136 711)
Gross profit 105 744
Net operating expenses 1 (67 144)
Operating profit 38 600
Other income 2 3 486
Finance costs 3 (14 138)
Profit before taxation 27 948
Taxation (8 128)
Profit for the year 19 820
Ordinary dividend (4 520)
Retained income for the year 15 300

SALIENT INFORMATION
Number of own stores 75
Number of franchise stores 114
Number of employees 312
Number of days in a year 360
Inflation rate (%) 5,70
Required rate of return 10,5
Prime lending rate (%) 10,75
Corporate taxation rate (%) 28,0

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Statement of financial position

At 30 June 2017

R 000 Notes 2017

ASSETS
Non-current assets
Property, plant and equipment 117 870
Intangible assets 28 270
Other investments and loans 2 21 362

Current assets
Inventory 20 874
Cash and cash equivalents 40 490
Total assets 228 866

EQUITY AND LIABILITIES

Capital and reserves
Ordinary share capital (40 cents each) 3 8 000
Retained income 60 666
Total equity 68 666

Non-current liabilities
Preference share capital 3 20 000
Debentures 3 48 000
Long-term loan 3 58 500
Deferred tax 6 249

Current liabilities
Trade and other payables 20 176
Short-term borrowings 4 101
Provisions 3 174
Total equity and liabilities 228 866

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Notes
1. Net operating expenses (operating expenses less franchise income) are made up of
the following:
R 000
Salaries and wages 69 880
Depreciation 8 150
Administration and marketing 1 326
Amortisation 1 046
Other operating costs 1 818
Franchise income (15 076)
Net operating expenses 67 144

2. Other income comprises of the following items:

R 000
Dividend income – JSE listed shares 537
Interest received – call account 1 826
Profit on sale of an associate 1 123
Other income 3 486

3. Finance costs relate to interest paid on all the company’s interest-bearing loans and
debentures. They also include a preference share dividend amount of R1,9 million.
Finance costs are paid annually in arrears at a fixed interest (or dividend) rate, unless
stated otherwise. At the beginning of the current financial year the company had loans,
debentures and preference shares totalling R140 million.

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Additional information
In its effort to remain one of the largest fast food outlets in the country, AFC is evaluating two
options for viability. However, due to funding constraints the company can only invest in one.
Below is one of the company’s independent projects.

Project Franchise 2023

The company has just spent R200 000 on a campaign to promote its franchise business to
sports stars in an effort to bolster brand awareness. There are plans to open ten franchises
throughout South Africa as AFC continues to support young entrepreneurs. It has been
established that location is key in the fast food market and new franchisees struggle to secure
good locations on their own. It is for this reason that AFC enters into a lease agreement on
behalf of its franchisees. AFC is responsible for paying an upfront refundable deposit
equivalent to an annual rental amount payable under the rental agreement (the deposit is
adjusted annually to keep up with the rental amount). The franchisees will pay the annual
rental directly into the landlords’ bank account at the start of the year. The average annual
rental per store is R200 000 and this is subject to an annual rental escalation clause of 10%.
The lease is initially for a six-year period.
AFC will incur an upfront setup cost of R1 500 000 to help new franchise businesses to get off
the ground – this amount is not recoverable from the franchisees, although it is fully tax
deductible. AFC estimates gross sales to be made by each franchise store to be R1,5 million
in the first year. Gross sales are expected to increase by 6% year on year. Total inspection
costs are estimated at R145 000 per annum. These costs include a 15% annual depreciation
on a mobile inspector, a special vehicle used to conduct site visits. The cost of the mobile
inspector is R500 000 (purchased at start of the project). The motor vehicle will be sold at the
end of the project (2023) for R50 000.
The royalty fee percentage remains fixed throughout the six-year franchise deal and the
royalty fees are received at the end of each year. The wear and tear allowed by SARS on
vehicles used by AFC averages 15% per annum. The company’s tax liability (or refund) is paid
(or received) one year after being due, except in the last year of the project where the tax is
paid (or received) in that last year. The project of opening the ten franchise stores is indivisible.

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REQUIRED
a) Calculate the following profitability ratios of African Fish & Chips (Pty) Ltd for the 2017
financial year; and provide, where possible, reasons for any changes from 2016
financial year ratios (given in brackets).

[Round rand amounts to the nearest rand and all other amounts to one decimal place]
i). Gross profit margin (48,2%)
ii). EBITDA margin (17,0%)
iii). Administration & marketing as % of operating expenses (2,0%)
iv). Income per franchise store (R128 806)
v). Average salary per employee (R202 714)
vi). Effective tax rate (27,6%)

(Calculation 12 marks; comment 6 marks) (18)

b) Using book values where applicable, calculate the following return on invested capital
ratios of African Fish & Chips (Pty) Ltd for the 2017 financial year; and provide, where
possible, reasons for any changes from 2016 financial year ratios (given in brackets).

[Round all amounts to one decimal place]

i). Return on assets (19,2%)
ii). Return on equity (26,2%)
iii). Return on capital employed (17,8%)
iv). Non-current asset turnover (1,3 times)

(Calculation 8 marks; comment 4 marks) (12)

c) Calculate the following liquidity ratios of African Fish & Chips (Pty) Ltd for the 2017
financial year; and provide, where possible, reasons for any changes from 2016
financial year ratios (given in brackets).

[Round all amounts to one decimal place]

i). Current ratio (1,9: 1)
ii). Inventory turnover times (5,6 times)
iii). Creditors’ payment period (58 days)
iv). Acid-test ratio (1,3: 1)
v). Business cycle (6 days)
vi). Cash ratio (1,3: 1)

(Calculation 12 marks; comment 6 marks) (18)

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d) Using book values where applicable, calculate the following capital structure/solvency
ratios of African Fish & Chips (Pty) Ltd for the 2017 financial year; and provide, where
possible, reasons for any changes from 2016 financial year ratios (given in brackets).

[Round all amounts to one decimal place]

i). Capital gearing ratio (0,74: 1)
ii). Debt ratio (72,1%)
iii). Times interest earned (3,3 times)
iv). Net interest cover (3,9 times)
v). Interest-bearing debt: equity ratio (2,2: 1)
vi). Net interest-bearing debt: equity ratio (1,5: 1)
vii). Interest-bearing debt: EBITDA (3,2: 1)
viii). Effective interest rate (9,6%)
(Calculation 16 marks; comment 8 marks) (24)

e) Calculate the following financial markets/investor ratios of African Fish & Chips (Pty)
Ltd for the 2017 financial year; and provide, where possible, reasons for any changes
from 2016 financial year ratios (given in brackets).

[Round all amounts to one decimal place]

i). Earnings per share (92 cents)
ii). Dividends per share (18,8 cents)
iii). Dividend cover (4,9 times)
iv). Dividend pay-out ratio (20,4%)
(Calculation 8 marks; comment 4 marks) (12)

f) Discuss the business risks that African Fish & Chips (Pty) Ltd faces in its business
operations and advise on how these risks can be mitigated or reduced.
(10)

g) To evaluate the project outlined above under “Additional information”, you are required
to perform the calculations below, and advise if the company should undertake
Project Franchise 2023:
i). Net present value
ii). Net present value index
iii). Internal rate of return
iv). Payback period
(26)

h) Discuss the qualitative factors that African Fish & Chips (Pty) Ltd would have to
consider over and above the decision made in (d) above.
(6)

i) Describe two types of projects that are dealt with in capital budgeting and provide a
business example for each type.
(4)

TOTAL: 130 MARKS

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QUESTION 21: KGORONG (15 marks; 27 minutes)

The following information relates to Kgorong (Pty) Ltd:

 Latest dividend declared and paid in 2013: R 550 000

 Expected growth in dividends:

2014: 10%
2015: 15%
2016: 20%
2017 and thereafter: 25% per annum

 28% is a fair rate of return on minority shares.

REQUIRED
a) Calculate the value of a minority share of 10% in Kgorong (Pty) Ltd.
(12)

b) What conditions should be met in order to obtain more reliable results when using
the Gordon Dividend Growth Model to value a minority share?
(3)

TOTAL: 15 MARKS

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QUESTION 22: AFRICAN BAG (12 marks; 22 minutes)

African Bag (Pty) Ltd (“African Bag”) is a Midrand-based retailer with operations throughout
Africa. The company imports and sells high-end handbag brands. More than 95% of its sales
are on credit, as most clients are not able to pay cash for the products.

The local economy has come under immense pressure because of the decline in global
demand of local resources and a record high unemployment rate. This, coupled with poor
credit risk management policy, has led to African Bag writing off 50% of its debtors’ book for
the year ended 31 December 2014.

The company also has a senior debt in its balance sheet, with a repayment date of 30
September 2015. One of the few options the company has to be able to continue as a going
concern is a fresh issue of shares to recapitalise its balance sheet. Jimmy Marcus, a leading
international retailer has, for years been trying to enter the South African market, and has now
made an offer to purchase 30% of African Bag.

The directors of African Bags have accepted the offer and the two companies expect the deal
to be completed on 30 June 2015 and the funds will be transferred immediately into African
Bag’s money market account on the same day. These funds will be kept in the account until
30 September 2015. Interest is earned/ paid equally throughout the year. Net operating profit
before tax for the 9 months ending on 30 September 2015 is expected to increase by 5% and
interest rates are not expected to change.

Information as at 31 December 2014

R'000
Enterprise value (after bad debt adjustment) 620 000
Net operating profit after tax (NOPAT) 68 054
Senior debt 200 000

Number of shares in issue 1 000 000

Interest on senior debt (p.a.) 10%
Interest on money market account (p.a.) 5%
Tax rate 28%

REQUIRED
a) Calculate the estimated EPS at 30 September 2015 of African Bag (Pty) Limited.

TOTAL: 12 MARKS

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QUESTION 23: FAST AND QUICK (20 marks; 36 minutes)

Fast Ltd made an offer to the shareholders of Quick Ltd on the basis of 4 shares in Fast Ltd
for every 5 shares held in Quick Ltd. The relevant financial information based on the latest
financial statements and market movements are as follows:

Fast Ltd Quick Ltd

Shares in issue (‘000) 200 000 60 000
Earnings after tax (R’000) 840 000 168 000
Dividend pay-out ratio 30% 40%
Net asset value (R’000) 6 400 000 1 020 000
Price per share (cent) 5 124 3 920
Debt: equity ratio 2:1 0,8:1

Both companies have paid dividends consistently in the past.

REQUIRED
a) What is the total number of shares that Fast Ltd will issue to the shareholders of
Quick Ltd?
(2)

b) What is the value placed on one Quick Ltd share as suggested by the offer of Fast
Ltd?
(2)

c) Advise the shareholders of Quick Ltd whether or not they should proceed with the
negotiations (consider the new business value, earnings and dividends). Note any
issues that they should address during the negotiation process.
(14)

d) Should Fast Ltd offer an additional R1 per Quick Ltd share in cash, over and above
the share exchange? Will this influence your initial recommendation?
(2)

TOTAL: 20 MARKS

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QUESTION 24: FAZEBOOK (35 marks; 1 hour)

FazeBook Limited (“FazeBook”) is a popular free social networking website that allows
registered users to create profiles, upload photos and video, send messages and keep in
touch with friends, family and colleagues. The site, which is available in 37 different languages,
includes public features such as:

 Marketplace - allows members to post, read and respond to classified ads.

 Groups - allows members who have common interests to find each other and interact.
 Events - allows members to publicise an event, invite guests and track who plans to
attend.
 Pages - allows members to create and promote a public page built around a specific
topic.
 Presence technology - allows members to see which contacts are online and chat.

Within each member's personal profile, there are several key networking components. The
most popular is arguably the Wall, which is essentially a virtual bulletin board. Messages left
on a member's Wall can be text, video or photos. Another popular component is the virtual
Photo Album. Photos can be uploaded from the desktop or directly from a smartphone camera.
An interactive album feature allows the member's contacts (who are generically called
"friends") to comment on each other's photos and identify (tag) people in the photos. Another
popular profile component is status updates, a micro blogging feature that allows members to
broadcast short Twitter-like announcements to their friends. All interactions are published in a
news feed, which is distributed in real-time to the member's friends.

Over the past year, the value of FazeBook shares has more than doubled. It has recently
made a bid for Wassup Limited (“Wassup”). Wassup has more than 450 million monthly users
and is popular with people looking to avoid text messaging charges. If successful it will be the
social networking giant's largest acquisition to date. In a statement announcing the proposed
deal, FazeBook’s founder Faizel Berg described Wassup's services as "incredibly valuable".
Wassup allows users to send messages over internet connections, avoiding text messaging
fees. The company claims it is currently registering one million new users a day. It makes
money by charging users a subscription fee of R1 per year, although it offers a free model as
well.

The bid offer is one share in FazeBook Limited for every four shares held in Wassup Limited.

Financial information relating to each company is given below:

Extract from the Statements of Financial Performance for the year ended 30 April 2017

FazeBook Wassup
R’m R’m
Turnover 1 500 450
Profit before taxation 156 33
Taxation 63 12
Profit after taxation 93 21
Dividends 12 12
Accumulated profit for the year 81 9

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FazeBook expects that the following specific synergies and related costs will flow from the
transaction:

 Some land and buildings of Wassup would be sold for R1 000 000 (after taxation) and
do not need to be replaced (the combined entity will have sufficient office space).
 Annual post-taxation wage savings at current prices are expected to be R750 000, while
future wage increases are expected to be double the inflation rate for next year and
equal to inflation for the following years.
 Fixed advertising and distribution cost savings of R200 000 (before taxation) would apply
for next year and for each year thereafter.
 Legal and other acquisition-related costs at present value are expected to amount to
R2,5 million (after taxation).

The following additional information is available:

 WACC of Wassup has been estimated at 18%.

 Company income taxation rate is 28%.
 Current rate of inflation is 5% per annum and it is expected to remain at approximately
this level in the foreseeable future.
 Unless otherwise mentioned, all fixed expenses are expected to grow by inflation only.

Statements of Financial Position as at 30 April 2017

FazeBook Wassup
R’m R’m
ASSETS

Non-current assets 600 300

Current assets 330 175

TOTAL ASSETS 930 475

EQUITY AND LIABILITIES

Share capital 270 150

(@ 150c each for both companies)
Retained earnings 210 135
Total equity 480 285

Non-current liabilities 300 90

Current liabilities 150 100

Total liabilities 450 190

TOTAL EQUITY AND LIABILITIES 930 475

Price earnings ratio (prior to bid) 20 12

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REQUIRED

(a) Calculate the present value of all specific synergies between FazeBook and
Wassup, net of associated costs.
[Round the saving up to the nearest million rand] (10)

(b) Establish the Rand value of FazeBook offer to Wassup, assuming that the offer
made by FazeBook reflects the fair market value of the two businesses.
(5)

(c) Discuss when the payment methods of (i) shares; (ii) cash, should be used and
the benefit(s) of using each particular method of payment.
(5)

(d) Calculate the earnings per share of FazeBook following a successful take-over.
(5)

(e) State what investigations you would expect FazeBook to have made prior to
instigating the take-over bid.
(7)

(f) Following a series of detailed talks and negotiations between FazeBook and
Wassup the board of directors of Wassup has decided that the proposed take-over
bid is not in the best interest of Wassup. Outline three (3) defensive tactics the
directors of Wassup can adopt to resist the proposed take-over.
(3)
TOTAL: 35 MARKS

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QUESTION 25: BOXER CASH & CARRY (35 marks; 1 hour)

Tesco PLC is a British multinational grocery and general merchandise retailer headquartered
in London, United Kingdom. The Britain’s economy has continued to be sluggish, especially
following Britain’s Brexit vote and the company is now looking at the possibility of entering the
South African food retail industry. The company is in advanced talks with Brains Limited, a
private equity firm which owns 70% of shares in Boxer Cash & Carry (Pty) Ltd (“Boxer”). Tesco
is interested in making an offer to Brain Limited for its entire stake in Boxer.

Boxer is one of the major retailers in South Africa and has a strong presence in rural areas.
This supermarket’s revenue is currently growing at an average of 22% per annum mainly due
to its aggressive store expansion programme. Having started with five retail outlets in
KwaZulu-Natal ten years ago, the company boasts of a portfolio of 45 retail outlets in KwaZulu-
Natal and Eastern Cape. Boxer’s management team is young and dynamic, having taken over
the reins about eight months ago when Brains Limited acquired Boxer.

The market has reacted negatively to this possible foreign direct investment and as result
Brains Limited’s share price has dropped to 18 500 cents as at 30 September 2016. Brains
Limited has 15 million authorised shares, 80% of which has been issued. Brains Limited has
cited “growing competition” in the food retail space as one of the reasons behind the sale. The
food retail sector in the JSE saw an increase in share price of 16%, and the sector P/E ratio
currently averages 21. The financial statements of Boxer Cash & Carry (Pty) Ltd are given
below.

Statement of comprehensive income for the year ended 30 September 2016

R million

Sale of merchandise 2 100

Cost of sales (1 660)
Gross profit 440
Salaries and wages (130)
Depreciation (20)
Cost of sales (110)
Trading profit 180
Other income 10
Finance costs (30)
Profit before taxation 160
Taxation (40)
Profit for the year 120

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Statement of financial position at 30 September 2016

R million
Assets
Non-current assets 300
Land and buildings 160
Equipment and fittings 110
Investments 30

Current assets 180

100
Inventory

Trade receivables 60
Cash 20

Total assets 480

Equity and liabilities

Equity 240
Ordinary share capital 60
Accumulated reserves 180

Non-current liabilities 150

8% Debentures 80
10% Long-term loan 70

Current liabilities 90
Provisions 50
Trade payables 40

Total equity and liabilities 480

Additional information:
1. The land and buildings can be sold at its open market value of R300m and the
estimated tax bill is R20m (for recoupments on allowances previously granted). The
estate agent charges 5% as a commission on the selling price.
2. The net realisable value of inventory is R45m and debtors can be factored (sold to a
financial institution) at 85% of the carrying value.
3. Early settlement of the current long-term loan (original maturity date is December
2020) will amount to a cancellation fee of R7m.
4. Boxer’s investments are stated at historical carrying value and the estimated fair
market value is R50m.
5. For valuation purposes, the weighted average cost of capital of 12,5% should be used.
The corporate tax rate of 28% has remained unchanged for the past decade.

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REQUIRED

a) Calculate the market capitalisation of Brains Limited at 30 September 2016.

(3)

b) Determine how much Tesco PLC should offer Brains Limited for its interest in Boxer
Cash & Carry (Pty) Ltd, using the net asset value method.
(7)

c) Determine how much Tesco PLC should offer Brains Limited for its interest in Boxer
Cash & Carry (Pty) Ltd, using the earnings multiple method.
(8)

d) Calculate the value of Boxer Cash & Carry (Pty) Ltd business using the free cash flow
model. Assume that operating expenses include post-tax provision for bad debt
adjustment of R2m (non-cash item) and that income and expenses will grow at 3% per
annum for the foreseeable future.
(5)

e) Calculate the following ratios for 2016 and provide possible reasons for change in
previous year’s ratios (previous year’s ratios are provided in brackets).

[Round off your answers to two decimal places]

i). Net debt to equity (47,34%)

ii). Employee costs as % of revenue (5,83%)

iii). EBIT margin (10,2%)

iv). Cash ratio (0,41: 1)

v). Capital gearing ratio (33,67%)

vi). Inventory turnover (12,3 times)

(12)

TOTAL: 35 MARKS

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QUESTION 26: LION BRANDS (50 marks; 1½ hours)

Lion Brands Limited (known as “Lion Brands”) is Africa’s leading food manufacturer and
continues to aggressively increase its footprints to countries outside the continent. Lion Brands
is the third biggest company on the JSE (based on the market capitalisation of approximately
R850 billion). The board of directors of the company is in advanced stages of talks with
relevant parties to discuss the acquisition of the following entities:

 Ellerine Cookies, a bakery division of Sasco Limited, and

 Twista (Pty) Ltd (“Twista”), a carbonated drinks manufacturer owned by Faf Molefe and
Marius Rabada

Ellerine Cookies
Ellerine Cookies is currently growing its profits at 80% of the inflation rate as consumers
become more health conscious. Revenue has of lately come under immense pressure due to
new industry players introducing healthier alternatives. Despite increased input costs following
the El Nino effect, the division continues to deliver strong results owing to sound cost control
measures being in place. Ellerine Cookies has also managed to service and reduce its debt
obligations amid increasing prime lending rate.

The board of directors of Sasco Limited is also considering shutting down the division and
moving its operating assets, including its non-current asset portfolio currently worth R300
million, to one of its most profitable divisions, in the event that the deal with Lion Brands falls
through. The audited financial statements of Ellerine Cookies are provided below:

Statement of comprehensive income for the year ended 31 December 2016

R 000
Turnover 178 381
Cost of sales (102 572)
Gross profit 75 809
Operating expenses (42 500)
Profit before interest, tax, depreciation and amortisation 33 309
Depreciation and amortisation (2 992)
Profit before interest and tax 30 317
Interest expense (4 712)
Profit before tax 25 605
Taxation expense (6 657)
Profit for the year 18 948

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Statement of financial position at 31 December 2016

R 000
Assets
Non-current assets 164 124
Current assets 111 033
Inventory 1 831
Trade receivables 63 421
Cash balances and investments 45 781

Total Assets 275 157

Equity and liabilities

Equity 144 876
Ordinary share capital (R1 each) 60 000
Retained income 84 876

Non-current liabilities
Long-term loan 40 000
Current liabilities 90 281
Trade payables 61 753
Accruals and provisions 28 528

Total equity and liabilities 275 157

Ellerine Cookies has just won a tender to supply bread to schools in the Ekurhuleni East
District with effect from January 2017 until December 2018. The division expects its profits to
increase by 20% per annum during this period and thereafter increase at its current growth
rate. Ellerine Cookies has committed an investment of R2 million over the next two years in
sports development (to be paid in equal instalments at the end of each year). The weighted
average cost of capital is estimated at 15%. The free cash flows of the entity approximate the
division’s net profit after reversing non-cash income and expenses.

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Twista
The company is currently owned 2 : 1 by Faf Molefe and Marius Rabada, respectively. Lion
Brands has made an offer to buy Faf Molefe’s entire stake in the business. Twista provides
top quality, innovatively flavoured soft drinks to the South African market at a competitive price,
all while conducting business in a responsible, fair and environmentally-friendly manner. The
competition is rife in the soft drinks industry and companies like Twista struggle to penetrate
the market due to limited distribution network and high marketing and branding costs.
Nonetheless, high margins and relatively low production costs result in good profits for most
soft drinks companies. Listed beverage companies have an average earnings-yield of 6,25%.
A listed share is said to trade at 10% above an unlisted share due to its liquidity (marketability).

The earnings of Twista for the past five years are reported below:

R 000 2012 2013 2014 2015 2016

Net profit 2 390 2 545 2 700 3 220 2 650

Earnings reported in the 2015 financial year include an after-tax profit of R400 000 made on
sale of a patent. During 2016, the longest-serving managing director of Twista resigned and
was paid R350 000 (net of tax) for the restraint of trade imposed on the director.

Additional information
 Lion Brands will offer Faf Molefe shares in the company in exchange for his stake in Twista
as Lion Brands has only issued 34% of the 10 billion authorised shares.
 The general inflation rate is currently at 6,25%.
 There were 366 days in the 2016 financial year.
 The corporate taxation rate is 28%.

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REQUIRED
(a) Calculate the following ratios of Ellerine Cookies for the year ended 31 December 2016
and provide possible reasons for movement in these ratios (2015 ratios are given
below in brackets).
i). Operating profit margin (20,2%)
ii). Return on capital employed (14,5%)
iii). Asset turnover (0,8 times)
iv). Inventory turnover (8,8 days)
v). Interest bearing debt to EBITDA (1,5 : 1)
vi). Net interest cover (7,2 times)
[Round all calculations to the nearest two decimal places. No marks are
awarded for simply stating the direction of the movement unless relevant
reason is given.]
(Calculations 12 marks; comments 6 marks)
(18)

(b) Calculate the value of Ellerine Cookies' business at 31 December 2016, using the free
cash flow (discounted cash flow) method.
(12)

(c) Use the net asset value method to check the reasonableness of the valuation
performed in part (b) above and state any assumptions made.
(5)

(d) Determine the number of shares Lion Brands should issue in exchange for the stake
in Twista (use price-earnings multiple method, if necessary).
(15)

TOTAL: 50 MARKS

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QUESTION 27: PBC (55 marks; 1󠄧⅔ hours)

PBC Limited (“PBC”) is one of the leading suppliers of cement in Southern Africa, with
manufacturing plants in South Africa, Zimbabwe and Botswana. The company also produces
aggregates, lime, burnt dolomite and limestone. The statement of comprehensive income and
statement of financial position for PBC are provided below:

Statement of comprehensive income for the year ended 30 September 2016

R mil 2016
Revenue 923
Cost of sales (644)
Gross profit 279
Operating costs (156)
Finance costs (50)
Interest income 8
Profit before taxation 81
Taxation ( 21)
Profit for the year 60

Shares in issue (‘000) 22 000

Share price – closing (cents) 3 440

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Statement of financial position at 30 September 2016

R mil 2016
Non-current assets
Property, plant and equipment 1 090
Goodwill 35
Investments 122

Current assets
Inventory 99
Trade and other receivables 120
Cash and cash equivalents 74
Total assets 1 540

Capital and reserves

Stated capital 550
Other reserves 27
Retained income 338
Total equity 915

Non-current liabilities
Long-term borrowings 465
Deferred taxation 18

Current liabilities
Provision 68
Trade and other payables 74
Total equity and liabilities 1 540

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ADDITIONAL INFORMATION:
2016 financial results

1. The following are some of PBC’s key performance indicators for the year ended 30
September 2015:
 EBITDA margin: 27,65%
 P/E ratio: 14,20 times
 Bad debt ratio: 6,89%
 Stock turnover: 5,88 times
 Debt-equity ratio: 0,58: 1
 Price to book value: 1,03: 1

2. Depreciation for the year ended 30 September 2016 was R71 million.

3. The credit sales make up 20% of total sales. Bad debts written off during the 2016
financial year amounted to R9,23 million.

ROBERT MURRAY LIMITED CONTRACT

PBC continues to face tough competition from foreign cement producers (due to dumping),
but the company still enjoys a 30% share of the South African cement industry. Due to strong
presence, PBC is one of the key limestone & cement suppliers of Robert Murray Limited
(“Robert Murray”), a major construction company in Africa. In August 2016 (two months ago),
Robert Murray won a bid to build a highway footbridge that would connect people between the
eastern and the western side of the Randburg business district.

The construction is expected to begin shortly (the start date is 1 November 2016 and
completion is expected to be on 30 June 2017) and PBC has already started clearing the area
next to the construction site to process and store its materials. This work by PBC should be
completed at the end of this month (31 October 2016) at a total cost of R1 million. PBC is also
raising a loan of R28 million from BnP Capital on 15 October 2016 to fund its supplies and
labour costs. The interest rate on this loan will be fixed at 150 basis points below prime and
the interest (not compounded) will be paid annually, whereas the capital portion will only be
repaid at the end of the loan term (14 October 2017).

PBC will be required to supply cement to Robert Murray at a fixed price for the duration of the
project to the total order value of R26 million. The orders will be spread evenly throughout the
project, starting at the beginning of November 2016. Delivery and other related costs will
amount to R500 000 per month but will be paid one month in arrears and borne by PBC. These
costs will not be transferred to Robert Murray.

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PBC will also supply limestone to Robert Murray for the next five months. The first load of
limestone will be sold and delivered to Robert Murray on 24 November 2016. This load will
cost PBC R4 million but will only be used by Robert Murray in December 2016. The cost of
production will increase by 15% in December 2016 and revert to November 2016 levels in
subsequent months. Assume sales take place in the same month of production.

PBC adds a margin of 50% on cost for all products sold to Robert Murray.

A new vehicle will be delivered to PBC’s site on 1 November 2016. The cost of the vehicle is
R200 000. The vehicle will be used by the site manager and is also expected to be used at
other company sites after the completion of the project. PBC expects this vehicle to have a
useful life of five years.

Operating income and expenses from the 2016 financial period (excluding the Robert Murray
contract) are expected to increase at an average annual rate of inflation + 4%. All income
earned and expenses incurred by PBC are distributed evenly throughout the year.

The prime rate is 10,5% while inflation is at 6%. The effective taxation rate should be used for
budgeting and projection purposes.

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REQUIRED

a) Calculate and comment on possible reasons for movement in the following ratios for
the year ended 30 September 2016:

[Round off answers to two decimal places.]

i). EBITDA margin

ii). P/E ratio
iii). Bad debt ratio
iv). Stock turnover
v). Debt-equity ratio
vi). Price to book value ratio

(Calculations 17 marks; comments 6 marks and presentation 2 marks)

(25)

b) Describe key business, currency and interest rate risks faced by PBC Limited.
(5)

c) Prepare a projected statement of comprehensive income for the three months ending
31 January 2017.

[Scale all rand values to R mil and show all workings.]

(25)

TOTAL: 55 MARKS

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QUESTION 28: umfula.co.za (30 marks; 54 minutes)

Umfula.co.za Ltd is a listed South African electronic commerce company with headquarters in
Cape Town. It is the largest internet-based wholesaler in South Africa and is seen as a
potential target for acquisition by financial analysts.

Umfula.co.za Ltd started as an online bookstore, but soon diversified, selling DVDs, VHSs,
CDs, video and MP3 downloads/streaming, software, video games, electronics, apparel,
furniture, food, toys, and jewellery. The company also produces consumer electronics —
notably, Umfula.co.za e-book readers, Umlilo tablets, Umlilo TV and Umlilo Phone — and is a
major provider of cloud computing services.

The value of the company has therefore been a matter of public debate in recent weeks and
the following financial information is available:

Year 2012 2013 2014 2015

R million R million R million R million

Turnover 263 265 290 300

Profit after tax 17 17 19 20

Total dividends 10 11 11 12

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Statement of financial position information on 31 December 2015

R million

Assets
Non-current assets 282
Current assets 168
Inventory 125
Trade receivables 43

Total assets 450

Equity and liabilities

Equity 258
Ordinary share capital 40
Accumulated reserves 218

Non-current liabilities
8% debenture 50
Current liabilities 142
Trade payables 82
Bank overdraft 60

Total equity and liabilities 450

All sales were on 30 days’ credit to commercial customers. In order to encourage customers
to pay on time, Umfula.co.za proposes introducing an early settlement discount of 1% for
payment within 30 days, while increasing its normal credit period to 45 days. It is expected
that, on average, 50% of customers will take the discount and pay within 30 days, 30% of
customers will pay after 45 days, and 20% of customers will not change their current paying
behaviour (thus paying in 60 days).

Umfula.co.za is currently placing orders of 1 500 units of the Umlilo-Phone (U-phone) per
month, the demand for which is constant. Pear Ltd is the only supplier of U-phone and the
cost of U-phone purchases over the last year was R54 million. The supplier has offered a 2%
discount for orders of U-phone of 3 000 units or more. The average stock on hand is 750 units
(1 500/2). Each order costs Umfula.co.za R3 000 to place and the holding cost is R50 per
unit per year. The revised accounts receivable policy will be financed by the overdraft facility.

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Additional information:

1. The shares of Umfula.co.za Ltd have a nominal (par) value of 100c per share and a market
value of R5.00 per share.

2. The cost of equity of the company is 9%.

3. The business sector of Umfula.co.za Ltd has an average price/earnings ratio of 20 times
(the adjusted price/earnings ratio of Umfula.co.za after considering its risk profile is
estimated to be 3 points below the business sector’s price/earnings ratio).

4. The 8% debentures are redeemable at nominal (par) value of R100 per debenture in
seven years’ time and the after-tax cost of debt of Umfula.co.za Ltd is 6% per year.

5. The expected net realisable values of the non-current assets and the inventory are R276m
and R130m, respectively.

6. In the event of liquidation, only 80% of the trade receivables are expected to be
collectable.

7. Umfula.co.za has an overdraft facility charging interest of 10% per year.

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REQUIRED

a) Calculate the impact on the collection period as well as the financial impact (in R millions)
of the net benefit or cost of the proposed changes in trade receivables policy and remark
on your findings.

[Round off the rand values to million and all other calculations to 1 decimal]

(Calculation 4 marks; comment 2 marks)

(6)

b) Determine (in millions) whether the bulk purchase discount offered by Pear Ltd is
financially acceptable; and explain the assumptions outlined by your calculation.

(Calculation 4 marks; comment 2 marks)

(6)

c) Calculate the value of Umfula.co.za Ltd using the following methods:

i). Market capitalisation (equity market value) (2 marks)
ii). Net asset value (liquidation basis) (2 marks)
iii). Price earnings method using the business sector average P/E ratio (2 marks)
iv). Gordon’s dividend growth model (2 marks)
g for the Gordon’s dividend growth model should be calculated as follows:
g = bre
Where:

𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 ℎ𝑖𝑠𝑡𝑜𝑟𝑖𝑐 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑎𝑛𝑑 𝑡𝑎𝑥

b = historic retention ratio { }
𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 ℎ𝑖𝑠𝑡𝑜𝑟𝑖𝑐 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥

𝑃𝑟𝑜𝑓𝑖𝑡 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟

re = current return on shareholders’ fund {𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠′ 𝑒𝑞𝑢𝑖𝑡𝑦}

(8)

d) Analyse and debate the relative merits of the valuation methods in part (c) above in
determining a purchase price for Umfula.co.za Ltd.
(8)

(Communication skills – clarity of expression, layout and communication 2 marks)

(2)

TOTAL: 30 MARKS

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QUESTION 29: HEALTH MATTERS LIMITED (100 marks; 3 hours)

PART A
Health Matters Limited (“Health Matters”) is a chain of pharmacies operating across South
Africa. Its aim is to offer customers a wide variety of medicine and other healthcare products
at affordable prices. A large portion of its medicine is sold over the counter and otherwise, is
imported from two different pharmaceutical companies incorporated in the UK and USA
respectively. In order to counter Rand/Pound/US Dollar fluctuations, a strict foreign currency
policy is followed.
Owing to a robust financial performance history and its brand popularity, Health Matters
successfully listed on the JSE a year ago in a bid to raise capital. The company wishes to
expand into the rest of Africa within the next few years. Zoe Padayachee, one of the directors
of Health Matters, is currently engaged in negotiations with Nigeria’s Federal Ministry of Health
in an effort to penetrate the African market, as the company continues to struggle to grow the
South African business.
At the last shareholders’ meeting, a possible acquisition of 25% of Health Matters by the UK
based pharmaceutical company, Johnson & Glaxo Limited (J&G) was discussed, and the
majority of affected shareholders voted in favour of the acquisition. Johnson & Glaxo Limited
has offered the 25% shareholders of Health Matters the following:
 A cash payment of £1 800 000 will be made on 31 October 2017.
 175 000 shares (fifty million shares are currently issued by J&G) will be issued to the
25% Health Matters shareholders. Johnson & Glaxo Limited is listed on both the JSE
and the FTSE. The market capitalisation of Johnson & Glaxo Limited is estimated to
remain around R4 billion for the next two months.
 The dividend due on the 175 000 shares above will be paid to the 25% Health Matters
shareholders on 31 October 2017 (the dividend yield will average about 4%).
 Johnson and Glaxo Limited (as it will be one of the three biggest shareholders) will be
able to appoint one-third of the board of directors of Health Matters Limited.
 The transaction date for this deal will also be 31 October 2017.

The following information relating to the past financial years of Health Matters is relevant:
Year 2014 2015 2016 2017

R million R million R million R million

Turnover 200 225 260 285

Profit after tax 14,0 16,0 18,0 20,0

Ordinary dividends 10,5 12,5 13,5 15,0

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The statement of financial position of Health Matters at the end of its financial year is
provided below.

