QUESTION 2 (60 marks) Magen Ltd ("Magen") is a large food producer listed in the consumer sector of the Johannesburg Stock Exchange ("JSE"). The entity has a 30 June financial yearend. Magen has various product lines that consist of daily and basic food items such as vegetables, canned foods, and cereals, amongst others. Magen however does not have any candy product lines. This sector in the food industry is known to be lucrative and to overcome this shortcoming, Magen has identified an entity called Desert Ltd ("Desert") that Magen is interested in acquiring. Desert owns and manufactures various candy products and has a 30 September financial yearend. The following are the annual financial results of Desert as at its financial yearend: 8 HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023 Note 1 The candy market sector grows by 2.2% annually on average. This trend is expected to continue in future periods. Desert currently has a 17% market share in the candy market. This market share is expected to immediately increase to 25% when Magen acquires Desert due to the business networks and resources of Magen which could be employed to Desert's advantage. In three years' time, the candy market is expected to have an increase in its annual growth to 3.3% which will then continue into the foreseeable future. At the same time, Desert will also capitalise on this growth by increasing its candy market share to 30%. Note 2 Should Magen acquire Desert, Desert's gross profit margin is expected to increase by 5% due to cost savings. This improved gross profit margin is expected to then be maintained in all future periods. Note 3 Included in operating expenses is depreciation to the value of R637 000. This depreciation is expected to decrease by 5% per annum for the following three years (the only percentage movement expected in depreciation for the following three years). Thereafter the depreciation is expected to reflect the capital cash expenditure each year. The operating expenses are expected to steadily increase by 6% annually. No other fixed asset movements are expected in the future besides an R440 000 planned equipment cash purchase in two years' time. Note 4 This amount is due to the profit on the sale of an investment in ordinary shares of Eva Ltd which Desert had previously purchased. Consequently, Desert no longer owns any shareholding in Eva Ltd. Note 5 Desert will maintain the entity's net working capital in the same ratio to the turnover as currently, in future years. Note 6 These long-term loans are the only non-current liabilities Desert has. These longterm loans have a marginal cost of debt of 11.9% before tax. Additional information: - Desert has 1500000 ordinary shares in issue from which R172 500000 funds were obtained when issued. These are the only shares in issue. - Long-dated RSA government bonds are currently offering yields of 8.8%. - The food industry's market premium is expected to be 2.4%. - The betas in different sectors of the food industry do have noticeable differences as can be observed when comparing Margen's 0.95 beta to Desert's beta of 1.23. Should these two entities however merge, the combined entity's beta will be 1.16 . - Assume that all entities' taxable income is the same as that entity's earnings before interest and taxation. - The South African Income Tax rate applicable to companies is 27%. No change in the tax rate is expected in the future. REQUIRED: Magen Ltd wishes to purchase all Desert Ltd's ordinary shares on 1 October 2023. Calculate the total current value of Desert Ltd by using the Free Cash Flow method. Should you omit an item intentionally from the Free Cash Flow value, provide a brief motivation. FORMULA SHEET: r=(1+mrn)m1PVA=PMT(r1(1+r)n1)Re=j=1nPjRj=j=1nPj(RjRe)2=2 WACC=Kd(1t)(D/V)+Ke(E/V) Value of right: =[1+RMcS] FV=PV(1+mr)nun FVA=PMT[r(1+r)a1]P2=Wb2b2+Wg2g2+2WbWgcovbg 13 HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023 TABLE A Future Value of R1 at the end of g periods \begin{tabular}{|c|c|c|c|c|c|c|c|c|c|c|c|c|c|} \hline A & ras & 15% & & 17% & & 19% & 20% & 21% & 22% & 23% & 245 & 25% & 305 \\ \hline t & 1.1400 & 1500 & 1.1600 & 1.1700 & 1800 & 1.900 & & 2100 & 12000 & 1.2300 & 1.2400 & 12500 & 13000 \\ \hline 2 & 1.2996 & 3225 & 156 & 13689 & & 1.4161 & & & & 1.5129 & & & 1.6900 \\ \hline 3 & 1.4315 & 5209 & & & & & & & & & & & 2 \\ \hline 4 & 1.6a90 & 7490 & 13106 & 39 & & & & & & & & & \\ \hline 5 & 1.9254 & 2.0114 & 03 & 24 & 2.2 & 23 & 24 & 2 & & & & & 3.7 \\ \hline E & 2.1950 & 231 & 2.4364 & ge & & 39 & 2sec0 & 3 & m & 28 & 62 & a) & 4.826a \\ \hline 7 & 28023 & 20600 & 28262 & 3.0012 & 3. 18ss & 3.3793 & 3.5032 & 3.7975 & 4.0227 & 4.2593 & & & 62749 \\ \hline a & 28526 & 3.0590 & 3.2784 & 3.5115 & 3.7580 & 4.0214 & 4.2998 & 45950 & 4.9077 & 5.2389 & 5.5895 & 5.9605 & 81573 \\ \hline 9 & 3.2519 & 3.5179 & 8030 & 4.1084 & 4.4355 & 4.7854 & 5.1508 & 55500 & 5.9874 & & 6.9310 & 7.4506 & 10.6045 \\ \hline 10 & 3.7072 & 4.0456 & 4.4114 & 4. 8068 & 5.2334 & 5.6047 & 6. 1917 & 67275 & 7306 & 70050 & B. 5044 & 0.3132 & 13.785a \\ \hline 11 & a & & & & & & & & & & & & \\ \hline 12 & 4.8 & & & & & & & & & & & & \\ \hline 13 & & & & & & & 0 & & & & & & \\ \hline 14 & & & & & 2 & 3 & e. & & 22 & & & & 730 \\ \hline 1 & & & & & & & & & & & & & \\ \hline 16 & & & & & & & & & & & & & \\ \hline 17 & 92 & 3 & & & & & s! & & & & & & \\ \hline 18 & 105 & & & & & & & & & & & & \\ \hline 18 & 120 & 8 & & & & & & & & & & & \\ \hline 20 & 137435 & & & & & & & & & & & & \\ \hline 2 & & & & & & & & & & & & & \\ \hline 2 & 10 & i7 & & & & & 31 & & & & & & \\ \hline 23 & 16 & & & & & & & & & & & & \\ \hline 24 & 2 & 8 & & & & & & & & & & & \\ \hline 25 & 19 & a & & & & & & & & & & & \\ \hline 2 & & & & & & & & & & & & & \\ \hline 21 & 199 & 53 & & & & & 1 & & & & & & 53 \\ \hline 28 & & 66 & & & & & & & & & & & \\ \hline 28 & & & & & & & & & & & & & \\ \hline 30 & & 66.2118 & & & & & 28 & & & & & & \\ \hline 3 & & & & & & & & & & & & & \\ \hline 3. & 6.2 & 1 & & & & & 22 & & & & & & 79 \\ \hline 33 & . & 00 & & & & & & & & & & & \\ \hline 34 & & & & & & & & & & & & & \\ \hline 35 & We & 93.718 & , & & & & 500 & 78 & & & & & \\ \hline 36 & & & & & & & & & & & & & \\ \hline 3 & & & & & & & & & & & & & 0.1 \\ \hline 3 & & & & & & & 67 & & & & & & 21372.1 \\ \hline 35 & 65.08? & 3 & & 96 & 4 & & 122 & & & & & & \\ \hline 40 & 138.984 & 267.864 & 378.721 & 533.869 & 50.379 & 105167 & 1469.77 & 20 & 04 & 39 & & 16 & 3611 \\ \hline 4 & & & & & & & & & & & & & \\ \hline 4 & & & & & & & & & & & & & 041 \\ \hline 43 & & & & & & & & & & & & & 70353 \\ \hline 48 & 17 & a & & 41 & & 5 & 3 & & & & 39 & 7.1 & 103153 \\ \hline 45 & 353.679 & 538.769 & 795.44 & 170.48 & 171668 & 250965 & 365726 & 5313.02 & 7694.7 & 11110 & 159047 & 229589 & 134107 \\ \hline 46 & & & & & & & & & & & & & \\ \hline \&7 & & & & & & & & & & & & & \\ \hline 4 & & & & & & & & & & & & & \\ \hline 4 & & & & & & & & & & & & & \\ \hline 50 & 00.233 & 108365 & 20.70 & 566.22 & 3027.36 & 5009.91 & 910044 & 13780.6 & 20706.6 & 312792 & 460904 & 700549 & 497929 \\ \hline \end{tabular} 15 HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023 TABLE B Futere Value of an Aasuity of R1 per period 17 HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023 TABLE C Present Value of R1 due at the end of n periods 18 HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023 HFMN331-1__Jul-De TABLE E Areas under the standard normal curve HFMN331-1_Jul-Dec2023_SA1_V4_ES_10102023