University of Fort Hare

Together in Excellence

NKUHLU DEPARTMENT OF ACCOUNTING

FINANCIAL MANAGEMENT 3B
AFM321E
____________________________________________________________________

EXAMINATION NOVEMBER 2013

ASSESSORS: PROF. W. BROWN PROF. G. BARTLETT

Ms. DENNY EMSLIE
MR MITCHEL DUVENHAGE

MODERATOR: KEVIN FREEMAN (NMMU)

• This paper consists of 12 pages (front page included).

• Silent, non-programmable calculators may be used.
• Clearly show all calculations.
• Answers may NOT be written in pencil. NO tippex may be used.

QUESTION TOPICS COVERED MARKS

1 Investments 60

2 Valuations 25

3 Mergers and Acquisitions 30

4 Financial Statement Analysis 20

5 Sources of Finance 15

TOTAL 150

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QUESTION 1 60 MARKS

You were recently appointed as the financial manager of Buccaneer Ltd, a listed company and
manufacturer of electronic equipment.

The company is constantly considering capital projects to maintain its position in the market. All
projects that meet the strategic criteria of the company are evaluated using discounted cash
flow techniques.

SECTION A

You establish that the company is using a rate of 15% as its cost of capital. On enquiry you
were told that the rate of 15% was decided upon some seven years ago by management. In
order to establish the reliability of this rate, you are requested by management to calculate the
current weighted average cost of capital.

The most recent Statement of Financial Position of Buccaneer reflects the following:

YEAR ENDING 30 JUNE (R’000) 2013

EQUITY AND LIABILITIES
Capital and reserves 430 000
Issued share capital 100 000
Share premium 50 000
Revaluation reserve 40 000
Accumulated profits 240 000
Non-current liabilities 130 000
Redeemable preference shares 50 000
Redeemable debentures 40 000
Mortgage bond 40 000
Current liabilities 200 000
Bank overdraft 40 000
Bankers acceptance credit facility 80 000
Trade accounts payable 80 000
Total Equity and Liabilities 760 000

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The following current market information is known:

Return on preference shares 9%

Return on debentures 12%
Return on mortgage bonds 11%
Growth prospects for the electronic manufacturing sector 6%
Buccaneer’s share price cum div R14,25
Reserve Bank repo rate 5%
90 days liquid Bankers’ acceptance rate 6,5%
Buccaneer’s beta 0,9
Rate of return for the market 15%
Yield to maturity on RSA bonds 6%

Note: The bank overdraft rate is generally set at 3.5% above the reserve bank repo rate.

You establish the following:

1. Buccaneer has an authorized share capital of 50 million ordinary shares of R4 each, of

which 25 million have been issued. The annual dividend of R1 per share has recently been
declared.
2. The redeemable preference shares carry a fixed dividend of 10% and are redeemable at
the option of the company, at a premium of 5%, between 30 June 2016 en 30 June 2018.
3. The R1000 redeemable debentures, with a fixed coupon rate of 10,5% per annum, are
redeemable in two equal capital payments on 30 June 2015 and 30 June 2017.
4. The mortgage bond was negotiated at a fixed interest rate of 12,5% and is redeemable in
four equal installments, which includes capital and interest, commencing 1 July 2015.
5. The bank overdraft facility of R50 million is made available at 1,5% above the prime rate.
Management regards 60% of the facility to be of a permanent nature.
6. The rotating bankers’ acceptance credit facility is available with regard to
90 days liquid bankers’ acceptances at an annual commission of 2%. This financing source
is utilized all the time.
7. Buccaneer’s suppliers grant credit of two months on a permanent basis. One
supplier, representing 30% of creditors, offers credit terms of 1/10, 60 net.
Buccaneer does not make use of the discount and also does not include the cash
flow attributable to suppliers in the cash flow projections of projects.

REQUIRED Marks

Calculate the weighted average cost of Buccaneer’s capital by using the market
value of the various capital components as its target capital structure. 40
(Show calculations to the nearest R’000)

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SECTION B

Buccaneer is currently considering the commissioning of a modern production plant for the
production of electrical circuits.
The project manager have submitted the following projections of the sales, variable cost
of sales and fixed cost of sales for the first year (values stated as at the end of the first
year)

Cash flow End of year 1 values

Sales 300 000
Variable cost of sales -180 000
Fixed cost of sales -70 000

The following annual capacity utilization and annual price increases are expected:

Annual plant capacity utilization

Year 1 2 3 4
80% 100% 100% 100%
Annual price increases
Year 1 2 3 4
Sales 6% 6% 7% 7%
Variable cost of sales 7% 8% 8% 9%
Fixed cost of sales 5% 5% 5% 5%

 In calculating of the fixed costs deprecation of the new plant is excluded.

