CHINHOYI UNIVERSITY OF TECHNOLOGY

SCHOOL OF ENTREPRENEURSHIP AND BUSINESS SCIENCES

DEPARTMENT OF ACCOUNTING SCIENCES AND FINANCE

BSc (HONS) IN ACCOUNTANCY

MARKING GUIDE

COURSE: ADVANCED CORPORATE FINANCE (MAIN)

CODE: CUAC 401

DATE: Nov/Dec 2022

DURATION: 3 HOURS 30 MINUTES

INSTRUCTIONS TO CANDIDATE

1. Answer all six (6) Questions

DR. T.J MABVURE

QUESTION ONE

a. Discuss the two forms of equity capital that are used in the introduction stage of a business.
(10 Marks)
ANSWER
A business angel (also known as an angel Investor, informal investor, angel funder, private
investor, or seed investor) is a private investor that invests part of his or her own wealth
and time in early-stage innovative companies. This is an affluent individual who provides
capital for a business start-up, usually in exchange for convertible debt or ownership
equity. A small but increasing number of angel investors invest online through equity
crowd-funding or organize themselves into angel groups or angel networks to share
research and pool their investment capital, as well as to provide advice to their portfolio
companies. Apart from getting a good return, business angels expect to have fun. It is
estimated that angel investment amounts to three times venture capital. Angel investors are
often retired entrepreneurs or executives, who may be interested in angel investing for
reasons that go beyond pure monetary return. These include wanting to keep abreast of
current developments in a particular business arena, mentoring another generation of
entrepreneurs, and making use of their experience and networks on a less than full-time
basis. In addition to funds, angel investors can often provide valuable management advice
and important contacts. Angels typically invest their own funds, unlike venture
capitalists who manage the pooled money of others in a professionally managed fund.

Venture is a type of private equity. It’s a form of financing that is provided by firms or
funds to small, early-stage, emerging firms that are deemed to have high growth potential,
or which have demonstrated high growth (in terms of number of employees, annual
revenue, or both). Venture capital firms or funds invest in these early-stage companies in
exchange for equity–an ownership stake–in the companies they invest in. Venture
capitalists take on the risk of financing risky start-ups in the hopes that some of the firms
they support will become successful. Venture capital is a way of corporate financing by
which a financial investor takes participation in the capital of a new or young private
company in exchange for cash and strategic advice. Venture capital investors look for fast-
growing companies with low leverage capacity and high-performing management teams.
Their main objective is to make a profit by selling the stake in the company in the medium
term. They expect profitability higher than the market to compensate for the increased risk
of investing in young ventures.

On option based financing, these cater for the debt capital that is given in the early ages of
a firm. This is so because the cash flows will still be so low, such that plain vanilla bonds
won’t do as they are expensive to the firm. The option based financing are in the form of
convertible bonds, bonds with warrants, callable bonds, and puttable bonds.
(10 Marks)

DR. T.J MABVURE

b. The strategies that are used by firms in accomplishing their mandate and achieve the main goal of
maximising the shareholder value are; Marketing, Human resources, Production, and Financial.
The finance manager/director is mainly concerned with which strategy? What are the main issues
under this strategy that the finance manager/director has to grapple with as he/she advises the top
management and the board of directors on the direction to take at every stage of growth of the
company? (10 Marks).
ANSWER

The finance manager/director concerned with the financial strategy. Below are the matters
that the financial manager is seized with at each level of the PLC.

Introductory stage
▪ Net cash flows will be negative or very low because revenues are still low and there are
outflows in concept development
▪ Dividends are nil because profits still low and cash flows are negative. Retention ratio is
100% in order to gain market share in the growing market.
▪ P/E ratio will be very high. Market perception that the company will do well in the
future are very high. Price per share relative to earnings per share is high.
▪ Total return(Dividend yield plus capital gain yield)
▪ The investors are the promoters of the product concept and they are the sponsors. The
investors are venture capitalists using venture capital (venture capitalists have different
portfolios in different SBUs, i.e invest in a controlling stake. They will be looking for
capital gains and not dividends. They sell their equity holdings and as soon as the
company grows they pull out. Angel capitalists are an alternative to venture capitalists.
▪ Financing structure will be all equity finance. Therefore the gearing ratio will be Nil.
The Company cannot sustain loan obligations as they come due.
▪ Operating risk (business risk) will be very high so the required rate of return by debt
holders will be high and cannot be sustained. Total risk=Operating risk+Financail risk),
so financial risk has to be maintained at low levels.

Growth Stage

▪ Still fighting competitors if the barriers to entry are very low.

