Question 1 [30]

Securotech (Pty) Ltd re9uires additional funding to develop a face recognition system to add to its current line of security products. The company re9uires an additional R4.2 million for this purpose but is uncertain whether to raise funds from additional e9uity finance or by making use of debt finance. As the project team's finance representative, you need to assist the team in identifying and recommending the best financing option to management. The following information is available to the team:

Statement of financial position as at 28 February 2021

R

Assets

Non-current assets

4 500 000

Current assets

1560 000

Total assets

6 060 000

E9uity and liabilities

E9uity:

3 550 000

Share capital (300 000 issued ordinary shares)

2 300 000

Non-distributable reserves

750 000

Distributable reserves

500 000

Liabilities:

Long-term liabilities

2 000 000

15% non-convertible preference shares

800 000

Long-term loan

1 200 000

Current liabilities

510 000

Trade and other payables

450 000

Bank overdraft

60 000

Total e9uity and liabilities

6 060 000

Additional information:

The shareholders' re9uired return Ck.) is 18%.

The company recently paid a dividend of R9.50 per share and expects dividends to increase by 4% per year.

Preferencesharesarecurrently trading in the market at 12%.

The long-term loan matures in six years. The loan's interest is 11.2% per annum, while the current market rate for long-term loans is 16%.

The corporate tax rate is 28%.

The company has set its target debte equity ratio at 30:70.

Required:

Show all calculations used to prepare the answer and round off all answers to the nearest rand.

Use the information provided to determine and recommend the best financing option for the project to Securotech's management.

Question 2 [30]

AltEn Ltd is an electricity provider that generates electricity using different technologies and then supplies electricity to the national electricity grid. The company is considering whether to invest in one of two competing technologies to generate more electricity. The one project generates electricity using wind power (WP), while the second project uses solar power (SP). Both projects re9uire an initial investment of R12 000 000. Alt En, however, has capital available to invest in only one of the two projects.

AltEn's executive management (EXCO) has decided to evaluate the expected returns and risks from these opportunities and the returns and risks from existing operations CEO) based on an analysis of three possible economic conditions. The economic conditions are pessimistic, normal and optimistic.

From their analysis, they have prepared the following estimated returns and risks for the projects and existing operations and the probabilities for the different economic scenarios:

Expected returns from WP, SP and EO

Economy

Probability (P)

WP CRwp)

px RwP

Optimistic

35%

25.0%

8.8%

Normal

45%

25.0%

10.0%

Pessimistic

25%

(5.0%)

(1.3%)

WP=

17.5%

Economy

Probability (P)

SP CRsp)

PxRsP

Optimistic

35%

(2.0%)

(0.7%)

Normal

40%

17.0%

6.8%

Pessimistic

25%

30.0%

7.5%

SP=

13.6%

Economy

Probability (P)

EO CRrn)

PxRrn

Optimistic

35%

(10.0%)

(3.5%)

Normal

40%

20.0%

8.0%

Pessimistic

25%

30.0%

7.5%

EO =

12.0%

EXCO also believes that the risks and returns per R1.00 of existing operations' current market value are similar to those of the stock market. The current rate of return of short-term government bonds is 8% per year.

Required:

For both projects WP and SP, calculate:

2.1.

2.2.

2.3.

Their covariance with existing operations Their beta values

Their re9uired returns using the capital asset pricing model (CAPM)

(14)

(6)

(10)

Question 3 [41]

Fem Fashion (Pty) Ltd and Styles (Pty) Ltd are competitors. Their retail store branches are selling ladies fashion clothing and accessories. Their shareholders expect them to follow the most efficient capital financing strategies that will optimise shareholder returns, measured in earnings per share (EPS).

The current 2021 economic environment is depressed and consumer spending on fashion items and accessories has decreased significantly since the middle of 2020. Expectations arethatconsumer confidence and spending are still decreasing, and economic growth predictions are downwards adjusted. Both companies expect that sales and profits will not improve in the remainder of 2021.

You have been provided with the following information concerning the current (2021) financial position of both companies:

Sales revenue

FEM

R4 250 000

STYLE

R3 825 000

EBIT (percentage of sales)

45%

42%

Taxation

28%

28%

Ordinary shares issued Debt at 12% per annum

Debt at 10% per annum

2 600 000

R1800000

1900 000

R2 500000

Additional information:

Fem Fashion's management expects sales to decrease by 8% in 2022 and EBIT to e9ual 40% of decreased sales.

Styles' management estimates that sales in 2022 will decrease by 12% and EBIT will e9ual 38% of decreased sales.

Required:

Which company is adding more value for its shareholders despite the poor economic conditions and downwards adjusted expectations? Support your answer with relevant calculations.

Question 4 [19]

Farmers Friend (Pty) Ltd is a supplier of products to the agricultural industry. The company wishes to add a surveillance drone to its product range. The drone will enable farmers to survey and manage remote areas on their farms. Farmers can also use the drone for security purposes.