 Debtors amount to two months of sales.
 The plant carries one month’s inventory of raw material. Sixty percent of variable costs
comprise of raw materials.
 The new plant’s cost price is R150 million and has, after an economic life of 4 years, an
estimated remaining value, in real terms, of R20 million. The price index for such capital
equipment is set at 8% per annum. The wear and tear allowance is calculated at 20% per
annum on the original cost and the company tax rate is 28%.

REQUIRED
Marks

Calculate the economic viability of the proposed plant in nominal terms and on the
assumption that Buccaneer’s weighted average nominal cost of capital amounts to 12% per
annum. . 20

Financial Management IIIB Examination Page 4

(Show calculations to the nearest R’000)

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QUESTION 2 25 MARKS

Constructco (Pty) Ltd, an engineering and construction company is interested in acquiring a

small BEE engineering company called Technoco (Pty) Ltd. Both companies do not have long
term debt and, should Technoco be taken over, it will not result in an increase in finance risk for
Constructco.

The statement of financial position for Technoco (Pty) Ltd as at 31 December 2012 is as follows:

Non current Assets 651 600

Current Assets Inventory 515 900
Receivables 745 000
Bank 158 100
1 419 000
2 070 600

Current liabilities Accounts Payable 753 600

Bank Overdraft 862 900
1 616 500

Capital and Reserves Ordinary Shares of R1 each 50 000

Retained Income 404 100
2 070 600

Technoco's summarised income statements for the last 5 years is as follows:

2008 2009 2010 2011 2012

R R R R R
Profit before abnormal items 30 400 69 000 49 400 48 200 53 200
abnormal items 2 900 (2 200) (6 100) (9 800) (1 000)
profit after abnormal items 33 300 66 800 43 300 38 400 52 200
less: dividends 20 500 22 600 25 000 25 000 25 000
Added to retained income 12 800 44 200 18 300 13 400 27 200

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 Other information available to you:

a. There have been no changes in the issued share capital of Technoco in the past 5
years.

b. The estimated values of Technoco's non-current assets and inventory as at 31 December

2012 are:

Replacement Realisable
cost value
R R
Non-current assets 725 000 450 000
Inventory 550 000 570 000

c. It is expected that 2% of Technoco's receivables as at 31 December 2012 will be

uncollectible.

d. The cost of Capital of Constructco is 9%. The directors of Technoco estimate that the
shareholders of Technoco require a minimum return of 12% on their investment in the
company.

e. The current P/E ratio of Constructco is 12. The industry norm for engineering
companies like Technoco have P/E ratios of around 10, although this is based on much
larger companies.

f. Technoco has a very experienced management team who have been with the company
for a long time. It is noted though, that the Managing Director, Mr Thomas, who has
been with the company for 15 years will be retiring in 2014.

REQUIRED: MARKS
(a) Estimate the value of the total equity of Technoco (Pty) Ltd 12
as on 31 December 2012 using each of the following
bases:
 Replacement cost of assets
 Realisable value of Assets
 The dividend valuation model
(b) Estimate the value of the company using the P/E multiple model. 13
Your answer should include a discussion of the factors affecting
the P/E multiple and any changes that you may wish to make to
derive at maintainable earnings.

(ignore taxation)

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QUESTION 3 30 MARKS

Club Safari is a Safari tour operator in South Africa. It is wanting to expand its operations into
extreme sport tours in order to capture the ever growing overseas tourist market. Club Safari
has earmarked a small extreme sports company called Extreme SA and the directors feel that
acquiring this company will fit well with their growth strategy. Both companies have the same
level of risk.

Club Safari has decided to offer the shareholders of Extreme SA five shares for every four
shares held. The after tax savings in administrative tasks after the merger would amount to
R2 400 000.