▪ Net cash flows are still low because of the heavy expenditures incorporated in
strengthening the brand.
▪ Dividends payments are very low

DR. T.J MABVURE

 ▪ P/E ratio still very high
▪ Capital gains being sought for, other than dividends
▪ Gearing low because at this stage the business risk is still relatively high, that’s why
there is need for reducing financial risk by reducing borrowings
▪ Equity financing, but changed from venture because the company will be listed to
facilitate a new share issue (IPO) for expansion of the company. Equity is now
shareholders equity and the venture capitalists will pull out. At listing there will be a
price which will determine the price at which the venture will sell their share. Private
placements (approaching institutional investors such as the MIPF, PTC, NSSA, OLD
MUTUAL, etc) would also be considered when the company does not want to list.
▪ Option based financing; financing with imbedded options such as convertible
debentures, convertible bonds will be considered. This are issued at a lower cost than
plain vanilla bonds. These will be converted after a period of time agreeable. The option
to convert is not obligatory, only exercised when it’s profitable to do so. Also there can
be debentures with warrants attached, i.e. the right to buy an agreed number of the
company’s ordinary equity at an agreed time and at an agreed price (strike
price/exercise price) .A convertible is known as a European option because it can only
be exercised at an expiration date. A bond with a warrant is an American option
because it can be exercised at any time before the expiration time. It gives an option
within an option. With a warrant you become a shareholder and also a bond holder, the
warrant can be detached from the bond,i.e it can have its own market value. It’s a
highly valued instrument compared to the convertible. At this stage the company has to
take advantage of financial leverage because earnings are increasing but cannot borrow
outright because business risk is still high and financial risk has to be minimized. To go
around this problem, option based instruments have to be used. Option based bonds
(sweeteners) are cheaper than plain vanilla bonds. They reduce the total cost of
borrowing. Option based bonds can be issued at low coupon rates because they will gain
value, that is they are participating in the growth of the company. Ordinary
bondholders have a fixed return and they don’t benefit from the increase in the value of
the share. After the exercise the equity base will increase and the debt will decrease,
that is the capital structure will shift, for the convertible bonds. For the bond with
warrants, the debt levels will remain the same and the equity will increase, also with
these bonds there will be a fresh injection of funds as the shares have to be bought. With
the options the company will be preparing for the restructuring of the balance sheet, i.e
restructuring at the initial public offer (IPO) and then another restructuring at the
exercise of the options.
DR. T.J MABVURE
Maturity

This is a stage at which the balance sheet will also be restructured.

▪ Rights issue/seasoned issue; New shares to existing shareholders. The rationale is to
reward the shareholders for being loyal because they have made the company grow by
accepting low or no dividends for capital gains. The company does not want to dilute
the earnings of the shareholders.
▪ Exercise of options if convertibles and warrants had been issued.
▪ Net cash flows are now high, that is positive. High turnover with low cost of R&D. Main
expenditure is advertising rather than promotional because brand is now established.
Consolidating your position by tour brand. No need to reinvest as the market
opportunities for expansion is now low.
▪ Dividends now high because growth opportunities now reduced,i.e retentions now
reduced.
▪ Cash cow because some of the cash flows can be used to finance new SBUs.
▪ The returns now dividends yields rather than capital gains.
▪ Bond holders now interested in dividends rather than capital gains and also this holds
for all the former shareholders who the company started with.
▪ The P/E ratio now low
▪ The operating risk now very low
▪ Gearing ratio low, can now afford to have plain vanilla debt because the cash flows are
there.

Decline

▪ Divesting/harvesting
▪ Zero opportunities
▪ Total dividend, that is 100% payout
▪ Not able to increase borrowings because the required rate of return will be high. If the
company increase borrowings and the company is wound up the share of the debt
holders will increase in the company. Therefore the debt/equity ratio has to be
decreased.
▪ The company will grow(g) at the same rate as the growth of the economy
(10 Marks)

[Total: 20 Marks]

DR. T.J MABVURE

QUESTION TWO

a. Firms are exposed to systematic and non-systematic risk.

i. Using clear illustrations show that non-systematic risk can be diversified away, whereas
systematic cannot. (10 marks)
ANSWER
Firm specific risk, industry specific risk, and sector specific risk are diversifiable risk. This is risk
specific a sector, firm, and industry. In order to do away with this risk there is need to invest in
more firms or industries as investing in one firm, industry, or sector is akin to putting eggs in one
basket. Market risk cannot be diversified away regardless or the number of counters you may
invest in. The diagram attracts 3 Marks. (10 Marks)

ii. Discuss differences between systemic risk and systematic risk. (10 Marks)
ANSWER
Market risk is the non-diversifiable risk of a firm. It’s also known as systematic risk and it is
represented by the beta (β) coefficient. The three kinds of market risk are: Inflation risk, interest
rate risk, and exchange rate risk. These risks cannot be diversified away regardless of the many
counters, sectors, or industries one may invest in. (10 Marks)
NB. Students to explain satisfactorily each type of risk, and not just state the risk. Three marks
for each risk and a mark for good presentation.
[Total: 20 Marks]

