TEST 1

MODULE DESCRIPTION : MANAGEMENT ACCOUNTING 302

MODULE CODE : RKV302

FACULTY : BUSINESS AND ECONOMIC SCIENCES

QUALIFICATION : BACHELOR OF COMMERCE

DATE : 23 SEPTEMBER 2021

DURATION (IN MINUTES) : 90 MINUTES

TOTAL MARKS : 60

PAGES : 7 (INLCUDING COVER AND FORMULA PAGE)

EXAMINER : MR L MOLATLHWE
MS S BROWN

MODERATOR : MRS J PIENAAR (INTERNAL)

INSTRUCTIONS

1. Attempt all questions.

2. Show all workings clearly and round to two decimals, unless stated otherwise.
3. If necessary, state any assumptions that you have made.
4. The use of financial calculators are permitted. Show all keystrokes.

THIS PAPER CONSISTS OF TWO QUESTIONS

QUESTION MARKS MINUTES ABLE TO PRINT PAPER UNABLE TO PRINT PAPER

Question 1 30 45 NORMAL EXTRA NORMAL
EXTRA TIME
Question 2 30 45 TIME TIME TIME
Overall Time 60 90 90 MIN 113 MIN 113 MIN 136 MIN

DO NOT TURN THE PAGE BEFORE TOLD TO DO SO

Question 1 (30 Marks; 45 Minutes)

Ramen Investments (Ramen) is a medium sized company that was started five years ago
by two friends, Raino and Menza. The two friends want to use their skills and experience
in the food and hospitality industries to build a Ramen as a premium brand that is known
for its exceptional service offering in Gqeberha and surrounding areas. Currently, Ramen
operates a full-service restaurant and a conference centre. The facility was built two years
ago on a smallholding which the two friends bought when they started the company.
Ramen’s long-term plan is to build a spa as well accommodation suites so that they can
offer full-service packages to conference clients.
The recent covid-19 pandemic has seriously impacted Ramen’s plans as most hospitality
establishments were forced to close under full lockdown regulations. However, with the
easing of lockdown regulations, Ramen commenced with operating the restaurant on a
limited capacity basis with the conferencing facilities remaining closed. During these
periods, profit fluctuated with the changing lockdown regulations as expressed by
different levels, with level 1 being the less strict and level 5 being the strictest of
regulations as only essential businesses operates.
The friends want to decide if they should go ahead with the plans for building
accommodation suites or delay them further. They are concerned about the impact of
covid-19 on the business going forward, given that it is predicted to continue for the
foreseeable future. This concern is premised on the fact that the restaurant and
conference operations will have to carry all the fixed costs during the construction period
and must therefore be profitable to do so. The disruptions due to the changing regulation
levels had a very negative effect on profits especially for companies operating in the
hospitality sector.
In an order to assist with planning for the future, Ramen plans to have a strategy session
soon to decide on how best to move forward. In order to assist in the decision making at
this session, the following predictions on the likely level of monthly profit the company can
achieve from the restaurant and conference centre under different levels of lockdown in
the next three years has been established as follows.
Lockdown level Probability Profit (R)
Level 1 10% 85 000
Level 2 20% 65 000
Level 3 50% 45 000
Level 4 15% -18 000
Level 5 5% -60 000

The main reason for the losses in levels 4 and 5 are the fixed costs the company must
incur including municipal rates and taxes as well as security costs.
Also included in the strategy discussion is whether Ramen should employ a financial
manager. The friends are not sure about the benefit this appointment will have for the
company, and they are also concerned about the likely challenges they may face once
this decision is made. However, they are sure that they want to remain involved in the
company and focus on using their skills, strengths and experience to build the brand they

RKV302 Test 1 2021 Page 2 of 7

have in mind as financial management is not their core strength and it involves a lot of
administrative functions in their view.
Alternative opportunity
Ramen is considering introducing team building activities on the property as part of
diversifying revenue streams. However, doing this now will mean that the company must
delay the spa and accommodation suites plan in order to manage liquidity levels. The
good thing about team building activities is that they will have minimal impact on the fixed
costs, and their revenue is not dependent on hospitality patrons in the same way as
accommodation revenues are. Furthermore, members of the public can also book these
activities for leisure purposes amongst friends and family members at short notice for a
day’s outing as they are subject to less stringent lockdown regulations.
The following projections have been made as possible profits from the team building
activity under each lockdown level as per above.
Lockdown level Probability Profit
Level 1 10% 45 000
Level 2 20% 38 000
Level 3 50% 32 000
Level 4 15% 10 000
Level 5 5% -1 000

If it is introduced, teambuilding is expected to contribute twenty-five percent to Ramen’s

overall profitability in the medium term.
REQUIRED: MARKS
a) Calculate Ramen’s expected return and standard deviation for the existing
operations and interpret these indicators to assist with Ramen’s decision 5
making during the planned strategy session.

b) Discuss, using the principles of risk and return, the benefit Ramen will have
by introducing teambuilding activities in addition to the existing operations. 5

c) Assuming Ramen goes ahead and introduces teambuilding activities as

part of its current operations, calculate the expected return and standard
deviation for the company’s operations and comment on the results.
10
You may assume that the correlation between the two income streams has
been correctly calculated as -0.9.

d) Briefly discuss the possible corporate strategy frameworks that Ramen can
use in their upcoming strategy session and recommend the most 5
appropriate framework.

e) Discuss the role, potential benefits and challenges Ramen may encounter
5
with the appointment of a financial manager.