STATEMENT OF FINANCIAL POSITION AT 30 SEPTEMBER 2017

Notes Rand
/ Info
ASSETS
Non-current assets a 65 000 000
Current assets 66 825 000
Inventory b 60 000 000
Trade receivables b 6 825 000
Total assets 131 825 000

EQUITY AND LIABILITIES

Total equity 75 000 000
Ordinary share capital 1 60 000 000
Retained income 1 15 000 000

Non-current liabilities 46 750 000

Debentures 2 25 000 000
Preference shares 3 15 000 000
Interest-bearing borrowings 4 6 000 000
Deferred tax 750 000

Current liabilities 10 075 000

Trade payables 1 425 000
Interest-bearing borrowings 5 3 250 000
Bank overdraft 6 4 500 000
Provisions 900 000

Total equity and liabilities 131 825 000

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Notes
1. Health Matters has an authorised ordinary share capital of ten million shares and a market
value of ordinary shares of R180 000 000 (see “Additional information” for profits and
dividends).
2. Fifty thousand debentures (at a nominal value of R500 each) were issued on 1 October
2016 at a fixed rate of prime less 300 basis points. Interest is serviced annually and capital
is repaid on 30 September 2022. An exit fee of R1,20 for each debenture redeemed will
be paid on 1 October 2022. Similar debentures currently bear an interest rate of 8% per
annum.
3. The preference shares carry a dividend pay-out rate of 8% and will be redeemed at a
premium of 6% in 4 years’ time. However, the premium is only paid a year later (after
redemption). The dividend for the current year has already been paid and preference
shares in the similar risk class are currently yielding 10,5% per annum.
4. The R6 000 000 loan was obtained on 1 October 2014 from Katz Finance and the company
pays an annual interest of R542 400 to Katz Finance (the market value of the loan is
currently R6 007 924).
5. A short-term loan bearing interest rate of 8,5% per annum was obtained from Able Bank
Limited on 1 October 2016. The loan is repayable on 30 September 2018 and the company
does not intend renewing the facility. The interest rate on similar loans is 8,25% per annum.
6. The bank overdraft bears an average interest rate of 10,5% (after tax) per annum. The
overdraft is used for working capital requirements when the need arises, and the balance
fluctuates monthly.
7. The company has a target capital structure of 70% equity and 30% debt. Under the target
debt, debentures should be double the sum of other interest-bearing instruments (these
interest-bearing instruments should always be utilised in equal proportions).

Additional information
a) Non-current assets consist of land and building which was last revalued at R42 000 000
five years ago. The property price index used in these valuations has since increased at
4,5% per annum. All other non-current assets can be sold at R99 000 000 before incurring
disposal costs of R34 641. Ignore tax implications on asset disposal and revaluations.

b) Half of the inventory on hand can be sold at its cost, while the other half received much
later can be sold at a mark-up of 20% on sales. The debtors’ book can be sold at 80% of
its carrying value. Marketing and selling costs are estimated at R2 500 000.

c) Health Matters’ profits are expected to grow to R21 600 000 in the 2018 financial year,
while the dividend cover remains constant. Growth between from 2017 and 2018 financial
year will be maintained for the foreseeable future.

d) The prime lending rate currently is 10,5% and the company taxation rate is 28%.

e) There are 365 days in the 2017 financial year.

f) Foreign exchange spot rates (£ to R1):

30 September 2016 0,0593

30 September 2017 0,0586
31 October 2017 0,0605 (forecast)

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REQUIRED

i. Calculate the weighted average cost of capital (WACC) of Health Matters Limited at 30
September 2017 based on both the target and the existing capital structures.

[Round off percentages to one decimal place]

(24)

ii. Discuss what factors Health Matters would need to consider when financing its expansion
programmes in the future, if working towards its target capital structure.
(5)

iii. Determine how much it will cost Johnson & Glaxo Limited to buy the 25% stake in Health
Matters.
(5)

iv. Determine how much Johnson & Glaxo Limited should be offering the shareholders of
Health Matters for the stake in the business, assuming that the net asset value method
would be appropriate to value Health Matters business.
(5)

v. Comment on the differences between the valuation/s performed above and Johnson &
Glaxo Limited offer, by critically evaluating any limitations / assumptions made.
(5)

vi. Discuss three qualitative factors that the directors of Health Matters should consider in
planning its expansion into the rest of Africa (focus on political, social and economic factors
regarding Nigeria).
(6)

PART A: 50 MARKS

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PART B
Zoe Padayachee had previously worked in the pharmaceutical industry in the US and has built
strong relations with some of the large pharmaceutical companies. During her recent visit she
met with one of the directors of a large pharmaceutical company, Interpharm. In their meeting,
the director mentioned that Interpharm is considering distributing their products into Africa.
They were of the opinion that it would be a good idea to first retail their products through South
African outlets for a period of five years, before distributing to the rest of Africa.

Zoe Padayachee saw this as an opportunity and suggested that Interpharm consider retailing
its products through Health Matters’ stores. In a follow up meeting between Zoe Padayachee
and Interpharm, it was stated that Health Matters Limited would have to pay Interpharm a
once-off initiation fee of $2 500 000 on 31 October 2017 (start of the contract) for the exclusive
right to sell Interpharm products.

Research conducted by Health Matters costing R1 000 000 indicated that sales of
Interpharm’s product line would probably amount to R150 000 000 in year one and this would
be expected to increase by 6% annually thereafter for the remainder of the contract period.
Inventory costing $10 000 000 would be purchased from Interpharm in 2018 and the cost
would be expected to escalate by 5% annually thereafter. Health Matters would have to bear
all marketing costs in order to create a market for Interpharm in South Africa.

The research conducted determined the following marketing costs:

 Once-off marketing cost of R4 000 000.
 Printing and communication costs of R75 000 per month.
 TV and radio advertisements of 140 advertisements aired per year to the value of R50 000
per ad.

The above costs had been estimated to escalate at the inflation rate of 5% per annum
thereafter. The working capital requirements would be expected to amount to 12% of sales
per year and would be incurred at the beginning of each year. The starting working capital is
R18 000 000.

Assume for the purposes of this question that the initial upfront payment for the right to sell
Interpharm products can be amortised over the life of the project and SARS will permit a 4-
year allowance. The marketing costs are deductible in 2018 for tax purposes. All cash flows
take place at the end of the year unless specifically stated otherwise. Assessed losses from

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Health Matters’ business ventures are not ring-fenced and can be deducted from the
company’s overall profits.

The forecasted foreign exchange spot rates (for every one US dollar) are provided below:
31 October 2017 R13,00

31 October 2018 R13,50

31 October 2019 R13,20

31 October 2020 R13,05

31 October 2021 R12,80

31 October 2022 R12,70

31 October 2023 R12,65

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REQUIRED

i. Using the net present value method, advise the directors of Health Matters whether it
would be feasible to sell the products of Interpharm on an exclusive basis for a period
of five years.
(18)

ii. Discuss the qualitative factors that Health Matters needs to consider before entering
into the agreement with Interpharm.

(5)

iii. Using the information in Part A, calculate the following ratios for the 2017 financial
year and comment on how the ratios may be improved (one mark per each ratio
calculated):
o Profitability (Calculation 2 marks, comment 1 mark)
o Capital structure and solvency (Calculation 3 marks, comment 1 mark)
o Liquidity (Calculation 2 marks, comment 1 mark)
o Return on invested capital (Calculation 2 marks, comment 1 mark)
o Financial market/investor (Calculation 3 marks; comment 1 mark)

[Round all calculations to one decimal place and clearly show ratios by their
categories above]
(17)

iv. Based on information provided in both Part A and Part B, assess the internal and
external environment of Health Matters using a SWOT analysis.
(10)
PART B: 50 MARKS

TOTAL: 100 MARKS

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QUESTION 30: DISTELL (100 marks; 3 hours)

Distell Group Limited (“Distell”) is Africa’s leading producer and marketer of spirits, fine wine
ciders and ready-to-drinks. This Stellenbosch-based company is listed on the JSE Stock
Exchange and it employs about 5 300 people worldwide. Some of its popular brands are
Hunter’s, Savanna, Three ships, Amarula and Nederburg. Its main rivals in the South African
beverage market include SABMiller, Brandhouse and Edward Snell & Co. The average sector
PE ratio is about 15.
Recent extreme weather conditions have not been favourable to the industry as the raw
material prices went up; however, for exporters the effect was countered by a weakening rand
against major currencies. Despite tough economic environment, the Distell Group has been
able to deliver double-digit growth on revenue for the past 5 years. As part of its social
responsibilities, the company increased its workforce by 6% during the financial year under
review (2015).
In an effort to cement its strong position, Distell is set to make an offer to buy 100% of shares
in Namibia Breweries (Pty) Ltd. This will help the company to further diversify its portfolio as it
would be entering the very competitive, yet profitable beer market.

Financial information of Distell Group Limited is given below.

Source: Distell website (www.distell.co.za)

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NOTES
1. Only sales to major liquor stores and big wholesales are on credit with payment terms
varying from 30 days to 60 days. These have always made up 80% of total sales, while
the rest is sold to small liquor outlets and individuals. All purchases are made on credit.

2. Financial assets include investments in the Top 40 share index of the JSE Stock
Exchange. These funds can be accessed within 24 hours from the time a request is
made to the brokers. The value of the investment at 30 June 2015 was R204 068 000
(2014: R188 450 000). Transaction costs are negligible.

3. The expected rate of return in the market approximates 12,59% and the risk premium
is estimated at around 5,77% (Distell’s historic beta is 1,5).

4. Interest-bearing borrowings account is made up of:

 10-year debentures with a carrying value of R447 143 000 were issued five
years ago at a coupon rate of 7% and are currently trading at R502 123 000.
Only the interest is paid annually - the capital is repaid at the expiry of the
facility.

 A R2 billion long-term loan secured over land and buildings which was obtained
from Investec on 6 July 2014. This deal was done at a fixed rate of prime less
400 basis points. Interest is serviced annually and the capital is repaid on 5
July 2020 with an exit fee of R50 million. Similar loans currently bear interest
rate of 7% per annum.

 10 000 000 preference shares were issued on 28 June 2015 and repayable in
6 years’ time. The yield on similar preference shares has been 5,2% for the
past two months.

No other long-term interest-bearing loans were received or repaid during the

year.

5. Interest-bearing borrowings relate to a two-year 6,8% loan facility received on 3 July

2014 from Rand Merchant Bank and is repayable on 28 June 2016. The interest rate
on similar loans is 6,5%.

ADDITIONAL INFORMATION

 The company tax rate is 28% and you may ignore any CGT implications.

 Prime rate has remained at 10,25% for the past two years and the economists do not
foresee a rate change in the short term.

 The consumer price index is 6,3%. Assume 365 days in a year.

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REQUIRED Sub- Total

total

(i) Analyse the financial statements of Distell Group Limited for the year
(45)
ended 30 June 2015. You are required to calculate ratios under the
following categories:

 Profitability
 Capital structure and solvency
 Liquidity
 Return on invested capital
 Financial market/investor
(Cash flow related ratios not examinable)

For every ratio calculated, where possible you must (a) provide
possible reasons for the movement; (b) measures to be taken to
improve/maintain the ratio and (c) consequences of not
implementing proper measures addressed in (b). No marks are
given for merely stating that the ratio increased/decreased.

[Round number of shares to the nearest million and all other

calculations to one decimal place]

Communication skills – layout, structure and logical argument.

(5) 50

(ii) Calculate the weighted average cost of capital (WACC) of Distell

(18)
Group Limited at 30 June 2015.

[Round percentages to one decimal place and rand amounts to the

nearest R’000]

Communication skills – layout and structure

(2) 20

Total for Part A 70

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PART B
(This part is a continuation of the scenario above)

NAMIBIA BREWERIES INVESTMENT

Based in Namibia, this small brewery is experiencing financial difficulty due to a severe price
hikes in malt and hops, some of its key ingredients. Some of the raw material is usually
imported from neighbouring countries and with the weakening Namibian dollar, the rising
production costs are putting margins under pressure. With strict pricing regulations currently
in place, Namibia Breweries find it difficult to pass these costs to consumers. The company
was founded in 1856 and is considered the pride of the nation and has 15% of the beer market
share in Namibia. However, recent poor management decisions have rocked the financial
standing of the company. Despite this, the Distell board is of the opinion that there are valuable
synergies that can be unlocked between these two companies. Namibia Breweries operations
are strictly run on cash basis. The relevant financial information of Namibia Breweries is
provided below.

Abridged statement of financial performance for the year ended 31 May 2015

N$

Turnover 20 099 245

Raw material 1 (10 138 315)
Labour costs 2 (5 911 478)
Depreciation: manufacturing equipment (1 891 670)
Marketing expenses 3 (1 022 152)
Distribution costs 4 (482 532)
Share of head office costs 5 (352 001)

Profit before tax 301 097

Income tax expense (88 824)

Profit for the year 6 212 273

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NOTES
1. Raw material is made up of three components:

 Raw material A (50% of total raw material cost) currently sourced from a
supplier in Angola will now be provided by a Namibian company which has had
strong relations with Distell, at a cost of 75% of its value.

 Raw material B & C will be purchased from a South African farmer at a 10%
discount off what Namibia Breweries is currently paying. However, an
additional R85 000 p.a. will be incurred on transportation. To exit from its
existing contractual obligation with its old supplier, a penalty fee of N$20 000
will have to be paid.

2. In order to bring Namibia Breweries salary scales in line with Distell Group
remuneration policy, a salary increase adjustment of 12,5% will be effected.

3. Distell is planning to change the trading name of Namibia Breweries in the event of a
successful takeover. As a result, all marketing activities will be halted (no cost will be
incurred) until the end of 2016 financial year and thereafter it is expected that only 20%
of the current marketing expenses will be incurred going forward.

4. A special distribution route levy of N$27 000 has been imposed by the Namibian
government. This is payable at the end of the 2018 financial year and is treated as a
profit and loss item.

5. All Namibia Breweries head office activities will now be handled down in Stellenbosch
where Distell Group has capacity to undertake this task at no extra cost.

6. Namibia Breweries recorded profit before tax of N$1 351 369 in 2014 and N$1 038
778 in 2013. These profit levels are considered to be sustainable as opposed to
extraordinary costs incurred by the business during the 2015 financial year. Similar
companies (though bigger) listed on the Namibian Stock Exchange are trading at
earnings yield of 5%.

ADDITIONAL INFORMATION

 The Namibian government is giving a once-off grant of $50 000 to foreign companies
that are investing in its food and beverage production sector and Distell will also qualify
for this grant.

 The total annual cash flow upon acquisition will occur for the indefinite future. Income
and expenses are expected to increase at 5% per annum.

 The weighted average cost of capital is 20%.

 You are required to use the effective tax rate for relevant tax calculations.

 The purchase consideration for this acquisition will be by means of shares issued in
Distell Limited.

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REQUIRED Sub- Total

total

(i) Draft a memorandum to Distell Group Limited board of directors

(27)
advising them on the number of shares the Group should issue to the
shareholders of Namibia Breweries as a purchase consideration of
the company. Show all workings. Ignore control premium,
marketability and minority discounts.

[Round rand/dollar amounts to the nearest rand]

Communication skills – layout, structure and logical argument.

(3) 30

Total for Part B 30

TOTAL: 100 MARKS

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QUESTION 31: TILES & STYLES OF AFRICA (80 marks; 2½ hours)

Tiles & Styles of Africa (“Tiles & Styles”) is South Africa’s leading retailer of tiles, bathroom
fixtures and related products. The company provides superior ceramic tile flooring and walling
at competitive prices to a growing market. Listed on the JSE three years ago, today Tiles &
Styles has a network of 162 retail stores on the African continent.
As Tiles & Styles continues to enjoy strong brand affinity based on its reputation for a high
quality year-round value offering, the market has also responded positively sending the
company’s market capitalisation to an unprecedented R9,450 billion at the end of its 2017
financial year. This was despite constrained discretionary disposable income of its customers
and the Rand plunging to its lowest levels in more than 15 years against major currencies.
The Competition Tribunal has just approved the company’s offer to acquire 51% of Tile Ses’la
(Pty) Ltd (“Tile Ses’la”), one of its suppliers in an effort to ensure that the company continues
to attain its growth targets. Tiles & Styles has offered R5 billion in cash to the existing
shareholders of Tile Ses’la. This strategic acquisition has been well received by the market,
as it will likely lead to cost reduction and other synergistic benefits. Tiles & Styles also
continues to invest substantially in information technology and e-commerce to keep abreast
of opportunities in the rapidly changing environment.
The financial statements of Tiles & Styles, salient information and notes are provided below,
followed by the financial information relating to Tile Ses’la.

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Statement of comprehensive income of Tiles & Styles of Africa

For the year ended 31 December 2017
2017 2016
Notes Rm Rm
Revenue 6 662 6 819
In-store sales 6 058 6 585
Online sales 604 234
Cost of sales (3 748) (3 925)
Gross profit 2 914 2 894
Maintenance and other indirect expenses (301) (308)
Personnel costs (1 003) (1 031)
Depreciation, amortisation and impairments (410) (372)
Other operating expenses (256) (283)
Profit before interest and taxation 944 900
Net finance costs 1, 2 (101) (105)
Profit before taxation 843 795
Taxation (157) (150)
Net profit for the year 686 645
Interim dividend (70) (75)
Final dividend (134) (110)
Retained income for the year 482 460

SALIENT INFORMATION 2017 2016

Trading days 365 366
Number of retail stores 162 182
Number of employees (000) 25,4 26,1
Dividend growth (%) 10,0 10,0
Prime lending rate (%) 10,3 10,5
Corporate taxation rate (%) 28,0 28,0
Inflation rate (%) 4,8 6,4

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Statement of financial position of Tiles & Styles of Africa

For the year ended 31 December 2017
2017 2016
Notes Rm Rm
ASSETS
Property, plant and equipment 3 788 3 659
Goodwill 681 590
Intangible assets 334 151
Deferred tax 61 58
Other non-current assets 102 68
Total non-currents assets 4 966 4 526

Inventories 850 838

Trade and other receivables 1 049 994
Marketable securities 41 47
Cash and cash equivalents 404 64
Total current assets 2 344 1 943
TOTAL ASSETS 7 310 6 469

EQUITY AND LIABILITIES

Stated capital 542 542
Retained income and other reserves 3 154 2 645
Total equity 1 3 696 3 187

LIABILITIES
Medium and long-term borrowings 1 1 912 2 077
Net retirement benefits liability 240 212
Provisions 44 40
Total non-current liabilities 2 196 2 329

Short-term borrowings 2 651 250

Trade and other payables 600 538
Current tax liability 167 165
Total current liabilities 1 418 953
TOTAL EQUITY AND LIABILITIES 7 310 6 469

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NOTES
1. Tiles & Styles has a target capital structure of 30: 70 (Debt: Equity), and aims to
maintain a ratio of 3:1:1 (debentures: bank loans: preference shares) on its debt
composition. The company will maintain the current dividend growth rate going
forward.

The medium and long-term borrowings at 31 December 2017 were made up of the
following:
 R1 billion debentures were issued three years ago and are redeemable at a
premium of R3,6 million and the maturity date is 31 December 2021. The
premium is payable on 31 December 2022 and is not tax deductible. There is
no interest charged for the late settlement of the premium. The debentures
were issued at a fixed interest rate of 6,8% (similar debentures are currently
trading at a post-tax rate of 5,2%).

 A bank loan of R612 million was obtained on 28 December 2015 and the
interest paid yearly is fixed at R55,08 million. The going rate in the market for
similar loans is 8,5% per annum.

 600 million preference shares were issued on 28 December 2014 and are
redeemable on 28 December 2021. These preference shares carry a fixed
dividend pay-out of 7% (classified as finance costs). Preference share deals
structured this way are currently trading at 75% of the prime lending rate.
The providers of capital are willing to increase their facilities at prevailing market
rates. The providers of capital are also willing to reduce the existing facilities, should
the company wish to do so. However, issuing new ordinary shares will cost
approximately 0,5% of the market share price.

2. Finance costs on short-term borrowings are negligible. Interest rates given are before
tax unless stated otherwise. The total finance income earned during the financial year
(R12m) had declined by 20% from the previous year.

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The information below relates to Tile Ses’la (Pty) Ltd.

The Bala brothers identified an opportunity in the market, and started importing ceramic tiles
from different parts of the world. They founded Tile Ses’la (Pty) Ltd (Pty) Ltd in 1989 and six
years ago, having built up enough human capital and reserves, the company constructed its
own tile-manufacturing site in Alberton, Johannesburg. The company has since then produced
all its tile range locally, but continues to enjoy exclusive manufacturing and distributing rights
from international tile manufacturers to ensure that its clients get to choose from a wide variety
of the best tiles in the world.
The company supplies both the tile retailers and the end-consumers across the country. Rapid
changes in technology and increased competition in the sector has compelled the owners to
consider selling a major stake, or even all of its business. Below are the financial statements
of Tile Ses’la (Pty) Ltd.

Statement of comprehensive income of Tile Ses’la (Pty) Ltd

For the year ended 31 December 2017
2017 2016 2015
Rm Rm Rm
Revenue 3 670 3 539 3 189
Cost of sales (2 182) (2 117) (1 902)
Gross profit 1 488 1 422 1 287
Employee remuneration (184) (144) (134)
Depreciation and amortisation (113) (90) (81)
Other operating expenses (net) (128) (141) (115)
Trading profit 1 063 1 047 957
Finance income 127 119 95
Profit before taxation 1 190 1 166 1 052
Taxation (310) (316) (307)
Profit for the year 880 850 745

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Statement of financial position of Tile Ses’la (Pty) Ltd

For the year ended 31 December 2017
2017
Rm
ASSETS
Property, plant and equipment 1 989
Investments 732
Intangible assets 54
Total non-currents assets 2 775

Inventories 550
Trade and other receivables 327
Cash and cash equivalents 511
Total current assets 1 388
TOTAL ASSETS 4 163

EQUITY AND LIABILITIES

Stated capital 818

Retained income 2 794
Non-distributable reserves 161
Total equity 3 773

LIABILITIES
Subordinated loan 74
Provisions 12
Total non-current liabilities 86

Short-term borrowings 26
Trade and other payables 278
Total current liabilities 304
TOTAL EQUITY AND LIABILITIES 4 163

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Valuation information
1. The following items should be considered in establishing the sustainable earnings of
Tile Ses’la:
 Gross profit in 2015 was down by R83 million because of protests that led to Tile
Ses’la outlets being closed for three weeks. There was no material change in other
operating expenses during that year.

 On 22 June 2017 Tile Ses’la received an out-of-court settlement of R20 million after
one of its competitors infringed the company’s trademark.

 Other operating expenses in 2016 include a R40 million insurance pay-out which
was received by Tile Ses’la in September 2016 for loss of a key member of staff.
(The above amounts are net of tax and therefore tax implication on the above
transactions can be ignored).
2. In the event that the board of directors of Tile Ses’la decides to wind up the company
through disposing of its assets, the following financial information has been
established:
 The company’s land and buildings (recorded at a carrying value of R400 million) is
currently worth R4,24 billion. This is before taking into account selling and other
legal expenses of 0,3%.

 The company will be able to sell some of its trademarks with a carrying value of
R30 million for R380 million.

 40% of the company’s inventory will be sold at cost, while the remaining will be
sold at a mark-up of 20% based on the selling price.

 All the remaining assets will be sold at carrying value.

 The subordinated loan was obtained at the inception of the company from its
shareholders at a 0% interest rate. The agreement requires the company to pay a
fee equal to 0,43% of the current net asset value whenever it settles the loan in the
event of liquidation or sale of its assets.

 The company will settle all its other liabilities at carrying value.
Ignore any tax implications arising from note 2 above.
3. To determine annual free cash flows yearly, the company uses the following formula
below:
Free cash flows (FCF) =
Latest two years’ average net profit for the year
Add: Non-cash expenses for the previous year (if any)
Less: Non-cash income for the previous year (if any)

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Additional information
The future growth in profits in the near future for Tile Ses’la will average 4% per annum. Similar
companies listed on the JSE trade at an average P/E multiple of 13,29 (same industry as Tiles
& Styles). Analysts estimate that unlisted companies in the same sector should allow for a risk
factor of 1,5 in establishing the business value. The required rate of return to be used in the
valuation of Tile Ses’la is 14%.

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REQUIRED
a) Calculate the following ratios of Tiles & Styles for the year ended 31 December 2017
and provide insightful reasons for the movement from prior year.
[Round all answers to one decimal place]
i. Change in online sales (20016: 13,4%)
ii. Interest cover
iii. Store sales per employee
iv. Inventory turnover (days)
v. Dividend cover
vi. Return on capital employed
(Calculations 12 marks; comments 6 marks; presentation 2 marks)
(20)

b) Calculate the weighted average cost of capital of Tiles & Styles at 31 December 2017.
(10)

c) Advise how the acquisition of Tile Ses’la (Pty) Limited should be financed, assuming
that Tiles & Styles is working towards the target capital structure.
(Show all calculations)
(15)

d) Based on your calculation in part (c) above, determine the number of preference
shares that will be issued to finance the acquisition of Tile Ses’la (Pty) Ltd. Assume
the nominal value of a share does not change.
(3)

e) Advise the board of directors and shareholders of Tile Ses’la whether they should
accept the offer made by Tiles & Styles, using both the price-earnings multiple and the
discounted cash flow (DCF) methods.
(P/E multiple method 11 marks; DCF method 5 marks, conclusion 2 marks)
(18)

f) Use the net asset value method to check the reasonableness of the calculations
performed in part (c) above.
(7)

g) Describe different types of acquisitions, and provide an example for each. Explain
the type of acquisition of Tile Ses’la by Tiles & Styles.
(7)
TOTAL: 80 MARKS

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QUESTION 32: MAGNUS ORANGE (100 marks; 3 hours)

Magnus Orange Limited (“MO Ltd”) is a bus services company listed on the JSE Alternative
Exchange (AltX) under the Transportation Services Sector. The company operates bus routes
in major cities across South Africa, with the largest concentration in Gauteng. All its operating
routes are currently not linked between cities. Owing to rapid growth in urbanisation, the
company has experienced a high demand for its services and continues to seek ways to
improve profitability and efficiency.

In a recent newspaper article, the CEO of MO Ltd published the following statement:

“Today, through the support of our shareholders and other key stakeholders, we are proud to
announce that from the beginning of the 2019 financial year, MO Ltd will link the three
metropolitans in Gauteng, namely, Tshwane, Johannesburg and Ekurhuleni ("CitiLink
Project).

In addition, the bus services will also be extending to Mogale City metropolitan (“Mogale City
metro”). Mogale City municipality awarded MO Ltd a contract to provide bus services to its
residents for the next six years. MO Ltd is considering whether to partner with a local bus
operator in a joint venture (Project Nthuseng) or acquire a majority stake in one of these bus
providers (Project Dira). The project task team of MO Ltd is already working with the
management of Dira Bus Services Company (“DIRA”) to explore the possible acquisition of
51% of DIRA’s issued share capital. The project task team estimates that at least R50 million
will be required for each of the two projects. This will increase our asset base to about R400
million.
Chief Executive Officer, Magnus Orange

The finance and investment team provided the following working papers:
1. Extracts from the Statement of Profit and Loss of MO Ltd and key non-financial indicators
for the six months ending 31 March 2018 (WPPR 1).
2. Extracts from the Financial Position as at 31 March 2018 (WPPR 2).
3. Earnings based valuation for the acquisition of Dira Bus Services Company (WPPR 3).

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Extract – SPL
Prepared by: Pretty Blog Reporting Date: 31 March 2018
WPPR 1
Reported to: CEO Prepared on: 02 June 2018

Magnus Orange Limited

FINANCIAL INDICATORS:

Notes R’000
Revenue 1 461 000
Profit before taxation expense 2 26 174
EBITDA 68 248
Finance costs 9 454
Interim dividend 2 744
Earnings per share (cents) 113

Key non-financial indicators:

2017 FY 2018
Employee costs (R’000) 182 744 85 000
Number of employees 719 769
Black representation – Management (%) 24,0 29,1
Black representation - General (%) 78,1 79,9
Road accidents 60 42
Supplier and enterprise development spend (R’000) 12 145 10 178
Greenhouse gas emissions (tonnes) 17 034 9 104
Share price (cents) 1 440 1 383

Notes
1. Majority of the operating income and expenses are earned and incurred evenly
throughout the year.

2. Once-off income of R358 000 (non-operating) was received from one of the political
parties in January 2018. Due to subsequent bad publicity, MO Ltd board took a
resolution not to accept this income in the future. Since 2015 the effective tax rate
has averaged about 29,5% per annum. The current corporate tax rate is the same
as it has been in previous years of assessment. The prime lending rate is 10,25%.

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Extract – Financial Position

Prepared by: Pretty Blog Reporting Date: 31 March 2018 WPPR 2
Reported to: CEO Prepared on: 02 June 2018

Magnus Orange Limited

CAPITAL EMPLOYED
Notes R’000
Capital and reserves 121 885
Ordinary share capital 1 30 000
Retained income 42 227
Other reserves 1 533
Preference share capital 2 48 125

Non-current liabilities 102 875

Long-term loan 3 100 000
Deferred taxation 2 875

Current liabilities 127 280

Trade and other payables 109 258
Bank overdraft 4 18 022

Notes and additional information:

1. MO Ltd has 20 million authorised share capital. The Transportation Services Sector
share is expected to yield a return 14% (risk premium is 7,5%), while the beta of MO
Ltd share is estimated at 0,924.

2. 385 000 preference shares with a nominal value of R125 each are currently valued
at R54,155 million. These were issued four years ago at a fixed dividend rate of 8,2%
(which is approximately 80% of the prime lending rate).

3. The five-year loan was obtained from Captec Bank on 1 April 2016. The interest on
this loan is payable a year in advance (on 2 April) at an annual rate of 6%. Similar
loans, which also attract a low interest rate currently have an interest rate of 5,8%.

4. Bank overdraft facility (also from Captec Bank) is utilised throughout the year to meet
company’s liquidity requirements and the balances vary monthly. There is a limit of
R20 million on this overdraft. Captec Bank charges an interest at prime less 2%
(generally, overdraft facilities carry a prime interest rate).

5. MO Ltd is working towards an optimal capital structure of 30%: 70% (Debt: Equity).
Non-redeemable preference share capital should be 10% of capital employed.

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Valuation of DIRA (earnings-based)

Prepared by: Associate accountant Reporting Date: 31 March 2018 WPPR 3
Reported to: CEO Prepared on: 02 June 2018

Dira Bus Services Company has had three successive profitable years, obtaining a clean audit
report in each. The directors of the company also expect growth in profits of 5,5% per annum
for the next two years. DIRA has an experienced team of drivers and assemblers. Despite
rising oil prices and aging fleet, DIRA continues to maintain a very low staff turnover compared
to the industry. The company is also considering to have a black representative in its executive
committee. Unlisted shares are estimated to be trading at 5% below JSE-listed shares under
the Transportation Services Sector (average sector P/E is 10,7).

Note 2016 2017 2018

R’000 R’000 R’000
Profit for the year 10 975 9 250 11 471
Government grant 1 (2 000)
Fine 2 864
Maintainable earnings (ME) 10 975 9 250 10 235

Average sector P/E 10,7%

Positive Factors:
Outstanding financial performance & clean audit +1
Experienced drivers and assemblers +1
Negative Factors:
Rising prices and aging fleet -1
Marketability -2
9,7%

Value
ME x Adjusted P/E (10 235 x 9,7%) 99 280
Less: Marketable discount (99 280 x 5% estimated) (4 964)
Plus: Control premium (99 280 x 8%) 7 942
Less: Minority interest discount 0
Amount to be offered by MO Ltd 102 258

1. Once-off government grant of R2 million for the recapitalisation of the existing fleet.
2. Fine of R864 000 for uncompetitive behaviour payable to the Competition Commission. This will
only be paid during 2019 financial year.
Additional notes

1. Extracts from the statement of financial position

R’000 R’000
Assets Equity and liabilities
Non-current assets - Ordinary shares 116 500
- Fleet 100 000 - Retained Earnings 11 235
- Furniture & Equipment 25 515
Current assets Non-current liabilities 7 255
- Inventory 13 000 Current liabilities 3 525
Total 138 515 Total 138 515

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REQUIRED
a) Calculate the following ratios for Magnus Orange Limited for the period ended 31 March
2018, and provide practical ways to improve these ratios.
i. Net profit margin
ii. Return on assets
iii. Effective interest rate
iv. Debt equity ratio
v. Dividend yield
vi. Price/book ratio
(12)

b) Analyse and discuss the human, social and natural capital performance of Magnus
Orange Limited for the period ending 31 March 2018. Show all workings.
(15)

c) With reference to the capital expenditure projects to be undertaken by Magnus Orange

Limited, explain the following terms:
i. Divisible project
ii. Independent projects
iii. Mutually exclusive projects
iv. Capital rationing
(8)

d) Draft a report on capital structure and sources of finance, in which you cover the following:
i. Weighted average cost of capital of Magnus Orange Limited for the period ending 31
March 2018.
ii. Criteria to be used in deciding on how to finance the expansion to Mogale City metro.
iii. How the expansion to Mogale City metro should be financed (show workings).
(35)

e) Write an email to the Project task team of Magnus Orange Limited, in which you critically
evaluate the valuation calculation performed by the associate accountant. The email
should cover:
i. Any errors or inaccurate assumptions made by the associate accountant.
ii. Re-performance of the valuation of the stake in Dira Bus Services Company at 31
March 2018, using the price-earnings multiple method.
iii. Reasonability check of the valuation performed above, using the net asset value
method.
(25)

f) Critically evaluate the implementation of the e-toll system in Gauteng and advise on how
this should be best addressed going forward.
(5)

TOTAL: 100 MARKS

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QUESTION 33: MBOWENI TRADING (100 marks; 3 hours)

Mboweni Trading (Pty) Ltd (“Mboweni Trading”) is a fashion lifestyle retailer which specialises
in superior quality clothes and shoes at reasonable prices. The bulk of its merchandise is
imported from China, Thailand and Indonesia, while the remainder is uniquely designed and
manufactured from a factory located in Hammanskraal, which is located fifty kilometres north
of Pretoria. Mboweni Trading operates five retail stores in different parts of South Africa, two
of these are based in Gauteng and contribute 50% of the company’s revenue. The company
prides itself as the market leader when it comes to quality and pricing of its products. Of lately,
Mboweni Trading has dominated the South African media as a success story of black
economic empowerment after experiencing rapid growth in its bottom line owing to its unique
market position. The success of Mboweni Trading has not gone unnoticed by the investment
community, with the company receiving offers from investors willing to buy a stake in it. The
average offer price is R5,50 per share and is considered to reflect the true net worth of the
company.

As part of its long-term growth strategy, the company is exploring possibilities of venturing into
another line of business in order to maximise profits. This new product line will include the
manufacturing of linen, curtains and carpets. Mboweni Trading is considering an investment
in an industrial sewing system consisting of heavy duty sewing machines, embroidery and
pressing machines, which will be imported from China at a total cost of ¥2 100 000. This
excludes upfront setup costs of ¥100 000 and yearly maintenance costs of ¥15 780. The
assembling will take place on 1 October 2018 at the company’s factory and the payment of
the machine and setup costs will be effected on the same day. The industrial sewing system
will be brought into operation a week after assembling. In anticipation of this significant cash
outflow (machine and setup costs are incurred at the start of the project), the company will
take out a forward exchange contract on 1 September 2018.

The following economic forecasts have been made:

 The spot rate on 1 September 2018 – ¥0,500: ZAR1

 The FEC rate (1-month) on 1 September 2018 – ¥0,535: ZAR1
 The spot rate on 1 October 2018 – ¥0,512: ZAR1
 The spot rate on 30 September 2019 – ¥0,526: ZAR1
 The average rate for 12 months ending 30 September 2019 – ¥0,536: ZAR1
The company estimates immaterial movement in Yuan and Rand exchange rate after
September 2019. The company will continue sourcing its raw material from its BRICS aligned
partners in Brazil and China, as it continues to enjoy good relations with its suppliers. The
company’s labour force is made up mainly of the residents of Hammanskraal and this has led
to positive impact on the sustainable development of the surrounding communities.

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The following information relates to the industrial sewing system:

 The factory will operate eight standard working hours Monday to Friday and a four-
hour overtime shift on Saturday.

 About 20 000 kg of material will be purchased per annum. 5% of the material will be
wasted before the production process starts.

 On average a unit sold will use 2,5 kg of the input material and will be sold for R400
and the sales value will increase by 10% per annum. The finished units will be sold at
material cost price + 90%.

 The factory will employ ten factory workers at an hourly rate of R25 per worker.
Overtime is paid at a premium of 100% of standard hourly rate.

 The company aims to negotiate with its trade union to increase the wages of all its
employees by an average of CPI + 70 basis points per annum over the next eight
years.

 The existing factory manager (currently earning R150 000 per annum) will also be
responsible for the new industrial sewing system. However, the company will now pay
this factory manager a salary of R16 000 per month.

 A yearly government grant of R112 000 will be received in advance each year for the
duration of the use of the industrial sewing system. The grant (not taxable) is aimed at
encouraging companies to invest in underdeveloped segments of the economy and
combating unemployment.

 The industrial sewing system has an accounting useful life of eight years, depreciated
on a straight line basis.

 Direct cash factory overhead costs will amount to R85 000 per annum.

 The South African Revenue Services grants a s12C allowance of 25% per annum on
the industrial sewing system.

 The company will dispose of the industrial sewing system at its carrying value after five
years of operation.

 There will be no closing balances of inventory and work in progress at the end of each
year.