QUESTION THREE

Mandere Plc has sales per share of $1100 and earnings of $565 per share. The book value of Equity
was $846 per share. The company paid out dividends form the net earnings after tax of the firm at a
rate of 60%. It’s estimated that the current period, which is a high growth period will last for 20
years. During this period non-diversifiable risk will be 1.25, Money market rate will be 20%, and the
Return on the market for long term securities will be 30%. After the high growth period the growth
rate will stabilise to 15% p.a and the retention ratio will decrease to 20%. The non-diversifiable will
drop to 0.95 and the other market parameters will remain the same.

a. Calculate the Profit Margin, Sales to book value, retention ratio, and growth rate in earnings.
(5 Marks)

DR. T.J MABVURE

 ANSWER

𝑬𝑷𝑺 𝟓𝟔𝟓
𝑷𝒓𝒐𝒇𝒊𝒕 𝑴𝒂𝒓𝒈𝒊𝒏 = = ∗ 𝟏𝟎𝟎 = 𝟓𝟏. 𝟑𝟔% = 𝟎. 𝟓𝟏𝟑𝟔
𝑺𝒂𝒍𝒆𝒔 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆 𝟏𝟏𝟎𝟎

(1 Mark)

𝑺𝒂𝒍𝒆 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆 𝟏𝟏𝟎𝟎

𝑺𝒂𝒍𝒆𝒔 𝑻𝒐 𝑩𝒐𝒐𝒌 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑬𝒒𝒖𝒊𝒕𝒚 = = = 𝟏. 𝟑𝟎 (𝟏 𝑴𝒂𝒓𝒌)
𝑩𝑽𝑬 𝟖𝟒𝟔

𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐢𝐨 = 𝟒𝟎%

𝑷𝒂𝒚𝒐𝒖𝒕 𝑹𝒂𝒕𝒊𝒐 = 𝟏 − 𝟎. 𝟒𝟎 = 𝟎. 𝟔𝟎 (1 Mark)

𝑬𝑷𝑺 𝑺𝒂𝒍𝒆𝒔 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆 𝑺𝒂𝒍𝒆𝒔 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆

𝑮𝒓𝒐𝒘𝒕𝒉 = 𝒃 ∗ 𝑺𝒂𝒍𝒆𝒔 𝑷𝒆𝒓 𝑺𝒉𝒂𝒓𝒆 ∗ = 𝒃 ∗ 𝑷𝑴 ∗ == 𝟎. 𝟒𝟎 ∗ 𝟎. 𝟓𝟏𝟑𝟔 ∗
𝑩𝑽𝑬 𝑩𝑽𝑬

𝟏. 𝟑𝟎 = 𝟎. 𝟐𝟔𝟕𝟎𝟕𝟐 = 𝟐𝟔. 𝟕𝟎𝟕𝟐% = 𝟐𝟔. 𝟕𝟏%(2 Marks)

b. Determine the Price to Sales multiple and commend on your findings. (10 Marks)

ANSWER

𝑲𝒆 = 𝑹𝒇 + 𝜷(𝑹𝒎 − 𝑹𝒇) = 𝟐𝟎 + 𝟏. 𝟐𝟓(𝟑𝟎 − 𝟐𝟎) = 𝟑𝟐. 𝟓% (1 Mark)

𝑲𝒆𝒏 = 𝟐𝟎 + 𝟎. 𝟗𝟓(𝟑𝟎 − 𝟐𝟎) = 𝟐𝟗. 𝟓% (1 Mark)
𝑷𝒂𝒚𝒐𝒖𝒕 = 𝟔𝟎% = 𝟎. 𝟔
𝑷𝒂𝒚𝒐𝒖𝒕𝒏 = 𝟖𝟎% = 𝟎. 𝟖
𝒈𝒏 = 𝟏𝟓%

(𝟏 + 𝒈)𝒏
𝑷𝒂𝒚𝒐𝒖𝒕(𝟏 + 𝒈) (𝟏 − ) 𝑷𝒂𝒚𝒐𝒖𝒕𝒏 (𝟏 + 𝒈𝒏 )(𝟏 + 𝒈)𝒏
(𝟏 + 𝑲𝒆)𝒏
𝑷𝑺 = 𝑷𝑴 ⌈ + ⌉
𝑲𝒆 − 𝒈 (𝑲𝒆𝒏 − 𝒈𝒏)(𝟏 + 𝑲𝒆)𝒏