The most suitable drone available in the market re9uires an initial investment of R520 000, all costs included.

The project team responsible for investigating and making a recommendation about this new product's feasibility and profitability provided the following information and re9uested your assistance with the feasibility study:

Year

Net cash

flows#

1

R 380

000

2

R 355

000

3

R 300

000

#Note: Cash flows need to be adjusted for a wear and tear allowance and taxation.

Additional information:

Owing to rapid technology development, the company believes that the drone will have no value at the end of three years.

The company's current weighted average cost of capital is 15%.

The corporate tax rate is 28%.

Wear and tear allowances for years 1, 2 and 3 are 50%, 30% and 20%, respectively.

Required:

Round off all calculations to the nearest rand.

Apply the net present value (NPV) technique to assess the viability of the acquisition of the surveillance drone and use theresults of the analysis to make a recommendation to management. The cash flows must be adjusted for the effects of the wear and tear allowance and taxation. Support your recommendations with practical reasons.

Question 5 [55]

The management of Farmers Friend (Pty) Ltd is considering two options to finance the surveillance drone should the project team recommend purchasing the drone. The most suitable drone available in the market re9uires an initial investment of R520 000, all costs included. The cash flows must be adjusted for the effects of the wear and tear allowance and taxation.

The options are as follows:

1.Securing a medium-term loan bearing an annual interest rate of 13%. The loan is repayable in three instalments, payable at the end of each of the three years. The instalments are R220 231 per year. The NPVs%,3 = R12 915 and the NPV14%,3 = CR40 516).

2.A financial lease repayable over three years at a cost of R212 790per year. The N PV10%, 3 = R11 755 and the N PV14%,3 = CR22 314).

Additional information:

All payments are made at the end of each year.

The corporate tax rate is 28%

The loan will 9ualify as a financial instrument as per section 24J of the Income Tax Act. The yield-to maturity method will apply.

From an ownership perspective, the ownership of the leased asset will vest in the lessor. The lessee will be allowed to deduct the finance lease payments in terms of Section 11(a) of the Income Tax Act.

Required:

Show all calculations and round off all answers to the nearest cent.

Determine which financing option will be the most cost-efficient option for the company. Use the method that incorporates the effect of Section 24J of the Income Tax Act for purposes of calculating the effective cost (Internal rate of Return) of the medium-term loan.

Question 1 [30]

Securotech (Pty) Ltd re9uires additional funding to develop a face recognition system to add to its current line of security products. The company re9uires an additional R4.2 million for this purpose but is uncertain whether to raise funds from additional e9uity finance or by making use of debt finance. As the project team's finance representative, you need to assist the team in identifying and recommending the best financing option to management. The following information is available to the team:

Statement of financial position as at 28 February 2021

R

Assets

Non-current assets

4 500 000

Current assets

1560 000

Total assets

6 060 000

E9uity and liabilities

E9uity:

3 550 000

Share capital (300 000 issued ordinary shares)

2 300 000

Non-distributable reserves

750 000

Distributable reserves

500 000

Liabilities:

Long-term liabilities

2 000 000

15% non-convertible preference shares

800 000

Long-term loan

1 200 000

Current liabilities

510 000

Trade and other payables

450 000

Bank overdraft

60 000

Total e9uity and liabilities

6 060 000

Additional information:

The shareholders' re9uired return Ck.) is 18%.

The company recently paid a dividend of R9.50 per share and expects dividends to increase by 4% per year.

Preferencesharesarecurrently trading in the market at 12%.

The long-term loan matures in six years. The loan's interest is 11.2% per annum, while the current market rate for long-term loans is 16%.

The corporate tax rate is 28%.

The company has set its target debte equity ratio at 30:70.

Required:

Show all calculations used to prepare the answer and round off all answers to the nearest rand.

Use the information provided to determine and recommend the best financing option for the project to Securotech's management.

Question 2 [30]

AltEn Ltd is an electricity provider that generates electricity using different technologies and then supplies electricity to the national electricity grid. The company is considering whether to invest in one of two competing technologies to generate more electricity. The one project generates electricity using wind power (WP), while the second project uses solar power (SP). Both projects re9uire an initial investment of R12 000 000. Alt En, however, has capital available to invest in only one of the two projects.

AltEn's executive management (EXCO) has decided to evaluate the expected returns and risks from these opportunities and the returns and risks from existing operations CEO) based on an analysis of three possible economic conditions. The economic conditions are pessimistic, normal and optimistic.

