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A) Any two ratios relating to capital structure using book values.

b) Advise the board members of Afrika Farming Group whether they should undertake the drone

project or not.

c) Assume the drone project will be undertaken. Calculate the number of shares to be issued or

bought back as well as the debt amount required, in order to finance the initial investment of the

drone project, taking the target capital structure into account. (Use market values).

MAC3702 Assignment 2 Semester 2 QUESTION 2 (50 marks; 90 minutes) Afrika-Farming Group (AF Group) is one of the smallest agricultural companies newly listed on the JSE's Altx Board. AF Group's head office is located in the heart of Limpopo province with 5 well established farms in Africa, and its revenue stream is primarily from sheep and crops. The sheep enterprise produces meat and wool. The crop production includes corn, wheat and soybean. AF Group is a supplier to Carry- Rite Holdings, which is the largest food retailer in Africa. 65% of the revenue generated by AF Group is from Carry-Rite Holdings and the remainder is from other food retailers. The market capitalisation for AF Group as at 31 March 2020 was R62,5 million. Joy Africa, AF Group's Chief Operations Ofcer (C00), recently attended the ARC Agri lndaba conference at Gallagher Estate in Midrand. He recognised the importance of investing in the latest technology to enhance the company's performance. The conference highlighted the use of new drone farming technology' that will enable farmers to perform well during the fourth industrial revolution (4|R\") movement. The COO therefore embarked on developing a program that will be used for the agricultural drone. The introduction of the drone farming technology is expected to increase the market value of AF Group's shares by 8.5%. The program will require an upfront investment of R10 million for the development of the ve farms' drones in total at the start of the project (assumed to be early April 2020). The COO started a series of communications with various stakeholders that will assist with the program. During the lndaba conference, he engaged with a foreign company that offers components necessary to custom build drones. This cost forms part of the initial investment AF Group will have to spend. The company will appoint a specialist to analyse the data generated by the drones and provide a detailed report to the C00 that will highlight any areas of improvement necessary to enhance performance. The report is part of the assessment provided to banks to provide proof that the farms are able to generate future cash flows. The following additional information related to the drone project is as follows: 1. Initial working capital of R1 000 000 will be invested in the project. A third of the working capital will be released soonerfrom the project in March 2023. 2. The actual drone technology will be deployed in April 2021 soon after development, and will be in use for three years after which the actual drones (hardware) will be sold for R850 000 each. 3. The data specialist will be employed from the start of the project at a cost to company of R40 000 per month. This amount will increase in line with current inflation rate. 4. It is anticipated that the data generated by the drone technology, will be put to use and in turn savings of R50 000 on fertilization and other direct farming cost will flow from the first year of the project. These costs usually escalate with 6% year on year. 5. Revenue for AF Group is expected to grow with 10% per annum in general. The research shows that of the total annual revenue generated, we can expect a 10% additional revenue to flow directly from the use of drone technology by farming more sustainably. 6. Drone software will be updated twice per year at an estimated cost of R10 000 per drone per update. The updates will start in the year after implementation. This cost will stay constant as per the agreement signed with the developer. 7. Wear and tear on the drones (hardware) are allowed by the South African Revenue Service over a period of five years from the time the asset is brought into use. 8. Cash flows take place at the end of the year unless suggested otherwise, and the company requires an internal rate of return of 18%. \"Drone farming technology: An agricultural drone an unmanned aerial vehicle used to help optimise agn'culture operationsI increase crop production and monitors crop growth. Sensors and digital imaging capabilities can give farmers a richer picture of their fields. \"Fourth industrial revolution (din) - Is a period in which one or more technologies is replaced by another technology in a short amount of time and is characterised by new innovations. Expansion Plans The company has recently been looking to expand its operations. Koppies Dairy (Pty) Ltd (Koppies) has been identified as a potential business to acquire. Koppies is a dairy processing company and produces dairy food Items and dairy-based beverages in South Africa. The business operates according to ethiml business practices and management places big emphasis on integrity. Responsibility is cascaded from the leadership. to support services and entities, and people at all levels must ensure that Koppies' vision flows seamlessly through the entire value chain. The directors of AF Group presented as part of the annual report the following annual financial statements for the period ending 31 March 2020. AFRIKA-FARMING GROUP Statement of financial position At 31 March 2020 - s\" Notes R'llllll R'OOO sssss - Non-current assets _-m-Hl Other financial assets PropertyI plant and equipment Investments accounted for using the equity method Long-ten'n deposits Other assets Deferred tax assets Goodwill Current assets Cash and cash : uuivalents Inventories Trade and other receivables Other current financial assets Contract assets Current income tax assets Total 888818 | Equity I Capital and reserves 1 I 17 613 I 12 086 | | Non-current liabilities | 3 91 2 l 4 250 Borrowings 2 | 3 912 | 4 250 | | Current liabilities 3 477 2 896 Borrowings 2 1 272 1 393 Other financial liabilities 900 599 Current taxation 71 3 512 Trade and other payables 592 392 Total equity and liabilities I 25 002 | 19 232 AFRIKA-FARMING GROUP Statement of profit or loss For the year ended 31 March 2020 2020 2019 Notes R'000 R'000 Revenue 46 732 34 443 Cash operating costs 29 3'82! 22 7892 Operating profit 16 950 11 654 Other income 432 160 Net foreign exchange gain 52 45 Selling and general administrative expenses 53 232} 2 903) Profit before net finance costs 14 202 8 956 Net finance costs 103 1? nance income Finance costs 3 Profit before tax 14 099 8 939 Income tax f3 7362 g2 3692 Profit for the year 10 363 6 570 The following information applies to 2020 and 2019: 2020 2019 Inflation rate (96) 4,0 4,75 Prime interest rate (5%.) 10,25 10,0 JIBAR (12 month) (96) 7,75 8,10 Operating days 350 350 Corporate tax rate South Africa (%) 28 28 Target capital structure (20% streamer Ilo the Loan and the 20:80 20:80 bahnce is equaffy split between bonds and dabenurrasj Notes to the financial statements for 31 March 2020 and 2019 respectively. 1. The following make up the capital and reserves at the end of the year. R'000 2020 2019 Ordinary shares (issued at R10 each) 5 000 5 000 Non-distributable reserves 4 323 1 389 Retained earnings 8 290 5 697 Total equity 1? 613 12 086 2. Borrowings relate to capital portion outstanding: R'000 2020 9% Loan 2 791 12% Corporate Bonds 410 6,33% Debentures 711 Total debt securities and long term borrowings 3 912 Short-term loans 846 Bank overdraft 426 5 184 12 3. 9% Loan: AF Group obtained a loan from Land Bank on 1 April 2017 and it was secured over the company's property, plant and equipment and will be repaid on 30 March 2025 This loan carries an interest rate 01 8,9851%. The interest rate on similar loan trades at prime interest rate less 250 basis points. 12% Corporate Bonds: The corporate bonds were issued three years ago, and are considered part of the permanent capital structure. Similar bonds are trading at 150 basis points above the prime interest rate. 6.33% Debentures: Debentures are redeemable on 31 March 2026 and upon redemption AF Group will pay the debenture holders an extra R30 000 (which is deductible for tax purposes). The average going interest rate in the market for such debentures is estimated at 8.35% per annum before tax. 11,25% Short-term loan 5: The short-term loans will be repaid on 30 September 2020. Bank overdraft: The bank overdraft is a revolving facility attracting an interest rate at prime. The company was first granted the overdraft facility line in April 2017. Included in the finance costs for 2020 is R104 000 allocated to short-term borrowings