(1 Mark)
(𝟏. 𝟐𝟔𝟕𝟏)𝟐𝟎
𝟎. 𝟔𝟎(𝟏. 𝟐𝟔𝟕𝟏) (𝟏 − ) 𝟎. 𝟖(𝟏. 𝟏𝟓)(𝟏. 𝟐𝟔𝟕𝟏)𝟐𝟎
(𝟏. 𝟑𝟐𝟓)𝟐𝟎
𝑷𝑺 = 𝟎. 𝟓𝟏𝟑𝟔 ⌈ + ⌉𝑭
⌈ 𝟎. 𝟑𝟐𝟓 − 𝟎. 𝟐𝟔𝟕𝟏 (𝟎. 𝟐𝟗𝟓 − 𝟎. 𝟏𝟓)(𝟏. 𝟑𝟐𝟓)𝟐𝟎 ⌉
⌈ ⌉
𝑷𝑺 = 𝟎. 𝟓𝟏𝟑𝟔(𝟕. 𝟕𝟓𝟕𝟗𝟕𝟖𝟑𝟐𝟕 + 𝟐. 𝟓𝟗𝟔𝟎𝟗𝟏𝟗𝟗𝟓) = 𝟓. 𝟑𝟏𝟕𝟖𝟓𝟎𝟓𝟏𝟕 (4 Marks)

Comment

The PS multiple is 5.32. This is the fundamental PS. If the market PS is below 5.32then it
means that the market is undervaluing the firm and if the market PS is above 5.32 it means
that the market is overvaluing the firm. The PS multiple can also be used to compare firms
across industries, across countries, etc. If the PS multiple is below or above the one across
markets, industries, then the finance manage has to be guided accordingly and advise how the

DR. T.J MABVURE

firm should steer itself to within the levels of other industries or markets. However comparison
across industries and markets are always without its other challenges as there may be
fundamental differences in these different markets. (3 Marks)

NB. To earn full marks student has to comment on issues of the PS multiple in relationship to
the local market as well as across industries and across markets.

QUESTION FOUR

Donald PLC has reported the following

2019(Reported) 2020(Projected)
$’000 $’000
Net Income 14 000 18 500
Capital Expenditures 2 000 3 800
Depreciation 2 500 2 800
Working Capital (2018, $800) 600 400
Debt (Market Value) 30 000
Equity (Market Value) 80 000
Principal Repayments 6 000 6 000
Proceeds from new Debt Issues 9 000

The firm plans to increase the debt ratio to 35% by end of year 2020. This debt ratio is considered
optimal. To achieve this target the company plans to finance its capital expenditures and working
capital needs between 2019 and 2020 by 30% Equity and 20% Preferred capital.
Required
Calculate the FCFE for 2019 and 2020 (10 Marks)

ANSWER

𝐏𝐫𝐨𝐜𝐞𝐞𝐝𝐬 𝐟𝐫𝐨𝐦 𝐧𝐞𝐰 𝐝𝐞𝐛𝐭 𝐢𝐬𝐬𝐮𝐞𝐬 = 𝐏𝐫𝐢𝐧𝐜𝐢𝐩𝐚𝐥 𝐫𝐞𝐩𝐚𝐲𝐦𝐞𝐧𝐭𝐬 + 𝐝(𝐂𝐀𝐏𝐄𝐗 + 𝚫𝐖𝐂)

𝐏𝐫𝐨𝐜𝐞𝐞𝐝𝐬 𝐟𝐫𝐨𝐦 𝐧𝐞𝐰 𝐝𝐞𝐛𝐭 𝐢𝐬𝐬𝐮𝐞𝐬 = 𝟔𝟎𝟎𝟎 + 𝟎. 𝟓(𝟑𝟖𝟎𝟎 − 𝟐𝟎𝟎) = $𝟕𝟖𝟎𝟎 (2 Marks)

2019 2020
Net Income 14000 (1/2 Mark) 18500 (1/2 Mark)
Depreciation 2500 (1/2 Mark) 2800 (1/2 Mark)
Cash Flow from Operations 16500 (1/2 Mark) 21300 (1/2 Mark)
CAPEX (2000) (1/2 Mark) (3800) (1/2 Mark)
∆WC 200 (1/2 Mark) 200 (1/2 Mark)
Principal Repayments (6000) (1/2 Mark) (6000) (1/2 Mark)
Proceeds from New Debt Issues 9000 (1/2 Mark) 7800 (1/2 Mark)
FCFE 17700 (1/2 Mark) 19500 (1 /2Mark)