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The following are the financial statements of Mboweni Trading (Pty) Ltd for the year ended
30 June 2018:
Statement of comprehensive income for the year ended 30 June 2018
Notes R
Sale of merchandise 20 423 000
Cost of sales (9 476 000)
Gross profit 10 947 000
Depreciation and amortisation (438 000)
Employee costs (2 904 000)
Marketing and administration costs (2 415 000)
Bad debt expenses (68 000)
Other trading expenses 1 (1 928 000)
Interest income 141 000
Other income 2 1 230 000
Profit before finance costs 4 565 000
Finance costs 3 (607 000)
Profit before income tax 3 958 000
Income tax expense (1 050 000)
Net profit for the year 2 908 000

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Statement of financial position at 30 June 2018

Notes R
Non-current assets 10 916 000

Property, plant and equipment 7 245 000

Intangible assets 2 001 000
Investment property 1 670 000

Current assets 6 435 000

Inventories 65 000
Trade and other receivables 2 292 000
Cash and cash equivalents 4 078 000

Total assets 17 351 000

Equity and liabilities

Capital and reserves 8 250 000

Stated capital 4 2 400 000

Non-distributable reserves 5 750 000
Distributable reserves 5 100 000

Non-current liabilities 7 716 000

Medium-term borrowings 6 7 444 000

Provision 200 000
Deferred taxation 72 000

Current liabilities 1 385 000

Short-term borrowings 7 502 000

Trade and other payables 868 000
Current income tax liabilities 15 000

Total equity and liabilities 17 351 000

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Notes
1. Other trading expenses include R13 000 loss incurred by the procurement department
for stolen inventory and incorrect purchases. This amount, although only representing
about 0,2% of the value of all the merchandise bought on credit during the year, has
been gradually declining over the years to current levels, and this is considered
reasonable.

2. Other income relates to proceeds from the auction of non-core assets during the year.
Auction expenses have already been netted off against this amount.

3. Finance costs are made up of the interest and dividends paid on the following facilities:

Medium-term borrowings 584 680

Short-term borrowings – Vaal Building Society (overdraft) 22 320

4. Two million shares were issued when the company was formed at R0,75 each. The
additional shares were issued fifteen months ago at a premium of R2,25 each. The
total dividend declared and paid for the 2018 financial year end was R950 000. The
dividend is expected to grow at 6,05% per annum for the foreseeable future.

5. Non-distributable reserves relate to the revaluation surplus on the company’s property,

plant and equipment following the revaluation done three years ago. There were no
movements in this account during the current year.

6. Medium-term borrowings comprise of the following:

 A five-year term loan from Netbank obtained on 1 July 2016 currently bears a post-
tax amount of R142 560 per annum (a fixed rate of 8,25% per annum). Similar
loans bear an interest rate of 8,56% per annum.
 Another loan for R2,4 million was obtained from BEADvest Bank on 17 July 2017
at a fixed rate of 8,40% per annum. Similar loans also average 8,56% per annum.
 Two million 7% preference shares will be redeemed at R1,60 per share in four
years’ time. The dividend is cumulative and similar preference shares yield prime
less 270 basis points in the market.
 There were no loans repaid and no preference shares redeemed during the year.

7. The short-term borrowings relate to the company’s bank overdraft facility which is used
to bridge any gap in the liquidity requirements of the company. The interest rate is
charged on the outstanding amount at prime lending rate.

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Additional information
1. The average performance of Mboweni Trading’s competitors for the year ending in
2018 is provided below (industry average):

Revenue growth – 2018 (%) 8,5

Return on assets, using NOPLAT (%) 15,2
Return on equity, using opening balances (%) 28,0
Net interest cover (times) 7,0
Dividend pay-out ratio (%) 43,6
Creditors’ payment period (days) 36
Capital gearing ratio (x: 1) 0,45
Bad debt expense ratio (%) 0,8
Fixed asset turnover (times) 3,0
Effective interest rate, using book values (%) 7,5

2. The following are the funding options Mboweni Trading is considering to use in order
to finance any costs required at the start of the industrial sewing system project:
a. The company has enough authorised share capital to finance the project.
b. 400 000 non-redeemable preference shares can be issued at R3,00 with a
dividend yield of 90% of the prime lending rate.
c. BEADvest Bank is willing to provide up to R2 million of the funds required for
the project. However, the bank has indicated that the pricing will be as follows:

Capital borrowed Interest rate charged

First R1 000 000 Market-related rate
The balance (the portion over R1 million) Market-related rate + 8,44%

d. The cost of equity will increase by 4 percentage points if more than R1,5 million
debt is raised.

3. All rates are before taking into account the corporate tax rate of 28%, unless stated
otherwise. The prime lending rate is 10% and the CPI is expected to average 4,8% for
the foreseeable future.

4. The company operates 360 days a year and the factory is running for 52 full weeks a
year. The cash flows are assumed to take place at the end of each year, unless stated
otherwise.

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REQUIRED
a) As the management accountant of Mboweni Trading, draft an email to the company
management, commenting on the company’s performance as compared to the
industry average and provide practical ways Mboweni Trading can improve its ratios.
(Calculations 20 marks; discussion 15 marks)
(35)

b) Calculate the weighted average cost of capital of Mboweni Trading at 30 June 2018
using market values.
(17)

c) Advise the management of Mboweni Trading on how the industrial sewing system
should be funded (net amount required), if the decision is to undertake the project.
Assume R4 million is required to finance the project and the cost of capital should be
used to support the financing decision.
(Calculations 12 marks; discussion 3 marks)
(15)

d) Advise the management of Mboweni Trading whether they should invest in the
industrial sewing system. Show all relevant workings and explain qualitative factors
they should consider.
(20)

e) Given the nature of Mboweni Trading business, describe key risks that the business
is faced with and provide possible mitigating factors.
(10)

f) Calculate the foreign exchange profit or loss of Mboweni Trading at 1 October 2018
for the forward exchange contract that would have been taken out on 30 September
2018, given the following prevailing rates on 1 October 2018:
 The spot rate – ¥0,520: ZAR1
 The FEC rate (1-month) – ¥0,508: ZAR1
 The FEC rate (4-months) – ¥0,500: ZAR1
 Average rate for 4-month period ending 1 October 2018 – ¥0,516: ZAR1
(3)
TOTAL: 100 MARKS

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ANSWERS:

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SOLUTION 01: EDCARS (120 marks; 3½ hours)

i. Profitability ratios

Ratios 2016 2015 Possible reasons

Gross Profit Margin: 10 400 > Higher margins in non-

23 700 clothing brands
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛
𝑆𝑎𝑙𝑒𝑠 = 43,88% = 41,85% > Good relations with
suppliers - discounts

EBIT Margin: 10 400 + 1 500 − 9 000 > Cost of marketing

23 700 campaigns
𝐸𝐵𝐼𝑇
𝑆𝑎𝑙𝑒𝑠 = 12,23% = 13,66% > Running of new stores
& promotional costs

EBITDA Margin: 2 900 + 500 > Market campaigns

23 700
𝐸𝐵𝐼𝑇𝐷𝐴 > Running of new stores
𝑆𝑎𝑙𝑒𝑠 = 14,35% =15,06% & promotional costs

Net Profit Margin: 2 100 >More income

23 700 generated from non-
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
operating activities
𝑆𝑎𝑙𝑒𝑠 = 8,86% = 7,07%
> Low finance costs

Effective tax rate: 900 >Poor tax planning

3 000 (penalties & interests)
𝑇𝑎𝑥𝑎𝑡𝑖𝑜𝑛
𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 = 30 % = 27,79% > Some expenses not
tax allowed

Bad debt as % credit sales: 1 000 >Stricter lending policies

16 600
𝐵𝑎𝑑 𝑑𝑒𝑏𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 > Sound debt collection
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 = 6,02% = 6,52% processes

> Non-clothing retail

customers better
creditworthiness

Total op costs per store: 9 000 > Deteriorating of Rand

3 100 for non-Dollar expenses
𝑇𝑟𝑎𝑑𝑖𝑛𝑔 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑜𝑟𝑒𝑠 = R2,90m =R2,42m > The introduction of
new stores (setup costs)
& extra costs to promote

Revenue per employee: 23 700 > Incentives to staff to

22 200 sell products and hit
𝑅𝑒𝑣𝑒𝑛𝑢𝑒
targets
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 = R1,06m = R0,88m
> High value products

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ii. Return on invested capital

Ratios 2016 2015 Possible reasons

Return on other investment: 1 100 > Investments made

4 700 towards end of year
𝑂𝑡ℎ𝑒𝑟 𝑖𝑛𝑐𝑜𝑚𝑒
𝑂𝑡ℎ𝑒𝑟 𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡𝑠 = 23,4% = 27,19% > Strain in the economy
decreasing dividends

Return on Assets (RoA): 2 900 > Better utilisation of

22 000 assets/longer trading
𝐸𝐵𝐼𝑇
hours
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 13,18% = 12,37%
> Assets fully deployed
at start of a branch

Return on Equity (RoE): 2 100 >Profits boosted by non-

9 900 operating activities
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝐸𝑞𝑢𝑖𝑡𝑦 = 21,21% = 20,94% > Investors are getting
better return than what
the industry offers

Return on Capital Employed 2 900 > Indication that new

(RoCE): 8 300 + 9 900 stores are generating
profits early for the
𝐸𝐵𝐼𝑇 = 15,93% =15,70% company
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦

Non-current asset turnover: 23 700 >Better utilisation of

8 500 assets
𝑅𝑒𝑣𝑒𝑛𝑢𝑒
𝐹𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 = 2,79 times = 2,22 times > New stores and
equipment not kept
idling for long period

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iii. Liquidity ratios

Ratios 2016 2015 Possible reasons

Current ratio: 13 500 >Increase of sales might

6 300 have led to more debtors
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 2,14: 1 = 2,01: 1 > Possible revaluation of
stock at hand.

Acid-test ratio: 13 500 − 5 100 > Slight improvement –

6 300 improved cash
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
generated from
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 1,33: 1 = 1,30: 1 operations.

Cash ratio: 800 + 4 700 > Ability to cover its

6 300 current obligations out of
𝐶𝑎𝑠ℎ + 𝑚𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠
cash and cash
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 0,87: 1 = 0,31: 1 equivalent

> More suppliers and

credit grantors happy to
provide funding

Debtors’ collection period: 6 700 >Stricter lending policies

𝑥 365
16 600
𝑇𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 > Sound debt collection
𝑥 365 = 147 days
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 = 180 days processes

Creditors’ payment period: 3 200 > Suppliers more lenient

𝑥 365
90% 𝑥 12 100 to the company (track
𝑇𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠
𝑥 365 record)
𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 = 107 days = 89 days
> Interest-free credit and
company taking
advantage

Inventory days: 5 100 > Fashion out of stock

𝑥 365
13 300 and not sold
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 = 140 days = 129 days > High value items move
slowly

Cash conversion cycle: = 147 + 140 - 107 > Better credit control
processes in place (NCR
Debtors’ days +inventory days = 180 days = 220 days intervention)
- Creditors’ days > Better terms
negotiated with
suppliers

Inventory turnover (times): 13 300 > Fashion out of stock

5 100 and not sold
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = 2,61 times = 2,83 times > High value items move
slowly

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iv. Capital structure/solvency

Ratios 2016 2015 Possible reasons

Interest cover (TIE): 2 900 > Increasing operating

1 200 costs and new store
𝐸𝐵𝐼𝑇
costs
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 = 2,42 times = 2,75 times
>High interest rates
currently paid

> High debt for most part

of year

Net interest cover: 2 900 > Increase in cash

1 000 reserves from profits
𝐸𝐵𝐼𝑇
𝑁𝑒𝑡 𝑓𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 = 2,9 times = 2,78 times > Increase in interest
rates

Effective interest rate: 1 200 > Good relations /

11 000 negotiations with banks
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠
(low rates)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐼𝐵𝐷) = 10,91% =11,28%
> Better company credit
status leading to
cheaper credit

IBD to EBITDA: 8 300 > Repayment of loan

3 400 (2015: R10bn)
𝐼𝐵𝐷
𝐸𝐵𝐼𝑇𝐷𝐴 = 2,44: 1 =2,99: 1 > Increase in operating
profit from new stores

Debt-equity ratio: 8 300 > Repayment of short-

9 900 term portion to reduce
𝐼𝐵𝐷
gearing
𝐸𝑞𝑢𝑖𝑡𝑦 = 83,84% = 86,32%

Debt-equity ratio (net): 8 300 − 800 > Cash generated from

9 900 operations & interest
𝐷𝑒𝑏𝑡 − 𝑐𝑎𝑠ℎ
received increased
𝐸𝑞𝑢𝑖𝑡𝑦 = 75,76% = 77,34%
> Repayment of short-
term portion to reduce
gearing

Debt ratio: 12 100 > Repayment of short-

22 000 term portion to reduce
𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
gearing
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 55% = 56,21%

Capital gearing ratio: 5 300 + 3 000 > Repayment of short-

8 300 + 9 900 term portion to reduce
𝐼𝐵𝐷 = 46,95% gearing
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦 = 45,6%

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Current vs Target Capstruct: 5 300 + 3 000 > Though short of target,

8 300 + 9 900 year to year seems to be
𝐼𝐵𝐷
getting closer –
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦 = 45,6% : 54,4% = 40%:60% repayment of loans &
profitability

v. Financial / investor ratios

Ratios 2016 2015 Possible reasons

Earnings per share (EPS): 2 100

200
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = R10,50 per share

Dividend per share (DPS): 600 + 700

200
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = R6,50 per share

P/E multiple: 140 > Tough market

10,5 conditions (competition)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
and investors losing
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 = 13,33 =14,20 confidence

Earnings Yield: 10,5 > Tough market

140 conditions (competition)
𝐸𝑃𝑆
and investors losing
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 = 7,5% = 7,04% confidence

Dividend yield: 6,50 > Decline in share price

140 while maintaining
𝐷𝑃𝑆
dividend growth
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 = 4,6% = 3,8%

Dividend cover: 10,5 > Dividends increased to

6,50 meet expectations
𝐸𝑃𝑆
despite low profits
𝐷𝑃𝑆 = 1,62 times = 2,0 times
> Dividend policy more
generous to attract
investors

Dividend pay-out ratio: 6,50 > Dividends increased to

10,5 meet expectations
𝐷𝑃𝑆
despite low profits
𝐸𝑃𝑆 = 61,90% = 50,14%
> Dividend policy more
generous to attract
investors

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Price / Book value multiple: 140 𝑥 200 > Tough market

9 900 conditions (competition)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑠𝑎𝑡𝑖𝑜𝑛
and investors losing
𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 ′ 𝑒𝑞𝑢𝑖𝑡𝑦 = 2,83: 1 =3,18: 1 confidence while
profitability improves

Price / Sales multiple: 140 𝑥 200 > Tough market

23 700 conditions (competition)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑡𝑎𝑙𝑖𝑠𝑎𝑡𝑖𝑜𝑛
and investors losing
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 = 1,18 times = 1,44 times confidence though sales
achieve high growth

Key risks faced by Edcars Group Limited

Fashion trends – risk of buying out of season products, obsolescence and availability of in-
fashion products
Regulations/laws – Tightened laws relating to lending and administering debtors and BEE
compliance may hinder sales growth
Political situation – Service delivery protest and possible closure of businesses, looting and
threats may disrupt the company operations
Operational risk – undetected theft and increased security (especially on high value items) on
premises may lead to additional operating costs
Competition – Increased competition from local and foreign retailers may cause the market
share of the company to shrink
Forex – volatility of rand against other currencies may lead to increased cost of sales on
products sourced outside the country
Economics – Increase pressure on consumers and unemployment may lead to credit default
by consumers and decreased sales due to unaffordability
Regulations/laws – The government may not intervene to address challenges in the local
textile industry and the dumping of products by foreign companies
Customer satisfaction – faults/guarantees on appliances and mobile phones sold may have a
severe reputational damage and reinstatement costs
Funding – Downgrading of SA credit rating and increased cost of borrowing will lead to
company paying more interest rates and possible struggle to raise funds

TOTAL: 120 MARKS

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 MAC3702/QB001

SOLUTION 02: CARLO TITO MARIO AFRICA (160 marks; 4¾ hours)

(Ratios grouped according the classification in FO Skae)

Profitability ratios: MARGIN

Gross profit margin

2 914 2 894
6 662 6 819

= 43,7% = 42,4%

Possible reasons:
Improved relations with suppliers or cheaper suppliers have been sourced
Reduction in fuel prices, insurance costs
Bulk purchases of raw material
Increase selling price
Shut down of non-profitable stores

Possible ways of improvement:

Switch to cheaper suppliers or negotiate better prices with current ones
Increase selling price

EBITDA margin

944 + 410 900 + 372

6 662 6 819

= 20,3% = 18,7%

Possible reasons:
Improved efficiencies in the buying department (refer to GP margin)
Entered into fixed contracts with service providers to avoid price escalations
Laid off of redundant employees and reduced of employee benefits

Possible ways of improvement:

Rent out excessive office space, lay off redundant employees
Get rid of “nice-to-have” company benefits
Negotiate better rates with service providers

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EBIT margin

944 900
6 662 6 819

= 14,2% = 13,2%

Possible reasons:
Improved efficiencies in the buying department (refer to GP margin)
Entered into fixed contracts with service providers to avoid price escalations
Laid off of redundant employees and reduction of employee benefits
(Improvement mainly driven by GP margin – and does not support better expense management)

Possible ways of improvement:

Rent out excessive office space, lay off redundant employees
Get rid of “nice-to-have” company benefits
Negotiate better rates with service providers

Net profit margin

686 645
6 662 6 819

= 10,3% = 9,5%

Possible reasons:
Improved efficiencies in the buying department (refer to GP margin)
Entering into fixed contracts with service providers to avoid price escalations
Laying off of redundant employees and reduction of employee benefits
(Improvement mainly driven by GP margin – and does not support better expense management)

Possible ways of improvement:

Rent out excessive office space, lay off redundant employees
Get rid of “nice-to-have” company benefits
Negotiate better rates with service providers

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Profitability ratios: CHANGE

Change in online sales

604 − 234
234
= 18,1% (given)
= 158,1%

Possible reasons:
Significant contribution in e-commerce
Aggressive market campaigns for online purchases (including incentives)
More affluent areas are penetrated by the company
Increased selling prices for online customers

Possible ways of improvement:

Incentivise online buyers
Cold call regular in-store customers to switch to online
Perform analytics on online sales to promote products likely to be purchased

Change in cost of sales

3 748 − 3 925
3 925
= 3,7% (given)
= (4,5%)

Possible reasons:
Improved relations with suppliers or cheaper suppliers have been sourced
Reduction in fuel prices, insurance costs (entered into fixed contract)
Bulk purchases of raw material
Shut down of non-profitable stores leading to less purchase

Possible ways of improvement:

Enter into long-term fixed contracts with suppliers to lock prices
Switch to cheaper suppliers
Buy manufacturers’ businesses or manufacture some products internally

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Change in personnel costs

1 003 − 1031
1 031
= 7,3% (given)
= (2,7%)

Possible reasons:
Laid off of redundant employees and reduced employee benefits
Froze salaries
Shut down of non-profitable stores and let go of staff

Possible ways of improvement:

Fix the basic salary and increase commission
Freeze salaries especially for senior management

Change in net finance costs

101 − 105
105
= 4,0% (given)
= (4,0%)

Possible reasons:
Decrease in interest rates
Decrease in loans (repayment)
Increase in interest income (due to increased cash levels)

Possible ways of improvement:

Negotiate with banks better rates
Repay loans as soon as possible

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Profitability ratios: MATERIALITY

Average salary

1 003 000 1 031 000

25,4 26,1

= R39 488,20 = R38 905,70

Possible reasons:
Salaries increased to keep up with inflation
Incurred costs of retrenchment or transfers
Increased staff benefits (e.g. pension fund and medical aid contribution)

Possible ways of improvement:

Fix salaries and introduce commission based incentives where necessary
Reduce workforce amid online sales platform increased sales

Average revenue generated by store

6 662𝑚 6 819𝑚
162 182

= R41 123 456,8m (R41,1m) = R37 467 0333 (R37,5m)

Possible reasons:
Shutdown of less profitable stores
Increase sales volume (due to staff incentives and aggressive promos)

Possible ways of improvement:

Review less profitable stores and close down where necessary
Introduce new range of tiles and supplementing products

Online sales as % of revenue

604 234
6 662 6 819

= 9,1% = 3,4%

Possible reasons:
Investment in e-commerce and technology led to ease of access
Aggressive market campaigns for online purchases (including incentives)
More affluent areas are penetrated by the company
Increased selling prices for online customers

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Possible ways of improvement:

Incentivise online buyers
Cold call regular in-store customers to switch to online
Perform analytics on online sales to promote products likely to be purchased

Operating profit per store

944𝑚 900𝑚
162 182

= R5 827 160,5 (or R5,8m) = R4 945 055,0 (or R5,0m)

Possible reasons:
Improved efficiencies in the buying department (refer to GP margin)
Entered into fixed contracts with service providers to avoid price escalations
Shutting down of less profitable stores

Possible ways of improvement:

Dispose of stores not yielding good profits
Rent out excessive office space, lay off redundant employees
Get rid of “nice-to-have” company benefits
Negotiate better rates with service providers

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RETURN ON INVESTED CAPITAL

Return on assets

944 900
7 310 6 469

= 12,9% = 13,9%

Possible reasons:
Assets acquired (or store opened late in the year) towards the end of the year
Revaluation of assets during the year (not done in recent years)
Possible breakdown during the year or strikes
Investment in technology – but benefits not yet flowing

Possible ways of improvement:

Consider opening shops for longer and on weekends
Establish systems to fair value the assets
Consider impairment on assets
Dispose of assets that are non-core or yield low returns

Return on capital employed

944 900
3 696 + 1 912 3 187 + 2077

= 16,8% = 17,1%

Possible reasons:
Capital might not be applied/released as soon as received (e.g. loans held in business account)
Funds tied in bank and other non-current assets
Reduction of stores and capital not injected into more profitable businesses
Use of closing balances does distort the figures

Possible ways of improvement:

Keep low levels of cash
Set up capital management team to monitor capital movement

Return on equity

686 645
3 696 3 187

= 18,6% = 20,2%

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Possible reasons:
Capital might not be applied/released as soon as received (e.g. loans held in business account)
Reduction of stores or decline in sales led to less profits being generated
Use of closing balances does distort the figures

Possible ways of improvement:

Keep low levels of cash
Set up capital management team to monitor capital movement
Identify profitable projects on regular basis to ensure timely injection of capital into new ventures

Effective tax rate

157 150
843 795

= 18,6% = 18,9%

Possible reasons:
Possible assessed losses from previous years (from other stores if operating independently)
Government (including foreign) granting tax incentives
Tax planning expertise used by the company
Low tax rates in other SADC regions / DTA

Possible ways of improvement:

Regular reviews of tax legislation to ensure maximisation of profits

Asset turnover

6 662 6 819
7 310 6 469

= 0,9 times = 1,1 times

Possible reasons:
New investment in technology
Assets acquired (or store opened late in the year) towards the end of the year
Revaluation of assets during the year (not done in recent years)
Possible breakdown during the year or strikes
Company kept more cash at hand

Possible ways of improvement:

Consider opening shops for longer and on weekends
Establish systems to fair value the assets
Consider impairment on assets
Dispose of assets that are non-core or yield low returns

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Non-current asset turnover

6 662 6 819
4 966 4 526

= 1,3 times = 1,5 times

Possible reasons:
New investment in technology
Assets acquired (or store opened late in the year) towards the end of the year
Revaluation of assets during the year (not done in recent years)
Possible breakdown during the year or strikes

Possible ways of improvement:

Consider opening shops for longer and on weekends
Establish systems to fair value the assets
Consider impairment on assets
Dispose of assets that are non-core or yield low returns

LIQUIDITY

Current ratio

2 344 1 943
1 418 953

= 1,7: 1 = 2,0: 1

Possible reasons:
Significant increase of short term borrowings to maintain cash levels
Increase of trade purchases to take advantage of cheap funding

Possible ways of improvement:

Repay short-term borrowings with excess cash
Negotiate with suppliers for discount on early payments and settle early

Acid-test ratio

2 344 − 850 1 943 − 838

1 418 953

= 1,1: 1 = 1,2: 1

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Possible reasons:
(Slight decline)
Increasing levels of inventory despite fewer stores and sales
Significant increase of short term borrowings to maintain cash levels
Increase of trade purchases to take advantage of cheap funding

Possible ways of improvement:

Repay short-term borrowings with excess cash
Negotiate with suppliers for discount on early payments and settle early
Decrease levels of stock (without losing on bulk purchase discounts)

Cash ratio

404 + 41 64 + 47
1 418 953

= 0,31: 1 = 0,12: 1

Possible reasons:
Loan taken to increase cash levels
Cash generated from profitable operations
Online sales may have been mainly (if not all) on cash

Possible ways of improvement:

Incentivise cash customers while charging interest and admin costs on credit customers
Renegotiate to repay loans late, without incurring much interest

Inventory turnover

3 748 3 925
850 838

= 4,4 times = 4,7 times

Possible reasons:
Stock held from stores that might have been closed down
Company may be struggling to sell some of its goods due to declining demand

Possible ways of improvement:

Decrease levels of stock (without losing on bulk purchase discounts)
For big orders, clients to place an order in advance before purchase

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Inventory days

850 838
𝑥 365 𝑥 366
3 748 3 925

= 82,8 days = 78,1 days

Possible reasons:
Stock held from stores that might have been closed down
Company may be struggling to sell some of its goods due to declining demand
(This is not helped by the fact that the current year is a day shorter)

Possible ways of improvement:

Decrease levels of stock (without losing on bulk purchase discounts)
For big orders, clients to place an order in advance before purchase For big orders, clients to
place an order in advance before purchase

Debtors’ collection period

1 049 994
𝑥 365 𝑥 366
6 662 6 819

= 57,5 days = 53,4 days

Possible reasons:
Debtors might be highly indebted and struggle to make payments timeously
No proper follow up is made on outstanding debt or penalty imposed
Possible ways of improvement:
Incentivise cash customers while charging interest and admin costs on credit customers
Impose limits on accounts and reduce these if breached

Creditors’ payment period

600 538
𝑥 365 𝑥 366
3 748 3 925

= 58,4 days = 50,2 days

Possible reasons:
Company settling creditors late to take advantage of “interest-free” borrowing
Better deals struck with suppliers to delay payments
Possible ways of improvement:
Shift purchases to suppliers with better trading terms
Delay payment of creditors to the latest day if no interest is charged

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CAPITAL STRUCTURE & SOLVENCY

Effective interest rate

101 + 24
2 077
= 6,8% (given)
= 6,0%

Possible reasons:
Company negotiated better rates during the year
Possible reclassification of financial instruments
General decline in interest rates
Better credit score received from rating agency

Possible ways of improvement:

Negotiate with banks for better rates or restructure the deals and classification of costs
Reduce exposure to decrease the financial risk

Times interest earned

944 900
101 + 24 105 + 8

= 7,6 times = 8,0 times

Possible reasons:
Increase in interest expense – loans only repaid towards the end of the year
Capital not reinvested immediately after the shutdown of stores
Decline in gross profit as the result of store closure
Possible ways of improvement:
Negotiate with banks for better rates or restructure the deals and classification of costs
Reduce exposure to decrease the financial risk

Times interest earned (Net)

944 900
101 105

= 9,3 times = 8,6 times

Possible reasons:
Increase in interest income – due to increase cash reserves
Increase in operating profit at the back of stringent cost controls

Possible ways of improvement:

Invest excess cash in interest yielding markets (especially money markets)
Consider increasing use of equity to finance future products

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Capital gearing

1 912 2 077
1 912 + 3 696 2 077 + 3 187

= 34,1% = 39,5%

Possible reasons:
Increase in the profits for the year, lowering exposure in borrowings
Slight decrease in borrowings (through repayments or conversion)

Possible ways of improvement:

(Consider capital structure) if increasing debt: declare higher dividend or borrow more
If decreasing debt: Repay debt quicker and refinance via equity

Interest-bearing debt: equity

1 912 2 077
3 696 3 187

= 51,7% = 65,2%

Possible reasons:
Increase in the profits for the year, lowering exposure in borrowings
Slight decrease in borrowings (through repayments or conversion)

Possible ways of improvement:

(Consider capital structure) if increasing debt: declare higher dividend or borrow more
If decreasing debt: Repay debt quicker and refinance via equity

Interest-bearing debt: equity (net)

1 912 − 404 2 077 − 64

3 696 3 187

= 40,8% = 63,2%

Possible reasons:
Increase in the profits for the year, lowering exposure in borrowings
Increase in profits leading to high levels of cash
Slight decrease in borrowings (through repayments or conversion)

Possible ways of improvement:

(Consider capital structure) if increasing debt: declare higher dividend or borrow more
If decreasing debt: Repay debt quicker and refinance via equity

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Debt ratio

2 196 + 1 418 2 329 + 953

7 310 6 469

= 49,4% = 50,7%

Possible reasons:
(Slight improvement) – idling assets
Increase in the profits for the year, lowering exposure in borrowings
Increase in profits leading to high levels of cash
Increase in profits leading to buying stock on cash
Financing of new assets (technology & shops) using equity

Possible ways of improvement:

(Consider capital structure) if increasing debt: declare higher dividend or borrow more
If decreasing debt: Repay debt quicker and refinance via equity

Interest-bearing debt to EBITDA

1 912 2 077
944 + 410 900 + 372

= 1,4: 1 = 1,6: 1

Possible reasons:
Increase in the profits for the year, lowering exposure in borrowings
Slight decrease in borrowings (through repayments or conversion)
Increase in operating profit at the back of stringent cost controls

Possible ways of improvement:

Implement stringent measures to contain costs, while aggressively promoting online platform
Repay debt with excess cash from operations

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FINANCIAL MARKETS/INVESTOR

P/E ratio

9 457 1
9 457
686 1,1275
645
= 13,8 times
= 3,0 times

Possible reasons:
Positive reception of the online initiatives implemented by the company
Reduced financial risk (repayment of loan and increase in cash reserves)
Potential acquisition of key suppliers may lead to decrease in cost of manufacturing

Possible ways of improvement:

Implement share-based incentives for management to ensure value creation
Continue to restructure business to steer all stores towards profitability
Improve on marketing the company online services

Earnings yield

686 645
9 457 1
9 457
1,1275
= 7,3%
= 7,7%

Possible reasons:
Positive reception of the online initiatives implemented by the company
Reduced financial risk (repayment of loan and increase in cash reserves)
Potential acquisition of key suppliers may lead to decrease in cost of manufacturing

Possible ways of improvement:

Implement share-based incentives for management to ensure value creation
Continue to restructure business to steer all stores towards profitability
Improve on marketing the company online services

Price / Book value multiple

9 457 1
9 457
3 696 1,1275
3 187
= 2,6 times

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= 2,6 times

Possible reasons:
(Slight difference if 2 decimals are used: from 2,63 in 2016 to 2,55 in 2018)
Investors’ response in line with the increase in the net asset value – meeting expectations
Company initiatives may not have been viewed to add extra value (beyond what is expected) –
reduction of stores and the IT infrastructure investment

Possible ways of improvement:

Implement share-based incentives for management to ensure value creation
Continue to restructure business to steer all stores towards profitability
Improve on marketing the company online services

Price / sales value multiple

9 457 1
9 457
6 662 1,1275
6 819
= 1,4 times
= 1,2 times

Possible reasons:
(Slight difference if 2 decimals are used: from 2,63 in 2016 to 2,55 in 2018)
Investors’ response in line with the increase in the sales value – meeting expectations
Company initiatives may not have been viewed to add extra value (beyond what is expected) –
reduction of stores and the IT infrastructure investment

Possible ways of improvement:

Implement share-based incentives for management to ensure value creation
Continue to restructure business to steer all stores towards profitability
Improve on marketing the company online services

Dividend cover

686 645
70 + 134 70 + 110

= 3,4 times = 3,6 times

Possible reasons:
More dividend declared at the back of increased cash reserves
Market expectations to increase dividend annually
Could be in line with dividend policy in place
Lack of investment opportunities after closing down stores

Possible ways of improvement:

Improve on marketing the company online services and investment in technology
Increase in-store sales while maintaining expenses in order to increase the profitability

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Dividend pay-out ratio

70 + 134 70 + 110
686 645

= 29,7% = 27,9%

Possible reasons:
More dividend declared at the back of increased cash reserves
Market expectations to increase dividend annually
Could be in line with dividend policy in place
Lack of investment opportunities after closing down stores

Possible ways of improvement:

Improve on marketing the company online services and investment in technology
Increase in-store sales while maintaining expenses in order to increase the profitability

Dividend yield

70 + 134 70 + 110
9 457 1
9 457
1,1275
= 2,2%
= 2,1%

Possible reasons:
(Slight increase)
Industry data needed to put in perspective
More dividend declared at the back of increased cash reserves
Market expectations to increase dividend annually
Could be in line with dividend policy in place
Lack of investment opportunities after closing down stores

Possible ways of improvement:

Improve on marketing the company online services and investment in technology
Increase in-store sales while maintaining expenses in order to increase the profitability

TOTAL: 160 MARKS

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SOLUTION 03: DRESSED FOR SUCCESS (30 marks; 54 minutes)

RATIOS for 2X14

(i) Gross profit percentage

Gross profit
=
Turnover

345 113
= 908 191 𝑥 100

= 38%

GP margin improved from 32% to 38% due to:

Reason:
 Sales increasing at a higher rate than cost of sales (better inventory cost control)
 Higher margins on the new exclusive brand introduced in 2014
 Favourable exchange rate movement (e.g. strengthening Rand lowered costs)
 Bulk purchases to cut shipping costs and bulk purchase discounts

(ii) Net operating profit percentage

Operating profit (EBIT)

=
Turnover

157 479
= 𝑥 100
908 191

= 17,34%

The net operating profit percentage has increased from 16,6% to 17,34% due to:

Reason:
 Increase in operating profit percentage is less than 1% (compared to 6% increase
on gross margin) – company’s operating costs do not seem to be monitored
closely
 The increase in operating costs may be due to extra costs incurred on promoting
the new product range

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(iii) Change in turnover

Turnover for 2X14−Turnover for 2X13

= Turnover for 2X13

908 191−814 521

= 814 521
𝑥 100

= 11,50%
Increase in sales of 11,50% compared to 10,31% for the previous year due to:

Reason:
 The newly launched clothing brand is popular amongst most teenagers
 Increase in sales due to general inflation

(iv) Return on assets (ROA)

EBI
=
Total assets

157 479
= 𝑥 100
792 621

= 19,87%

A decline in ROA from 23,5% to19,87% due to:

Reason:
 Increase in current assets of 77% could indicate inefficiencies in working capital
management or underutilisation
 Operating profit increasing at a lower rate than assets

(v) Return on equity (ROE)

Profit after tax
= Equity

96 432
= 343 876 𝑥 100

= 28,04%

Slight decline in return on equity ratio (from 28,5% to 28,0%) due to:

Reason:
 Retained income not effectively ploughed back into the business

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(vi) Debtors’ collection period

Closing balance of trade receivables

= Credit sales
x 365

89 669
= 908 191 x 65% x 365

= 55,4 days

Increase in debtors’ collection period (adverse) from 29,1 to 55,4 days due to:

Reason:
 Customers are struggling to settle their accounts (despite decrease in credit
sales % (decrease from 70% to 65%)
 Poor credit collection policy / credit control measures

(vii) Inventory turnover

Cost of sales
= Inventory

563 078
= 214 000

= 2,7 times

Increase in inventory turnover (adverse) from 4,6 times to 2,7 times due to:

Reason:
 Unnecessary high levels of stock kept at stores
 Large consignments of imported stock to limit the ordering cost
 Poor inventory control.