From their analysis, they have prepared the following estimated returns and risks for the projects and existing operations and the probabilities for the different economic scenarios:

Expected returns from WP, SP and EO

Economy

Probability (P)

WP CRwp)

px RwP

Optimistic

35%

25.0%

8.8%

Normal

45%

25.0%

10.0%

Pessimistic

25%

(5.0%)

(1.3%)

WP=

17.5%

Economy

Probability (P)

SP CRsp)

PxRsP

Optimistic

35%

(2.0%)

(0.7%)

Normal

40%

17.0%

6.8%

Pessimistic

25%

30.0%

7.5%

SP=

13.6%

Economy

Probability (P)

EO CRrn)

PxRrn

Optimistic

35%

(10.0%)

(3.5%)

Normal

40%

20.0%

8.0%

Pessimistic

25%

30.0%

7.5%

EO =

12.0%

EXCO also believes that the risks and returns per R1.00 of existing operations' current market value are similar to those of the stock market. The current rate of return of short-term government bonds is 8% per year.

Required:

For both projects WP and SP, calculate:

2.1.

2.2.

2.3.

Their covariance with existing operations Their beta values

Their re9uired returns using the capital asset pricing model (CAPM)

(14)

(6)

(10)

Question 3 [41]

Fem Fashion (Pty) Ltd and Styles (Pty) Ltd are competitors. Their retail store branches are selling ladies fashion clothing and accessories. Their shareholders expect them to follow the most efficient capital financing strategies that will optimise shareholder returns, measured in earnings per share (EPS).

The current 2021 economic environment is depressed and consumer spending on fashion items and accessories has decreased significantly since the middle of 2020. Expectations arethatconsumer confidence and spending are still decreasing, and economic growth predictions are downwards adjusted. Both companies expect that sales and profits will not improve in the remainder of 2021.

You have been provided with the following information concerning the current (2021) financial position of both companies:

Sales revenue

FEM

R4 250 000

STYLE

R3 825 000

EBIT (percentage of sales)

45%

42%

Taxation

28%

28%

Ordinary shares issued Debt at 12% per annum

Debt at 10% per annum

2 600 000

R1800000

1900 000

R2 500000

Additional information:

Fem Fashion's management expects sales to decrease by 8% in 2022 and EBIT to e9ual 40% of decreased sales.

Styles' management estimates that sales in 2022 will decrease by 12% and EBIT will e9ual 38% of decreased sales.

Required:

Which company is adding more value for its shareholders despite the poor economic conditions and downwards adjusted expectations? Support your answer with relevant calculations.

Question 4 [19]

Farmers Friend (Pty) Ltd is a supplier of products to the agricultural industry. The company wishes to add a surveillance drone to its product range. The drone will enable farmers to survey and manage remote areas on their farms. Farmers can also use the drone for security purposes.

The most suitable drone available in the market re9uires an initial investment of R520 000, all costs included.

The project team responsible for investigating and making a recommendation about this new product's feasibility and profitability provided the following information and re9uested your assistance with the feasibility study:

Year

Net cash

flows#

1

R 380

000

2

R 355

000

3

R 300

000

#Note: Cash flows need to be adjusted for a wear and tear allowance and taxation.

Additional information:

Owing to rapid technology development, the company believes that the drone will have no value at the end of three years.

The company's current weighted average cost of capital is 15%.

The corporate tax rate is 28%.

Wear and tear allowances for years 1, 2 and 3 are 50%, 30% and 20%, respectively.

Required:

Round off all calculations to the nearest rand.

Apply the net present value (NPV) technique to assess the viability of the acquisition of the surveillance drone and use theresults of the analysis to make a recommendation to management. The cash flows must be adjusted for the effects of the wear and tear allowance and taxation. Support your recommendations with practical reasons.

Question 5 [55]

The management of Farmers Friend (Pty) Ltd is considering two options to finance the surveillance drone should the project team recommend purchasing the drone. The most suitable drone available in the market re9uires an initial investment of R520 000, all costs included. The cash flows must be adjusted for the effects of the wear and tear allowance and taxation.

The options are as follows:

1.Securing a medium-term loan bearing an annual interest rate of 13%. The loan is repayable in three instalments, payable at the end of each of the three years. The instalments are R220 231 per year. The NPVs%,3 = R12 915 and the NPV14%,3 = CR40 516).

2.A financial lease repayable over three years at a cost of R212 790per year. The N PV10%, 3 = R11 755 and the N PV14%,3 = CR22 314).

Additional information:

All payments are made at the end of each year.

The corporate tax rate is 28%

The loan will 9ualify as a financial instrument as per section 24J of the Income Tax Act. The yield-to maturity method will apply.

From an ownership perspective, the ownership of the leased asset will vest in the lessor. The lessee will be allowed to deduct the finance lease payments in terms of Section 11(a) of the Income Tax Act.

Required:

Show all calculations and round off all answers to the nearest cent.

Determine which financing option will be the most cost-efficient option for the company. Use the method that incorporates the effect of Section 24J of the Income Tax Act for purposes of calculating the effective cost (Internal rate of Return) of the medium-term loan.