DR. T.J MABVURE

QUESTION FIVE
Machismo Plc has reported net earnings after-tax (Net Income) of $2 500 000 and paid a 30%
dividend. The shareholders equity was reported to be having a book value of $5 000 000. The other
information for the company is presented below.
Current Information $’000
Operating Earnings 7 000
Capital Expenditures 5 900
Depreciation 4 800
Working capital 13% of Revenues
Revenues 10 000
Tax rate for all periods 30%

High Growth Period Information

Length of Period 4 years
The Current growth rate will be maintained in the high Growth phase. Capital expenditures,
revenues, depreciation, earnings, and dividends will grow at this growth rate.
Debt Capital ratio 10%
Preference Share Capital Ratio 5%
Pre-tax cost of debt 13%
Cost of Preferred capital 10%
Working capital as a percentage of Revenues 13%
Non-diversifiable risk 1.70
Risk Premium 8%
Return on market for short term securities 18%

Transition Growth Period Information

Length of period 4 years
Growth rate in operating earnings & revenues will decline from year four (4) to year eight (8)
linearly. The growth rate will be 17.5% in year eight (8).
Growth rate in Capital expenditures 17.5%
Growth rate in Depreciation 22%
Non-diversifiable Risk will drop from 1.70 to 1.0 in year 8 linearly
Return on the market for shares 20%
Return on the market for short term securities 14%
Working capital as a percentage of revenues 10%
Debt ratio 20%
Preference Share Capital Ratio 10%
After tax cost of debt 11%
Cost of preferred Capital 8%

Stable Growth Period Information

Growth rate in operating earnings and revenues will be 8% in perpetuity
After tax cost of debt 10%
Cost of preferred capital 7%
Capital expenditures and Depreciation will cancel out each other
Non-diversifiable risk 0.6
Return on the market for long-term securities 15%
Money Market Rate of Return 10%
Debt ratio 25%
Preferred capital ratio 15%
Working capital as a percentage of Revenues 9%

DR. T.J MABVURE

Required
Determine the value of Machismo Plc and comment on how your findings will assist all the
stakeholders and potential stakeholders of the company. (25 Marks)
[Total: 25 Marks]

ANSWER

𝑹𝒆𝒕𝒆𝒏𝒕𝒊𝒐𝒏 𝑹𝒂𝒕𝒊𝒐 = 𝟏 − 𝑷𝒂𝒚𝒐𝒖𝒕 𝑹𝒂𝒕𝒊𝒐 = 𝟏 − 𝟎. 𝟑𝟎 = 𝟎. 𝟕𝟎 (1/2 Mark)

𝑵𝑰 𝟐 𝟓𝟎𝟎 𝟎𝟎𝟎 𝟏
𝑹𝑶𝑬 = ∗ 𝟏𝟎𝟎 = ∗ 𝟏𝟎𝟎 = 𝟓𝟎% ( 𝑴𝒂𝒓𝒌)
𝑩𝑽𝑬 𝟓 𝟎𝟎𝟎 𝟎𝟎𝟎 𝟐

𝒈 = 𝒃 ∗ 𝑹𝑶𝑬 = 𝟎. 𝟕𝟎 ∗ 𝟓𝟎% = 𝟑𝟓% (1/2 Mark)

HIGH GROWTH PHASE

𝑲𝒆 = 𝑹𝒇 + 𝜷(𝑹𝒎 − 𝑹𝒇) = 𝟏𝟖 + 𝟏. 𝟕(𝟖) = 𝟑𝟏. 𝟔% (1/2 Mark)

𝑾𝑨𝑪𝑪 = 𝑾𝒆 𝑲𝒆 + 𝑾𝒅 𝑲𝒅 (𝟏 − 𝑻) + 𝑾𝒑 𝑲𝒑
𝑾𝑨𝑪𝑪 = 𝟎. 𝟖𝟓 ∗ 𝟑𝟏. 𝟔 + 𝟎. 𝟏𝟎 ∗ 𝟏𝟑(𝟏 − 𝟎. 𝟑𝟎) + 𝟎. 𝟎𝟓 ∗ 𝟏𝟎 = 𝟐𝟖. 𝟐𝟕 (𝟏/𝟐 𝐌𝐚𝐫𝐤)

YEAR 0 1 2 3 4
CAPEX (g=35%) 5900.00 7965.0000 10752.7500 14516.2125 19596.8869
DEPRECIATION 4800.00 6480.0000 8748.0000 11809.8000 15943.2300
(g=35%)
REVENUES 10000.00 13500.0000 18225.0000 24603.7500 33215.0625
(g=35%)
WC(13% Of 1,300.00 1755.0000 2369.2500 3198.4875 4317.9581
Revenues)
∆WC 455.0000 614.2500 829.2375 1119.4706