(viii) Debt equity ratio

Interest bearing debt

= Shareholders′ equity
x 100 OR Interest bearing debt: Shareholders’ equity

188 386
= 343 876 x 100

= 54,8 : 1

Increase in debt equity ratio from 37,8 : 1 to 54,8 : 1

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Reason:
 Significant increase in long-term loan (up almost 70%) – high interest rate or
additional loan taken to finance the new clothing line
 Excess cash in hand is not used to reduce the loan liability
 Information on target capital structure needed to compare with current position

(ix) Cash ratio

= Cash: Current liabilities

= 158 765: 260 359

= 0,61 : 1

Improvement in cash ratio from 0,57 : 1 to 0,61 : 1

Reason:
 Increase in cash reserves and investments (more sales are now on cash basis)
 Though there is a significant increase in current liabilities, cash at hand
increased even more

TOTAL: 30 MARKS

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SOLUTION 04: SPLITZ STORES (18 marks; 32 minutes)

a) Evaluation of opinions provided by Board

Arguments in favour of paying out surplus cash to shareholders

Paying out surplus cash to shareholders would enable them (shareholders) to utilise cash for
own purposes

Excess cash on balance sheet may render company a takeover target

Paying out cash will increase ROE

Lower levels of solvency & liquidity after paying out surplus cash

If returns on cash < WACC then better to distribute cash to shareholders

Gearing the Splitz Stores balance sheet

Introducing a reasonable degree of leverage does enhance shareholder value due to the tax
shield

Gearing will introduce financial risk

Splitz Stores will need to meet debt covenants, which may be restrictive

Splitz Stores might need to provide the assets as security

Gearing will lower WACC

Arguments for retaining cash on the balance sheet

Having cash available for investment or to survive tough times may be prudent
Splitz Stores operates in the fashion industry (higher risk) therefore having cash available is
sensible

Splitz Stores can move rapidly to pursue opportunities instead of trying to raise debt

Dividends tax of 10% is withheld on dividend paid to shareholders

Any valid argument

8 MARKS

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b) Identifying and explaining the risks

BUSINESS RISKS

Business risk - changes in fashion trend will result in stock obsolescence

Business risk - stock theft especially small/accessory items

Business risk - entry of foreign retailers in local markets (or low barriers to entry)
Business/information risk - consolidation and centralising of functions at different stores
(150 operations)

Business risk - decision taken not in the best interest of the company but for family interest

FINANCIAL RISKS

Currency risk - changes in exchange rates not in favour of Splitz stores

Financial / investment risk - cash resources not optimally utilised

Financial risk - cash handling at stores and remittance

Credit risk - some of the customers will not be able to settle their accounts

REGULATORY/LEGAL RISKS

Legal risk - identity theft at application and possible lawsuits

Regulatory risk - credit check will not be done accurately

Regulatory risk - NCA will impose regulation that will impact the growth of business (e.g.
stricter credit policy, additional documentation, etc.)

10 MARKS
TOTAL: 18 MARKS

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SOLUTION 05: NEW MUTUAL (30 marks; 54 minutes)

PART A

Ratios Hola MTM Comments

DPS: (280+640) / 505 = 1,82

920 / 505
Dividend yield: > In relation to share price, Hola
R1,82 yields a higher dividend return
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 R58,85
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 > Hola has a more aggressive
= 3,09% = 2,79% dividend pay-out policy

OR > Hola attracting investors with a

Note: where use of total MV:
[R58,85x505m] or [R55,29x505m] Use of average generous dividend policy
AND R1,82𝐜
Total dividend: R920m R55,29 > Hola’s dividend pay-out ratio is
high at 45%
= 3,29%

EPS: 2 043 / 505 = 4,05

Price-earnings ratio: > Investors have less confidence in
R58,85 MTM (not much future growth
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 R4,05 perceived)
𝐸𝑃𝑆
= 14,53 =13,06 > Hola - right strategy in place

Note: where use of total MV:

OR > Hola - impact on the share price
[R58,85 x 505] or [R55,29 x505] Use of average of the recent litigations and fines
AND R55,29
Earnings: R2 043m R4,05𝐜 > Government tender won by Hola
increased investor confidence
= 13,65

> Hola’s financial risk based on

Net debt-equity ratio: (7 104 + 817) − 2 548 5 373 / 26 607 level of borrowing is higher
6 888 + 19 179
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 − 𝑐𝑎𝑠ℎ > Significant cash resources held by
𝐸𝑞𝑢𝑖𝑡𝑦 = 0,20: 1 = 0,16: 1 Hola

OR Equity: 33 875 + 2 548 + 7 375

> Risk of default (by both
+ 2 989 -7 104 – 12 259 - 817 companies) is low

> Under/poor-utilisation of assets

Return on assets: by Hola (idling)
2 900 + 1 060 3 960
𝐸𝐵𝐼𝑇 46 787 >Revaluation and depreciation
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 policies for Hola might need to be
= 8,46% = 12% reviewed
> Cost control & weakening rand

 Total assets: 33 875 + 2 548 > Hola has a high depreciation and
+ 7 375 + 2 989
amortisation (EBITDA R8 761 &
EBIT R3 960)

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> Both companies are paying above

Effective taxation rate: 2 900 − 2 043 857 SA corporate tax rate (different tax
2 900 regimes)
𝑇𝑎𝑥𝑎𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥𝑎𝑡𝑖𝑜𝑛 = 29,55% = 35,79% > Non-deductible expenses incurred

> Import and other taxes

> Significant number of Hola clients
EBITDA per customer: 8 761 might be on a prepaid call plan
2,8
𝐸𝐵𝐼𝑇𝐷𝐴 > Decline in fixed line revenue
𝐶𝑢𝑠𝑡𝑜𝑚𝑒𝑟𝑠 = R3 129 = R3 680 (Hola)

> Hola’s new government tender is

likely to increase the ratio

Change in share price: 5 885 − 5 283 602 > Significant increase in share price
5 283 - Hola (investor confidence
𝐶𝑙𝑜𝑠𝑖𝑛𝑔 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 − 𝑜𝑝𝑒𝑛𝑖𝑛𝑔 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒
𝑂𝑝𝑒𝑛𝑖𝑛𝑔 𝑠ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒
restored)
= 11,40% = -2,27%
> Hola - Possible sharp decline in
prior year

> Negative sentiments re MTM

share (more info required)

Max: 24 marks
PART B
o The company may fail to comply with relevant authorities (RICA, pricing, etc.) – compliance risk
o Competition threats from foreign investors and Whatsapp may squeeze company margins
o Campaigns to lower data costs and increasing labour strikes may impact the operations of the
business – political risks
o Foreign operations and foreign transactions expose the company to financial loss –
financial/currency
o Foreign operations may be subject to hostile reception and government interference – political
risks
o The company may struggle to service its debt due to changes in interest rates and financial
leverage – financial risks
o Changes in credit ratings may have an impact on ability to raise funds and service debt – financial
risks
o Vandalism of infrastructure may disrupt the services provided to its customers (cables, towers,
etc.)
o Hacking of systems and access to trading secrets, network downtime, etc. may have an impact
of the running of the business – information risks
o B-BBEE ratings – failure to comply may have negative financial implications
o The company faces a brand and reputation risk as a result of failure in systems and processes
o Technological advances may leave the company behind
Max: 6 marks

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SOLUTION 06: TOY STARS (10 marks; 18 minutes)

Additional working capital required:

Workings R

Increase in trade receivables (i) 331 632

Increase in inventory (ii) 102 240

Increase in cash (iii) 17 804

Increase in trade payables (iv) (131 040)

Additional working capital required 320 636

Workings

(i) Calculation of increase in trade receivables calculation

Trade receivables = R647 000

Credit sales (2X13) = R4 400 000 x 50%

= R2 200 000

accounts receivable
Current ratio (2X13) = %
credit sales

R647 000
= %
R2 200 000

= 29,4%

2X14 credit sales

R5 120 000 x 65% = R3 328 000

Increase in trades receivable

(R3 328 000 − R2 200 000) x 29,4% = R331 632

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(ii) Calculation of increase in inventory

Inventory (2013) = R626 000

Inventory
Current ratio (2013) = %
Turnover

R626 000
= %
R4 400 000

= 14,2%

Increase in inventory

(R5 120 000 − R4 400 000)x 14,2% = R102 240

(iii) Calculation of increase in cash

Profit after tax

Net profit percentage (2013) = %
Turnover

R192 000
= %
R4 400 000

= 4,4%

Profit after tax

Earnings per share (2013) =
Number of shares

R192 000
=
700 000

= 27,4 cents

Earnings per share - dividend per share

Profit retained (2013): = %
Earnings per share

27,4 - 12
= %
27,4

= 56,2%
Increase in cash
Increase in sales x NP% x profit retained = R720 000 x 4,4% x 56,20%
= R17 804

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(iv) Calculation of increase in trade payables

Trade payables
Current ratio (2013) = %
Turnover

R800 000
= %
R4 400 000
= 18,2%
Increase in trade payables
(R5 120 000 − R4 400 000)x 18,2% = R131 040

Conclusion:
The additional working capital required to support the increased sales budget for
20x14 is R320 636.
TOTAL: 10 MARKS

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SOLUTION 07: A GREYS (20 marks; 36 minutes)

MEMORANDUM

TO: Manager
DATE: xx Month 2016
FROM: Consultant

WORKING CAPITAL MANAGEMENT OF A GREYS (PTY) LIMITED

Dear Sir

As per your request, we have investigated the working capital management of A Greys (Pty)
Limited and detail our findings below.

INVENTORY
The idea of reducing your inventory levels will result in a shortening of the working capital
cycle, save holding and other inventory related costs and free some much needed funds.
This can be brought about by limiting new purchases.
One major, problem which we would like to bring to your attention however, is the fact that
the Just-in-time philosophy promotes a zero inventory holding policy. This can only be
achieved by buying from a small group of reliable suppliers.

In A Greys’ case, it would appear that the suppliers are definitely not reliable and
furthermore they are based throughout the country, which implies that you would have to
wait for the supplies to be freighted to you. It is critical for you to realise that as you operate
a hospital, keeping zero stock levels would not be advisable as lives could be lost while you
wait for desperately needed supplies to arrive.

A safety stock of 10 days can be recommended: R750 000 x 10/75 days = R100000.

ACCOUNTS RECEIVABLE
Problems need to be addressed:
The long processing time which it takes for your personnel to process patient accounts. At
this stage it can take up to 90 days for your staff to process accounts. You should attempt to
keep this to a minimum – as soon as the patient has been discharged you should start
processing their accounts and submit them to the medical aid or mail them to the patient in
the case of private patients.

The medical aids take far too long to process accounts – one member of staff should be
assigned to follow up on the status of accounts at the different medical aids and to exert
pressure on them to process your accounts more timeously and to remit payment thereof
faster.

Major deficiencies exist as regards the checking of creditworthiness, which appears to be

resulting in the high debt levels. The following could be proposed in this regard:
 A Grey should have a well-documented, sound credit policy in place.
 All private patients should pay a substantial deposit.
 They must furthermore supply administrative staff with references who can be
contacted to check on creditworthiness.

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 All medical aid patients must give a medical aid card proving their membership. One
member of staff should then actually confirm with the medical aid that the patient is in
fact a member of the medical aid and that the procedure has been pre-authorised. No
medical aid patient must be submitted without an authorisation number.
 There appears to be no debt collection policy with regard to amounts outstanding,
particularly the private portion of accounts. By not following up such amounts, the
hospital will suffer financial loss. All amounts outstanding should be followed up and
handed over for debt collection where necessary.

ACCOUNTS PAYABLE
The current effective cost of creditor financing is:
Kf = (0.03/0.97) x (365/20) = 56.44%

The current effective interest rate on the overdraft is only 15%. It would therefore be
recommended to rather make use of the bank overdraft facility as far as possible.

CASH RESOURCES
A culture of banking cheques and cash timeously should be developed. Medical aids should
be requested to rather make direct transfers in your bank accounts (EDI) – this would
eliminate the lag on the banking of the cheques and the funds would thus be available
quicker.

RECOMMENDATIONS
In addition to ways in which to improve the working capital management, the following can
be considered as being short-term solutions to your current problems:

 A Greys could consider factoring you debtors/.

 Negotiate an increase in the bank overdraft facility.
 Consider possibly making use of a banker’s acceptance.
 Negotiate with the bank for a lower rate or consider approaching other banks to
negotiate facilities at a lower rate.
 Negotiate an increase in the creditors’ payment period.
 Encourage private debtors to pay quicker by offering them discounts; and to charge
interest and administration fees on long outstanding accounts.
 Improve the debt collecting and efficiency within the accounts department by offering
performance related bonuses. Change the current “relaxed” culture to a professional
culture.

Please note that these are only short-term solutions to your problem. You should also
ensure that your mix of short-term financing to long-term financing is correct – in other words
that you are not financing fixed assets with short-term sources of financing.

TOTAL: 20 MARKS

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SOLUTION 08: ZENZEL (20 marks; 36 minutes)

(a) Comparison of current vs new credit terms

Current credit New credit terms

sales & credit Current credit Additional credit
terms sales sales

A B C

Credit sales R25 750 000 R25 750 000 R2 500 000
Discount rate 3% 5% 5%
Discount on % of credit sales 20% 55% 60%

Pay in 10 days 20% 55% 60%

45 days 80%
50 days - 45%
65 days - 40%

Bad debt R2 300 000 R2 300 000 R45 000

WACC 20%
Contribution rate 32%
Increase in inventory R1 250 000
Increase in trade payables
financing R850 000

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(b) Calculations

Current credit New credit terms

sales & credit Current Additional
Calculation terms credit sales credit sales

A B C
Contributions 1 R8 240 000 R8 240 000 R800 000
Discount 2 (R154 500) (R708 125) (R75 000)
Bad debt 3 (R2 300 000) (R2 300 000) (R45 000)

Contribution before
holding cost R5 785 500 R5 231 875 R680 000
Tax on contribution
before holding cost 7 (R1 619 940) (R1 464 925) (R190 400)

After tax cost R4 165 560 R3 766 950 R489 600

Holding cost (after tax
cost) (R536 164) (R395 068) (R123 836)

Debtor holding cost 4 (R536 164) (R395 068) (R43 836)

Inventory holding cost 5 – – (250 000)
Creditors – saving in
holding cost 6 – – 170 000

R3 629 396 R3 371 882 + R365 764

R3 629 396 = R3 737 646

Increase /(Decrease) in annual cash flow after tax

(new total less current total) R108 250

Note 7: Tax on contribution before holding cost

Contribution before
holding cost R5 785 500 R5 231 875 R680 000

x 28% tax x 0.28 x 0.28 x 0.28

Tax on contribution before

(R1 619 940) (R1 464 925) (R190 400)
holding cost

Additional notes on the impact of holding costs (opportunity cost) on credit terms

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Due to the fact that more sales are made on credit with the new credit terms it takes longer for
the cash to be available to make payments. As this is the case the company can consider the
effect of the holding (opportunity) cost on the cash flow.

Remember that the holding cost is calculated by making use of the company’s WACC and
WACC is considered as an after tax cost, therefore the impact of direct tax is not calculated
on the holding cost.

Companies do not always take the holding cost into consideration as it is not always significant
enough to impact the decision. You do however need to calculate it for MAC3702 purposes
and if you do decide not to include it based on the fact that it is insignificant, you do need to
state your reasoning and show your calculation.

Calculations:

1 Contributions = credit sales x contribution rate

A and B = R25 750 000 x 32%

= R8 240 000

C = R2 500 000 x 32%

= R800 000

2 Discount = credit sales x % making use of credit x discount rate

A = R25 750 000 x 20% x 3%

= R154 500

B = R25 750 000 x 55% x 5%

= R708 125

C = R2 500 000 x 60% x 5%

= R75 000

3C Bad debt increase = R2 345 000 – R2 300 000

= R45 000

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4 Holding cost = (credit sales x percentage on 10 days/365 x WACC) +

(credit sales x percentage on other days/365 x WACC)

A = (R25 750 000 x 20% x 10/365 x 20%) + (R25 750 000 x 80%
x 45/365 x 20%)

= R536 164

B (R25 750 000 x 55% x 10/365 x 20%) + (R25 750 000 x 45%
x 50/365 x 20%)

= R395 068

C = (R2 500 000 x 60% x 10/365 x 20%) + (R2 500 000 x 40% x
65/365 x 20%)

= R43 8365

5C Increase in inventory = increase in inventory x WACC

holding cost

= R1 250 000 x 20%

= R250 000

6C Increase in creditors = increase in trade payables x WACC

= R850 000 x 20%

= R170 000

Conclusion:
The company should accept the new credit policy, as it results in an increase of annual cash
flow before tax.
TOTAL: 20 MARKS

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SOLUTION 09: KINGSTON (25 marks; 45 minutes)

a) Calculate cost of debt (loan)

Loan 𝐾𝑑1 = (10,5% + 2%) x 0,72 = 9%

b) Calculate cost of debt (debentures)

Debentures 𝐾𝑑2 = 10% x 0,72 = 7,2%

c) Calculate cost of equity

Using Gordon’s Dividend Growth Model

𝐷1
𝐾𝑒 = +g
𝑃0

28
𝐾𝑒 = + 0,12
625
𝐾𝑒 = 16,48%

Using Capital Asset Pricing Model

𝐾𝑒 = Rf + ß (Rm – Rf)

𝐾𝑒 = Rf + ß (Rp)

𝐾𝑒 = 7% + 1,2 * (7,9%)

𝐾𝑒 = 16,48%

d) Calculate market value of loan (Vd1)

Key Variables Value

FV R10 000 000 -10 000 000

N 3 years 3
i (10,5% + 2%) x 0,72 9
PMT R10 000 000 x (10,5% - 1%) x 0,72 -684 000
Comp PV Calculation 9 453 240

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e) Calculate market value of debentures (Vd2)

Key Variables Value

FV R16 000 000 -16 000 000

N 5 years – (2021 – 2016) 5
i 7,2% 7,2
PMT R16 000 000 x 12% x 0,72 -1 382 400
Comp PV Calculation 16 939 648

f) Calculate market value of equity (Ve)

𝑅40 000 000

Number of shares = 𝑅2,50

= 16 000 000

Ve = R6,25 x 16 000 000

Ve = R100 000 000

g) Calculate Weighted Average Cost of Capital (WACC)

Current capital structure

Market Cost of
Instrument values Weight (A) Capital (B) WACC

Ordinary shares 100 000 000 0,79 16,48% 13,02%

Debentures 16 939 648 0,13 7,20% 0,94%
Long-term loan 9 453 240 0,08 9,00% 0,72%

Total 126 392 888 1/100% 14,68%

TOTAL: 25 MARKS

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SOLUTION 10: QUEEN POWER (45 marks; 1󠄧⅓ hours)

a) Calculate weighted average cost of capital

Cost of capital
Ordinary shares 𝐷1
𝐾𝑒 = 𝑃0
+g

26
𝐾𝑒 = + 0,04 {g = (26-25)/25 * 100)}
200

𝐾𝑒 = 17%

Preference shares 𝐷𝑖𝑣𝑖

𝐾𝑝 = 7,5% {10% x 15m / 20m} : 𝐾𝑝 = 𝑀𝑉

Debentures 𝐾𝑑 = 8% x 0,72

= 5,76%

Target capital structure

Cost of WACC
Instrument Weight (A)
capital (B) (A x B)

Ordinary shares  0,60 17,00% 10,20%

Preference shares  0,20 7,50% 1,50%
Debentures 0,20 5,76% 1,15%

Total 1/100% 12,85%

 Ordinary shares: 80% x 75% = 60%
 Preference shares: 80% x 25% = 20%

Current capital structure

Market Cost of
Instrument values Weight (A) Capital (B) WACC

Ordinary shares  50 000 000 0,57 17,00% 9,69%

Preference shares 20 000 000 0,23 7,50% 1,73%
Debentures  17 000 000 0,20 5,76% 1,15%

Total 87 000 000 1/100% 12,57%

 Number of shares in issue: R40 000 000 / R1,60 = 25 000 000

Ordinary shares: 25 000 000 x R2,00 = R50 000 000

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 Debentures:
Key Variables Value

FV R16 000 000 – R757 574 -15 242 426

N 10 years – (2016 – 2010 lapsed period) 4
i 8% x 0,72 (after tax effect) 5,76
PMT R16 000 000 x 12% x 0,72 -1 382 400
Comp PV Rounded to nearest Rand 17 000 000

Max: 22 marks

Comments:
The current capital structure is not far off the target as demonstrated by calculations above
(12,57% vs 12,85%). The company is currently not operating at its optimal capital structure.
The company must introduce more debt to achieve its target capital structure. The new project
presents an opportunity for the company to achieve its optimal capital mix. Currently the
company has low level of debt, although debt seems to be cheaper (after-tax benefit) and if
the company increases its debt proportion, WACC will decrease.

Max: 3 marks

b) Calculate following ratios

EBIT
i. Return on assets Total assets

30 000 000 x 0,38

= 84 050 000

= 13,56%
Net profit
ii. Return on equity Total equity

30 000 000 x 0,20

= 65 000 000

= 9,23%
Interest−bearing debt (IBD)
iii. Capital gearing ratio
IBD+Total equity

16 000 000
= 81 000 000

= 19,75%
Sales
iv. Asset turnover Total assets

30 000 000
=
84 050 000

= 0,36 times

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Market value
v. Price / BV multiple Book value

50 000 000
= 65 000 000

= 0,77 times
IBD
vi. Debt-equity ratio Total equity

16 000 000
=
65 000 000

= 24,62%
EPS
i. Earnings yield Share price

6 000 000
EPS = 25 000 000 = 24c
24c
E/Y=
200c

= 12%
Max: 20 marks

TOTAL: 45 MARKS

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SOLUTION 11: CHAPTERS & NOVELS (50 marks; 1½ hour)

PART A

Cost of capital
Ordinary shares 𝐷1
𝐾𝑒 = +g
𝑃0 −𝑓𝑐
18,75 𝑥 1,125
𝐾𝑒 = + 0,125
650−25
𝐾𝑒 = 15,9%

𝑅3 000 000
𝐷1 = = 18,75c
𝑅40 000 000/250𝑐

𝑅3𝑚−𝑅2,67𝑚
𝑔 = = 12,5%
𝑅2,67𝑚

Preference shares
𝐾𝑝 = 7,5% {10,5% - 3%}

Debentures 𝐾𝑑 = 9% x 0,72

= 6,5%

Target capital structure

Cost of WACC
Instrument Weight (A)
capital (B) (A x B)

Ordinary shares
ᵩ
0,40 15,90% 6,36%

Preference shares
ᵩ
0,10 7,50% 0,75%
Debentures 0,50 6,50% 3,25%

Total 1/100% 10,36%

ᵩ Ordinary shares: 50% x 80% = 40%

ᵩ Preference shares: 50% x 20% = 10%

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Current capital structure

Market Cost of
Instrument values Weight (A) Capital (B) WACC


Ordinary shares 104 000 000 0,57 15,90% 9,06%
Preference shares 46 000 000 0,25 7,50% 1,88%
Debentures  33 746 255 0,18 6,50% 1,17%

Total 183 746 255 1/100% 12,11%


ORDINARY SHARES:
Number of shares in issue: R40 000 000 / 250c = 16 000 000
Market value = 650c x 16 000 000 = R104 000 000

 PREFERENCE SHARES:
Market value = R3 450 000 / 0,075 = 46 000 000

 DEBENTURES:
Amount Key Calculation

0 CF0 (2017)
2 484 000 CF1 (2018) 3 450 000 x 0,72
2 484 000 CF2 (2019)
32 484 000 CF3 (2020) (3 450 000 x 0,72) + 30 000 000
3 000 000 CF4 (2021) 30 000 000 x 10%
6,5 I/Y 9% x 0,72

NPV Market value = 33 746 255

Max: 22 marks

Comments:
The current capital structure indicates that the company has not yet reached its ideal capital
structure as WACC is currently 12,11% as opposed to just 10,36%. The current funding
structure of the company is costing more than its targeted structure. The company will have
to introduce more debt (which is cheaper) to move the current capital structure towards the
targeted/optimal capital structure. Changes in cost of capital will also impact the company in
its attempt to move towards the target capital structure.

Max: 3 marks

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PART B

Financing the new project:

Current capital structure Market Value

Ordinary shares R104 000 000

Preference shares R46 000 000

Debentures R33 746 255

Capital employed R183 746 255

New investment R76 253 745

R260 000 000

Total capital structure after new investment

Capital structure Current New Capital

capital investment structure after new
structure investment
(Balancing
figure)

Equity R104 000 000 - R104 000 000

Preference shares R46 000 000 (R20 000 000) R 26 000 000

Debentures R33 746 255 R96 253 745 R130 000 000

Total R183 746 255 R76 253 745 R260 000 000

Project Thewuka should be financed entirely through the issue of debentures (R76 253 745).
Should the conditions allow, CNA should buy back its preference shares to the market value
of R20 000 000 to operate at its target capital structure. Instead of the preference share
buyback, CNA can always wait for another investment opportunity to move towards its target
capital structure. The company should not utilise its authorised share capital for Project
Thewuka. The debentures in the scenario are the cheapest source (6,5% after tax), while
ordinary shares are the most expensive (15,9%), hence the advice to use debentures to
finance the new initiative.

Max: 10 marks

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PART C
Notes Existing (E) Proposed (P)

Gross profit 1 R12 000 000 R12 000 000

Discount 2 (R187 500) (R270 000)

Bad debt expenses 3 (R1 750 000) (R1 650 000)

Profit before holding costs R10 062 500 R10 080 000

Tax on profit above (at 28%) (R2 817 500) (R2 822 400)

R7 245 000 R7 257 600

Holding costs - debtors 4 (R393 160) (R308 556)

Benefit/(loss) from option R6 851 840 R6 949 044

The company should implement the new policy as it increases profits by R97 204 (R6,95m –
R6,85m) .

1 Gross profit = credit sales x gross profit margin

E and P = R30 000 000 x 40%

= R12 000 000

2 Discount = credit sales x % making use of credit x discount rate

E = R30 000 000 x 25% x 2,5%

= R187 500

P = R30 000 000 x 30% x 3%

= R270 000

3 Bad debt expenses

E = Given

P = R30 000 000 x 5,5%

= R1 650 000

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4 Debtors = (credit sales x percentage on 8 days/365 x WACC) +

(Holding costs) (credit sales x percentage on other days/365 x WACC)

E = (R30 000 000 x 25% x 8/365 x 12,11%) +

(R30 000 000 x 75% x 50/365 x 12,11%)

= R393 160

P = (R30 000 000 x 30% x 10/365 x 12,11%) +

= (R30 000 000 x 70% x 40/365 x 12,11%)

= R308 556

Max: 10 marks
PART D

o The company’s trading stock (especially books and magazines) may become outdated
and therefore not saleable (obsolescence).
o Increased competition from e-businesses may push the company out of the market.
o Rapid growth and diversification may lead to complexities in running the company.
o Customers (including governments) may not settle their accounts (bad debts).
o The company may distribute materials without proper rights leading to possible lawsuits,
which could also lead to reputational damage.
o Cargos may not reach intended destinations (due to theft, breakdowns, etc).
o Environmental lobby groups (e.g. anti-deforestation campaigns) may disrupt the
operations of the company.
o Government may impose laws that are detrimental to the company (or the company may
contravene laws).
o The company may default on its loan obligations (including servicing of interest and
interest rate changes).
o Political instability and political intervention may impact on the success of foreign
operations.
o Movement in exchange rates may lead to increase in the cost or reduction in profits.
o Possibility of fraud taking place in other parts of the continent, and impact thereof on the
reputation of the company.
o Any other valid point

Max: 5 marks

TOTAL: 50 MARKS

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SOLUTION 12: SIMON & SON (40 marks; 72 minutes)

a) Cost of capital and underlying assumptions

Instrument Cost of equity

Ordinary shares 𝐷1
𝐾𝑒 = 𝑃0
+g

P0 = Cum div – div = Share price ex div

6(1,08)
𝐾𝑒 = 60
+ 0,08

𝐾𝑒 = 18,8%

Preference shares 𝐾𝑝 = 12%

Debentures 𝐾𝑑 = 13,89% x 0,72

= 10,00%

Capital structure Portion of Cost of Weighted

capital capital cost of
structure * capital
Ordinary shares 0,60 18,8% 11,28%

Preference shares 0,20 12,0% 2,40%

Debentures 0,20 10,0% 2,00%

Total 1/100% 15,68%

* As per target capital structure

8 MARKS

Assumptions (any 3 of the assumptions below):

 The appropriate cost of capital to evaluate the project is WACC.
 When financing the project, the target capital structure will be maintained at 60% equity
and 40% debt.
 The project is marginal. Most investments are indeed small, relative to the total capital
value of the firm.
 The project has the same level of risk as the firm’s existing activities. If the project has
a risk structure that differs from that of the existing activities, an appropriate risk-adjusted
rate should be used.
 Cost of equity, debt and WACC will remain the same.
3 MARKS

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(b) Memorandum

To: Directors of Simon & Son Ltd

From: AB Consultants

Date: XX/XX/201X

EVUALUATION OF THE FUNDING OPTIONS AS SUGGESTED BY THE BOARD OF

DIRECTORS
Financing through issuing of new shares:
View of Managing Director (MD)

We would need to clarify the MD’s view.

When a company uses new shares (equity) to finance an investment there is a couple of
things to consider.

 It is normally very costly to obtain equity through the issue of new shares as there are
considerable marketing expenses and professional fees that need to be paid.
 The issuing of new shares can also have an impact of the existing control in the
company.
 Due to the fact that there is a higher risk for the equity holders than for the debt holders,
the equity holders normally require a higher rate of return on their investment resulting
in a more expensive form of finance than debt.
 Dividends paid to shareholders are also not tax deductible.
 It is a flexible form of finance as there is no risk of defaulting on the interest or capital
repayments (as there is no obligation to pay these).

Financing through issuing of cumulative redeemable preference shares (debt):

View of Chief Operating Officer (COO)

We are not in agreement with the view of the COO.

Preference shares are not the cheapest form of debt finance. Bond financing is cheaper than
preference shares due to following:
 Debt holders tend to ask for lower returns than preference shares and ordinary
shareholders as their investments are in most instances secured.
 The preference share dividend is also not tax deductible and therefore more expensive.
 Preference shareholders rank after debt when there is a claim against the company.

Financing through issuing a mix of debt and equity:

View of Finance Director (FD)

We are in agreement with the views of the FD based on the following.

 An appropriate mix of debt and equity (the optimal capital structure) would tend to lower
the firm’s WACC.
 There is no single optimal capital structure for all companies. Each company and each
industry will have an optimal mix. This optimal capital structure will be based on the

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company’s ability to access a particular market, the current capital structure and
therefore the ability to restructure the statement of financial position of the company.
 When a project is financed the company should aim to maintain the current level of
WACC and therefore maintain the target capital structure.
 The new project should have a similar risk profile to that the company.

If you need any additional information with regards to the funding methods, please feel free
to contact us.

Yours sincerely

Funding consultants
10 MARKS

(c) Company’s capacity to raise debt or equity

Instrument Market value

Ordinary shares MV = Number of shares x cum div share price
= 1 000 000 x (R66 – R6)
= R60 000 000

Preference shares Annual dividend = R12 000 000 x 9%

= R1 080 000
Final capital redemption = R12 000 000 x 1,05
= R12 600 000
INPUT in calculator (HP10bII)

N 10
I/YR 12
PMT R1 080 000
FV R12 600 000
COMP PV R10 159 104

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Debentures Annual interest after tax = R15 000 000 x 11% x 0,72
= R1 188 000
Final capital redemption = R15 000 000

Debentures (cont.)
INPUT in calculator (HP10bII)
N (8 – 3) = 5
I/YR 13,89% x 0,72 = 10
PMT R1 188 000
FV R15 000 000
COMP PV R13 817 275
Instrument Market Value

Ordinary shares R60 000 000

Preference shares R10 159 104

Debentures R13 817 275

Total R83 976 379

New investment R16 250 000

Total capital structure after new

R100 226 379
investment

Capital Target capital Current capital Capacity

structure structure structure

Equity 60% R60 135 827 R60 000 000 R135 827

Pref. shares 20% R20 045 276 R10 159 104 R9 886 172

Debentures 20% R20 045 276 R13 817 275 R6 228 001

Total R100 226 379 R83 976 379 R16 250 000

Conclusion:

The company has almost no capacity to raise equity (only about R135 827 to raise), but has
some capacity to raise debt (through the issue of preference shares for R9 886 172 and
debentures for R6 228 001).

14 MARKS

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(d) Qualitative factors

 The current load shedding might have an impact on the implementation of the solar
panels.
 The appointment of a specialist service provider for the maintenance of the project.
 Training that the current employees should receive to enable them to use the solar
panels.
 Additional security to ensure that the solar panels are not vandalised or stolen.
 The period of installation and the short to medium term solution to the load shedding
problem.
 The impact of bad weather conditions.
 Any other valid point.
5 MARKS

TOTAL: 40 MARKS

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SOLUTION 13: S & S (10 marks; 18 minutes)

The loan can only be taken up in factors of R75 000, therefore there are 6 possibilities on how the capital structure can be combined.
R375 000 / R75 000 = 5 + 1 where there is R0 debt.

Option Capital Portion of Required Adjustment Total rate of Total rate of Weighted rate
structure capital rate of return before return after of return
structure return tax tax (after tax)

1 Debt 5/5 = 100% 17,5% -(0 x 1,25%) = -0,00% 17,50% 12,60% 12,60%

Equity 0/5 = 0% 15,0% +(5 x 0,25%) = 1,25% 16,25% 16,25% 0,00%

WACC 12,60%

2 Debt 4/5 = 80% 17,5% -(1 x 1,25%) = -1,25% 16,25% 11,70% 9,36%

Equity 1/5 = 20% 15,0% +(4 x 0,25%) = 1,00% 16,00% 16,00% 3,20%

WACC 12,56%

3 Debt 3/5 = 60% 17,5% -(2 x 1,25%) = -2,50% 15,00% 10,80% 6,48%

Equity 2/5 = 40% 15,0% +(3 x 0,25%) = 0,75% 15,75% 15,75% 6,30%

WACC 12,78%

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Option Capital Portion of Required Adjustment Total rate of Total rate of Weighted rate
structure capital rate of return before return after of return
structure return tax tax (after tax)
4 Debt 2/5 = 40% 17,5% -(3 x 1,25%) = -3,75% 13,75% 9,90% 3,96%

Equity 3/5 = 60% 15,0% +(2 x 0,25%) = 0,50% 15,50% 15,50% 9,30%

WACC 13,26%

5 Debt 1/5 = 20% 17,5% -(4 x 1,25%) = -5,00% 12,50% 9,00% 1,80%

Equity 4/5 = 80% 15,0% +(1 x 0,25%) = 0,25% 15,25% 15,25% 12,20%

WACC 14,00%

6 Debt 0/5 = 0% 17,5% -(5 x 1,25%) = -6,25% 10,75% 8,10% 0,00%

Equity 5/5 = 100% 15,0% +(0 x 0,25%) = 0,00% 15,00% 15,00% 15,00%

WACC 15,00%

Conclusion:

Based on the calculations the best optimal structure is option 2, where the project is financed through R300 000 debt (4 x R75 000) via a loan
from CapC Bank and R75 000 (1x R75 000) through the issuing of new shares. At this point WACC is the lowest and therefore the most cost-
efficient.

TOTAL: 10 MARKS

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SOLUTION 14: SIMUNYE GOLD (50 marks; 1½ hour)

a) Calculate cost of capital

Ordinary shares 𝐷1
𝐾𝑒 = 𝑃0−𝑓𝑐
+g

𝑅1,86
𝐾𝑒 = (𝑅25−𝑅0,20)
+ 0,10 { g = (186-169)/169 }

𝑲𝒆 = 17,5%

Preference shares 20 400 000 𝐷𝑖𝑣𝑖

𝐾𝑝 = 255 000 000
{𝐾𝑝 = 𝑀𝑉
}

𝑲𝒑 = 8%

Loan: Ifafa Bank 𝑲𝒅𝟏 = (8,25% + 0,75%) x 0,72

𝑲𝒅𝟏 = 6,48%

Loan: Netbank 𝑲𝒅𝟐 = (8,25% + 0, 50%) x 0,72

𝑲𝒅𝟐 = 6,3%

Debentures: JPM 𝑲𝒅𝟑 = 8,50% x 0,72

𝑲𝒅𝟑 = 6,12%

Max: 10 marks

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b) Calculate weighted average cost of capital

Target capital structure

Values Cost of
Instrument Weight (A) Capital (B) WACC

Ordinary shares 0,48 17,50% 8,40%

Preference shares 0,12 8,00% 0,96%
Ifafa Bank loan 0,12 6,48% 0,78%
Netbank loan 0,08 6,30% 0,50%
JPM Debentures 0,20 6,12% 1,22%

Total 1/100% 11,86%

TARGET CAPITAL STRUCTURE WEIGHTINGS

SOURCE INSTRUMENT CALCULATION WEIGHT

DEBT 40%
Loan – Ifafa Bank (50% x 1,5/2,5) $ = 40% x 50% x 1,5 / 2,5 $ 12%
Loan – Netbank (50% x 1,0/2,5) $ = 40% x 50% x 1,0 / 2,5 $ 8%
Debenture – JPM (50%) = 40% x 50% 20%

EQUITY 60%
Ordinary share (<80%) = 60% x 80% 48% (max)
Preference share (bal.) = 60% x 20% 12%

TOTAL 100%

$ Alternative:
Ifafa = 570 / (570+380)
Netbank = 380 / (570+380)

Max: 7 marks

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c) Calculate weighted average cost of capital (BV)

Current capital structure

Book Values Cost of

Instrument Weight (A) Capital (B) WACC

Ordinary shares 1 200 000 0,47 17,50% 8,23%

Preference shares 240 000 0,10 8,00% 0,80%
Ifafa Bank loan 570 000 0,23 6,48% 1,49%
Netbank loan 380 000 0,15 6,30% 0,95%
JPM Debentures 135 000 0,05 6,12% 0,31%

Total 2 525 000 1/100% 11,78%

Max: 4 marks

d) Calculate the bid price

Bid price = (20% x 25m) + (50% x 60m) + (30% x 50) = CAD50 000 000
= 50 000 000 x R9,50
Bid price = R475 000 000

Max: 2 marks

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e) Determine the new acquisition should be financed

Current capital structure Book Value

Ordinary share capital R1 200 000 000
Preference share capital R240 000 000
Loan: Ifafa Bank R570 000 000
Loan: Netbank R380 000 000
Debentures: JP Mogano Bank R135 000 000
Total R2 525 000 000
New investment R475 000 000
Total capital structure after new investment R3 000 000 000

Instrument % Target capital Current capital Capacity

structure structure

Ordinary shares 43,3% 1 300 000 000 1 200 000 000 100 000 000

Preference shares 16,7% 500 000 000 240 000 000 260 000 000

Loan: Ifafa Bank 12,0% 360 000 000 570 000 000 (210 000 000)

Loan: Netbank 8,0% 240 000 000 380 000 000 (140 000 000)

Debentures: JPM 20,0% 600 000 000 135 000 000 465 000 000

Total 100% 3 000 000 000 2 525 000 000 475 000 000

Conclusion:
To operate at its target capital structure, Simunye will have to issue new ordinary shares to the value
of R100m (4 million shares at R25 each). The company is not able to issue more shares as only 4
million shares (96% shares issued – 96 million shares) are available from its authorised share capital
– unless a special resolution is undertaken to increase its authorised share capital.
The company will also have to issue preference shares worth R260m. Since the preference shares
are irredeemable, they are classified as equity. Ordinary share capital will then make 72% (1 300 ÷
1 800) of total equity, which is well within the 80% limit.
Simunye must reduce its loan exposure to Ifafa Bank and Netbank by R210m and R140m
respectively. This is good because the loan interest rates after tax (6,80% and 6,30%) are slightly
higher the interest rate after tax on debentures (6,12%). The company should consider any hidden
costs that might arise from the cancellation or early repayment of these loans.
Debentures to the value of R465 million will have to be issued to bring it to 20% of total capital
employed (50% of total debt). This is currently the cheapest form of external funding at 6,12%
interest rate after tax.
Alternatively, Simunye can consider raising the entire amount (R475 million) from JP Mogano Bank
to avoid unnecessary admin costs and to save time and then correct its capital structure as time
goes on.
Max: 11 marks

f) Calculate the market values for capital employed

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INSTRUMENT M ARKET VALUE COST OF EQUITY

Ordinary shares 96 000 000 × R25 = R2 400 000 000 𝑲𝒆 = 17,5%

INSTRUMENT M ARKET VALUE COST OF PREF.

