QUESTION 1

Read the case study/ scenario below and answer the questions based on the case study. Gecko Limited (GL) is a company that is in the fast moving consumer goods market (FMCG). The company is listed on the Johannesburg Securities Exchange (JSE) in order to raise capital from different sources to expand operations. GL has analysed an investment into a new computer platform from the 2021 year onwards. Below is the net present value analysis (NPV) for the proposed investment prepared by the CFO of the company:

Notes: GLs Chief Financial Officer (CFO) expects that revenue and operating costs will increase by inflation (around 6%) year on year. However, the CFO is of the opinion that the net present value should be prepared using real amounts, not nominal, and as a result has not included the effects in the revenue or operating costs above.

The opportunity cost represents annual instalments in terms of the supply licence agreement, to which GL will no longer be entitled.

GL is currently in a lease agreement with OPCO SA (Pty) Ltd. The annual instalments on the lease are R480 000 per annum. The lease agreement was entered into on1 March 2017 and will conclude in 2022. As the platform rented will be necessary to expand into this market, it has been included in the analysis above.

GL obtained a long-term loan of R15 million on 1 January 2010 to finance various operations. The long-term loan is repayable in 25 equal annual instalments, which commenced on 31 December 2010. The loan bears interest at a fixed rate of 13% per annum. The loan agreement provides that the loan cannot be repaid earlier than the agreed repayment profile.

The amount for the provision has been reliably estimated by the CFO.

Additional Information:'

The tax rate is 28%.

The nominal return on equity rate (6%) has been used to discount these cash flows. The CFO has not used the WACC rate as he is of the opinion that the only providers of capital that require a return are the shareholders. The Weighted Average Cost of Capital (WACC) rate is 10%.

The initial cost of investing in this new market is R50 million and it is expected that the annual net cash flow on the project will be R10.5 million from 2025 onwards.

Critique the net present value calculation prepared by the CFO of GL. Your answer should make use of the following table:

Total marks : 25

2021 2022 2023 R 2024 R Notes R 1 R 18 000 000 -4 500 000 -1 000 000 1 18 000 000 -4 500 000 - 1 000 000 18 000 000 -4 500 000 - 1 000 000 18 000 000 -4 500 000 - 1 000 000 2 -800 000 Turnover Operating costs Opportunity cost Supply licence agreement instalments Operating cost savings Cost platform lease Depreciation Interest on long-term loan Provision for changes in legislation Net cash flows -800 000 300 000 -480 000 -700 000 -800 000 300 000 -480 000 -700 000 -712 469 -800 000 300 000 -480 000 -700 000 3 300 000 -480 000 -700 000 -267 032- 4 -897 536 -503 344 5 5 -2 500 000 9 922 464 10 107 531 10 316 656 8 052 968 Issue Explanation 2021 2022 2023 R 2024 R Notes R 1 R 18 000 000 -4 500 000 -1 000 000 1 18 000 000 -4 500 000 - 1 000 000 18 000 000 -4 500 000 - 1 000 000 18 000 000 -4 500 000 - 1 000 000 2 -800 000 Turnover Operating costs Opportunity cost Supply licence agreement instalments Operating cost savings Cost platform lease Depreciation Interest on long-term loan Provision for changes in legislation Net cash flows -800 000 300 000 -480 000 -700 000 -800 000 300 000 -480 000 -700 000 -712 469 -800 000 300 000 -480 000 -700 000 3 300 000 -480 000 -700 000 -267 032- 4 -897 536 -503 344 5 5 -2 500 000 9 922 464 10 107 531 10 316 656 8 052 968 Issue Explanation