Question 2 (30 Marks; 45 Minutes)

RKV302 Test 1 2021 Page 3 of 7

 This question consists of two unrelated parts

Part A (20 Marks; 30 Minutes)

Always Connected Ltd (AC) is a fast-growing internet provider located in Gqeberha and
is dominant in the Eastern Cape market. The company is listed under the small cap index
of the Johannesburg Stock Exchange (JSE) and has been in the business for over ten
years. The company invests in fibre and satellite infrastructure to provide fast, reliable,
and uncapped Wi-Fi connections to both business as well as homeowners. During the
last two years, AC has experienced exponential growth due to the covid-19 pandemic
resulting in large demand for fast and reliable connectivity, especially for homeowners.
This is as more people work from home, students doing the majority of their schooling
online and young kids needing some form of entertainment while their parents work. Due
to AC offering unique packages which consists of uncapped Wi-Fi with no restricting
speed of connection, the company experienced a significant increase in sales for its
services.

This rapid demand for internet connectivity led management to fast-track some of their
investment plans. As such, additional infrastructure rollout as well as support teams are
required in new locations in Gqeberha, Jeffreys Bay, East London and Port Alfred, these
being the dominant markets where home connectivity demand remains high at the
moment. This growth includes providing service to areas outside of these towns which
traditionally did not have high internet demand.

Although AC is listed on the JSE, the finance director’s view was that as long as the
company is cash generative and has a positive return above the prime interest rate, there
is no need to have an objective measure to evaluate projects against. AC correctly
calculated the projected return (IRR) of 16.5% for this expansion project. However, the
board wants the company to develop an objective measure in line with finance literature
and best practice to assist in evaluating projects. They want to use the current planned
investment as a pilot and without this objective measure, the expansion will not be
considered.

The finance director remembers that he studied the concept of Weighted Average Cost
of Capital (WACC) as a possible measure to use to evaluate expansion projects, but his
memory is vague as he did not find this an interesting topic and he barely managed to
pass it. Therefore, he is not sure what WACC exactly is, how to calculate it and whether
it has benefit for the company at all.

RKV302 Test 1 2021 Page 4 of 7

As a financial manager working part-time to finance your studies, the finance director
asked that you prepare notes to include in his board presentation on WACC. He
requested the notes to include guidance to help him address the question of whether
WACC is appropriate to be used for evaluating new projects, including the one described
above. This measure will be in addition to calculating the Net Present Value and projected
return which the finance director used relative to the prime interest rate to evaluate
proposed projects.

The finance director has provided you with the following incomplete information which he
understands is important for WACC calculation.

Extract from the Statement of Financial Position at 31 August 2021

Equity Notes R
Retained earnings 1 575 000
Shareholders’ equity 1 5 000 000

Liabilities
Preference shares 2 ?
Loan from Bank 3 ?
Non-redeemable debentures 4 ?

Notes:
1. There are 1 million shares (authorised, 3 million) in issue, currently trading at R9.20
per share. There were flotation costs of 2% on these shares on issue. The company
has expected earnings per share (EPS) of R2 for the current financial year, and R3.50
for the next financial year, with a dividend pay-out ratio of 15%.
2. Preference shares of R1 000 face value were issued on 31 August 2016 at a 10%
discount and are redeemable in five years’ time at a premium of 10%. A total of 2 000
shares were issued at a 12% dividend rate and the current dividend rate for similar
preference shares is 8% per annum.
3. The loan was taken out on 31 August 2021 with forty-eight monthly repayments of
R50 000. The first payment took place on 1 September 2021.
4. Plans were already underway to issue 3 000, 10% Non-redeemable debentures with
a R1 000 face value at a 5% discount. Flotation costs of 4% on the issue are expected.
Debentures of similar risk currently have a market related interest rate of 9%.

Additional information:
• The current growth rate is 10%.
• AC has correctly estimated a beta of 1.4 with a target debt-to-equity ratio of 40%.
• The long-term borrowing rate and short-term borrowing rates are 9% and 12%
respectively per annum.
• The corporate tax rate is 28%.
REQUIRED: Marks

RKV302 Test 1 2021 Page 5 of 7

 a) Discuss the appropriateness of WACC as a measure to evaluate the
expansion project as well as any other factors that Always Connected 5
Ltd should consider when making the expansion decision.

b) Recommend whether or not Always Connected Ltd should accept the 15

proposed expansion project and support your recommendation with
relevant calculations.

Part B (10 Marks; 15 Minutes)

After finalising the investment case for the expansion, the finance director established
that Always Connected Ltd will require an additional R15 000 000 in order to continue
with the proposed expansion. These funds include the incremental working capital in
addition to the infrastructure cost.

He is unsure of what effect the additional funding will have on AC’s weighted average
cost of capital if any at all. This is important as he would not like to move away from the
capital structure of a 40% debt-to-equity ratio the company is trying to maintain.

In addition, the finance director has established that AC will have R3 000 000 of equity
funding inclusive of next financial year’s retained earnings and that the bank has indicated
that should incremental borrowings exceed R5 000 000 of debt, the interest rate will
increase available to contribute towards the project. This debt amount excludes existing
debt the company has in place.

REQUIRED: Marks
a) Prepare a memorandum to the finance director explaining the impact
additional funds will have on the company’s WACC. Make use of
calculations where necessary. NB: You are not required to calculate 9
WACC.
Communication and Logic (1)

RKV302 Test 1 2021 Page 6 of 7

FORMULA PAGE:

Portfolio standard deviation:

RKV302 Test 1 2021 Page 7 of 7