Preference shares 𝑲𝒑 = 8%
R255 000 000 (given)

INSTRUMENT M ARKET VALUE (FINANCIAL CALC METHOD) COST OF DEBT

PV of interest + capital
Loan: Ifafa Bank FV - 570 000 000
PMT -37 962 000 (570 m x 9,25%ßx0,72) 𝑲𝒅𝟏 = 6,48%
N 2
I 6,48%
Comp 571 868 484
PV
ß 8,25% + 1% = 9,25%

INSTRUMENT M ARKET VALUE (M ARKET YIELD METHOD) COST OF DEBT

INTEREST
Loan: Netbank 𝑲𝒅𝟏 𝑲𝒅𝟐 = 6,30%

380m x (8,25% + 1,25%)x 0,72

=
0,063
= R412 571 429

INSTRUMENT M ARKET VALUE (FINANCIAL CALC.) COST OF DEBENTURES

PV of interest + capital + premium

Debentures: JPM FV - 141 750 000 (135 000 000 x
1,05) 𝑲𝒅𝟑 = 6,12%
PMT - 8 748 000 (135mx 9%x0,72)
N 3
I 6,12%
Comp 141 944 431
PV

Max: 12 marks

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g) Calculate weighted average cost of capital (MV)

Current capital structure

Market values Cost of Capital

Instrument Weight (A) (B) WACC

Ordinary shares 2 400 000 0,63 17,50% 11,03%

Preference shares 255 000 0,07 8,00% 0,56%
Ifafa Bank loan 571 868 0,15 6,48% 0,97%
Netbank loan 412 571 0,11 6,30% 0,69%
JPM Debentures 141 944 0,04 6,12% 0,25%

Total 3 781 383 1/100% 13,50%

Max: 4 marks

TOTAL: 50 MARKS

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SOLUTION 15: SANRAL (20 marks; 36 minutes)

e-TOLL SYSTEM

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

CAPEX  (20 562 322)

Working capital (1 677 123) 1 677 123

Operational costs–ETCC (1 300 000) (1 300 000) (1 300 000) (1 300 000) (1 300 000)

e-toll collections  5 796 000 6 143 760 6 512 386 6 903 129 7 317 316

(22 239 445) 4 496 000 4 843 760 5 212 386 5 603 129 7 694 439

Discounted at 7% 1,0000 0,935 0,873 0,816 0,763 0,713

(22 239 445) 4 203 760 4 228 602 4 253 307 4 275 187 5 486 135

Net present value  207 546

 ALTERNATIVE (using HP10bII+ financial calculator)

-22 239 445 CFj

4 496 000 CFj

4 843 760 CFj

5 212 386 CFj

5 603 129 CFj

7 694 439 CFj

7i

SHIFT DOWN NPV 208 639

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FUEL LEVY SYSTEM

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

CAPEX  (23 429 684)

Working capital (234 187) 234 187

Fuel levy  5 775 000 6 121 500 6 488 790 6 878 117 7 290 804

Operational costs (650 000) (650 000) (650 000) (650 000) (650 000)

(23 663 871) 5 125 000 5 471 500 5 838 790 6 228 117 6 874 991

Discounted at 7% 1,0000 0,935 0,873 0,816 0,763 0,713

(23 663 871) 4 791 875 4 776 620 4 764 453 4 752 054 4 901 869

Net present value  323 000

 ALTERNATIVE (using HP10bII+ financial calculator)

-23 663 871 CFj

5 125 000 CFj

5 471 500 CFj

5 838 790 CFj

6 228 117 CFj

6 874 991 CFj

7i

SHIFT DOWN NPV 324 235

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Note  – CAPEX e-toll system

Roads 17 884 002

Gantries (civil works) 393 867

IT Systems 1 837 480

Control centre – Paarl 229 756

Customer centre 217 217

*20 562 322

Note  – e-toll collection

Year 1 e-toll collection = 2 300 000 x 70% x R3,60

= R5 796 000

Year 2: 5 796 000 x 1,06 = 6 143 760

Year 3: 6 259 680 x 1,06 = 6 512 386

Year 4: 6 760 454 x 1,06 = 6 903 129

Year 5: 7 301 291 x 1,06 = 7 317 316

OR

Year 1 Year 2 Year 3 Year 4 Year 5

e-toll registered (2,3m x 70%) 1 610 000 1 706 600 1 808 996 1 917 536 2 032 588

Toll fee of R3.60 x R3,60

5 796 000 6 143 760 6 512 386 6 903 130 7 317 317

OR

Year 1 Year 2 Year 3 Year 4 Year 5

Due collections (2,3m x R3,60) 8 280 000 8 776 800 9 303 408 9 861 613 10 453 309

Unregistered/unpaid (2 484 000) (2 633 040) (2 791 022) (2 958 484) (3 135 993)

5 796 000 6 143 760 6 512 386 6 903 129 7 317 316

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Note  – CAPEX fuel levy

Roads 17 884 002

IT Systems 5 545 682

*23 429 684

Note  – Fuel levy collection

Year 1 fuel levy income = 35 000 000 litres x 30%

= 10 500 000 x R0,55

= R5 775 000

Year 1 Year 2 Year 3 Year 4 Year 5

Fuel esc at 6% 10 500 000 11 130 000 11 797 800 12 505 668 13 256 008

Fuel levy per litre 0,55 0,55 0,55 0,55 0,55

5 775 000 6 121 500 6 488 790 6 878 117 7 290 804

Conclusion: SANRAL should invest in the fuel levy system as it yields a higher NPV.

TOTAL: 20 MARKS

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SOLUTION 16: MASHESHA (30 marks; 54 minutes)

PART A
INVESTMENT DECISION
0 1 2 3 4 5
Fleet of vehicles (4 800 000)
Cancellation fee ( 100 000)
Resale value 1 200 000
Contract fees – variable (w1) 474 000 508 536 545 272 662 291 713 019
Contract fees – fixed (w1) 5 718 600 6 055 997 6 413 301 6 791 686 7 192 395
Maintenance (yr 2: 2%; yr 3: 4%
etc) ( 336 000) ( 342 720) ( 356 429) ( 377 815) ( 408 040)
Salaries (264 000 x 12) (3 168 000) (3 389 760) (3 627 043) (3 880 936) (4 152 602)
Other costs ( 65 000) ( 68 835) ( 72 896) ( 77 197) ( 81 752)
Fuel costs (w2) ( 498 000) ( 532 752) ( 575 905) ( 894 798) ( 969 706)
Tax (w3) ( 326 368) ( 355 730) ( 382 564) ( 353 705) ( 709 328)
(4 900 000) 1 799 232 1 874 736 1 943 736 1 869 526 2 783 987
I/YR = 15% CF0 CF1 CF2 CF3 CF4 CF5
Net Present Value 1 813 198
OR
(4 900 000) 1 799 232 1 874 736 1 943 736 1 869 526 2 783 987
1.000 0.870 0.756 0.658 0.572 0.497
(4 900 000) 1 565 332 1 417 300 1 278 978 1 069 369 1 383 642
Net Present Value 1 814 621

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a) CONTRACT FEES
0 1 2 3 4 5
Rand per km (0.75 x 1,059) 0.75 0.79 0.84 0.89 0.94 1
X
Total km 600 000 605 400 612 665 704 565 713 019
=
Total variable fees 474 000 508 536 545 272 662 291 713 019

Total fixed fees 5 718 600 6 055 997 6 413 301 6 791 686 7 192 395
(450 000 x 12 months x 1,059)

b) FUEL COSTS
0 1 2 3 4 5
Fuel increase (per litre) 0.5 0.7 0.75 0.8 0.9
Fuel cost per litre 11.41 11.91 12.61 13.36 14.16 15.06
X
Litres used per km (7 and 9/100) 0.07 0.07 0.07 0.09 0.09
=
Fuel cost per km (A) 0.83 0.88 0.94 1.27 1.36

Total km (B) 600 000 605 400 612 665 704 565 713 019

Total fuel costs (A x B) 498 000 532 752 575 905 894 798 969 706

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c) TAXATION
0 1 2 3 4 5
Taxable income 2 125 600 2 230 466 2 326 300 2 223 231 2 293 315
Wear & Tear ( 960 000) ( 960 000) ( 960 000) ( 960 000) ( 960 000)
Recoupment 1 200 000
1 165 600 1 270 466 1 366 300 1 263 231 2 533 315
Tax @ 28% 326 368 355 730 382 564 353 705 709 328

Conclusions:
MASHESHA should accept the proposal as the project yields a positive NPV.
TOTAL: 20 MARKS

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PART B

 Possible disruptions of current operations and loss of existing business (capacity)

 Possible use of existing fleet or enter into a lease agreement
 Reliability of economic forecast data especially on fuel price and exchange rate
 Insurance and liability on theft/hacking, hijacking while distributing airtime
 Costs relating monitoring the movement of fleet & security features required
 Possible increase in its transportation footprint (as more areas and clients are accessed)
 Breakdowns, backups to avoid disruptions
 Accessibility and quality of roads (wear & tear and maintenance costs)
 Additional road tariffs (e-toll or fuel levies increased)
 Delayed monthly payments from Moya
5 MARKS

PART C

 Reputation / image of MASHESHA (reliability & improving client relations)

 Impact on staff (strikes, retrenchment) when shutting down the delivery section
 Possible lawsuits from clients where MASHESHA has not acted appropriately
 Access to sensitive corporate information and premises by MASHESHA
 Control over time management of deliveries
 MASHESHA’s inability to service the clients (MASHESHA’s financial position)
 Immediate cancellation of contract
 Validity check of claims (on distance travelled) by MASHESHA
5 MARKS

TOTAL: 30 MARKS

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SOLUTION 17: PICTURE PERFECT (15 marks; 27 minutes)

a) Evaluate existing and new printer

Net present value of the existing printer:

Description Note Year 0 Year 1 Year 2 Year 3 Year 4

Opportunity cost: (Current (180 000)

realisable value forfeited)
Working capital (35 000) 35 000

Cash flows  200 000 200 000 200 000 200 000

Sale at end of useful life 40 000

Taxation  22 400 (42 000) (42 000) (56 000) (67 200)

Net cash in-/outflow (192 600) 158 000 158 000 144 000 207 800

NPV @ 15% 1,000 0,870 0,756 0,658 0,571

NPV per annum (192 600) 137 460 119 448 94 752 118 654

NPV for existing printer 277 922

 Cash flows = R350 000 – R50 000 – R100 000

 Taxation on exiting printer:
Description Calculation Year 0 Year 1 Year 2 Year 3 Year 4

Opportunity benefit: R180 000 – (80 000)

realisation allowance R100 000
forfeited
Tax recoupment on sale 40 000

Cash inflows 200 000 200 000 200 000 200 000

Wear and tear allowance 100 000 / 2 (50 000) (50 000)

Taxable income (80 000) 150 000 150 000 200 000 240 000

Taxation at 28% (22 400) 42 000 42 000 56 000 67 200

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Net present value of the new printer:

Description Note Year 0 Year 1 Year 2 Year 3 Year 4

Investment (250 000)

Working capital (50 000) 50 000

Cash inflows  230 000 230 000 230 000 230 000

Sale at end of useful life 60 000

Taxation (Refer to  - (46 900) (46 900) (46 900) (63 700)
separate calculation
below)
Net cash in-/outflow (300 000) 183 100 183 100 183 100 276 300

Fair rate of return @ 1,000 0,870 0,756 0,658 0,571

15%

Fair value per periods (300 000) 159 297 138 424 120 480 157 767

NPV for new printer 276 245

 Cash flows = R450 000 – R70 000 – R150 000

 Taxation on exiting printer:

Description Calculation Year Year 1 Year 2 Year 3 Year 4
0
Cash inflows - 230 000 230 000 230 000 230 000

Wear and tear 250 000 / 4 - (62 500) (62 500) (62 500) (62 500)

Tax recoupment on - - - - 60 000

sale
Taxable income - 167 500 167 500 167 500 227 500

Taxation at 28% - 46 900 46 900 46 900 63 700

Conclusion:
It is evident from the calculations that the NPV of existing printer is higher than the NPV
of the new printer; therefore, we would advise management to continue with the existing
printer.
12 MARKS

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b) Two qualitative factors to consider when evaluating if the existing printer should be
replaced or not (you may mention any two of the factors listed below):
 The reliability of printer
 The lifespan
 Guarantees given by the manufacturer and supplier
 The reliability of the supplier
 Quality of the printer
 Quality of the parts i.e. the cartridge
 Ease of operating
 Training of staff
 Availability of spare parts
 Ethical consideration i.e. purpose of products manufactured
2 MARKS

c) Mutually exclusive projects are projects where only one of several alternatives
may be chosen at a time. Therefore, if two projects are mutually exclusive, the
acceptance of one will automatically lead to the rejection of the other.

For independent projects, the acceptance or rejection of one project has no

bearing or influence on the acceptance or rejection of any other project.
1 MARK

TOTAL: 15 MARKS

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SOLUTION 18: CITY OF NKANDLA (25 marks; 45 minutes)

a) Investment decision

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Purchase price –
buses (1) (25 080 000)
Modification (a) (5 320 000)
Working capital (b) (4 000 000) 4 000 000
Ticket sales – adult
(2)
11 250 000 11 700 000(4) 12 168 000 12 654 720 13 160 909
Ticket sales – child
(3)
1 250 000 1 300 000(4) 1 352 000 1 406 080 1 462 323
Running costs –
fixed (5) (4 000 000) (4 000 000) (4 000 000) (4 000 000) (4 000 000)
(34 400 000) 8 500 000 9 000 000 9 520 000 10 060 800 14 623 232

Discount factors 1,000 0,909 0,826 0,751 0,683 0,621

(34 400 000) 7 726 500 7 434 000 7 149 520 6 871 526 9 081 027

NPV (@10%) 3 862 573

ALTERNATIVE (Using HP10bII+ calculator)

-34 400 000 CFj

8 500 000 CFj
9 000 000 CFj
9 520 000 CFj
10 060 800 CFj
14 623 232 CFj
10 I/YR

NPV 3 869 344

Conclusion:
The NPV of the project is positive and therefore I would support the decision of the Council to
invest in the fleet.

16 MARKS

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WORKINGS

(1)
$48,000 x 50 x 10,45 (actual payment rate) = R25 080 0000

(2)
No of buses x ticket price x no of days x no of tourists
50 x R30 x 250 x 30 = R11 250 000
Tourists = 50 (capacity) x 80% x ¾ (ratio)

(3)
No of buses x ticket price x no of days x no of tourists
50 x R10 x 250 x 10 = R1 250 000
Tourists = 50 (capacity) x 80% x ¼ (ratio)
Ticket = R30 x 1/3

(4)
Increase at an annual rate of 4%

(5)
Contract amount / 5 years = R4 000 000

(a)
Mark allocated if amount and year are both correct

(b)
Mark allocated if both year 0 and year 5 are correctly shown

b) Discounted payback period

Cash flows Cash flows Cumulative

(part A) PV (part A) Balance
Year 0 (34 400 000) (34 400 000) (34 400 000)
Year 1 8 500 000 7 726 500 (26 673 500)
Year 2 9 000 000 7 434 000 (19 239 500)
Year 3 9 520 000 7 149 520 (12 089 980)
Year 4 10 060 800 6 871 526 (5 218 454)
Year 5 14 623 232 9 081 027 3 862 573

5 218 454
The discounted payback period is 4,57 years: that is 4 full years and 9 081 027 = 0,57 years ( it

will take just over 6 months to generate R5 218 454 based on R9 081 027 that will be made
in the entire year 5).
4 MARKS

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c) Qualitative factors

Economic climate – due to economic recession and high unemployment rate, few people
are going on holiday
 Location of the City of Nkandla (access and attractions)

 Reliability of the buses

 Maintenance and repairs (spare parts and service agreements)

 Public liability & insurance

 Drivers’ proper & fitness test

 Weather – open top busses in the event of bad weather

 Reliability and track record of the SAFE

 Additional licensing requirements

 Any valid qualitative factor

5 MARKS

TOTAL: 25 MARKS

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SOLUTION 19: PURIFIED H2O (20 marks; 36 minutes)

SANDTON MARKET

w1 Sales

Sandton Conference Centre (20 rooms x 50 bottles x 26 days x 12 months x R4.00) =

R1 248 000a

Good Life restaurant (200 000 x R4.50) = R900 000 b

Walk-in customers:
3x +½x = 105 000
3,5x = 105 000
x = 30 000
500ml: 30 000 x R5 = R150 000
1l: 30 000 x R7,5 = R225 000
5l: 30 000 x R25 = R750 000
10l: ½ x (30 000) x R50 = R750 000
Walk-in customers R1 875 000 c

TOTAL: R4 023 000 (a + b + c)

w2 Fixed costs
Total Fixed costs R975 000
Less: Depreciation R 75 000 (R600 000 / 8 years)
Net Fixed costs R900 000

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w3 Income tax (Sandton)

PIETERMARITZBURG MARKET

w4 Income tax (Pietermaritzburg)

Conclusion/Recommendation:
The Sandton market should be invested in as it yield a higher NPV (R4 966 822) than the
Pietermaritzburg market (R3 952 864).
TOTAL: 20 MARKS

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SOLUTION 20: AFRICAN FISH & CHIPS (130 marks; 3½ hours)

a. Financial analysis (a – e)

Ratios 2017 2016 Possible reasons

> Increase in produce prices due to
Gross Profit Margin: dry season
105 744 > Increase in fuel prices for
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 242 455 transportation to different stores
𝑆𝑎𝑙𝑒𝑠 (especially inland stores)
= 43,6% = 48,2% > Possible depreciation of rand
against the dollar for any
ingredients sourced outside the
country

> Improved relations with labour

EBIT Margin: 38 600 union, stable and harmonious
242 455 labour practice in place
𝐸𝐵𝐼𝑇 > Effective campaigns and media
𝑆𝑎𝑙𝑒𝑠 = 15,9% = 13,6% platforms in place to market the
company (marketing costs)
> Increase franchise income as a
result of additional stores opened
in the previous year
> Experience by staff leading to
less expenses
> Review of depreciation policies
and possible sale of ineffective
assets

> Improved relations with labour

EBITDA Margin: union, stable and harmonious
38600 + 8150 + 1046 labour practice in place
𝐸𝐵𝐼𝑇𝐷𝐴 242 455 > Effective campaigns and media
𝑆𝑎𝑙𝑒𝑠 platforms in place to market the
= 19,7% =17,0% company (marketing costs)
> Increase franchise income as a
result of additional stores opened
in the previous year
> Experience by staff leading to
less expenses
> Review of depreciation policies
and possible sale of ineffective
assets

Net Profit Margin: 19 820 > Increased operating costs due

242 455 severe dry season and limited
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 rainfall, leading to price increase
𝑆𝑎𝑙𝑒𝑠 = 8,2% = 8,5% > Possible decrease in franchise
income in 2017 compared to the
success in 2016
> Possible increase in interest
rates due to downgrades
> Possible reduction in other
income (interest) due to invested
cash withdrawn to repay loans

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Admin & marketing as % of 1 326 > More effective campaigns in the

operating expenses: 67 144 + 15 076 marketing department and better
controls in managing day to day
𝐴𝑑𝑚𝑖𝑛 & 𝑚𝑎𝑟𝑘𝑒𝑡𝑖𝑛𝑔 𝑐𝑜𝑠𝑡𝑠 = 1,6% = 2,0% costs in running the stores
𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 > Increased brand awareness
and well established entity
requiring less promotion

Income per franchise store: 15 076 000 > Royalty fee might have been
114 increased during the year
𝐹𝑟𝑎𝑛𝑐ℎ𝑖𝑠𝑒 𝑖𝑛𝑐𝑜𝑚𝑒 > Effective marketing campaign
𝐹𝑟𝑎𝑛𝑐ℎ𝑖𝑠𝑒 𝑠𝑡𝑜𝑟𝑒 = R132 246 = R128 806 led to more sales by franchises
> Capacity (size of) franchise
stores increased

Average salary per employee: 69 880 000 > Annual salary adjustments
312 (above inflation rate)
𝑆𝑎𝑙𝑎𝑟𝑖𝑒𝑠 𝑎𝑛𝑑 𝑤𝑎𝑔𝑒𝑠 > Bonuses (and other incentives)
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑒𝑠 = R223 974 = R202 714 paid to enhance company
revenue

Sales per store: 242 455 Slight increase (as opposed to

75 revenue increase of 15%)
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 > New stores may not be fully
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑡𝑜𝑟𝑒𝑠 = R3 232 733 = R3 197 442 operational or are not situated in
best locations
> Stores opened in the current
year towards the end of the year

Sales per day: 242 455 000 > Stores opened in the current
360 year towards the end of the year
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 > Stores opened on public
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 = R673 486 = R681 486 holidays and more weekends (but
not busy)

Effective tax rate: 8 128 > Delayed tax payments may lead
27 948 to extra tax charges and penalties
𝑇𝑎𝑥𝑎𝑡𝑖𝑜𝑛 > Some of the company’s
𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑡𝑎𝑥 = 29,1% = 27,6% expenses are not tax deductible
(or may be credited to
franchisees)
> Possible special levy charged
for sale of “junk” food

Capital gearing ratio: > Repayment or conversion of

126 500 loans during the year (R145m at
𝐼𝐵𝐷 126 500 + 68 666 start of the year)
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦 > Some profits of the company
= 64,8% = 74,1% are retained to increase the net
IBD: 20 000 + 48 000 + 58 500 worth of the company (equity)
= 126 500

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IBD: EBITDA > Repayment or conversion of

126 500 loans during the year (R145m at
𝐼𝐵𝐷 38600 + 8150 + 1046 start of the year)
𝐸𝐵𝐼𝑇𝐷𝐴 > Increase in operating profits
= 2,7: 1 = 3,2: 1 during the year, due to the
IBD: 20 000 + 48 000 + 58 500 reduction/containment of costs
= 126 500

Debt-equity ratio: > Repayment or conversion of

126 500 loans during the year (R145m at
𝐼𝐵𝐷 68 666 start of the year)
𝐸𝑞𝑢𝑖𝑡𝑦 > Some profits of the company
= 1,8: 1 = 2,2: 1 are retained to increase the net
IBD: 20 000 + 48 000 + 58 500 worth of the company (equity)
= 126 500

Debt-equity ratio (net): > Repayment or conversion of

126 500 − 40 490 loans during the year (R145m at
𝐼𝐵𝐷 − 𝑐𝑎𝑠ℎ 68 666 start of the year)
𝐸𝑞𝑢𝑖𝑡𝑦 > Some profits of the company
= 1,3: 1 = 1,5: 1 are retained to increase the net
IBD: 20 000 + 48 000 + 58 500 worth of the company (equity)
= 126 500

Compare CURRENT/TARGET: Current: Target: > Long-standing commitment on

Use capital gearing ratio 126 500 debt means the company not able
126 500 + 68 666 to speedily reach the target
𝐼𝐵𝐷 structure
= 64,8%: 35,2% = 60%: 40%
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦 > Increase in retained income
(and low dividend repayment)
moves the company closer to its
target capital structure

Total debt ratio: > Repayment or conversion of

160 200 loans during the year (R145m at
𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 228 866 start of the year)
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 > Possible revaluation of PPE or
= 70% = 72,1 mark-to-market of investments
LIABILITIES: 228 866 – 68 666 and loans
= 160 200

Interest cover (TIE): 38 600 > Possible increase in interest

14 138 rates leading to higher finance
𝐸𝐵𝐼𝑇 costs
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 = 2,7 times = 3,3 times > Repayment of loan made closer
to the end of the year (effectively
paid higher interest rate
throughout the year)
> Possible decline in operating
profit due to high operating costs
(sufficient information not
provided)

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Net Interest cover: 38 600 > Possible increase in interest

14 138 − 1 826 rates leading to higher finance
𝐸𝐵𝐼𝑇 costs
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 − 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 = 3,2 times = 3,9 times > Less interest income generated
due to cash used to repay loan
> Repayment of loan made closer
to the end of the year (effectively
paid higher interest rate
throughout the year)
> Possible decline in operating
profit due to high operating costs
(sufficient information not
provided)

Effective interest rate: 14 138 > Possible increase in interest

140 000 rates leading to higher finance
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 costs
𝐼𝐵𝐷 (𝑜𝑝𝑒𝑛𝑖𝑛𝑔) = 10,1% = 9,6% > Extra costs/premiums paid at
termination or reduction of the
OR funding facilities
IBD (average): 126 500 + 140 000
= 133 250

Current ratio: 20 874 + 40 490 > Increase in cash reserves as a

27 451 result of profits generated (sales
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 on cash basis)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 2,2: 1 = 1,9: 1 > Early repayment of creditors on
cash excesses
Liabilities: 20 176 + 4 101 + 3 174

Cash ratio: 40 490 > Increase in cash reserves as a

27 451 result of profits generated (sales
𝐶𝑎𝑠ℎ + 𝑚𝑎𝑟𝑘𝑒𝑡𝑎𝑏𝑙𝑒 𝑠𝑒𝑐𝑢𝑟𝑖𝑡𝑖𝑒𝑠 on cash basis)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 = 1,5: 1 = 1,3: 1 > Early repayment of creditors on
cash excesses
Liabilities: 20 176 + 4 101 + 3 174

Quick ratio: > Increase in cash reserves as a

40 490 result of profits generated (sales
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 27 451 on cash basis)
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 > Early repayment of creditors on
= 1,5: 1 = 1,3: 1 cash excesses

Liabilities: 20 176 + 4 101 + 3 174

Inventory turnover (days): 20 874 > Reduced levels of stock to

𝑥 360
136 711 avoid holding costs and spoilage
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 (better inventory management)
𝑥 360
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 > Changes in policy/valuation
= 55,0 days = 64 days method of stock

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Creditors’ payment period: > Changes in credit terms by

20 176 suppliers to enforce early
𝑇𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 𝑥 360
136 981 repayment
𝑥 360 > Early repayment of creditors
𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠
= 53 days = 58 days due to excess cash in hand

Business cycle: > Reduced levels of stock to

avoid holding costs and spoilage
Inventory days–creditors’ days = 55,0 – 53,0 = 64 – 58 (better inventory management)
> Changes in policy/valuation
2 days 6 days method of stock

Inventory turnover (times): 136 711 > Reduced levels of stock to

20 874 avoid holding costs and spoilage
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 (better inventory management)
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 > Changes in policy/valuation
= 6,5 times = 5,6 times method of stock

Return on Assets (RoA): 38 600 > Inventory levels still significantly

228 866 high for the nature of the business.
𝐸𝐵𝐼𝑇 > Excess cash in hand not quickly
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 16,9% = 19,2% invested in viable business
ventures
> Revaluation of assets during the
year or changes in accounting
policies
> Increase in operating costs due
to climate change, exchange rates
> Breakdown or major disruption
in the operations during the year

Return on Equity (RoE): 19 820 > General increase in profits

68 666 during the year without much
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 change in shareholders’ funds
𝐸𝑞𝑢𝑖𝑡𝑦 = 28,9% = 26,2% > Shareholders’ funds invested
wisely / in projects that generate
significant returns

Return on Capital Employed > Repayment or conversion of

(RoCE): 38 600 loans during the year (R145m at
126 500 + 68 666 start of the year)
𝐸𝐵𝐼𝑇 > Better containment of operating
= 19,8% =17,8% costs and robust sales team to
𝐼𝐵𝐷 + 𝐸𝑞𝑢𝑖𝑡𝑦
transfer costs to consumer
IBD: 20 000 + 48 000 + 58 500

Non-current asset turnover: 242 455 > Devaluation of assets during the
167 502 year or changes in accounting
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 policies
𝑁𝑜𝑛 − 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 = 1,5 times = 1,3 times > Overtime and longer hours of
operation during the year
> Major service / maintenance of
NCA: 117 870 + 28 270 + 21 362 machine during the year

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Earnings per share: > General increase in profits

19 820 (sales, other income, etc.) during
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 20 000 the year without changes in
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 shares issued
= 99 cents = 92 cents

Dividend per share: > General increase in profits

4 520 (sales, other income, etc.) during
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 20 000 the year leading to more dividend
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 declared
= 22,6 cents = 18,8 cents > Meeting expectations from
shareholders (or maintaining the
dividend cover)

Dividend cover: 19 820 > Reduced needs for funds for

4 520 capital expansion programmes
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 > Reduction of excess cash
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 reserves
= 4,4 times = 4,9 times > Increase in dividend promised
to shareholders not linked to the
dividend cover

Dividend pay-out ratio: 4 520 > Reduced needs for funds for
19 820 capital expansion programmes
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 > Reduction of excess cash
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 reserves
= 22,8% = 20,4% > Increase in dividend promised
to shareholders not linked to the
dividend cover

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f. Key risks faced by African Fish & Chips (Pty) Ltd

 Risk: High levels of stock may be lead to products getting damaged or expiring
Mitigation: Implement systems (manual/IT) that monitors levels of stock (optimum)

 Risk: New competitors may enter the market due to low barriers to entry (including
overseas players, “heat & eat” products, franchise businesses venturing out)
Mitigation: Embark on proactive strategy to deter new entrants through expanding
franchises and identifying key locations to occupy

 Risk: Department of Health may impose health regulations that will affect the pricing
and running of the business
Mitigation: Consider introducing “healthier” options on the menu (grilled fish, 100%
juice, water, etc.)

 Risk: The company is highly geared and runs a risk of defaulting on its debt obligations
Mitigation: Consider injecting more capital into the business or offer option to convert
some debt to equity (especially to non-redeemable preference shares)

 Risk: Department of Agriculture (re chips, rolls, etc.) & Fisheries may impose
conditions not suitable for business (e.g. issue of fishing licenses, land expropriation)
Mitigation: Enter into forward contracts/binding agreements with suppliers to supply
a fixed number of products

 Risk: Changes in interest rates may increase financing costs and cash flows of the
business (including credit ratings, economic climate and eating out)
Mitigation: Negotiate fixed rate terms and enter into relevant derivatives to avoid
movements in interest rates. Reduce the levels of debt and switch to equity to finance
future projects

 Risk: Labour unrest / protests for better pay and working conditions may affect the
bottom line of the business
Mitigation: Enter into negotiations with bargaining unions early in the prior year to
avoid possible disruptions, and include incentives and benefits to keep employees
committed to the business

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 Risk: Contaminated or spoilt products may be sold to customers, leading to possible

reputational damage and lawsuits
Mitigation: Employ independent person (or upskill managers) to regularly test the
quality of products served to customers

 Risk: Supply to inland stores may be interrupted due road accidents and increased
transportation costs
Mitigation: Enter into long-term contracts with logistics companies to fix prices in the
near future and take insurance policies to ensure no additional costs are incurred

 Risk: Customers may become more health conscious and shy away from AFC
products (including social activists campaigning against deep fried food)
Mitigation: Consider introducing “healthier” options on the menu (grilled fish, 100%
juice, water, etc.)

 Risk: Climate change and severe weather conditions will directly impact the input costs
of the business
Mitigation: Consider overseas suppliers and continue to monitor weather forecasts to
ensure that necessary stock levels are maintained to avoid major losses

 Risk: Cash businesses face risk of inappropriate handling of cash by staff and possible
robbery
Mitigation: Segregation of duties to ensure that cash is handled separately from the
serving of the order, and introduce safes that cannot be opened by premises staff

 Risk: Operation of franchise businesses may affect the image of AFC if franchisees
do not strictly adhere to AFC’s terms and conditions
Mitigation: Regular inspections and surprise site visits and impose severe penalties
for infringements

 Any other valid point/s

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g. Decision to invest in Project Franchise 2023

i). Net present value

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 7

2017 2018 2019 2020 2021 2022 2024
Description

Industry research
-
– sunk cost
Setup costs (1 500 000)
Mobile inspector
(500 000)
(MI)
Rent deposit (2 000 000) 3 221 020
Rent adjustment (200 000) (220 000) (242 000) (266 200) (292 820)
Franchise income 600 000 636 000 674 160 714 610 757 486 802 935
Inspection costs (70 000) (70 000) (70 000) (70 000) (70 000) (70 000)
Sale of MI 50 000
Taxation  420 000 (127 400) (137 480) (148 165) (159 491) (355 718)
Net cash-flows (4 000 000) 750 000 218 600 224 680 230 245 235 175 3 648 237
INPUT keys: CF0 CF1 CF2 CF3 CF4 CF5 CF6
I/Y = 10,5%
Net Present
(674 474)
Value



Taxation
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
2017 2018 2019 2020 2021 2022 2023
Description

Setup costs (1 500 000)

Wear & Tear (75 000) (75 000) (75 000) (75 000) (75 000) (75 000)
Franchise income 600 000 636 000 674 160 714 610 757 486 802 935
Inspection costs (70 000) (70 000) (70 000) (70 000) (70 000) (70 000)
Scrapping
-
allowance
Taxable income (1 500 000) 455 000 491 000 529 160 569 610 612 486 657 935
Taxation @ 28% 420 000 (127 400) (137 480) (148 165) (159 491) (171 496) (184 222)

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WORKINGS

RENT
Rent expense 2 000 000 2 000 000 2 200 000 2 420 000 2 662 000 2 928 200
Escalation 0 200 000 220 000 242 000 266 200 292 820
Total rent 2 000 000 2 200 000 2 420 000 2 662 000 2 928 200 3 221 020

FRANCHISE
Gross sales 15 000 000 15 000 000 15 000 000 15 000 000 15 000 000 15 000 000
Escalation 0 15 900 000 16 854 000 17 865 240 18 937 154 20 073 384

Royalties (at
600 000 636 000 674 160 714 610 757 486 802 935
4%)

INSPECTION
Given 145 000 145 000 145 000 145 000 145 000 145 000 145 000
Depreciation (75 000) (75 000) (75 000) (75 000) (75 000) (75 000)
Inspection
70 000 70 000 70 000 70 000 70 000 70 000
costs

Vehicle cost 500 000 Sale 50 000

Tax base (50 000)
SCRAP 0

ii). Net present value index

𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 + 𝑁𝑃𝑉

𝑁𝑃𝑉𝐼 =
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡

4 000 000 − 674 474

𝑁𝑃𝑉𝐼 =
4 000 0000

NPVI = 0,831

iii). Internal rate of return

Net cash-flows (4 000 000) 750 000 218 600 224 680 230 245 235 175 3 648 237
INPUT keys: CF0 CF1 CF2 CF3 CF4 CF5 CF6

COMP IRR: 6,12%

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iv). Payback period

Cash flows Cumulative

Period
Balance
0 (4 000 000)
1 750 000 (3 250 000)
2 218 600 (3 031 400)
3 224 680 (2 806 720)
4 230 245 (2 576 475)
5 235 175 (2 341 300)
6 3 648 237 -

Time required in 2 341 300 ÷

0,64 years
Year 6 3 648 237

Payback Period 5,64 years



Conclusion: Based on the evaluation methods used, the company should not invest in Project
2023 for the following reasons:

o The net present value is negative and the net present value index is below 1,
o The internal rate of return is far below the required rate of return and
o It would take the company 5,64 years to recover its initial investment (this period is as
long as the duration of the project).

