QUESTION $3(34$ marks$)$From: snrfinanacialmanager@mph$.$comTo: manacc@mph$.$comSent: $22$ July $2024$Subject: Financial performanceGood dayWith reference to previous communication during May $2024,$ the South African furnituremarket faces certain threats that can impact its growth and sustainability. Some of the keythreats to the South African furniture market include competition from imported furniture,fluctuating raw material costs and limited access to finance, where cash flow constraints canalso be a challenge for small and medium$-$sized furniture manufacturers.The Finance Director has asked me to prepare a few reports and calculations to assist withpossible acquisitions to strengthen My Pride Home's vertically integrated supply chain. Bydoing so$,$ My Pride Home can also manage and or limit some of the identified threats above.During May $2024,$ you assisted me in providing calculations for the Finance Director relatingto making a bid on a supplier, to assess the possible acquisition of them.My Pride Home is listed on the Johannesburg Stock Exchange $($JSE$).$ My Pride Home isconsidering making a bid for Cushion Up Ltd$.$ Cushion Up Ltds stock is also listed andprincipally traded on the JSE.Based on the information provided, the calculated value of the equity in Cushion Up Ltd byforecasting future cash flows to equity and discounting them to present value using the costof equity resulted in a valuation of R $1069\mathrm{.}5$ million, or R $26\mathrm{.}74$ per share.Key financial information relating to Cushion Up Ltd for the latest financial year is givenbelow. All figures are in Rmillion unless otherwise stated.MAC$4868[$CONFIDENTIAL$]$ Page $30$ of $39[$TURN OVER$]$Statement of profit or loss for the year ended$30$ September $2023$Cushion Up LtdR'millionRevenue $168$Cost of sales $(54)$Gross profit $114$Operating expenses $($including depreciation of R $5$ million$)(20)$Profit from operations $94$Finance costs $(7)$Profit before tax $87$Taxation $(23)$Profit after tax $/$ Profit for the year $64$Dividends declared $(25)$Net income for the year $39$Earnings per share $($cents$)160\mathrm{.}00$Share Price information $($prices in cents$)$ Cushion Up LtdShare price movements:High for last financial year $2400$Low for last financial year $1760$Share price today $(22$ July $2024)2080$P$/$E ratios today $13$Extracts from the statement of Financial Positionat $30$ September $2023$Cushion Up LtdR'millionEquity and LiabilitiesEquity and reservesIssued share capital $($ordinary R$1$ shares$)40$Revaluation reserve $12$Accumulated income $128180$LiabilitiesNon$-$Current LiabilitiesBank loans $9090$Current LiabilitiesBank loans and bank overdraft $4$Taxation $23$Trade and other payables $4067$Total Liabilities $157$Total Equity and Liabilities $337$MAC$4868[$CONFIDENTIAL$]$ Page $31$ of $39[$TURN OVER$]$General information: In the current economic climate, the industry average for return on equity for theindustry is $30\%$ which shareholders would be satisfied with when financialperformance evaluations are done. The average gearing ratio for the industry $($long$-$term debt as a proportion of totallong$-$term funding or Debt$/($Debt $+$ Equity$)$ x $100)$ is $40\%$ based on book values. Generally, companies aim to maintain a dividend cover of at least $2$ times toprovide a reasonable cash return on investment to shareholders, while at the sametime keeping an adequate amount of retained earnings to grow the business. Generally, an interest cover ratio of $2$ to $3$ is regarded as an acceptable minimum.A ratio of lower than $2$ would be seen as high$-$risk. A ratio of $3$ to $7$ is seen as goodas investors would often prefer to see an interest coverage ratio of $3$ or above.A ratio of more than $7$ may be interpreted as safe. The average P$/$E ratio for the industry is currently estimated at $12.$ Cushion Up Ltd has $40$ million shares in issue$\mathrm{.}3\mathrm{.}1$ Calculate and discuss the following key ratios for Cushion Up Ltd$,$ and comparethese to the industry averages provided:$($a$)$ Return on equity $($ROE$)($b$)$ Capital gearing ratio $($using the formula: Debt$/($Debt $+$ Equity$)$ x $100)($c$)$ Dividend cover$($d$)$ Interest coverShow all calculations. $(8$ marks$)3\mathrm{.}2$ Calculate the range of possible values that My Pride Home could place onCushion Up Ltd$,$ using the P$/$E valuation method and using the share priceinformation provided in the scenario.Show all calculations. $(3$ marks$)$MAC$4868[$CONFIDENTIAL$]$ Page $32$ of $39[$TURN OVER$]3\mathrm{.}3$ Prepare a report to the board of directors of My Pride Home, where you evaluatethe proposed acquisition of Cushion Up Ltd$.$You should use the figures provided in the scenario and figures you havecalculated in your answers to parts $(3\mathrm{.}2)$ to support your recommendations$/$advicewhere relevant. If you have not been able to do the calculations for part $(3\mathrm{.}2)$ youshould make, and state, appropriate assumptions.Your report should include the following headings$/$sections:$($a$)$ Recommendations of a bid price $(8$ marks$)$Advise the board of My Pride Home as to how much it should offer forCushion Up Ltd shares.$($b$)$ Method of payment$/$funding the acquisition $(6$ marks$)$Evaluate and recommend appropriate methods to pay for or fund theacquisition of Cushion Up Ltd$.($c$)$ Potential problems with the acquisition $(9$ marks$)$In the light that not all acquisitions are successful, discuss potential reasonswhy the acquisition of Cushion Up Ltd by My Pride Home could fail.Show all calculations.$[$CIMA adapted$]$Thank you for doing this, I can always count on you.Kind regardsSenior Financial ManagerMy Pride Home