QUESTION 1 (35 marks, 63 minutes)

Tech-Savvy Limited (TSL) is a technology innovation company based in Cape Town. The company

focuses on developing technological solutions which are key to making modern workers more productive.

TSL is listed on the Johannesburg Stock Exchange and has several branches across the SADC region.

During 2020 TSL identified several areas where blockchain technology can be used (use cases) in the

health, property, education, supply chain and other sectors. Blockchain is a system of recording

information in a way that makes it difficult or impossible to change, hack, or cheat the system. It is

essentially a digital ledger of transactions that is duplicated and distributed across the entire network of

computer systems on the blockchain. Any change made in the ledger has to be accepted by all the other

users across the network, making it virtually impossible for fraudulent transactions to be effected.

TSL has received support and interest from the government of South Africa by way of a grant from the

Technology Innovation Agency, for the research and development of a pilot solution for the Department of

Health for the recording of patient information.

Following the success of the pilot project TSL has pitched the adoption of the blockchain technology to

several potential users and received very positive feedback. TSL plans to set up a blockchain development

unit in order to deliver on the blockchain revenue stream. The following information was sourced from the

integrated annual report of TSL.

Extract from the statement of financial position at 31 May 2021

Rand

Equity and Liabilities

Ordinary shares (80 cents each) 500 000

Retained income 720 000

Shareholders' capital and reserves 1 220 000

15% Preference shares (R100 each) 120 000

Long term loan - FNB Bank (16,67%) 680 000

Total equity and liabilities 2 020 000

Additional information

1. Ordinary share dividends declared and paid in the previous five (5) years were as follows:

Year Dividend per share

2017 72 cents

2018 80 cents

2019 91 cents

2020 95 cents

2021 105,2 cents

The TSL Board intends to maintain the average growth in dividends.

2. The market price for ordinary shares is currently R12 per share and that of preference shares is R96

per share. New issues will have no effect on these prices, although ordinary share issue costs will

be 4% per share issued.

3. TSL aims to maintain a debt: equity ratio of 1: 1 going forward (based on book values).

4. To service the new blockchain technology clients TSL is planning to buy new high tech coding

infrastructure at a cost of R800 000 at the start of the new financial year. The company will use this

infrastructure for 5 years and then scrap it for R50 000.

5. The following options are available to finance the new initiative:

• New ordinary shares can be issued (retained earnings cannot be utilised).
• A maximum of 4 000 additional 15% preference shares of R100 each can be issued.
• A loan from Crypto Bank of R200 000 at prime + 800 basis points.
• A top-up loan from FNB Bank of R50 000 at the same rate as the existing loan, which is

considered to approximate the fair market interest rate.

The loans can only be taken at the total amounts as made available by the banks.

6. The South African Income Tax Act stipulates a company tax rate of 28% and an allowance on new

coding infrastructure of 20% per annum. The prime lending rate is currently 10,5% and is expected

to stay unchanged for the foreseeable future. The required rate of return on preference shares is

11%.

REQUIRED

(a) Determine how the new coding infrastructure should be financed, considering the funding options

available to TSL as well as the current capital structure on 31 May 2021 using book values.

For this part, assume preference share are redeemable and therefore categorised as debt.

(Calculations 10 marks; comments 2 marks) (12)

(b) Calculate the weighted average cost of capital of TSL based on market values after the

financing of the new project. For this part, assume preference shares are nonredeemable.

[Round rand amounts to the nearest cent and other numbers to the nearest two decimal

places] (13)

(c) Assuming the information below determine how long (in years) it will take TSL to recover its initial

capital investment in the new infrastructure using the discounted payback method. (5)

Description Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

2021 2022 2023 2024 2025 2026

Net cash-flows (800 000) 491 200 491 200 491 200 491 200 0

(d) Discuss qualitative factors that should be taken into account by the Board of TSL before

deciding to buy the new coding infrastructure, as well as advantages for TSL of venturing into

the development of Blockchain technology (5)

QUESTION 1 TOTAL [35]