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h. Factors to consider before investing in PROJECT FRANCHISE 2023

 Impact on existing franchise businesses should be assessed to avoid unhealthy

competition
 Rapid growth (addition of ten stores) may lead to difficulty in managing the franchise
business
 Possible lawsuits and complaints from existing franchisees, possibly interdicting the
launch of the planned franchise stores
 Franchisees may breach the conditions of the lease and eviction or financial impact
will be borne by AFC
 Availability of resources to run with the setting up and inspection of the new stores
 Ability to integrate the new stores into the company’s system interface
 Clarity on the role and involvement of AFC in the businesses of the franchisees without
interference (independence)

i. Different types of projects and business case examples

 INDEPENDENT PROJECTS: The acceptance or rejection of one project has no
bearing or influence on the acceptance or rejection of any other project (you can
choose or reject either or both projects). Example – SABMiller opening a distribution
outlet in Botswana (project 1) is unlikely to affect the decision to buy a new machine at
one of its local plants in South Africa (project 2).

 MUTUALLY EXCLUSIVE PROJECTS: Only one of several alternatives may be

chosen at a time (acceptance of one project immediately leads to the rejection of the
other). Example – Netcare Group deciding on either setting up a debtors’ collection
department (project 1) or outsourcing the debtors’ collection function to specialised
debt collectors.

 DIVISIBLE PROJECTS: The whole project or a fraction thereof may be initiated

(project can be increased or reduced in size). Example – City of Cape Town building
a stadium can decide to erect a 40 000-seater or increase it to a 60 000-seater.

 INDIVISIBLE PROJECTS: The whole project must be undertaken in its entirety or not
at all (project cannot be scaled up or down). Example – ClearVu Fencing company
contracted to fence the Gautrain railway.

TOTAL: 130 MARKS

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SOLUTION 21: KGORONG (15 marks; 27 minutes)

a) Determining value of company using the fair rate of return provided

2014 2015 2016 2017

YEAR 0 (P1) (P2) (P3) (P4)
Rand Rand Rand Rand Rand
Expected dividend to be paid
2014 550 000 x 1,10 605 000
2015 605 000 x 1,15 695 750
2016 695 750 x 1,20 834 900
2017 834 900 x 1,25 1 043 625
Gordon's dividend growth model
2018 and onward  43 484 375
605 000 695 750 834 900 44 528 000

Fair rate of
return (or your
rate) 28,00% 0,781 0,610 0,477 0,373

Net present
value 17 904 104 472 505 424 408 398 247 16 608 944

Using financial calculator: NPV is R17 883 392

 Calculation
D5
P4 =
ke -g

R1 043 625 x 1,25

= 28% - 25%

R1 304 531,25
= 3%

= R43 484 375

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The value of 100% of Kgorong (Pty) Ltd is R17 904 104

Therefore, the value of 10% = R17 904 104 x 0,10

= R1 790 410

Alternative if financial calculator is used:

Therefore, the value of 10% = R17 883 392 x 0,10

= R1 788 339

ALTERNATIVE SOLUTION

(a) Determining value of company using the fair rate of return provided

2014 2015 2016

YEAR 0 (P1) (P2) (P3)
Rand Rand Rand Rand
Expected dividend to be paid
2014 550 000 x 1,10 605 000
2015 605 000 x 1,15 695 750
2016 695 750 x 1,20 834 900
Gordon's dividend growth model
2018 and onward  34 787 500
605 000 695 750 35 622 400

Fair rate of
return (or your
rate) 28,00% 0,781 0,610 0,477

Net present
value 17 888 798 472 505 424 408 16 991 885

Using financial calculator: NPV is R17 883 392

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 Calculation
D4
P3 = ke -g

R 834 900 x 1,25

=
28% - 25%

R1 043 625
= 3%

= R34 787 500

The value of 100% of Kgorong (Pty) Ltd is R17 888 798

Therefore, the value of 10% = R17 888 798 x 0,10

= R1 788 880

Alternative if financial calculator is used:

Therefore, the value of 10% = R17 883 392 x 0,10

= R1 788 339
12 MARKS

b) More reliable results will be obtained when the following conditions are met:

 The business enterprise is a going concern

 The source of the value to the shareholder is essentially only the future stream of
dividends
 The dividends are expected to grow by a constant rate that is likely to be sustainable in
future
 Expected dividend growth rate is lower than the discount rate
MAX 3 MARKS
TOTAL: 15 MARKS

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SOLUTION 22: AFRICAN BAG (12 marks; 22 minutes)

Calculate estimated EPS at 30 September 2015

No of shares in issue pre-sale to Jimmy Marcus 1 000 000

Valuation of African Bag (620 000 - 200 000) 420 000

Amount to be invested by Jimmy Marcus (x / (x + R420 000) = 30%) 180 000

No of shares to be issued to Jimmy Marcus (R180 000 / (R420 000 / 1 000 000))1 428 571

Total number of shares after issue (1 000 000 + 428 571) 1 428 571

Operating profit after tax - 30 Sep 2015 (68 054 x 1,05) 71 457
Finance costs (200 000 x 0,1 x 9/12 x 0,72) (10 800)
Interest income (180 000 x 0,05 x 3/12 x 0,72) 1 620
Net profit for the period 62 277

Earnings per share (62 277 / 1 428 571) – cents 4,36

Note 1
Alternative calculation:
Assume 30% of shares = x

𝑥
30% = (𝑥 +1 000 000)

0,3 (x+ 1 000 000) = x

x = 0,3x + 300 000

0,7x = 300 000

x = 428 571
TOTAL: 12 MARKS

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SOLUTION 23: FAST AND QUICK (20 marks; 36 minutes)

a) The total number of shares issued to Quick Ltd will be = 60 000 000 ÷ 5 x 4

= 48 000 shares in Fast Ltd

2 MARKS

b) The suggested purchase price per Quick Ltd share is (5 124 x 4) ÷ 5 =4 099,20 cent
2 MARKS

c) Acceptance of Fast Limited offer?

Combined

Fast Ltd Quick Ltd

1 008 000 000 168 000 000

EPS in cent
248 000 000 60 000 000
= 406,45 = 280

Total dividends (earnings x payout ratio) 302 400 000 67 200 000

302 400 000 67 200 000

DPS in cent (dividend/number of shares)
248 000 000 60 000 000
= 121,94 = 112

7 420 000 000 1 020 000 000

NAV (cent)
248 000 000 60 000 000
= 2 991,94 = 1 700

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Combined Quick Ltd

Fast Ltd

Market value of Quick Ltd 2 459 520

(60 000 x R40,992)
Market value of Fast Ltd before transaction 10 248 000
(200 000 x R51,24)
Market value of combined entity 12 707 520
Number of shares of combined entity 248 000 000
Fast Ltd price per share (combined entity) 5 124
(cents)
5 124 3 920
P/E ratio [price/EPS]
406,45 280
= 12,6 times = 14,0 times

Earnings (cents) 406,45 x 4 280 x 5

= 1 625,8 = 1 400

Dividends (cents) (406,45 x 30%) x 4 (280 x 40%) x 5

5112 x 5
121,94 x 4
= 487,76 = 560

Net asset value (cents) 2 991,94 x 4 1 700 x 5

= 11 967,76 = 8 500

Cash value if shares are disposed of 5 124 x 4 3 920 x 5

(cents)
= 20 496 = 19 600

On the basis of increased earnings, book and cash value, we recommend that they proceed
and accept the offer from Fast Ltd.

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Other factors to consider:

 Fast Ltd has a much higher risk as a result of its dividend to earnings ratio of 2:1, and
this is reflected in its lower P/E ratio of 12,2 before the transaction (10 248 ÷ 840 000).
 What are the respective future growth rates of the companies?
 At what date will the transaction take place?
14 MARKS

d) Will an additional R1 influence your initial recommendation?

 additional R5 for every 4 shares

 revised cash values (R204,96 vs. R196)
Recommend to proceed as in c above.
2 MARKS
TOTAL: 20 MARKS

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SOLUTION 24: FAZEBOOK (35 marks; 1 hour)

(a) Present value of synergies and related costs

Year 0 Year 1
R R

1. Sale of land and buildings 1 000 000

2. Wage savings 825 000

 Wage savings – year 1: R750 000 x (1+ (2 x 5%) PV = 698 775

 Wage savings – years after:

P0 = Cf1/(WACC-g) {in year 1: P1 = Cf2/(WACC-g)}
P1 = R825 000 x (1+0,05) / (0,18 – 0,05) 6 663 462
(“continuing value”)
PV = 5 643 952
3. Fixed advertising & distribution cost savings
 Cost savings from year 1 (fixed – R200K all years):
P0 = Cf1/(WACC-g)
Cf1 = R200 000 x (1 – 28%)
= R144 000
P0 = R144 000 / (0,18 – 0,05) 1 107 692

4. Legal and other acquisition-related costs (2 500 000)

Totals (392 308) 7 488 462

Discount factors of 18% 1,000 0,847

Discounted values (392 308) 6 342 727

PV of all synergies between FazeBook and Wassup R5 950 419 Max: 10 marks

The present value of all specific synergies between FazeBook & Wassup, net of associated
costs is R6 million.

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(b) Value of proposed bid

Number of shares in issue:

FazeBook shares (R270m ÷ R1,50) 180m shares
Wassup shares (R150m ÷ R1,50) 100m shares

Number of FazeBook shares to be issued (100m ÷ 4) 25m shares

Earnings per share – FazeBook (R93m ÷ 180m) 51,67c

Share price – FazeBook (R0,5167 x 20) R10,33

Fair value of Wassup (R10,33 x 25m) R258m Max: 5 marks

ALTERNATIVE
Market value of FazeBook (R93m x 20) R1 860m

Share price of FazeBook (R1 860 ÷ 180) R10,33

Fair value of Wassup (R10,33 x 25m) R258m

(c) Payment method: Shares vs Cash The points below can also be made
to address “benefits” of choosing one
Consider the following: method over the other.

 P/E ratio (future earnings growth)

Use shares when the acquirer has a high or higher PE ratio than the target company
(the acquirer is expected to generate better earnings than the target company).

 Synergy risks
Use shares when the acquiring shareholders want the target company shareholders
to share the synergy risks (if cash, the acquirer takes the entire risk in the event that
the synergies do not materialise).

 Cash levels
Use shares when cash reserves of the acquirer are low.

 Control
Use cash when the acquirer does not want to change its shareholding structure

 Covenants / cash restrictions

Use shares when there are covenants in place to restrict the use of cash of the
acquiring company.

 Capital structure
Use cash/shares when the acquiring company is moving/maintaining its capital
structure

 Costs

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Use cash to avoid share issue costs (and possible tax liability for a cash offer – as
profit may be taxable immediately).
Max: 5 marks
(d) Post-takeover EPS of FazeBook

Earnings of FazeBook R93m

+ Earnings of Wassup R21m
+ Cost savings R1m
Wage savings (R0,8m)
Advertising & distribution cost savings (R0,2m)

=
Projected post-takeover earnings R115m

FazeBook shares in issue post takeover (180m+25m): 205m

EPS (R115m ÷ 205m): 56,10c

Max: 5 marks

(e) The investigation which FazeBook would be expected to have carried out before
the takeover attempt would include:

 Examination of financial results of Wassup over recent times – insight into the
past and current performance which gives an indication of their stability /future
prospects
 An assessment of the future trading prospects of Wassup.
 An assessment of the quality of the staff/management styles of Wassup.
 A valuation of the shares of Wassup.
 An assessment of potential synergistic benefits of the takeover.
 Wassup strategies and culture – will it align with FazeBook?
 An evaluation of the amount of risk involved.
 An assessment of full disclosure of liabilities and/or pending lawsuits of
Wassup.
 An assessment of technology and intellectual property of Wassup.
 An assessment of customer base and relationship of Wassup.
 An evaluation of environment and social impact of Wassup.
 Any other valid point(s).

Max: 7 marks

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(f) Defensive tactics which Wassup might use to resist the take-over include:

 Action to increase the Wassup share price, including the release of new
information and promises of increased dividends.
 Persuading the Wassup shareholders that the bid price is too low in view of the
company’s prospects.
 Making Wassup less attractive to FazeBook by selling or destroying key assets
(scorched earth defences).
 Making Wassup less attractive to FazeBook by such means as giving senior staff
new contracts which guarantee large compensation payments in the event of the
takeover (golden parachute).
 Inserting clauses in the Memorandum of Incorporation (MOI) that would make it
difficult to approve the takeover (e.g. 80% of shareholders to approve the merger
may be required)
 Any other valid point(s).

Max: 3 marks

TOTAL: 35 MARKS

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SOLUTION 25: BOXER CASH & CARRY (35 marks; 1 hour)

a) Calculate the market capitalisation of Brains Limited.

Market capitalization = No of shares x Share price

= (15 000 000 x 80%) x R185
= R2,2 billion
3 MARKS

b) Determine offer price for Boxer Cash & Carry (net asset value).

Item Calculations Value

Land & buildings R300m x 95% - R20m R265m
Equipment and fittings R110m
Investments R50m
Inventory R45m
Trade receivables R60m x 85% R51m
Cash R20m
Total liabilities R150m + R90m (R240m)
Cancellation fees (R7m)
Net asset value R294m

Offer price R294m x 70% R206m

7 MARKS

c) Determine offer price for Boxer Cash & Carry (earnings multiple method).

Average P/E multiple of similar listed companies 21

Entity level (e.g. SWOT)

“Strong presence” in rural areas (two very populous provinces) 1

High growth rate (currently 22% p.a.) 1

New and young management team (inexperience) -3

Customer concentration high in rural areas (diversity) -1

Adjusted P/E multiple 19

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Valuation (Owner level) R million

Value of 100% equity in Boxer (19 x R120m) R2 280
Add: Control premium (assume 9,64%) R220
OR Less: Minority discount -
R2 500
Less: Marketability discount (assume 12%) (R300)
Value of Boxer Cash & Carry R2 200

Offer price (70% of R2 200) R1 540

8 MARKS

d) Calculate the value of Boxer Cash & Carry (free cash flow).
Annual cash flows
Market value =
WACC−g

120m+20m+2m Ignore tax effect on depreciation

Market value =
(12,5%−3%)

Market value = R1,5bn (approx.)

Not required: Offer price based on FCF should be R1 050 (R1 500 x 70%)

5 MARKS

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e) Calculate ratios for 2016 and provide reasons for change:

Ratio Formula Calculation 2016 2015

Net debt to equity ratio IBD−cash R150m−R20m

(A) Equity R240m 54,17% 47,34%

Increase due to:

Additional funds borrowed during the year
Possible interest capitalised into the loan balance

Employee costs as % of Salaries & wages R130m

revenue (B) Sales R2 100m 6,19% 5,83%

Increase due to:

Hiring & training of additional employees for new stores
Poor incentive scheme in rewarding employees

EBIT margin (C) EBIT R180m

Sales R2 100m 8,57% 10,20%

Decrease due to:

Possible increase in salaries and wages
Possible increase in operating (and marketing) costs for new stores
Cash R20m
Cash Ratio (D)
Current liabilities R90m 0,22: 1 0,41: 1

Decrease due to:

Possible decrease in cash reserves due to store expansion

Gearing ratio (E) IBD R150m

IBD+Equity R150m+R240 38,46% 33,67%

Increase due to:

Additional funds borrowed during the year
Possible interest capitalised into the loan balance

Inventory Turnover Cost of sales R1 660m

(F) Inventory R100m 16,60 times 12,30 times

Increase due to:

More aggressive approach in inventory management
Efficient systems in the buying department

12 MARKS

TOTAL: 35 MARKS

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SOLUTION 26: LION BRANDS (50 marks; 1½ hour)

PART A

Ratios 2016 2015 Possible reasons

Operating profit margin: 30 317 > Increase in input costs

178 381 (especially agriculture
products)
𝐸𝐵𝐼𝑇
𝑥 100 = 17%
𝑆𝑎𝑙𝑒𝑠 = 20,2%

Return on capital employed 30 317 > Continued increase in

(40 000 + 144 876) profits (80% of inflation
𝐸𝐵𝐼𝑇
𝑥 100 rate) coupled with
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 = 16,4% = 14,5% reduced debt levels

Asset turnover: 178 381 > Decline might indicate

275 157 poor utilisation of assets
𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 = 0,6 times = 0,8 times > Accounting policies
and estimates to be
reviewed

> To take into account -

assets not recorded at
MV and industry
average

Inventory turnover: 1 831 > Improved inventory

𝑥 366
102 572 control systems
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
𝑥 366 (especially for perishable
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 goods)
= 6,5 days = 8,8 days > Difficulty in sourcing
raw material could have
pushed the company to
keep low levels in stock

IBD to EBITDA: 40 000 >Reduced debt levels

33 309 during the year (lowered
risk of default)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡
> Continued increasing
𝐸𝐵𝐼𝑇𝐷𝐴 = 1,2: 1 = 1,5: 1 profits to ensure ability
to repay debt

Net interest cover: 30 317 > Increase in prime rate

4 712 might have led to
𝐸𝐵𝐼𝑇
increase in interest
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒 = 6,4 times = 7,2 times expense

Total: 18 marks

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PART B
R 000
Description 2016 2017 2018 2019

Cash profits – 2016 (18 948+(2 992x0,72)) 21 102

Cash profits – 2017 & 2018 (increase by 20%) 25 322 30 386

Cash profits – 2019 (30 386 x 1,05) 31 905

Continuing value (31 905 x 1,05)/(0,15 – 0,05) 𝐶𝐹𝑖 335 002

WACC − g
Social development (1 000) (1 000)

Expected cash flows 24 322 29 386 366 907

Discount factors (at 15%) 0,870 0,756 0,658

Present values 21 160 22 216 241 425

Value of business 284 801

Alternative (Financial calculator)

Amount Key Display

0 CF0

24 322 CF1

29 386 CF2

366 907 CF3

15 I/Y

NPV 284 620

The value of Ellerine Cookies' business at 31 December 2016 is R285 million.

Total: 12 marks

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PART B (ALTERNATIVE)
R 000
Description 2016 2017 2018 2019

Cash profits – 2016 (18 948+(2 992x0,72)) 21 102

Cash profits – 2017 & 2018 (increase by 20%) 25 322 30 386

Cash profits – 2019 (30 386 x 1,05) 31 905

Continuing value (31 905)/(0,15 – 0,05) 𝐶𝐹𝑖 319 050

WACC − g
Grant (1 000) (1 000)

Expected cash flows 24 322 348 436

Discount factors (at 15%) 0,870 0,756

Present values 21 160 263 418

Value of business 284 578

Alternative (Financial calculator)

Amount Key Display

0 CF0

24 322 CF1

348 436 CF2

15 I/Y

NPV 284 617

The value of Ellerine Cookies at 31 December 2016 is R285 million.

Total: 12 marks

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PART C
Test of reasonableness:
R 000

Net asset value as per balance sheet (275 157 – (40 000 + 90 281)) 144 876
Add: revaluation of non-current assets (300 000 – 164 124) 135 876

Total value 280 752

The value of Ellerine Cookies using the net asset value model is R281 million (about R4 million
below the FCF model valuation). Not enough information has been provided to substantiate
the difference between the two valuations.

Assumptions/limitations:
o Taxes and other relevant costs might have been overestimated and therefore decreasing
the market value of the non-current assets.
o Other assets and liabilities will be realised and settled at carrying values (viz CVs =
realisable values).
o The financial implication of transferring assets to other divisions of Sasco Limited is the
same as selling these assets to a 3rd party.
o Any other valid point
Total: 5 marks

PART D

1. Determine maintainable earnings of Twista.

(R 000) 2012 2013 2014 2015 2016

Net profit 2 390 2 545 2 700 3 220 2 650

“Exceptional items” (400) 350

Maintainable earnings 2 390 2 545 2 700 2 820 3 000

Increasing trend, therefore use 2016 earnings (R3 million).

2. Determine the implied/adjusted P/E ratio of Twista.

P/E multiple of listed companies (1/6,25%) 16

Positive factors (decreasing risk)
Stable growth in earnings +1
Innovative and environmentally friendly production process +1
Negative factors (increasing risk)
Rife competition -2
Limited distribution network and marketing costs -1
Adjusted P/E multiple – Twista 15

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3. Determine value of Twista after adjusting for control premium and marketability discount.
R million

Price-earnings valuation before adjustments (R3m x 15) 45

Add: Control premium (R45m x 10% estimated) 5

Value before marketability discount adjustment 50

Less: Marketability discount (R50m x 10% - given) (2)

Established value of Twista 48

4. Determine the value of Twista that Lion Brands is buying (Faf Molefe’s share).
Faf Molefe’s shareholding: 2/(1+2) = 66,67%

Established value of Twista = R48m

Value of the stake being sold (66,67% x R48m) R32 million

5. Determine the number of shares to be issued by Lion Brands to Faf Molefe.

Number of shares issued by Lion Brands (34% x R10bn) 3 400 000 000

Share price of Lion Brands R850bn / 3,4 bn R250

Number of shares to be issued (R32m / R250) 128 000

128 000 shares must be issued by Lion Brands to Faf Molefe to facilitate the acquisition of a
66,67% stake (two-thirds) in Twista.
Max: 12 marks

TOTAL: 50 MARKS

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SOLUTION 27: PBC (55 marks; 1󠄧⅔ hours)

a) Analysis of financial statements

Ratios 2016 2015 Possible reasons

EBITDA margin: 279 − 156 + 71 > Increase in costs

923
> Weaker rand leads
to increase import
𝐸𝐵𝐼𝑇𝐷𝐴
costs
𝑆𝑎𝑙𝑒𝑠 = 21, 02% = 27,65%
> Poor cost control
mechanisms

Bad debt expense ratio: 9,23 >Stricter lending

923 𝑥 20% policies
> Sound debt
𝐵𝑎𝑑 𝑑𝑒𝑏𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒
collection processes
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 = 5,00% = 6,89%
> Improved relations
with clients

Earnings per share (for

calculation of P/E ratio)
60
22
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = R2,73 per share

P/E multiple: > Slow growth in

construction industry
34,40
2,73 > Negative outlook on
𝑀𝑎𝑟𝑘𝑒𝑡 𝑝𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
Zimbabwe economy
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
> Entry of new cement
= 12,60 =14,20
producers in market

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Stock turnover: > Better inventory

management systems
644
in place
99
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠
>Products
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 manufactured at the
= 6,51 times = 5,88 times back of valid orders

Debt-equity ratio: 465 > Better debt

915 management
> Interest paid
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡
annually instead of
𝐸𝑞𝑢𝑖𝑡𝑦 = 0,51: 1 = 0,58: 1
bullet payments

Price to book value: 34,40 𝑥 22𝑚 > Possible decrease

915𝑚 in share price
> Slow economic
𝑴𝒂𝒓𝒌𝒆𝒕 𝒑𝒓𝒊𝒄𝒆 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆
growth (JSE listed
𝑬𝒂𝒓𝒏𝒊𝒏𝒈𝒔 𝒑𝒆𝒓 𝒔𝒉𝒂𝒓𝒆 = 0,83: 1 = 1,03
companies under
strain)

25 marks

b) Describe key business, currency and interest rate risks

Business risks:
 Possible machinery breakdowns and downtime
 Legal implications on environmental issues
 Health and safety issues - employees
 Labour actions and government intervention on labour relations
 Compliance risk and government interventions (BEE, carbon emissions, competition laws)

Currency risks:
 Movement in rand against foreign currencies (in sourcing goods from outside the country)
 Movement in rand against foreign currencies (in translating financial performance of
subsidiaries and other entities outside the country)

Interest rate risks:

 Increase in the prime rate (for prime linked variable loans)
 Decrease in the prime rate (yet loans are at a fixed rate)
5 marks

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c)
Projected statement of comprehensive income for the three months ending 31 January
2017

Sales 284
Existing sales (923 x 1,1 x 3/12 254
Robert Murray – Cement (26 / 8 x 3) 10
Robert Murray -Limestone (13 x 1,5) (based on cost of
sales) 20

Less: Cost of Sales (199)

Existing cost of sales (644 x 1,1 x 3/12) 177
Robert Murray – Cement (10 x 100/150) 7
Robert Murray – Limestone (4 + (4 x 1,15) + 4) 13
Robert Murray – Delivery costs (0,5 x 3) 2

Gross Profit 85
Less: Operating costs (53)
Existing operating costs (156 x 1,1 x 3/12) 43
Clearing costs – incurred before November -
Additional depreciation (200/5 x 3/12) 10
Less: Net finance costs (12)
Finance costs (50 x 3/12) + (28 x (10,5%-1,5%) x 3/12) 14
Interest income (8 x 3/12) (2)
Net profit before taxation 20
Less: Taxation (21/81 x 20) (5)
Net profit after taxation 15

25 marks

TOTAL: 55 MARKS

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SOLUTION 28: umfula.co.za (30 marks; 54 minutes)

a) Calculation of net cost/benefit

Current receivables = R43m

Average collection period of current receivables:

= Accounts Receivable/Credit sales x 365
= 43/300 x 365
= 52.3
= 52.3 days

Revised receivables:
Receivables paying within 30 days = 300 x 50% x 30/365 = 12.3 = 12
Receivables paying within 45 days = 300 x 30% x 45/365 = 11.1 = 11
Receivables paying within 60 days = 300 x 20% x 60/365 = 9.9 = 10
Revised receivables = 12 + 11 + 10 = 33

Average collection period of revised receivables:

= Accounts receivable/Credit sales x 365
= 33/300 x 365
= 40.15
= 40.2 days

The net benefit or cost of the proposed changes in trade receivables policy:
Reduction in receivables = 43 – 33 = 10
Reduction in financing cost = 10 x 10% = 1
Cost of discount = 300 x 50% x 1% = 1.5 = 2

Net cost of proposed changes in receivables policy = 2 – 1 = 1

ALTERNATIVE:
The net benefit or cost of the proposed changes in trade receivables policy

Current receivables days = 43/300 x 365 = 52.3 days

Revised receivables days = (30 x 50%) + (45 x 30%) + (60 x 20%)
= 40.5 days
Decrease in receivables days = 52.3 – 40.5 = 11.8 days
Decrease in receivables = 300 x 11.8/365 = 9.7
Decrease in financing cost = 9.7 x 10% = .97 = 1
Cost of discount = 300 x 50% x 1% = 1.5 = 2

Net cost of proposed changes in receivables policy = 2 – 1 = 1

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Comments
 The proposed changes in trade receivables policy are not financially acceptable.
 However, if the trade terms offered are comparable with those of its competitors,
Umfula.co.za needs to investigate the reasons for the (on average) late payment of
current customers.
 This analysis also assumes constant sales and no bad debts, which is unlikely to be
the case in reality.
6 MARKS

b) Cost of current inventory policy

Cost of materials (CoM) = R54m per year (given)

Annual ordering cost

= 12 months per year x order costs
= 12 x 3 000
= R36 000 per year

Annual holding cost

= Holding cost per unit x average stock on hand
= 50 x 750 (given)
= R37 500 per year

Total cost of current inventory policy

= CoM + annual ordering cost + annual holding cost
= 54m + 36 000 + 37 500 = R54.074m per year

Umfula.co.za will need to increase its order size to 3 000 units to gain the bulk discount.

Annual demand
= 12 months per year x demand per month
= 12 x 1 500 = 18 000 units per year
Revised number of orders
= Annual demand/order size
= 18 000/3 000
= 6 orders per year

Revised ordering cost

= Orders per year x cost per order
= 6 x 3 000 = R18 000 per year

Revised holding cost

= Holding cost per unit x average stock on hand
= 50 x (3 000/2)
= R75 000 per year

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Cost of materials after bulk purchase discount

= CoM x (100% - discount %)
= 54m x 98% (100% - 2%)
= R52.92m per year

Total cost of revised inventory policy

= Cost of materials after bulk purchase discount + Revised ordering cost + revised holding
cost
= 52.92m + 18 000 + 75 000
= R53.013m per year

Evaluation of offer of bulk purchase discount

Net benefit of taking bulk purchase discount:
= 54.074m – 53.013m = R1.061m per year

The bulk purchase discount is more financially favourable.

However, this evaluation is based on a number of unrealistic assumptions:

o For example, the ordering cost and the holding cost are assumed to be constant, which
is unlikely to be true in reality.
o Annual demand is assumed to be constant, whereas in practice seasonal and other
changes in demand are likely.
6 MARKS

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c) (i) Market capitalisation of Umfula.co.za Ltd

Value of ordinary shares in the Statement of Financial Position = R40.0 m

Nominal (par) value of ordinary shares = 100 cents (R1)
Number of ordinary shares of company = R40m/R1
= 40m shares
Ordinary share price = R5.00 per share
Market capitalisation = 40m x 5 = R200m
2 MARKS

(ii) Net asset value (liquidation basis)

Current net asset value (NAV) = 282m + 168m – 142m – 50m = R258 m
Decrease in value of non-current assets on liquidation = 276m – 282m = R6 m
Increase in value of inventory on liquidation = 130m – 125m = R5m
Decrease in value of trade receivables = 43m x 20% (100% - 80%) = R8.6m
NAV (liquidation basis) = 258m – 6m + 5m – 8.6m = R248.4 m
2 MARKS

(iii) Price/earnings method

Historic earnings of Umfula.co.za Ltd = R20 m

Average price/earnings ratio of the business sector = 20 times
Adjusted price/earnings ratio of Umfula.co.za Ltd: 20 – 3 = 17
Price/earnings ratio value of Umfula.co.za Ltd = 17 x 20m = R340m

(Price/earnings ratio calculation using forecast earnings would receive full credit)
2 MARKS

(iv) Dividend growth model value (using Gordon’s Dividend Growth model)

Gordon’s growth model estimates the dividend growth rate using g = bre

Historic retention ratio (b) = (7+6+8+8) / (17+17+19+20) x 100 = 39.7%

Current return on shareholders’ funds (re) = 20/258 x 100 = 7.8%

Dividend growth rate (g)

= bre
= 39.7% x 7.8% = 3.1%

Value of Umfula.co.za Ltd

Po = D1/Ke - g

D1 = D0 x (1 + g)
= 12m x 1.031%

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= 12.4
Ke - g = 9% - 3.1%
= 5.9%

Po = 12.4/5.9%
= R 210.2m
= R210m
2 MARKS

d) Merits of the valuation methods

Net asset value is an asset-based valuation method, while the price/earnings ratio method
and the dividend growth model are both income-based methods. Market capitalisation can
be seen as an objective measure of company value provided by the capital markets.

Market capitalisation
 While market capitalisation is often seen as an objective measure of company value, it must
be recognised that market capitalisation is not fixed, but constantly changing as share
prices change with the random arrival of new information on the capital market.
 In terms of determining a purchase price for Umfula.co.za Ltd, market capitalisation
represents a minimum value that existing shareholders can currently obtain on the capital
market.
 Shareholders will therefore expect to be offered more than the current market price of their
shares if they are to be persuaded to sell their shares to a bidding company.
 Compared with other valuation methods, however, market capitalisation offers a value that
is immediately verifiable for a listed company and existing shareholders will use it as a
benchmark against which to measure any offer that is made to them.

Net asset value (liquidation basis)

 In terms of determining a purchase price for Umfula.co.za Ltd, liquidation NAV is arguably
more useful than book value NAV or replacement cost NAV, provided that information
needed to calculate it can be reliably established, since it values a course of action open
to the shareholders that is a real alternative to accepting an offer from a bidder.
 That said, it is usually found to be a value much lower than any possible purchase price
because it does not value a company as a going concern, and few companies are
purchased with the sole objective of liquidation.

Price/earnings method
 This is a widely-used valuation method and provided that appropriate information is used,
it can be useful in helping to determine a purchase price.
 Appropriate information will include expected future earnings rather than historical
earnings, since it is future income from a company that is purchased, not past income.
 In the case of Umfula.co.za Ltd, the earnings one year forward could be forecast to be
R21.1m (20m x 105.6%), using the historical earnings growth rate of 5.6% (((20m/17m) 1/3
- 1) x 100). With these earnings rather than the most recent earnings of R20m, the
price/earnings ratio value becomes R358.7m (17 x 21.1), an increase of R18.7m on the
previously calculated value of R340m. This increase would need to be considered in

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determining a purchase price for Umfula.co.za Ltd, provided that earnings growth was
expected to continue in the future.
 Appropriate information will also include the price/earnings ratio used in the valuation, and
the origin and meaning of the applied price/earnings ratio must be carefully considered if
the calculated company value is to have any significance. Using sector average
price/earnings ratio implies that Umfula.co.za Ltd is an average company, and this may be
an inappropriate assumption to make.

Dividend growth model

 This valuation method provides a deprival value for target company shareholders, i.e. it
values what they would give up (the right to receive future dividends) if they accepted an
offer for their shares.
 Like market capitalisation, it represents a minimum value when considering the purchase
price of a company, in this case a minimum value for shareholders who do not control
dividend policy.
 While the dividend growth model has many weaknesses, the value it provides is useful in
determining a purchase price, providing its limitations are kept in mind.

8 MARKS
Presentation & layout: 2 MARKS

TOTAL: 30 MARKS

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SOLUTION 29: HEALTH MATTERS LIMITED (100 marks; 3 hours)

(a) Calculate WACC – existing capital structure
INSTRUMENT M ARKET VALUE COST OF EQUITY
𝐷1
𝐾𝑒 = +g
𝑃0 −𝑓𝑐
16,2𝑚
Ordinary R180 000 000 (given) 𝐾𝑒 = + 0,08
180𝑚

shares 𝐾𝑒 = 17%
Workings
21,6𝑚−20,0𝑚
𝑔= x 100
20,0𝑚

𝑔 = 8,0%

OR
21,6𝑚
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑐𝑜𝑣𝑒𝑟 =
15,0𝑚

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 𝑐𝑜𝑣𝑒𝑟= 1,3333

21,6𝑚
𝐷1 =
1,3333

𝐷1 = 16,2m

INSTRUMENT M ARKET VALUE COST OF DEB.

FV - 25 060 000 (25 000 000 + (120 x 500)) 𝐾𝑑1 = 8% x 0,72
PMT - 1 350 000 (25 mil x (10,5%-3%) x 0,72)
Debentures N 5
I/Y 5,8% = 5,8%
PV 24 621 723

INSTRUMENT M ARKET VALUE COST OF PREF.