The financial statements for each company are as follows:

Statement of Income for the Year ended 31 December 2012

Club Safari Extreme SA

Rmil Rmil

Sales 182.6 75.2

Operating Profit 43.6 21.4

Interest 12.3 10.2
Net Profit before taxation 31.3 11.2
Taxation 6.3 1.6
Net profit after taxation 25 9.6
Dividends 6 4
Accumulated Profits for the year 19 5.6

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Statements of Financial Position as at 31 December 2012

Club Safari Extreme SA

Rmil Rmil

Non-current assets 135.4 127.2

Net current assets 65.2 3.2
200.6 130.4
Long term liabilities 120.5 104.8
80.1 25.6
Capital and reserves
R0.5 ordinary shares 20 8
Retained profit 60.1 17.6
80.1 25.6

Price/earnings ratio before the bid 20 15

REQUIRED: 30 MARKS
(a) Calculate the total value of the proposed offer. 10
(b) Calculate the earnings per share of Club Safari if it does acquire 5
Extreme SA and the cost savings are achieved.
(c) Calculate the share price of Club Safari following the acquisition 4
assuming that the savings are achieved and the price earnings
ratio decreases by 5%.
(d) Calculate the effect of the takeover on the wealth of the 9
shareholders of each company (based on C above).
(e) An exchange ratio based on market values might lead to one of 2
the firms experiencing a dilution in earnings per share. Why
might shareholders be prepared to accept a dilution in EPS?

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QUESTION 4 20 MARKS

Falx Clothes Limited is a clothing retailer that has was incorporated 15 years ago and is now
listed on the JSE. You have been provided with an extract from their financial statements below
(note that all figures are in Rmillions):

STATEMENT OF FINANCIAL POSITION 2013 2012

Assets
Non-current assets 1 197 1 093
Property, plant and equipment 775 724
Goodwill 90 90
Intangible assets 94 77
Derivative financial assets 34 21
Available-for-sale assets 3 1
Loans and receivables 143 141
Deferred tax 58 39
Current assets 5 720 5 131
Inventories 670 530
Trade and other receivables 3 421 3 033
Derivative financial assets 7 28
Prepayments 62 51
Cash and cash equivalents 1 560 1 489
Total assets 6 917 6 224
Equity and liabilities
Total equity 5 981 5 046
Share capital and premium 205 159
Treasury shares -1 274 -1 191
Retained earnings 6 944 6 001
Non-distributable reserves 106 77
Non-current liabilities 97 84
Post-retirement medical benefit obligation 47 41
Cash-settled compensation obligation 12 1
Straight-line operating lease obligation 38 42
Current liabilities 839 1 094
Trade and other payables 598 875
Derivative financial liability - 1
Provisions 73 73
Tax payable 168 145
Total liabilities 936 1 178
Total equity and liabilities 6 917 6 224

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STATEMENT OF COMPREHENSIVE INCOME 2013 2012
Revenue
Sale of merchandise 8 830 7 858
Cost of sales -3 820 -3 403
Gross profit 5 010 4 455
Other income 208 189
Trading expenses -2 759 -2 421
Depreciation and amortisation -138 -129
Employment costs -890 -828
Occupancy costs -746 -652
Trade receivable costs -533 -390
Other operating costs -452 -422

Trading profit 2 459 2 223

Interest received 728 637
Dividends received 3 -
Profit before tax 3 190 2 860
Tax expense -965 -917
Profit for the period, fully attributable to owners
of the parent 2 225 1 943
Other comprehensive income/(loss)
Movement in effective portion of cash flow hedge 11 -12
Deferred tax on movement in effective portion of cash
flow hedge -3 3
Other comprehensive income/(loss) for the period,
net of tax 8 -9
Total comprehensive income for the period, fully
attributable to owners of the parent 2 233 1 934

Basic earnings per share (cents) 526.3 455.8

weighted average number of shares (millions) 422.8 426.3

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Industry ratios

Current ratio 5.9 : 1

Acid test ratio 5:1
Stock turnover 11.6
Average collection period 120 days
Total asset turnover 2.9
Debt ratio 25%
Debt / equity ratio 35%
Times interest earned 5 times
Gross profit margin 51%
Net profit margin 16%
Return on assets 25%
Return on equity 30%

Marks
REQUIRED
Based on the information provided, analyse and discuss the financial position and
performance of the company based on the following areas:
- Liquidity 20
- Asset management
- Debt management
- Profitability

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QUESTION 5 15 MARKS
EL motors has a paid-up ordinary share capital of R4,500,000. This is represented by 6 million
shares. EL motors has no loan capital. Net after tax earnings for the last year were
R3,600,000. The P/E ratio of the company is 15.
The company is wanting to buy and move to bigger premises which will cost R10,500,000 and is
considering financing this through a rights issue at R8 per share.

REQUIRED: 15 MARKS

(a) Calculate the current market price of the ordinary shares 5

(b) Calculate the value of the right. 6

(c) Explain the advantages and disadvantages of a rights issue. 4

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