EBIT (g=35%) 7000.00 9450.0000 12757.5000 17222.6250 23250.5438

Less T(EBIT) 2100.00 2835.0000 3827.2500 5166.7875 6975.1631
Less CAPEX-DEP 1100.00 1485.0000 2004.7500 2706.4125 3653.6569
Less ∆WC 455.0000 614.2500 829.2375 1119.4706
FCFF 4675.0000 6311.2500 8520.1875 11502.2531

(3 Marks)

𝟒𝟔𝟕𝟓. 𝟎𝟎𝟎 𝟔𝟑𝟏𝟏. 𝟐𝟓𝟎 𝟖𝟓𝟐𝟎. 𝟏𝟖𝟕𝟓 𝟏𝟏𝟓𝟎𝟐. 𝟐𝟓𝟑𝟏

𝑷𝑽 = + + + = $𝟏𝟓𝟕𝟔𝟔. 𝟔𝟒 (𝟐 𝐌𝐚𝐫𝐤𝐬)
(𝟏. 𝟐𝟖𝟐𝟕)𝟏 (𝟏. 𝟐𝟖𝟐𝟕)𝟐 (𝟏. 𝟐𝟖𝟐𝟕)𝟑 (𝟏. 𝟐𝟖𝟐𝟕)𝟒

81, 41
TRANSITION PHASE

𝟑𝟓 = 𝟏𝟕. 𝟓
𝒈= = 𝟒. 𝟑𝟕𝟓 (𝟏/𝟐 𝐌𝐚𝐫𝐤)
𝟖−𝟒
𝟏. 𝟕𝟎 − 𝟏. 𝟎
𝜷= = 𝟎. 𝟏𝟕𝟓 (𝟏/𝟐 𝐌𝐚𝐫𝐤)
𝟖−𝟒
DR. T.J MABVURE
Year 4 5 6 7 8
g 35 30.625 26.25 21.875 17.5
β 1.7 1.525 1.35 1.175 1
(1/2 Mark)

Ke 23.15 22.1 21.05 20

Kp 8 8 8 8
Kd 11 11 11 11

We 0.7
Wd 0.2
Wp 0.1

𝑲𝒆 = 𝑹𝒇 + 𝜷(𝑹𝒎 − 𝑹𝒇)

𝑲𝒆𝒀𝟓 = 𝟏𝟒 + 𝟏. 𝟓𝟐𝟓(𝟐𝟎 − 𝟏𝟒) = 𝟐𝟑. 𝟏𝟓 (1/2 Mark)

𝑲𝒆𝒀𝟔 = 𝟏𝟒 + 𝟏. 𝟑𝟓(𝟐𝟎 − 𝟏𝟒) = 𝟐𝟐. 𝟏 (1/2 Mark)
𝑲𝒆𝒀𝟕 = 𝟏𝟒 + 𝟏. 𝟏𝟕𝟓(𝟐𝟎 − 𝟏𝟒) = 𝟐𝟏. 𝟎𝟓 (1/2 Mark)
𝑲𝒆𝒀𝟖 = 𝟏𝟒 + 𝟏(𝟐𝟎 − 𝟏𝟒) = 𝟐𝟎 (1/2 Mark)

𝑾𝑨𝑪𝑪 = 𝑾𝒆 𝑲𝒆 + 𝑾𝒅 𝑲𝒅 (𝟏 − 𝑻) + 𝑾𝒑 𝑲𝒑

𝑾𝑨𝑪𝑪𝒚𝟓 = 𝟎. 𝟕 ∗ 𝟐𝟑. 𝟏𝟓 + 𝟎. 𝟐 ∗ 𝟏𝟏 + 𝟎. 𝟏 ∗ 𝟖 = 𝟏𝟗. 𝟐𝟎𝟓 (1/2 Mark)

𝑾𝑨𝑪𝑪𝒚𝟔 = 𝟎. 𝟕 ∗ 𝟐𝟐. 𝟏 + 𝟎. 𝟐 ∗ 𝟏𝟏 + 𝟎. 𝟏 ∗ 𝟖 = 𝟏𝟖. 𝟒𝟕 (1/2 Mark)
𝑾𝑨𝑪𝑪𝒚𝟕 = 𝟎. 𝟕 ∗ 𝟐𝟏. 𝟎𝟓 + 𝟎. 𝟐 ∗ 𝟏𝟏 + 𝟎. 𝟏 ∗ 𝟖 = 𝟏𝟕. 𝟕𝟑𝟓 (1/2 Mark)
𝑾𝑨𝑪𝑪𝒚𝟖 = 𝟎. 𝟕 ∗ 𝟐𝟎 + 𝟎. 𝟐 ∗ 𝟏𝟏 + 𝟎. 𝟏 ∗ 𝟖 = 𝟏𝟕 (1/2 Mark)