CF0 0
CF1 - 1 200 000 (15 000 000 x 8%)
Preference CF2 - 1 200 000
𝐾𝑝 = 10,5% (given)
CF3 - 1 200 000
shares CF4 - 16 200 000 (15 000 000 + 1 200 000)
CF5 - 900 000 (15 000 000 x 6%)
I/Y 10,5
NPV 14 370 353

INSTRUMENT M ARKET VALUE COST OF LOAN

Loan – Katz
𝑀𝑉𝑑2 = 6 007 924 (given) Interest paid
Finance 𝐾𝑑2 =
Market value
390 528
=
6 007 924

6,5%

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CALCULATION OF WACC – based on existing capital structure

Portion of Weighted
Market value of capital Cost of cost of
Capital structure instruments structure capital capital

Ordinary shares R180 000 000 0,80 17,0% 13,6%

Debentures R24 621 723 0,11 5,8% 0,6%

Preference shares R14 370 353 0,06 10,5% 0,6%

Long-term loans R6 007 924 0,03 6,5% 0,2%

Total R225 000 000 1 / 100% 15,0%

CALCULATION OF WACC – based on target capital structure

Portion of Weighted
capital Cost of cost of
Capital structure Allocation structure capital capital

Ordinary shares 0,70 17,0% 11,9%

Debentures “x + x + 2*(x + x) = 30” 0,20 5,8% 1,2%

Preference shares 0,05 10,5% 0,5%

Long-term loans 0,05 6,5% 0,3%

Total 1 / 100% 13,9%

Max: 24 marks

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ALTERNATIVE DEBENTURE CALCULATION

OR
CF0 -1 350 000 r/w (25 mil x (10,5%-3%)x 0,72)
CF1 -1 350 000 1
Debentures CF2 -1 350 000 1−
(1 + 0,058)5
CF3 -1 350 000 𝑃𝑉𝐴 = 1 350 000𝑥 ( )
(0,058)
CF4 -1 350 000
CF5 -26 410 000 (25 060 000r/w + 1 350 000)
25 060 000
PV 24 621 723 r/w 𝑃𝑉𝐹 =
(1 + 0,058)5

Annuity factor: 4,235

FV factor: 0,754

ALTERNATIVE LOAN CALCULATION

PV of capital + interest OR
FV -15 000 000
PMT - 1 200 000 (15 000 000 x 8%) 1
LOAN N 4 1−
(1 + 0,105)4
I/Y 10,5 𝑃𝑉𝐴 = 1 350 000𝑥 ( )
(0,105)
PV 13 824 053
15 000 000
PV of premium 𝑃𝑉𝐹1 =
FV - 900 000 (15 000 000 x 6%) (1 + 0,105)4
N 5
I/Y 10,5 900 000
PV 546 300 𝑃𝑉𝐹2 =
(1 + 0,105)5

PV of loan: 13 824 053 + 546 300 = 14 370 353 Annuity factor: 3,136
FV factor (capital): 0,671
FV factor (premium): 0,607

ALTERNATIVE WACC CALCULATION

𝑉𝑒 𝑉𝑝 𝑉𝑑1 𝑉𝑑2
𝑊𝐴𝐶𝐶 = 𝑉𝑡𝑜𝑡𝑎𝑙
x Ke +
𝑉𝑡𝑜𝑡𝑎𝑙
x Kp +
𝑉𝑡𝑜𝑡𝑎𝑙
x Kd1 +
𝑉𝑡𝑜𝑡𝑎𝑙
x Kd2

180𝑚 14,3𝑚 24,6𝑚 6𝑚

𝑊𝐴𝐶𝐶 = 225𝑚
x 17% +
225𝑚
x 10,5% +
225𝑚
x 5,8% +
225𝑚
x 6,5%

𝑊𝐴𝐶𝐶 = 13,6% + 0,6% + 0,6% + 0,2%

𝑊𝐴𝐶𝐶 = 15,0%

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(b) Factors to consider when deciding on financing options

Health Matters would need to consider the following factors before choosing a financing
instrument:
1. Cost consideration:
 Currently in the market the debentures are the cheapest form of finance available
to the company (at 5,8%).
 Making it even cheaper is the fact that there is a tax deduction on the interest
paid on the debentures. However, additional costs should be factored in (e.g.
premium and structuring costs that might be charged).

2. Capital structure:
 Health Matters should also consider the target or optimal capital structure first
to ensure the appropriate use of financing options.
 The company should increase debenture and long-term loan funding while
reducing share capital in working towards the target capital structure.

3. Control:
 The shareholding of the company is likely to be affected by the issue or
repurchase of ordinary shares.
 All other instruments are not convertible and do not carry any voting rights or
share in retained profits of the company – their issue will therefore not affect the
control.

4. Constraints (covenants & security):

 Loans and debenture contracts generally have certain level of profits and
liabilities that the company needs to maintain – any breach of these conditions
may lead to additional costs or facilities may be withdrawn.
 Some assets might have already been encumbered on existing loans, which
might restrict the company in taking more loans and debentures.

5. Cash flows (matching):

 Pattern of cash flows might also affect the decision to fund an expansion
project. Some pharmacies may take a number of years to recover the initial cash
outlay – therefore a form of debt that requires huge annual repayments upfront
may put the company under serious strain.

Max: 5 marks

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(c) Cost associated with the purchase of shares in Health Matters

R

Cash settlement (£1 800 000 / 0,0605) 29 752 066

Value of shares in Johnson & Glaxo Limited

Number of shares issued by J&G: 50 million 175 000
= 0,0035
50 000 000
Share price: R4 billion / 50 million = R80
∴value of shares: R80 x 175 000 (OR 0,0035 of R4 billion) 14 000 000

Dividend received (4% x R4 billion x 0,0035) OR 4% x R14m) 560 000

Costs borne by Johnson & Glaxo for purchase of Health Matters 44 312 066

Max: 5 marks

(d) Valuation of 25% stake in Health Matters (NAV method)

ASSETS
Non-current assets (excluding L&B) 99 000 000
Land and Building (42m x (1,045)5 –OR use of financial 52 339 641
calculator
Inventory (60m x 0,5) + (60m x 0,5) + (60m x 0,5 x 20/80) – 2 500 65 000 000
Account receivables (6,825m x 0,8) 5 460 000
Less: LIABILITIES & OTHER COSTS
Non-current liabilities (46 750 000)
Current liabilities (10 075 000)
Disposal of assets (34 641)

Estimated value of Health Matters 164 940 000

Value of stake purchased (25% x 164 940 000) 41 235 000

Minority interest discount (adjust between 0-15%) -

Max: 5 marks
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(e) Difference between the valuations and offer price

 Johnson Glaxo Limited is offering the 25% shareholders of Health Matters R44 312 066.
Health Matters is a listed company and currently has a market capitalisation of R180
million (25% of this value is R45 million).
 Johnson & Glaxo will have a significant influence in the running of the business as one of
the major shareholders with voting rights of 33% in the boardroom. This should have
motivated for a higher purchase offer (premium added to the bid price for “control” of
Health Matters).
 The pricing of the deal by referencing it to future market events can be problematic as the
assumptions made are not reasonable. The foreign exchange rates and share prices are
subject to high volatility (especially the Rand in relation to other currencies). The inevitable
movement in these will have a direct impact on the final purchase price on 31 October
2017.
 Using the NAV method, the valuation of Health Matters is approximately R15 million below
the market capitalisation (R180m – R164,94m). Considering the nature of Health Matters
business (retail sector), the NAV method as the business tends to be asset driven.
 However, the reliability of realisable values and associated costs is questionable and
detailed analysis of the data supporting these values would be required. This is
complicated further by the fact that Johnson & Glaxo Limited is not buying the entire
business, where it would have been easy to establish values that are more reliable.
 There is no information provided regarding the carrying values of loans and other liabilities
(including the deferred tax and provisions).
 The NAV method can be used to check the reasonability of the value of the company
already known (R180 million) – in this scenario R41 million under the NAV method is not
significantly different from the market based valuation of R45 million.

Max: 5 marks

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(f) Qualitative factors (political, social & economic factors)

Political factors
 Political instability in Nigeria especially in the wake of Boko Haram terrorist group may
interrupt the operations of the company
 Perceptions of corruption activities may be real and have severe consequences on the
company
 Ongoing xenophobic attacks in South Africa may cause Nigerian people to boycott the
company’s products
 Nigeria’s labour policies, bilateral trade policies and strict laws (especially health-
related) imposed on foreign businesses may be detrimental to the survival of the company.
 Lack of government subsidies may prevent the company from realising decent profit
margins

Max: 2 marks

Social factors
 People without medical aid may find the medicine sold by Health Matters to be unaffordable
 The medicine may be illegally obtained and used for purposes not intended for (this may
lead to addiction and severe side effects)
 People may be more health conscious or use other forms of indigenous medicine
 The population growth may be slow, leading to tough competition for market players

Max: 2 marks

Economic factors
 The volatility of Rand to Naira will expose Health Matters to possible foreign currency losses
(on capital expansion programmes, translation of subsidiary, increasing input costs, etc.)
 Recent negative GDP growth rate may cause the company to struggle to grow its business
especially as a new player in the industry
 High inflation and interest rates will have a negative impact on the company’s cost base
and on customer affordability (disposable income)

Max: 2 marks

PART A: 50 MARKS

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PART B
i). Calculate NPV for Interpharm deal
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
2017 2018 2019 2020 2021 2022
Description
‘000 ‘000 ‘000 ‘000 ‘000 ‘000
Sales 150 000 159 000 168 540 178 652 189 372
Cost of sales (135 000) (138 600) (143 876) (148 173) (154 000)
Upfront marketing (4 000)
Printing & comm (900) (945) (992) (1 042) (1 094)
TV & radio ads (7 000) (7 350) (7 718) (8 103) (8 509)
Working capital (18 000) (1 080) (1 145) (1 213) (1 286) 22 725
Research cost-sunk
Exclusive rights (32 000)
Taxation 1 407 (1 114) (2 192) (3 698) (7 215)
Or use
factors: Net cash-flows (54 500) 7 427 9 846 12 549 16 349 41 279
Y1: 0,878
Y 2: 0,771
INPUT keys: CF0 CF1 CF2 CF3 CF4 CF5
Y 3: 0,677
Y 4: 0,594
Y 5: 0,522 I/Y = 13,9%

Net Present Value (650)

Cost of sales Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

2017 2018 2019 2020 2021 2022

Description
‘000 ‘000 ‘000 ‘000 ‘000 ‘000

Cost in dollars ($) 10 000 10 500 11 025 11 576 12 155

Rate R13 x R13,5 x R13,2 x R13,05 x R12,8 x R12,7

Cost in Rand (R) 135 000 138 600 143 876 148 173 154 000

Working capital Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

2017 2018 2019 2020 2021 2022

Description
‘000 ‘000 ‘000 ‘000 ‘000 ‘000

12% of Sales – REQ (18 000) (19 080) (20 225) (21 438) (22 725)

(Top-up)/Reversal (18 000) (1 080) (1 145) (1 213) (1 286) 22 725

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Taxation Year 1 Year 2 Year 3 Year 4 Year 5

2018 2019 2020 2021 2022

Description
‘000 ‘000 ‘000 ‘000 ‘000

Upfront marketing (4 000)

Sales 150 000 159 000 168 540 178 652 189 372

Cost of sales (135 000) (138 600) (143 876) (148 173) (154 000)

Printing & Comm (900) (945) (992) (1 042) (1 094)

TV & radio ads (7 000) (7 350) (7 718) (8 103) (8 509)

W&T-Exclusive rights (8 125) (8 125) (8 125) (8 125)

Taxable income (5 025) 3 980 7 830 13 209 25 769

Taxation @ 28% 1 407 (1 114) (2 192) (3 698) (7 215)

Advice: The management of Health Matters should consider not accepting the deal with
Interpharm as the deal will yield a negative NPV.
Max: 18 marks

ii). Qualitative (non-quantitative) factors to consider before entering into

agreement

 Will the stock be received on time when shipping from the US (consider expiry date?
 Will the quality of the stock be consistent with the products sold in the US?
 Will the handling of the stock not impose health hazard and/or require extensive care
in handling?
 Will Health Matters adhere to all rules and regulations for the medicine imported into
South Africa?
 Have the products been properly tested in South Africa for any unknown side effects and
reaction?
 What recourse does Health Matters have if products are damaged?
 What recourse does Health Matters have if patients get ill from the medicine received
from Interpharm?
 What recourse does Health Matters have if some local importers (or from other countries
within Africa) start selling the products of Interpharm before the expiry of the five-year
deal?
 Will the sale of Interpharm products improve the image/reputation of Health Matters?
 Has Health Matters consider the impact of Interpharm deciding to terminate the contract
before the five-year period?

Max: 5 marks
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iii). Calculate and comment on ratios for 2017:

PROFITABILITY Calculation Comments (to improve)

Change in revenue: > Consider increasing selling prices (including

the sale of new products from Interpharm)

> Increase advertising budget to promote the

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝐶𝑌 − 𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑃𝑌 R285m − R260m
products offered. Increase commission given
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 𝑃𝑌 R260m
> Extend credit lines to reliable existing
customers
= 9,6%
> Review prior year marketing strategy and
align (2016: 16% growth)

Change in net profit: > Impose strict adherence to cost centre

budgets

> Make use of derivatives to hedge foreign

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝐶𝑌 − 𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃𝑌 R20m − R18m
currency risk
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑃𝑌 R18m
> Improve controls and provide incentives in
the buying department (bulk purchases)
= 11,1%
> Renegotiate terms with suppliers, credit
providers and other service providers

Net profit margin: > Impose strict adherence to cost centre

budgets

> Make use of derivatives to hedge foreign

𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 R20m
currency risk
𝑆𝑎𝑙𝑒𝑠 R285m
> Improve controls and provide incentives in
the buying department (bulk purchases)
= 7,0%
> Renegotiate terms with suppliers, credit
providers and other service providers

Max: calculation 2 marks, comment 1 mark

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CAPITAL STRUCTURE Calculation Comments (to improve)

Capital gearing ratio: > Consider capital structure – if using market

values, debt is still fairly low

> Health Matters can still increase its debt (by

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐼𝐵𝐷) R25m + R15m + R6m
converting bank overdraft/short-term
𝐼𝐵𝐷 + 𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 R25m + R15m + R6m + R75m borrowings into a LT loan)

= 38,0%

OR MARKET VALUES:
20% - see WACC calculation

(above)

Interest-bearing debt to > Consider capital structure – if using market

Equity: values, debt is still fairly low
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐼𝐵𝐷)
𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 R25m + R15m + R6m
R75m > Health Matters can still increase its debt (by
converting bank overdraft/short-term
borrowings into a LT loan)
= 61,3% (0,6: 1)

ST borrowing can be
included
OR MARKET VALUES:
R24,6m + R14,3m + R6m
R180m
= 24,9% (0,2: 1)

Debt ratio: > Consider reducing bank overdraft & short-

term loan for a lower interest rate facility
𝑇𝑜𝑡𝑎𝑙 𝑙𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 R46,75m + R10,075m
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 R131,825m > Review assets, provisions and deferred tax to
ensure recorded at fair values

= 43,1% (0,4: 1)

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Current vs Target capital: MARKET VALUES: > Consider funding Interpharm/Nigeria deal(s)
through use of debt
(use capital gearing ratio) Current: 20%: 80%
> Debentures are the cheapest and are well
Target: 30%: 70% below the targeted level (11% instead of 20%)
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐼𝐵𝐷) (Refer to Part A (i)) > Explore share buyback options to reduce
𝐼𝐵𝐷 + 𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦
ordinary shares

OR BOOK VALUES:

Current: 38%: 62%

Target: 30%: 70%

Comment if using Book

Values should be opposite of
the comment given on MV

Max: calculation 3 marks, comment 1 mark

LIQUIDITY Calculation Comments (to improve)

Current ratio: > Ratio may be considered too high

(industry figures required to put into
perspective)
Current assets: Current liabilities R66,825m: R10,075m > Reduce inventory levels to avoid stock
obsolete, expiry, theft and related holding
costs
= 6,6: 1
> Consider selling inventory at a lower
price to increase cash reserves (currently
depleted)

Quick (acid-test) ratio: > Ratio seems rather low and puts
company at risk of not meeting its short
Receivables: Current liabilities R6,825m: R10,075m term obligation

> Give more credit to customers, but

= 0,7: 1 incentivise to pay early so as not to default
on current liabilities

> Renegotiate the terms of the short-term

borrowing facilities to long-term loan

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Inventory days: > Days likely to be even longer as sales

figure used is total sales (and not credit
sales)
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 R60m
𝑥 365 𝑥 365 > Reduce inventory levels to avoid stock
𝑆𝑎𝑙𝑒𝑠 R285m obsolete, expiry, theft and related holding
costs

= 77 days > Analyse stock movement to identify fast

selling from slow-moving goods (including
products with a short lifespan) to manage
stock effectively.

Debtors’ collection period: > Debtors kept at extremely low levels

(consider the debtors’ policy in place)
𝑇𝑡𝑟𝑎𝑑𝑒 𝑟𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 R6,825m
𝑥 365 𝑥 365
𝑆𝑎𝑙𝑒𝑠 R285m > Give more credit to customers, but
incentivise to pay early so as not to default
on current liabilities
= 9 days

Max: calculation 2 marks, comment 1 mark

RETURN ON CAPITAL Calculation Comments (to improve)

Asset turnover: > Value may be even lower as the non-current

assets were last valued few years ago
𝑆𝑎𝑙𝑒𝑠 R285m
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 R131,825m > Industry average and last year’s performance
must be taken into account
= 2,2 times
> Consider depreciation policies and prudence
OR: in accounting for assets
OR Fixed asset turnover:
R285m
> Assets should be tested for impairments and
R65m dispose unproductive/idling assets
= 4,4 times

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Dividend pay-out ratio: > Pay-out ratio fairly high and may hinder the
company’s growth/expansion plans

> Possible revisit the dividend policy in an effort

𝑇𝑜𝑡𝑎𝑙 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 R15m
to reduce dividend paid
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 R20m

Also under “Financial market”

= 75%

Return on Equity: > Implement robust controls to manage and

contain costs
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 R20m
𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 R75m > Company not in a position to buy back shares
unless it raises debt capital first
= 26,7%

OR MARKET VALUES:
R20m
R180m

= 11,1%

Max: calculation 2 marks, comment 1 mark

FINANCIAL MARKET Calculation Comments (to improve)

Price Earnings ratio: > Fairly low – low investor confidence

𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 (𝑡𝑜𝑡𝑎𝑙) R180m > Consider detailing future capital expenditure to
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 (𝑡𝑜𝑡𝑎𝑙) R20m grow the business
= 9 times > Reposition the company to change investor
Earnings yield: 1/PE = 11,1% perceptions and foster aggressive growth strategy

Dividend pay-out ratio: > Pay-out ratio fairly high and may hinder the
company’s growth/expansion plans
𝑇𝑜𝑡𝑎𝑙 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑 R15m
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 R20m > Possible revisit the dividend policy in an effort to
reduce dividend paid
= 75%
Also under “Return on capital” Dividend cover inverse (1,33)

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Price sales multiple: > Industry average/norm to be considered

> Consider detailing future capital expenditure to

grow the business
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 (𝑡𝑜𝑡𝑎𝑙) R180m
𝑆𝑎𝑙𝑒𝑠 R285m > Reposition the company to change investor
perceptions and foster aggressive growth strategy
= 0,6 times

Price/ Book value multiple: > Indicates growth over the years (increase from
R200m to R285m in 4 years)
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 (𝑡𝑜𝑡𝑎𝑙) R180m
𝑥 365
𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 R75m > Consider detailing future capital expenditure to
grow the business
= 2,4 times
> Reposition the company to change investor
perceptions and foster aggressive growth strategy

Dividend yield: > Industry average/norm to be considered

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 (𝑡𝑜𝑡𝑎𝑙) R15m > High yield % - may suggest depressed share price.
𝑆ℎ𝑎𝑟𝑒 𝑝𝑟𝑖𝑐𝑒 (𝑡𝑜𝑡𝑎𝑙) R180m Consider gradually dropping the dividend cover and
plough profits back into the business

> Reposition the company to change investor

= 8,3%
perceptions and foster aggressive growth strategy

Max: calculation 3 marks, comment 1 mark

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iv). SWOT analysis – Health Matters

Strengths
 Health matters has a chain of pharmacies across South Africa representing diversification
 The company has delivered robust financial results over the past years and has a strong
brand and presence in South Africa
 Health Matters has an ability to source products at reasonable prices from the US and the
UK and passing the benefit to its customers.

Weaknesses
 Key-man dependency at executive level (Zoe Padayachee singlehandedly concluding the
Interpharm deal and working on the Nigerian deal as well)
 Limited exposure to international markets and Zoe Padayachee’s strong relationships with
Interpharm could influence her objectivity
 Low (no) cash reserves increases the financial risk of the business and the company may
not be able to carry out intended projects
 Only listed a year ago and with a market cap of only R180m, Health Matters may not be able
to compete with the major players in the sector
 Highest revenue growth in past 3 years is 16% - indicates that the business struggles to
aggressively expand its operations within the country.

Opportunities
 Advanced talks with the Nigerian government to establish its presence in Africa’s largest
economy
 Health matters can establish a long lasting relationship with Interpharm and become a big
distributor of both their product
 Health Matters and Interpharm can expand together into the rest of Africa and become the
biggest distributor and the possibility of Health Matters selling its distribution rights or
subcontracting to other retail outlets

Threats
 The fact that all products are imported from the UK and USA expose the company to
currency fluctuations (and heavy dependence on only two main suppliers)
 Expansion into the Nigerian market exposes company to foreign exchange risks
(transaction and translation)
 Risk of litigation if patients get ill from the medicine or incorrect medication is dispensed
 Health matters operates in a highly regulated environment. Failure to comply with
regulations could result in fines/penalties
 Interpharm can become Health matters’ biggest competitor in the market once its products
have been established with consumers
 Health matters recently listed and needs to adhere to all the rules and regulations of the
JSE Max: 10 marks

TOTAL: 100 MARKS

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SOLUTION 30: DISTELL GROUP LIMITED (100 marks; 3 hours)

i. RATIOS

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Workings - Financial market/investor

Profit for the year

𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒 =
Number of shares
Profit for the year
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 =
Earnings per share
R1 524 265 000
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 =
R7,26

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 209 953 857

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠ℎ𝑎𝑟𝑒𝑠 = 𝟐𝟏𝟎 𝟎𝟎𝟎 𝟎𝟎𝟎 (rounded to nearest million)

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ii. WACC

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PART B (i) – Valuations

Memorandum

To: Board of directors – Distell Group Limited

From: Eunice A Stewden

Date: 05 May 2016

Subject: Issue of shares as a purchase consideration of Namibia Breweries

Dear Sirs and Madams

In response to your e-mail request dated 28 February 2016, our team has run different models to help you
determine the fair bid price for the 100% stake in Namibia Breweries.

Based on the information provided, two valuation techniques were applied, namely Free Cash Flow (FCF)
and Price Earnings Multiple methods. These methods determined the value of Namibia Breweries as
follows:

Free Cash Flow – R25m

P/E multiple method – R18m

It should be noted that these methods yielded results that are substantially differ and therefore you are
urged to exercise your own judgment in assessing the fair value of the business.

It is therefore our recommendation that the board makes a minimum offer of 130 000 shares (R18 101 585)
in Distell Group Limited and a maximum of 180 000 shares (R25 080 777 / R140) – refer to the workings
appendix for detailed calculations.

The board will also have to look at the fluctuation of the share price especially after rumours/announcement
of the potential acquisition. Therefore, the share price might have to be adjusted for such movements.

Please do not hesitate to call us for further clarity on this valuation.

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PART B (i) – Valuations (Appendix)

Refer to the Excel spreadsheet to see relevant formulas

# See spreadsheet on myUnisa for detailed workings

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TOTAL: 100 MARKS

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SOLUTION 31: TILES & STYLES OF AFRICA (80 marks; 2½ hours)

PART A
2017 2016

Change in online sales

604 − 234
234
= 13,4% (given)
= 158,1%

Possible reasons:
Significant investment in e-commerce and technology
Aggressive marketing campaigns for online purchases (including promos)
Growing brand affinity and word of mouth might have encouraged customers to buy online
Increased selling prices for online customers (premium for convenience)

Interest cover (times interest earned)

944 900
101 + 12 105 + (12/0,8)

= 8,4 times = 7,5 times

Possible reasons:
Robust cost controls (better buying and salary freeze), leading to higher profits
Excess funds used to reduce company debt leading to reduction in interest expense
Negotiated lower rates with the lenders or decrease in repo rate (for floating instruments)
(Slight increase in gross profit also attributed – a mark can be given)

Store sales per employee

6 058 000 6 585 000

25,4 26,1

= R238 503,9 = R252 298,9

Possible reasons:
Company might have shifted focus to online sales (incentivising walk-ins to buy online)
The company may have not retrenched the “excess” employees in the sales department
Poor incentive packages/structures implemented (“commission” to store sales agents)

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Inventory days

850 838
𝑥 365 𝑥 366
3 748 3 925

= 82,8 days = 78,1 days

Possible reasons:
Stock held from stores that might have been closed down
Company may be struggling to sell some of its goods due to declining demand/growing competition
(This is not helped by the fact that the current year is a day shorter)

Dividend cover

686 645
70 + 134 75 + 110

= 3,4 times = 3,5 times

Possible reasons:
More dividend declared at the back of increased cash reserves
Market expectations to increase dividend annually
Lack of investment opportunities after closing down stores
This could also be in line with dividend policy in place (10% increase yearly)

Return on capital employed

944 900
3 696 + 1 912 3 187 + 2077

= 16,8% = 17,1%

Possible reasons:
Capital might not be applied/released as soon as received (e.g. loans held in business account)
Funds tied up in bank and other non-current assets
Reduction of stores and capital not injected into more profitable businesses
(Use of closing balances does distort the figures)

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PART B

CALCULATION OF WACC – based on target capital structure (see workings below)

Portion of capital Weighted cost

Capital structure structure Cost of capital of capital

Ordinary shares (workings) 0,70 12,4% 8,5%

Debentures (0,30 * 3÷5) 0,18 5,2% 0,9%

Bank loan (0,30 * 1÷5) 0,06 6,1% 0,4%

Preference share (as above) 0,06 7,7% 0,5%

1 / 100% 10,3%

Max: 10 marks

PART C

FINANCING DECISION – R5bn acquisition of Tile Ses’la (see workings below)

Consider Current Capital Capacity Target Capital 1 mark: adding to R5bn

SCALING Capital structure Structure (Balancing) % Structure 1 mark: balancing

(R ‘m)
Ordinary shares R9 450 +2 020 0,70 R11 470

Debentures R992 +1 957 0,18 R2 949

Bank loan R650 +333 0,06 R983

Preference shares R293 +690 0,06 R983 If 30:70 & the

amount is
increased by
Total R11 385 R5 000 100% R16 385 R5bn

ALL 4 instruments

Conclusion: Acquisition of Tile Ses’la must be financed as follows:

 Issue of ordinary shares worth R2,020 billion – Retained income in the form cash can be
used to reduce risk of dilution of control
 Issue of debentures for R1,957 billion – Consideration should be made to borrow from
different entities due to the amount required
 Taking a new banking loan facility of R333 million and
 Issue of redeemable preference share issue to the value of R690 million

271 Max: 15 marks

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WORKINGS

1(b) workings 1(a) workings

 
INSTRUMENT M ARKET VALUE COST OF EQUITY

(𝐑𝟐𝟎𝟒𝐦 𝐱 𝟏,𝟏𝟎)
Ordinary shares 𝑴𝑽𝒆 = R9,45 billion (given) 𝑲𝒆 = (𝐑𝟗 𝟒𝟓𝟎 𝐦 𝐱 𝟎,𝟗𝟗𝟓) + 𝟏𝟎%

𝑲𝒆 = 12,4%

INSTRUMENT M ARKET VALUE (FINANCIAL CALC.) COST OF DEBENTURES

CF0 0
CF1 - 48,96m (1bn x 6,8% x 0,72)
Debentures CF2 - 48,96m 𝐾𝑑1 = 5,2% (given)
CF3 - 48,96m
CF4 - 1 048,96m (1bn +48,96m)
CF5 - 3,6m
I 5,2
NPV 992m (or 992 064 186)
PV given ONLY if it is greater than PMT

ALTERNATIVE M ARKET VALUE (FINANCIAL CALC.) - ALT COST OF DEBENTURES

PV of capital + interest
FV - R1 000m
PMT - 48,96m (1bn x 6,8% x 0,72)
Debentures N 4
𝐾𝑑1 = 5,2% (given)
I 5,2
Comp PV 989,270m (c1)

PV of premium
FV - 3,6m
N 5
I 5,2
Comp PV 2,794m (c2)

Market value = R992m (c1 + c2)

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INSTRUMENT M ARKET VALUE COST OF LOAN

Interest paid 𝐾𝑑2 = 8,5% x 0,72

𝑴𝑽𝒅𝟐 =
𝐾𝑑2
Bank loan = 6,1%
55,08m x 0,72
𝑴𝑽𝒅𝟐 =
6,1%
𝑴𝑽𝒅𝟐 = 𝐑𝟔𝟓𝟎𝐦 (or R650 124 590) PV given ONLY if it is greater than PMT

INSTRUMENT M ARKET VALUE (FINANCIAL CALC.) COST OF PREF.

CF0 0 𝐾𝑝 = 10,3% x 75%

CF1 - 21m (1 912 – 1 000 – 612) x 7%
Preference shares CF2 - 21m
CF3 - 21m
= 7,7%
CF4 - 321m (1 912 – 1 000 – 612) + 21
I 7,7
NPV 293m (or 292 997 833)
PV given ONLY if it is greater than PMT

ALTERNATIVE M ARKET VALUE (FINANCIAL CALC.) COST OF PREF.

FV -300m 𝐾𝑝 = 10,3% x 75%

PMT - 21m
Preference shares I 7,7 c
= 7,7%
N 4
PV 292 997 833 c

Same approach can be used for Debentures

PART D

Calculating the number of preference shares to be issued

A. Nominal value per share (R300m ÷ 600m) R0,50

B. REQUIRED funds R690 mil

Number of preference shares to issue (B ÷ A) 1 380 mil

Max: 3 marks

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PART E

i). Valuation using the price-earnings method

1. Determine maintainable earnings of Tile Ses’la

Rm 2015 2016 2017

Profit for the year (given) 745 850 880

Loss of gross profit 83

Out of court settlement (20)

Insurance pay-out (40)

Maintainable earnings 828 810 860

No trend – use weighted average method 1/6 2/6 3/6

Weighted average maintainable earnings 138 270 430

Weighted average maintainable earnings 838

2. Determine the implied/adjusted P/E ratio of Tile Ses’la

P/E multiple of listed companies (given) 13,29

ANY 1 positive factor Positive factors (decreasing risk)
Well established business/market leader +0,5
Geographical diversification +0,5
Well-known brands – trade mark as proof +1
Exclusive distribution rights +0,01
ANY 1 negative factor Negative factors (increasing risk)
Rife competition -1,8
Rapid changes in technology -2,0
Unlisted company factor (given) -1,5

Adjusted P/E multiple – Tile Ses’la 10

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3. Determine value of Tile Ses’la after adjusting for control premium and marketability discount
R million
1 mark for the valuation
amount calculated and Price-earnings valuation before adjustments (R838m x 10) 8 380
adjusted PE (Must NOT
be a %) Add: Control premium (R8 380m x 12,17%) any % between 0% – 15% 1 020

Value before marketability discount adjustment 9 400

Less: Marketability discount (already priced) -

100% business value 9 400

51% x R9,4 billion -

Value of 51% stake of Tile Ses’la 4 794

Max: 11 marks

ii). Valuation using the free cash flow method

Free cash flows for 2018 R million

Average profit for 2016 & 2017 (880+850/2) 865

ONLY 1 markDepreciation
if years & amortisation for previous year (non-cash) 113
used are 2016 & 2015
Tax on depreciation & amortisation (37)

Free cash flows for 2018 941

Discounted free cash flows:

𝐶𝐹𝑖
=
WACC−g

941
=
(14%−4%)

100% business value = R9 410 million

51% of Tile Ses’la (Pty) Ltd = R4 799 million

Max: 5 marks

Conclusion: The board of directors, together with the shareholders, of Tile Ses’la (Pty) Ltd should
accept the Tiles & Styles of Africa offer of R5 billion as the valuations performed above show that
the company is worth R4,8 billion.

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PART F

i). Valuation using the net asset value method

Rm
ASSETS
PPE (1 989 – 400 + 4 240) – (4 240 x 0,003) 5 816
Investments 732
Intangible assets (54 – 30 + 380) 404
Inventory (550 * 40%) + (550 * 60%) + (550 * 60% * 20%) 616
Trade and other receivables 327
Cash and cash equivalents (can be netted off against price) 511
Less: LIABILITIES & OTHER COSTS
Non-current liabilities (86)
Settlement of the subordinated loan (3 773 * 0,0043) (16)
Current liabilities (304)

Estimated value of Tile Ses’la 8 000

Value of stake sold (51% x 8 000m) 4 080

Conclusion: According to net asset value method, the stake to be sold is worth R4,1 billion (R700 million
below the other two valuation methods, and R900 million below the offer made by Tiles & Styles of Africa).
The net asset value method will not consider the true value attached to the brand of Tile Ses’la (including
human capital, customer loyalty, brand, value of exclusive rights, etc.). The board of directors and
shareholders of Tile Ses’la should accept the offer as it is better than all three methods used.

Max: 7 marks

PART G

a) Types of acquisitions (general)

1. Horizontal acquisition: Two companies that are in direct competition and share the same product line
The type of and markets. Example – a beer manufacturing company buying another beer manufacturing company
acquisition
must be (AB InBev buying SABMiller).
defined
2. Vertical acquisition: Two companies both on a given chain of supply (customer and a supplier).
Example – ESKOM buying a coal mine like Anglo Coal.
3. Conglomerate acquisition: Two companies that trade in unrelated markets. Example – Woolworths
buying Kulula.com

b) Type of acquisition of Tile Ses’la – VERTICAL ACQUSITION (Tile retailer buying a tile
manufacturer) Max: 7 marks

TOTAL: 100 MARKS

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SOLUTION 32: MAGNUS ORANGE (100 marks; 3 hours)

PART A

RATIOS MO Ltd Ways to improve

(i). > Effective tax rate is fairly high –

consider getting tax experts to advise on
Net profit margin: 26 174 𝑥 0,705
better tax structures.
461 000
> Increase bus fares and consider
18 453
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 dropping less profitable routes.
461 000
𝑅𝑒𝑣𝑒𝑛𝑢𝑒 > Renegotiate diesel prices with
= 4%
supplier, switch maintenance service
providers or train employees.

> Renegotiate lending rates with

providers of capital.

(ii). > Review the depreciation policy in line

with the lifespan of the fleet.
Return on assets: 26 174 + 9454 − 358
121 885 + 102 875 + 127 280 > Sell old buses that are not being fully
𝐸𝐵𝐼𝑇
35 270 utilised or potential write-offs.
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠
352 040 > Apply procedures used in (i) above to
= 10% increase profitability.

(iii). > Renegotiate the interest rates and

bank charges with providers of capital.
Effective interest rate: 9 454
100 000 > Pay interest on time to avoid extra
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠
charges.
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐼𝐵𝐷) = 9,5%
> Consider engaging economists to
OR (if bank overdraft incl.)
predict rate movements and apply
= 8,0% appropriate measures.

(iv). > Repay existing interest-bearing

liabilities.
Debt equity ratio: 100 000
121 885 > Decrease (or at least maintain)
𝐼𝐵𝐷
dividends to be declared.
𝐸𝑞𝑢𝑖𝑡𝑦 = 82,0% (or 0,82: 1)
> Consider issue of shares (preferably to
existing shareholders).

> Introduce share incentive schemes to

motivate employees.

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(v). > Increase the final dividend declared

(this can be done by increasing
Dividend yield: profitability in the second half of the year
𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠 2 744 and scaling back on some of the
𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 12 838 𝑥 13,83 projects.

Number of shares issued: 2 744

177 550
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑝𝑟𝑒𝑓 𝑑𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 𝑝𝑒𝑟 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒 = 1,6%
18 453 − (48 125𝑥0,082)
1,13
18 453 − 3 946
1,13

= 12 838 053

(vi). > Embark on capital expansion

programmes and explore new markets
Price/book ratio: 177 550
to grow investor sentiments (note impact
121 885 − 48 125 of dividend yield).
𝑀𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦
𝐵𝑉 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 = 2,4 times
> Restructure the business to unlock its
full potential and look at better ways to
improve efficiencies.

12 MARKS

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PART B

Calculations MO Ltd Comments

(i). > Although this is annualised, it may not be

accurate as there may be bonuses which are
∆ in Employee costs: (85 000 𝑥 2) − 182 744
only paid towards the end of the year (so they
182 744 are outstanding on 2018 first semester
Alternative calculation:
170 000 − 182 744 figures).
85 000 − 182 744
182 744 > It is, however, possible that the company
182 744
= - 7,0% might have retrenched senior personnel and
employed general workers at lower rates.
= - 53,5%

Human

(ii). > This could be as a result of gearing up for

new bus routes and links.
∆ in number of employees 769 − 719
719 > The company may have recruited more
Human black people in order to improve its BEE
= 7,0%
credentials.

(iii). 2018 (annualised): > The assumption made is that the employee
costs will be at same level for the remainder
Average salary per 85 000 𝑥 2
of the year (this does not take into account
employee 221 any salary adjustments in the next semester
Human 170 000 or any bonuses).
769 > Based on the above assumption, it would
= R221 066 seem that the company might have
restructured its business, e.g. retrenched
2017: senior management and employed more
182 744 general workers at lower salaries.
719
= R254 164

(iv). Management: > The company seems to have made strides

in increasing the number of black managers
∆ in Black representation: 29,1 − 24,0
(through recruitment or retirement or removal
24,0 of white managers). The percentage of black
managers is still fairly low, considering that
Human the majority of the workforce is black.
= 21% (or 5,1 percent. points)
> The % of black employees to total
employees has slightly improved. The
company might have brought in people that

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are more determined to change. This initiative

must be somehow plausible as this is only six
OR months into the year.
General workforce: > However, considering the demographics of
79,9 − 78,1 the company (and the country), MO Ltd still
78,1 has a long way to go.