5 6 7 8
Ke 23.15 22.1 21.05 20
WACC 19.205 18.47 17.735 17

4 5 6 7 8
CAPEX (g=17.5%) 19,596.89 23026.3421 27055.9519 31790.7435 37354.1236
DEPRECIATION 15,943.23 19450.7406 23729.9035 28950.4823 35319.5884
(g=22%)
REVENUES 33,215.06 43387.1754 54776.3089 66758.6265 78441.3861
WC(10% Of 4,317.96 4338.7175 5477.6309 6675.8627 7844.1386
Revenues)
∆WC 1,119.47 20.7594 1138.9134 1198.2318 1168.2760

EBIT 23,250.54 30371.0228 38343.4163 46731.0386 54908.9703

Less T(EBIT) 6,975.16 9111.3068 11503.0249 14019.3116 16472.6911
Less CAPEX-DEP 3,653.66 3575.6015 3326.0484 2840.2612 2034.5352
Less ∆WC 1,119.47 20.7594 1138.9134 1198.2318 1168.2760
FCFF 11,502.25 17663.3550 22375.4296 28673.2340 35233.4680

DR. T.J MABVURE

 (3 Marks)

Diagram of the three stages showing time and the respective growth rates (1 Marks)

5 6 7 8
WACC 1.19205 1.1847 1.17735 1.17

𝟏𝟕𝟔𝟔𝟑. 𝟑𝟓𝟓𝟎 𝟐𝟐𝟑𝟕𝟓. 𝟒𝟐𝟗𝟔

𝑷𝑽 = 𝟒
+
(𝟏. 𝟏𝟗𝟐𝟎𝟓)(𝟏. 𝟐𝟖𝟐𝟕) (𝟏. 𝟏𝟖𝟒𝟕)(𝟏. 𝟏𝟗𝟐𝟎𝟓)(𝟏. 𝟐𝟖𝟐𝟕)𝟒
𝟐𝟖𝟔𝟕𝟑. 𝟐𝟑𝟒𝟎
+
(𝟏. 𝟏𝟕𝟕𝟑𝟓)(𝟏. 𝟏𝟖𝟒𝟕)(𝟏. 𝟏𝟗𝟐𝟎𝟓)(𝟏. 𝟐𝟖𝟐𝟕)𝟒
𝟑𝟓𝟐𝟑𝟑. 𝟒𝟔𝟖𝟎
+ = $𝟐𝟒𝟑𝟖𝟕. 𝟒𝟕𝟔𝟑𝟗
(𝟏. 𝟏𝟕)(𝟏. 𝟏𝟕𝟕𝟑𝟓)(𝟏. 𝟏𝟖𝟒𝟕)(𝟏. 𝟏𝟗𝟐𝟎𝟓)(𝟏. 𝟐𝟖𝟐𝟕)𝟒

(2 Marks)

STABLE PHASE

Kp 7
Kd 10

We 0.6
Wd 0.25
Wp 0.15

9
g 8
β 0.6

Rf 10
Rm 15

𝑲𝒆𝒀𝒓𝟗 = 𝑹𝒇 + 𝜷(𝑹𝒎 − 𝑹𝒇)

𝑲𝒆𝒀𝒓𝟗 = 𝟏𝟎 + 𝟎. 𝟔(𝟏𝟓 − 𝟏𝟎) = 𝟏𝟑% (1/2 Mark)
𝑾𝑨𝑪𝑪 = 𝑾𝒆 𝑲𝒆 + 𝑾𝒅 𝑲𝒅 (𝟏 − 𝑻) + 𝑾𝒑 𝑲𝒑
𝑾𝑨𝑪𝑪 = 𝟎. 𝟔 ∗ 𝟏𝟑 + 𝟎. 𝟐𝟓 ∗ 𝟏𝟎 + 𝟎. 𝟏𝟓 ∗ 𝟕 = 𝟏𝟏. 𝟑𝟓% (1/2 Mark)

Year 9
Ke 13

DR. T.J MABVURE

WACC 11.35

8 9
REVENUES 78,441.39 84716.6970
(g=8%)
WC(9% Of 7,844.14 7624.5027
Revenues)
∆WC 1,168.28 -219.6359

EBIT 54,908.97 59301.6879

Less T(EBIT) 16,472.69 17790.5064
Less ∆WC 1,168.28 -219.6359
FCFF 35,233.47 41730.8174
(1 Marks)

𝐅𝐂𝐅𝐅𝒏 (𝟏+𝒈) 𝟒𝟏𝟕𝟑𝟎.𝟖𝟏𝟕𝟒

𝑻𝑽 = = =1 245 696.0427 (1 Marks)
𝑾𝑨𝑪𝑪𝒏 −𝒈𝒏 𝟎.𝟏𝟏𝟑𝟓−𝟎𝟎𝟖

𝟏 𝟐𝟒𝟓 𝟔𝟗𝟔. 𝟎𝟒𝟐𝟕

𝑷𝑽 𝑶𝒇 𝑻𝑽 = = $𝟐𝟑𝟔 𝟓𝟒𝟔. 𝟗𝟕𝟑𝟑
(𝟏. 𝟏𝟕)(𝟏. 𝟏𝟕𝟕𝟑𝟓)(𝟏. 𝟏𝟖𝟒𝟕)(𝟏. 𝟏𝟗𝟐𝟎𝟓)(𝟏. 𝟐𝟖𝟐𝟕)𝟒

(1 Marks)

𝑷𝟎 = 𝟏𝟓 𝟕𝟔𝟔. 𝟔𝟒 + 𝟐𝟒 𝟑𝟖𝟕. 𝟒𝟕𝟔𝟑𝟗 + 𝟐𝟑𝟔 𝟓𝟒𝟔. 𝟗𝟕𝟑 = $𝟐𝟕𝟔 𝟕𝟎𝟏. 𝟎𝟖𝟗𝟕

(1 Mark)

COMMENT
The fair price according to the fundamentals is $276 701.0897. Any price above will mean the
price is overvalued and any price below means the firm is under-priced. So investors are better
guided when buying the firm in the Real Estate market. The value is also beneficial for
mergers and acquisitions purposes. (2
Marks)

QUESTION SIX
Ranco Plc has the following ratios.
A*/S 8.70
L*/S 5.98
Profit Margin 0.75
Dividend Payout Ratio 0.86
DR. T.J MABVURE
 Sales last year were $629 million

Required
The financing gap can be closed by internal sources as well as external sources. Ranco Plc is going
through a lot and therefore is unable to raise capital through external means. The company is already
over borrowed and the bond covenants no longer allow the company to flex its muscles by going
outside the firm for financial assistance. The existing shareholders are also unwilling to contribute
more capital as they are strained and there are fears that there will be a lot of dilution of their shares,
so to maintain its value no more raising capital has been ascended to. Gathering external capital is
very expensive in the environment that Ranco Plc is operating. As a finance manager of the company
you have been mandated to advise the company on the growth rate that the firm can grow at without
having to raise more capital through preferences shares, ordinary shares, as well as debt capital. The
company wants you to determine the growth rate scientifically, therefore you are required to make
the necessary calculations and then compile a report that you have to present at the next board of
directors meeting which is due in five days from now. (10 marks)
`

ANSWER

𝑨𝑭𝑵 = (𝑨∗ ⁄𝑺)∆𝑺 − (𝑳∗ ⁄𝑺)∆𝑺 − 𝑴𝑺𝟏 (𝟏 − 𝒅𝒊𝒗) (1 Mark)

𝟎 = (𝑨∗ ⁄𝑺)𝒈𝑺𝟎 − (𝑳∗ ⁄𝑺)𝒈𝑺𝟎 − 𝑴𝑺𝟏 (𝟏 − 𝒅) (1 Mark)
= 𝟖. 𝟕𝟎𝒈𝑺𝟎 − 𝟓. 𝟗𝟖𝒈 ∗ 𝟔𝟐𝟗 − 𝟎𝟕𝟓(𝟔𝟐𝟗 + 𝒈𝟔𝟐𝟗)(𝟏 − 𝟎. 𝟖𝟔) (1 Mark)
𝟖. 𝟕𝟎𝒈𝟔𝟐𝟗 − 𝟓. 𝟗𝟖𝒈 ∗ 𝟔𝟐𝟗 − 𝟎. 𝟕𝟓(𝟔𝟐𝟗 + 𝒈𝟔𝟐𝟗)(𝟏 − 𝟎. 𝟖𝟔)=0 (1 Mark)
𝟓𝟒𝟕𝟐. 𝟑𝒈 −3761.42g-0.75(88.06+88.06g)=0 (1 Mark)
𝟓𝟒𝟕𝟐.3g-3761.42g-66.045-66.045g=0 (1 Mark)
𝟏𝟔𝟒𝟒.835g=66.045 (1 Mark)
𝟔𝟔.𝟎𝟒𝟓
𝒈 = 𝟏𝟔𝟒𝟒.𝟖𝟑𝟓 =0.040152963 (1 Mark)

g=4.0153%

The maximum growth rate the company can achieve without having to employ external funds is
4.0153% (2 Marks)

END OF EXAMINATION

DR. T.J MABVURE