= 2,3% (or 1,1 percent. points)

(v). Annualised change: > It may be useful to compare first halves of

the two years to make sense of the number of
∆ in Road accidents: (42 𝑥 2) − 60
accidents.
60
Not annualised: > However, if annualised it shows that the
24
42 − 60 increase is likely to be around 40%. This
60 might be as a result of new drivers (as per
60
= 40% increase in personnel) who may not have vast
= −30% experience.
Social > The rate should be investigated further to
establish for example periods of high accident
rates (e.g. festive season or long public
holidays).

(vi). Annualised: > It may be useful to establish first whether

the spend is spread roughly equally
∆ in Supplier/enterprise (10 178 𝑥 2) − 12 145
throughout the year.
dev: 12 145
> However, the annualised % shows a
Not annualised: 8 211
significant improvement from the previous
12 145 year. Once again, this indicates the
10 178 − 12 145
12 145 = 67,6% determination by the company to positively
contribute to the economy (as seen by the
= −16,2% increase in black representation and job
creation).
Social

(vii). Annualised change: > It may be useful to compare first halves of

the two years or to look at the revenue growth
∆ in Greenhouse gas (9 104 𝑥 2) − 17 034
to put numbers into perspective.
emission: 17 034
> However, if annualised, increase of 6,9%
Not annualised: 1 174
may be attributed to aging fleet with old
17 034 vehicle efficiency technology.
9 104 − 17 034
17 034 = 6,9%
> This may also be due to additional routes or
= −30% more time on the road to generate revenue.

Natural

15 MARKS

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PART C

 Divisible project is projects where it can be taken as a whole or in part (scalability). CitiLink
is an example of a divisible project, as MO Ltd can decide to undertake the connection of
Johannesburg and Ekurhuleni metros first and then at a later stage connect Tshwane with
Johannesburg/Ekurhuleni or both. The company does not have to connect all the metros at
once (the project can be implemented on a “piecemeal” basis).

 Independent projects are projects where the acceptance or rejection of one project has no
bearing or influence on the acceptance or rejection of any other project. CitiLink and Project
Nthuseng are independent of each other. Whether MO Ltd decides to go ahead with CitiLink
or not to go ahead is irrelevant when having to decide on expanding to Mogale City.

 Mutually exclusive projects are projects where only one of several alternatives may be
chosen at a time. These three projects are not mutually exclusive – as all the alternatives can
be chosen. Projects Nthuseng and Dira are examples of mutually exclusive projects, since MO
Ltd can either purchase a stake in DIRA or enter into a joint venture with local bus operators.

 Capital rationing is when an entity is not able to undertake all identified projects due to limited
funds and as such, projects with higher returns have to be prioritised. An example would be if
MO Ltd cannot raise enough funds for both CitiLink and Project Nthuseng/Dira and therefore
has to choose one with better returns and reject the other one (or do part of it).

8 MARKS

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PART D

CAPITAL STRUCTURE / SOURCES OF FINANCE REPORT

Prepared by: Eunice A. Stoodant
Date: 10 July 2018
Subject: Company’s WACC and financing options
This report covers the following:
i. Detailed calculation of weighted average cost of capital of MO Ltd at 31 March 2018,
ii. Criteria to be used when deciding on how to finance the Mogale City expansion, and
iii. Advice on how to finance the Mogale City expansion project.

i. Detailed calculation of weighted average cost of capital of MO Ltd

INSTRUMENT M ARKET VALUE (iii) COST OF EQUITY (i)

𝐾𝑒 = Rf + β (Rm – Rf) OR
Ordinary shares 𝑴𝑽𝒆 : R177 550 000 (As calculated in Part A)
𝐾𝑒 = Rf + β (Rp)#

𝐾𝑒 = (14 – 7,5)# + 0,924 (7,5)

𝐾𝑒 = 13,43%

#
Notes:
If Rp = Rm – Rf, therefore
Rf = Rm – Rp

INSTRUMENT M ARKET VALUE (iii) COST OF PREF. SHARE (i)

Preference shares 𝑴𝑽𝒑 : R54 155 000 Dividend

𝑀𝑉𝑝 = OR rewrite:
Kp

Dividend
𝐾𝑝 =
MVp

385 000 x R125 x 8,2%

𝐾𝑝 =
54 155 000

3 946 250
𝐾𝑝 =
54 155 000

𝐾𝑝 = 7,29

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WACC calculation:

INSTRUMENT M ARKET VALUE (iii) COST OF LOAN (i)

CF0 (2018) - 4 320 000 (100 000 000 x 6% x 0,72)

CF1 (2019) - 4 320 000
Loan CF2 (2020) - 4 320 000 𝐾𝑑1 = 5,8% x 0,72
CF3 (2021) - 100 000 000
I/Y 4,18
NPV 100 886 597 𝐾𝑑1 = 4,18%

CALCULATION OF WACC USING MARKET VALUES

Portion of
Market value of capital Cost of Weighted cost
Capital structure instruments structure capital of capital

Ordinary shares Not required 0,60 13,43% 8,06%

Preference shares Not required 0,10 7,29% 0,73%

Long-term loan Not required 0,30 4,18% 1,25%

Total 1 / 100% 10,04%

CALCULATION OF WACC USING MARKET VALUES (not required)

Portion of
Market value of capital Cost of Weighted cost of
Capital structure instruments structure capital capital

Ordinary shares R177 550 000 0,54 13,43% 7,25%

Preference shares R54 155 000 0,16 7,29% 1,17%

Long-term loan R100 886 597 0,30 4,18% 1,25%

Total R332 591 597 1 / 100% 9,67%

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ii. Criteria to be used when deciding on how to finance the Mogale City expansion

 COST: MO Ltd should consider using an instrument which has the lowest effective cost
of capital (additional administration costs should also be considered). The company
should also factor in any possible changes to these rates when it determines the cheapest
form of finance. As it can be noted from the WACC calculation in (i) above, the Captec
loan bears the lowest cost of capital (4,19%) compared to equity (7,29% and 13,43%).
The bank overdraft is expensive and is not considered part of the permanent capital
structure by the company.

 CASH FLOWS (Matching): The pattern of cash flows should also be considered,
especially in matching the revenue to the service cost of debt. A six-year Captec loan can
be taken for the six-year duration of the project (if decision is to enter into a JV), which will
allow the company to service interest from the proceeds of the project. The company may
also prefer issuing shares (with no immediate repayment) for the acquisition of DIRA, as
the acquisition will likely generate revenue in years to come. MO Ltd will have to consider
the timing of the interest payment on the loan, as this payment is required upfront even
before the project starts yielding profits.

 CAPITAL STRUCTURE: The company has already established its optimal structure
(where WACC is lowest) and therefore, and it is operating at this overall optimal capital
structure of 30: 70 (see above). However, the use of equity is not at the ideal level where
preference share capital should be 10% of capital employed and therefore the company
should consider ways to fix this (where currently preference share capital is at 16%).

 CAPACITY (Availability): MO Ltd will have to establish from its providers of capital
(including possible new providers) whether they are able to provide the company with
required funds. It should be established if Captec and preference shareholders are willing
to increase their exposure to MO Ltd. There are 7,16 million shares (20m – 12,84m) that
can still be issued, without amending the memorandum of incorporation. The bank
overdraft, at high interest rate cannot be utilised to fund the permanent capital
requirements of the business.

 CONSTRAINTS: Taking a loan, bond or issuing a debenture may require some form of
security, e.g. property of the company including the investment being acquired. This is not
the case for ordinary and preference shareholders. Captec (and other lenders) may
require MO Ltd to achieve and maintain certain levels of profitability and assets, and
breaching such covenants may lead to lenders demanding immediate repayment of the
facility.

 CONTROL: The shareholding/ownership of MO Ltd will likely change if ordinary shares

are issued to raise funds for the project. This may lead to changes in decision-making
powers or votes. However, for loans and preference shares (non-convertible), there are
usually no voting rights or ownership changes when these instruments are used.

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iii. Advice on how to finance the Mogale City expansion project

Since the company has a given target capital structure, the project should be funded
according to its target capital structure (30: 10: 60).

Existing capital ¤ Additional %

Capital structure structure (iii) funds required Target capital structure

Ordinary shares R177 550 000 R52 004 958 60% R229 554 958

Preference shares R54 155 000 (R15 895 840) 10% R38 259 160

Long-term loan R100 886 597 R13 890 882 30% R114 777 479

TOTAL R332 591 597 R50 000 000 100% R382 591 597

As it can be seen from (i), the company’s ratio of debt to equity remains at its required levels. It
should be noted, however, that the company aims to have 10% of its capital employed
represented by preference share capital (and currently this is 16%). To reduce preference share
would lead to an increase in the weighted cost of capital.
To reach its target capital structure immediately, the company will have to issue ordinary shares
to the value of R52 million, and take a new loan of R14 million. This will lead to company having
more than the R50 million funds required. The excess (R16 million) can then be used to buy back
preference shares. All this will be subject to shareholders’ approval and will be guided by the
terms of the Memorandum of Incorporation and other binding documents.
35 MARKS

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PART E
From: Eunice A. Stoodant
Sent: Friday, 10 July 2018, 04:38PM
To: Mancom MO
Cc: Joe Blog (Head – Finance)
Subject: Valuation of 55% stake in Dira Bus Services Company
Good day,
Following team review of the valuation performed by the associate accountant, I have, as shown
below, highlighted what I believe to be incorrect in the valuation performed. I have re-performed
the earnings-based valuation and also checked the reasonableness of this valuation by
calculating the net asset value of Dira Bus Services Company.

i. Critically evaluating the valuation performed

Average P/E ratio
The P/E ratio is expressed as a % instead of a multiple.

Positive factors: Outstanding financial performance & clean audit

Generating profits three years in a row does not make the company unique and different from the
rest. There is no information to suggest that DIRA’s competitors are making losses in some years.
The same goes for an unqualified audit opinion – this should be standard for any company.

Negative factors: Marketability

It has been established that unlisted shares trade 5% below listed shares and the adjustment for
this has also been made. Therefore, the negative factors should not include “Marketability”. Rising
prices also affect the entire sector and should not be considered (already adjusted in sector P/E).

Other factors
The low staff turnover and a 0% black representative in the executive committee should have
been factored into the valuation.

Maintainable earnings
Maintainable earnings have fluctuated during the three-year period under review and therefore,
the weighted average should have been used. The maintainable earnings for 2018 have also
been incorrectly added. The timing of the payment of the fine is irrelevant (accrual basis applies).

Amount to be offered by MO Ltd

This amount is 100% of the value of the firm. The actual stake (51%) that is being bought has not
been brought into the calculation.

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ii. Re-performance of the valuation of the stake in Dira Bus Services Company:
Valuation of DIRA (earnings-based)
Reviewed by: Eunice A. Stoodant Pretty Blog Review Note 1
Reported to: Mancom – MO Ltd Date: 10 July 2018

Note 2016 2017 2018

R’000 R’000 R’000
Profit for the year 10 975 9 250 11 471
Government grant 1 (2 000)

Fine 2 864

Maintainable earnings (ME) 10 975 9 250 10 335

Use weightings (fluctuating) 1/6 2/6 3/6
Weighted earnings 1 829 3 083 5 168

Maintainable earnings 10 080

Average sector P/E 10,7

Positive Factors
Low staff turnover +1
Experienced drivers and assemblers +1
Negative Factors
Aging fleet -1
Lack of transformation -2
Expected % growth – management estimates n/a
9,7

Value
ME x Adjusted P/E (10 080 x 9,7) 97 776
Less: Marketable discount (97 776 x 5% estimated) (4 889)
Plus: Control premium (97 776 x 8%) 7 822
VALUE - MO Ltd 100 709
Shareholding to be purchased 51%
Amount to be offered by MO Ltd 51 362

iii. Reasonability check of the valuation performed above:

Net asset value:

Equity = Assets – Liabilities
Net asset value = 138 515 – 7 255 – 3 525
Net asset value = 127 735
Amount to be offered by MO Ltd = 127 735 x 51% = R65 145

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Conclusion
There is difference of about R14 million between the two valuations. This may require the review
of the price-earnings based valuation, in light of many assumptions that have been made. The
company should also consider verifying the completeness and accuracy of DIRA’s assets and
liabilities.
If all of the above is considered fair, then MO Ltd should consider offering between R51m and
R65m. The company should check if they will be able to raise the required funds (which are above
what the company intends to invest).
I hope this will be of great help. Please do not hesitate to contact me for clarity on any of the
matters raised.
Kind Regards
E
25 MARKS
PART F
The implementation of e-toll system in Gauteng
The e-toll system was introduced in Gauteng in order to finance the improvements of Gauteng’s
road network of 187km. These improvements have brought so much needed relief and ease of
traffic on Gauteng’s roads. However, it would seem that very few stakeholders actually endorsed
this means of financing the infrastructure. The extent of effective consultation by SANRAL may
also be questioned as many objections have been raised. The processes of ensuring collection
of toll fees were flawed, as to this day there is more than R10 billion currently owed by road users
and the collectability of these fees remain highly improbable.
Scrapping out the e-toll system would be the best news for most road users. However, the fact
remains that R67 billion is still owed by SANRAL. Therefore, the question becomes: if the e-toll
system is scrapped, who pays the R67 billion?
Running e-toll systems come with high maintenance costs, which will be avoided the minute the
system is scrapped. Therefore, scrapping the e-tolls will immediately reduce cash outflows (legal
implications should be considered).
Once the e-tolls are out of the way, it should be established exactly how much is owed on the
roads and a plan must be developed to repay the amount owed. This money should effectively
come from the government. By tackling corruption, instilling good governance at State entities,
eliminating wasteful and fruitless expenditure and reviewing of the cabinet structure, etc. may
result in money saved and then used to repay the loans.
Increasing the fuel levy would add extra burden on already financially distressed consumers who
are feeling the pinch of rising fuel prices and VAT. However, this option can be touted but this
should only be applicable to Gauteng as main road users. Non-Gauteng motorists would
somehow also indirectly pay this levy when they drive to Gauteng.
5 MARKS

TOTAL: 100 MARKS

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SOLUTION 33: MBOWENI TRADING (100 MARKS; 3 hours)

a) Draft an email to the management of Mboweni Trading

From: A. Student
Sent: Friday, 31 August 2018, 05:45 PM
To: Mancom – Mboweni Trading (Pty) Ltd
Subject: RE: Company performance analysis

Good day,

I have worked through the files which I received from the management team, containing
the financial statements of the company with key indicators/ratios of the industry
performance. In this email I will address the differences between the company’s
performance and the industry performance. I will wrap up this email by providing some
practical ways of improving the company’s performance. Please refer to the attachment
for all the workings, and note any assumptions I have made especially where the
information I had at my disposal was not sufficient.

Below is a list of the key ratios I have computed, using the information available from the
competitors as comparison (industry average are show in brackets):

a. Revenue growth in 2018 (8,5%):

You did not provide me with the company’s growth for 2018 (or the 2017 sales figure).
However, considering the growth in dividends I assumed that the company’s sales will
grow at minimum by 5%. The company has also experienced rapid growth in profit,
which supports the notion of strong revenue growth. Sales of the new product line are
expected to grow by 10%, which might also indicate the general growth in the
business.
To improve: The company should consider increasing its selling price, while
improving its in-store and after-sales service (change of packaging material, promoting
its products via social media, YouTube, Instagram and text messages). Mboweni
Trading can also restructure its salary package (within legal framework) by
incorporating a commission portion based on sales.

b. Return on assets, using NOPLAT (15,2%)

The company’s return on asset is 13,5% (1,7% below the industry) indicating that the
company is not as efficient in utilising its assets to generate profits. This might be due
to some property (especially land and investment property) not leased out to generate
rentals. The company has a lot of cash deposited into the bank account and trade
receivables – these assets may not be generating much returns/interest.
To improve: Excess cash should be invested in projects which will generate more
profit. The same goes for trade receivables – Mboweni Trading should change its
credit policy on debtors to ensure quick collection or charge interest on overdue
accounts. You should consider selling off redundant/less productive assets.

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c. Return on equity, using opening balances (28,0%):

The company outperforms the industry by far when it comes to creating value for its
shareholders (its RoE is 46,2%). In a space of a year the company has been able to
almost double its retained profits. The company’s moderate dividend pay-out ratio has
also increased shareholders’ equity funds. The rapid growth the company has
experienced is evidenced by the return the shareholders have made. This also
indicates the willingness of customers to pay a premium for Mboweni Trading’s
products, leading to higher profit margins.
To improve: Consider reducing the dividend pay-out ratio and ploughing more profits
into the business. The company can also dispose of assets (not effectively utilised)
that may be sold at more than their carrying value, leading to more realised profits.
Possibilities of cutting on marketing and administrations costs, especially by
centralising some of its activities in Gauteng where the majority of revenue is
generated.

d. Net interest cover (7,0 times):

There is no much difference between the company’s performance (6,9 times) and the
industry average, meaning that the company’s chances of defaulting on its interest
payment commitments are similar to the industry, giving it similar opportunities to raise
more funding.
To improve: Mboweni Trading should consider wisely and timeously investing its
excess cash in interest yielding products which will lead to a further reduction in net
finance costs. The company must regularly review its capital structure and where
possible renegotiate terms of the facilities received from funders.

e. Dividend pay-out ratio (43,6%):

With a pay-out ratio of 32,7%, Mboweni Trading retains more profits on average than
its competitors, and this gives the company the edge to embark on capital expansion
programmes and exacerbate the growth of the business.
To improve: No information on dividend policy has been furnished to assist in
establishing how the ratio can be improved. The company should be careful that
shareholders’ expectations are considered, as some may feel the company is not
declaring sufficient dividends and therefore the company may be required to decrease
the dividend cover.

f. Creditors’ payment days (36 days):

The company pays its creditors after 48 days of credit purchase, about 12 days later
than its competitors. This may explain big cash reserves as the company seeks to
delay payments to creditors, and if no late interest is charged, the company is utilising
a cheaper form of finance. The late payment of suppliers might also be as a result of
payments to foreign creditors which might not clear on company’s account
immediately.
To improve: The company should maintain good relationships with its suppliers and
ensure that the payment terms are accepted by all the parties. The company should
review suppliers’ terms to ensure full compliance.

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g. Capital gearing ratio (0,45: 1):

The company, with a capital gearing ratio of 0,47: 1, is slightly more geared than its
peers. This is also evidenced in the net interest cover ratio computed above. The
company has managed to effectively use more debt in its business to generate income
(the company has a positive financial leverage effect).
To improve: How the company should deal with the level of debt it uses in the
business will be guided by its optimal or target capital structure in place. The company
should, however consider decreasing its debt levels by using the cash reserves at
hand, as this would lower the interest expense incurred.

h. Bad debt expense ratio (0,8%):

Mboweni Trading’s bad debt expense ratio at 0,3% is lower than the industry average.
This may be owing to robust credit controls, especially credit granted to people that
can afford. The company has a collection period of 40 days, which may indicate the
effectiveness of collecting from customers.
To improve: Mboweni Trading should consider reducing the percentage of sales
made on credit. The company should impose interest on accounts not settled within
30 days.

i. Fixed asset turnover (3,0 times):

The company’s low fixed asset turnover (2,3 times) might be as a result of investment
property not generating any form of revenue (e.g. rental income), but may also point
to underutilisation of its assets (e.g. excess capacity/space in the company
factory/warehouse).
To improve: Mboweni Trading should consider increasing operating hours at its retail
stores and at its factory. The company should also at disposing some of its property,
especially idling and non-core assets.

j. Effective interest rate (7,5%):

Mboweni Trading is effectively charged a higher interest rate (at 7,9%) than its peers.
One would have to consider the types of funding instruments used which might be at
different rates. The company is paying a lower rate than the going rates in the market.
To improve: Mboweni Trading should renegotiate better rates and discounted
administration costs with its providers of capital. The company should also look at
repaying the BEADvest loan which has a higher interest rate using its cash reserves,
if they can be able to negotiate a new facility at an even lower rate.

I hope this email helps to identify areas where the company is doing better than its
peers and areas that require immediate attention from the shareholders.

Regards

A. Student

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Attachment – Ratio calculation and comments

RATIOS 2018

Return on assets:
𝑁𝑂𝑃𝐿𝐴𝑇 3 194 𝑥 0,735
𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 17 351
= 13,5%

NOPLAT:

4 565 – 141 – 1 230 = 3 194 (EBIT) OR

Using effective tax rate: Using the corporate tax rate:

1 050 ÷ 3 958 = 26,5% 3 194 𝑥 0,72

17 351
= 13,3%

Return on equity:
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 2 908
𝑇𝑜𝑡𝑎𝑙 𝑒𝑞𝑢𝑖𝑡𝑦 (𝐵𝑜𝑌) 2 400 + 750 + 3 142

Equity at Beginning of year = 46,2%

Distributable reserves at beginning of year:

5 100 + 950 – 2 908 = 3 142

Net interest cover:

𝐸𝐵𝐼𝑇 3 194
𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡 − 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑖𝑛𝑐𝑜𝑚𝑒 607 − 141
= 6,9 times

Dividend pay-out ratio:

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑 950
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡 2 908
= 32,7%

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RATIOS 2018

Creditors’ payment days:

𝑇𝑟𝑎𝑑𝑒 𝑝𝑎𝑦𝑎𝑏𝑙𝑒𝑠 868 000
𝑥 360 𝑥 360
𝐶𝑟𝑒𝑑𝑖𝑡 𝑝𝑢𝑟𝑐ℎ𝑎𝑠𝑒𝑠 6 500 000
= 48 days

Credit purchases:

13 000 ÷ 0,2% = 6 500 000

Capital gearing ratio:

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 7 444
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝑒𝑚𝑝𝑙𝑜𝑦𝑒𝑑 7 444 + 8 250
= 0,47: 1 (or 47%)

Bad debt expense ratio:

𝐵𝑎𝑑 𝑑𝑒𝑏𝑡 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 68 000
𝐶𝑟𝑒𝑑𝑖𝑡 𝑠𝑎𝑙𝑒𝑠 (𝑜𝑟 𝑆𝑎𝑙𝑒𝑠) 20 423 000
= 0,3%

Fixed asset turnover:

𝑅𝑒𝑣𝑒𝑛𝑢𝑒 20 423
𝑃𝑃𝐸 + 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 𝑝𝑟𝑜𝑝𝑒𝑟𝑡𝑦 7 245 + 1 670
= 2,3 times

Effective interest rate:

𝐹𝑖𝑛𝑎𝑛𝑐𝑒 𝑐𝑜𝑠𝑡𝑠 584 680
𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 − 𝑏𝑒𝑎𝑟𝑖𝑛𝑔 𝑑𝑒𝑏𝑡 (𝐵𝑜𝑌) 7 444 000
= 7,9%

Max: 35 marks

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b) Calculating the weighted average cost of capital

INSTRUMENT M ARKET VALUE COST OF EQUITY
No of shares issued: D1
1st issue: 2 million x R0,75 = R1,5 million 𝐾𝑒 = +g
MV
2nd issue: R2,4 million – R1,5 million
2nd issue: R900 000 (950 000∗1,0605)
𝐾𝑒 = +0,0605
No of shares: R900 000 ÷ (0,75+2,25) 12 650 000
No of shares: 300 000 (2nd issue)
Ordinary shares 𝐾𝑒 = 14%
Let the number of shares be “x”
(5 marks) (2m*R0,75) +(x*(R0,75+R2,25)) = R2,4m
R1,5m + R3x = R2,4m
R3x = R900 000
 x = 300 000 (2nd issue)

Total number of shares issued:

2 million + 300 000 = 2,3 million

MVe: 2 300 000 × R5,50 = R12 650 000

INSTRUMENT M ARKET VALUE COST OF LOAN 1

CF0 0
CF1 - 142 560 𝐾𝑑1 = 8,56% x 0,72
CF2 - 142 560
Netbank Loan CF3 - 2 542 560 (142 560+ 2 400 000) β
𝐾𝑑1 = 6,16%
(3 marks) I/Y 6,16
Comp NPV 2 385 928

β
FV: 142 560 ÷ (8,25%x0,72) = 2 400 000

INSTRUMENT M ARKET VALUE COST OF LOAN 2

Interest paid
𝑀𝑉𝑑2 = 𝐾𝑑2 = 8,56% x 0,72
Cost of debt 2

BEADvest Loan 𝐾𝑑2 = 6,16%

2,4mil x 8,4 x 0,72
𝑀𝑉𝑑2 =
(2 marks) 6,16%

𝑀𝑉𝑑2 = R2 356 364

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INSTRUMENT M ARKET VALUE COST OF PREF.

𝐾𝑝 = 10% - 2,7%
CF0 0
CF1 - 185 080 (R7,444m-R2,4m-R2,4m)*7%
Preference shares CF2 - 185 080 𝐾𝑝 = 7,3%
CF3 - 185 080
(3 marks) CF4 - 3 385 080 (185 080+ (1,60 x 2 mil)
I/Y 7,3
Comp NPV 3 036 759

INSTRUMENT M ARKET VALUE (ALTERNATIVE) COST OF LOAN 1

PV of interest + capital
FV - 2 400 000 𝐾𝑑1 = 8,56% x 0,72
Netbank PMT - 142 560
N 3 𝐾𝑑1 = 6,16%
I 6,16
Comp PV 2 385 928

INSTRUMENT M ARKET VALUE (ALTERNATIVE) COST OF PREF.

PV of dividend + capital 𝐾𝑝 = 10% - 2,7%

FV - 3 200 000 (R1,6 x 2 million)
Preference shares PMT - 185 080 𝐾𝑝 = 7,3%
N 4
I 7,3
Comp PV 3 036 759

CALCULATION OF WACC:

Portion of Weighted
Market value of capital Cost of cost of
Capital structure instruments structure capital capital

Ordinary shares R12 650 000 0,619 14,00% 8,67%

Netbank loan R2 385 928 0,117 6,16% 0,72%

BEADvest loan R2 356 364 0,115 6,16% 0,71%

Preference shares R3 036 759 0,149 7,30% 1,09%

Total R20 429 051 1 / 100% 11,19%

Max: 17 marks

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c) Advice on how to finance the industrial sewing system

Amount required: R4 000 000

Loan Pref. OSC

Maximum available funds 2 000 000 1 200 000 4 000 000

Rates 1: 8,56 x 0,72 90% x 10% Given

Rates 1: Cost of capital 6,16% 9% 14%

Rates 2: (8,56+8,44) 17% x 0,72 9% 14%+4%

Rates 2: Cost of capital 12,24% 9% 18%

Option 1: If the entire R2 million loan is borrowed from BEADvest

Capital Cost WACC

6,16% loan (cheapest) 1 000 000 6,16% 1,54

Preference share (max.) 1 200 000 9% 2,70

12,24 loan 1 000 000 12,24% 3,06

14% ordinary shares 800 000 18% 3,60

4 000 000 10,90%

Option 2: If only up to R1,5 million is borrowed from BEADvest

Capital Cost WACC

6,16% loan (cheapest) 1 000 000 6,16% 1,54

Preference share (max.) 1 200 000 9% 2,70

12,24 loan 500 000 12,24% 1,53

14% ordinary shares 1 300 000 14% 4,55

4 000 000 10,32%

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Conclusion (max: 3 marks):

The company should consider funding the new project by a loan of R1,5 million from the
BEADvest Bank. Although the loan is still cheaper than the issuing shares, if the new debt
exceeds R1,5 million the shareholders will expect a higher return to compensate for the
additional financial risk. This will lead to a higher weighted average cost of capital (looking
at the project alone). Mboweni Trading will then have to issue ordinary shares to the value
of R1,3 million. The company will have to issue all the non-redeemable preference shares
(R1,2 million) as this class is cheaper than ordinary shares and the loan portion which
exceeds R1 million. However, the company should note that the preference shareholders
will always be part of the company and in the event that their dividend is missed, they
could have voting powers to some extent. Mboweni Trading will also have to consider the
entire company target/optimal capital structure to establish the best capital mix. Cash
flows going forward will also have to be planned carefully – the company may have some
flexibility of ordinary and preference dividends where they can be deferred in the event
that there are no sufficient funds. Changes to the pricing (especially bank rates – fixed vs
floating) will have to be considered as well as any legislative amendments that may affect
the tax rate.

d) Advice on investing in the industrial sewing system

Description Oct 18 Oct 19 Oct 20 Oct 21 Oct 22 Oct 23

R’000 Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

Initial cost ① (4 112)

Maintenance cost ① (30) (30) (30) (30) (30)

Sales ② 3 040 3 344 3 678 4 046 4 451

Cost of material ② (1 600) (1 760) (1 936) (2 130) (2 343)

Wages ③ (666) (703) (741) (782) (825)

Grant received 112 112 112 112 112

Factory overheads (85) (85) (85) (85) (85)

Sale of machine ④ 1 542

Taxation ⑤ 103 73 40 3 (759)

Net cash flows (4 000) 874 951 1 038 1 134 1 951

INPUT keys CF0 CF1 CF2 CF3 CF4 CF5

I/Y = 10,3%

NPV = R308 762

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Advice: Based on the net present value (NPV) calculated, the management of Mboweni Trading
should invest in the industrial sewing system, as the NPV is positive . There is not enough
information to apply other project appraisal techniques (especially targets set by the company).
The company will also have to consider the following qualitative factors:

Max: 4 marks
 Job opportunities that the initiative will create (directly and indirectly) – this will, to a certain
degree, alleviate poverty and tackle social challenges.
 Embarking on the project may lead to improved relations with the government, especially
the Department of Labour.
 This project is likely to upskill the current workforce and allow growth and development of
staff.
 The initiative will open new market opportunities and diversify the business and product
offering of Mboweni Trading.
 Reputation and image of the company may be positively affected by the successful
implementation of the project.
 The company will have to consider whether the products will be of the desired quality and
whether there have not been any trademark infringements.
 The reliability and the quality of machine to produce the desired quality, together with
compliance with relevant laws governing the industry and the machines (SARB, etc.).
 The assessment of the environmental impact should be carried out, especially the effect
the plant may have on the quality of lives in the area, as well as disposing of waste
material.
 The technological changes, breakdown and patch upgrades on the system, including the
availability of skilled resources to ensure continuity of operations.

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Workings
① Industrial sewing system & setup costs:
Total costs
¥2,1m + ¥0,1m ¥2,2m
Exchange rate (0,535)
Cost in Rand 4 112 150

Yearly maintenance costs: ¥15 780 ÷ 0,526 = R30 000

② Sales:
Sales
Converted material (20 000 x 95%) 19 000 kg
Kilograms that make a unit (2,5)
Number of units (19 000 ÷ 2,5) 7 600
Average selling price (R400)
Sales value (7 600 x R400) 3 040 000

Yearly sales increase: 3 040 000 x 1,10 = R3 344 000 (Y2)

Cost of material % profit Ratio Amount

Cost of material (Balancing) 100 R1 600 000
+ Mark-up (3,04m x 90/190) 90 R1 440 000
= Selling price 190 R3 040 000

Cost of material will inevitably increase with sales

③ Wages:

Normal wages = Rate p.h. x No of hours p.d. x No of days p.w. x No of weeks p.y.
Hour rate Hours Days Weeks
Normal wages (10 people) R25 8 5 52 R520 000
Rate: 100% premium
Overtime wages (10 people) R50 4 1 52 R104 000

Factory manager (excess) Salary adjust: (R16K x 12) – R150k R42 000

Annual labour costs R666 000

Yearly salary adjustment: R666 000 x 1,055 = R702 630, etc. (4,8% + 0,7%)

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④ Disposal of industrial sewing system:

Sale of machine
Cost 4 112
Depreciation (5/8 years) (2 570)
Carrying value 1 542

⑤ Taxation expense:

Taxation Oct 19 Oct 20 Oct 21 Oct 22 Oct 23

R’000 Year 1 Year 2 Year 3 Year 4 Year 5
Taxable cash flows 659 766 886 1 019 1 168
Wear and tear (1 028) (1 028) (1 028) (1 028)
Recoupment 1 542
Taxable income (369) (262) (142) (9) 2 710
Taxation rate – 28%
103 73 40 3 (759)

Taxable cash flows calculation

R’000 Year 1 Year 2 Year 3 Year 4 Year 5

Maintenance cost (30) (30) (30) (30) (30)
Sales 3 040 3 344 3 678 4 046 4 451
Cost of material (1 600) (1 760) (1 936) (2 130) (2 343)
Wages (666) (703) (741) (782) (825)
Factory overheads (85) (85) (85) (85) (85)
659 766 886 1 019 1 168

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e) Risks faced by Mboweni Trading (Pty) Ltd

 Stock theft: The company sells valuable goods which can ‘easily’ be stolen from its retail
outlets and from its plant. Delivery trucks to company’s retail stores may be hijacked.
 Mitigation: The company should install enough CCTV cameras at its shops and its
factory. Security personnel must be deployed at key areas within the premises.
Appropriate insurance cover should be in place to ensure that the company is able to
recover any financial loss as a result of theft.

 Stock obsolescence: Customers may not afford some of the expensive and fashionable
items, leading to mark down on prices, damages and the company not being able to sell
them.
 Mitigation: Appropriate training and exposure should be given to the staff in the buying
department. There should be constant engagement and surveys with customers and
competitors to keep abreast of latest trends.

 Stock quality compromise: Inferior or reject clothes may be sold to customers, leading
to the company receiving more returned goods and damage to its reputation.
 Mitigation: Material and goods purchased, especially from overseas should be subject to
extensive inspection and quality checks must be in place at the end of the production cycle
for each item produced. The company’s return goods policy should allow customers to
return the purchased items if they are not happy with the purchase.

 Credit granted to customers: Credit may be granted to customers in contravention of

NCR guidelines or to customers who later struggle to settle their accounts (economic
factors, e.g. growth, unemployment and inflation rates).
 Mitigation: The company should hire credit specialists with vast knowledge and
experience in lending to ensure full compliance to relevant credit acts, and the company
should also take insurance to cover any potential loss due to bad debts.

 Cash flow and credit risks: The company may not be able to meet its financial
obligations arising from its preference share capital and loan commitments (in the form of
dividends, interest and capital repayments).
 Mitigation: The company should reduce its debt levels should it feel the debt is excessive
(and probably slow down on its expansion programmes). Where possible, Mboweni
Trading should approach the providers of capital with the view of renegotiating the terms.

 Increasing competition: The clothing industry is very competitive and the company may
lose share market to its competitors and new market entrants.
 Mitigation: The company should increase its level of promotional activities to combat
market share loss. Mboweni Trading should negotiate prices with its main suppliers to
push prices down while continuing to sell quality products.

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 Foreign currency risk: Mboweni Trading is exposed to currency fluctuation, as the

company sources its raw material and other finished products from South America and
Asia. The Rand may weaken against these currencies, leading to goods being sourced at
a higher price.
 Mitigation: The company should consider making use of derivatives to hedge the level of
exposure, e.g. forex options, forwards, futures and swaps. Mboweni Trading may also
consider local suppliers, if their prices are comparably reasonable.

 Legislation & policy changes: The government may impose stricter conditions on grant
money given to manufacturers like Mboweni Trading. The government may also impose
tough policies on procurement and nature of raw material used in the production process,
including safety and quality standards that must be adhered to.
 Mitigation: The company should regularly review policy drafts and any other pending
government policy implementation proposals. Mboweni Trading should build up more
reserves (buffer) and implement cost cutting initiatives to prepare for a rainy day (in the
event that the government stops paying the grant to the company).

 System integration and strategy execution: Mboweni Trading may fail to implement
new projects successfully. The company may also struggle to integrate its segmented
business operations throughout the country.
 Mitigation: The company should increase its investment in information technology to
ensure that its systems countrywide are well integrated and that the business benefits
from economies of scale. The company should assess all possible outcomes of the
project, extensively test all processes, run systems parallel and provide backup systems
in the event of project launch failure.

 Labour issues (human capital): The company may not be able to recruit employees with
necessary skills to match the job profiles. The employees may also not be satisfied with
their wages and other employment benefits accruing to them and may resort to labour
action, leading to disruption in business activities.
 Mitigation: The company should make use of experienced recruitment agencies if it does
not have in-house resources and prospective employees must undergo a rigorous
screening process. Mboweni Trading management should engage trade union timeously
and on an ongoing basis to ensure that the needs of the workers are prioritised.

 Environmental risks: Mboweni Trading may fail to dispose waste (textile waste and toxic
dyeing chemicals) from its factory responsibly and may increase pollution.
 Mitigation: The company should consider investing in low carbon emitting machinery, in
renewable energy and monitor the levels of pollution and implement initiatives to reduce
carbon emission, e.g. use of degradable material in packaging and in raw material.

 Any other point valid and applicable to the scenario.

Max: 10 marks

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f) Calculate the foreign exchange profit or loss of Mboweni Trading

Workings
Description Amount
Actual amount paid (¥2,1m + ¥0,1m) ÷ 0,535 (R4 112 150)
Amount that should have been paid at spot: R4 230 769
(¥2,2m ÷ 0,520)
Forward exchange profit R118 619

Max: 3 marks

TOTAL: 100 MARKS

© UNISA
2021

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