QUESTION THREE [35] Exe and Whye Mr X, the sole shareholder and managing director of Exe (Pty) Ltd, has been looking for an opportunity to expand his business. In a recent meeting with Mr. Y, the sole shareholder of Whye Trading (Pty) Ltd, it was agreed that as from 30 June 2020, Exe (Pty) Ltd would buy all of Mr Y's Shares in Whye Trading. They agree that the price paid for Mr Y's shares should be based on Whye Trading's free cash flows expected during the next three years ending 30 June 2021, 2022 and 2023, and thereafter a terminal value would be computed. Why Trading is financed entirely from equity, and Mr X intends to continue this policy following the acquisition. The parties have agreed that Whye Trading's free cash flow projections will be based on the following data: 1. Profit before Tax (PBT) Whye Trading's PBT figures for the last four years were: Years Ending 30 June PBT 2017 R100 000 2018 R110 000 2019 R132 000 2020 R171 600 These amounts are after deducting depreciation on existing equipment (refer to item 3, Equipment below). Projecting PBT for the years ending 30 June 2021 and beyond: PBT for 2021 is projected to grow at the average annual rate achieved since the end of 2017. PBT for 2022 should also grow at the same average annual rate, to be used for 2021, but is expected to be further boosted by 10% (i.e. the same growth rate for 2022 will be the average annual rate x 1.1). This additional growth in 2022 will result from the purchase on 30 June 2021 of new equipment costing R150 000. The anticipated useful life of this equipment is ten years. PBT for 2023 should continue to grow at the same average annual rate which was used to project PBT for 2021. The above projected growth in PBT is after allowing for all depreciation on existing and additional equipment. Assume a Terminal Value of R763 258 as at 30 June 2023 for free cash flows after 2023. 2. Taxation: An effective tax rate of 35% per annum is to be assumed and the Receiver of Revenue will allow the same depreciation deduction for tax purposes as is reflected in the accounting records. 3. Equipment: Whye Trading's existing equipment was purchased for R100 000 on 1 July 2016 and is expected to last another six years after 30 June 2020. Whye trading depreciates all equipment using the straight line method. As stated earlier, the purchase of additional equipment is planned for 30 June 2021. 4. Additional Working Capital: Net working capital at 30 June 2020 was R160 000. Growth in PBT is expected to require a similar growth in net working capital (i.e. the same growth percentages used to grow PBT). 5. Negative and positive free cash flows: Any positive free cash flow in Whye Trading will be absorbed by projects in Exe (Pty) Ltd, while any negative cash flow will be financed from internal funds in Exe (Pty) Ltd. 6. Cost of Equity: The cost of equity capital to be invested in Whye Trading is to be calculated from the historic rate of return show by quoted companies in the same industry of 19%, plus a premium of 0.25 on the historic return (0.25 x 19%) to account for additional risk. Required: Calculate the price payable at 30 June 2020 by Exe (Pty) Ltd for Mr Y's shares in Whye Trading (Pty) Ltd, in accordance with the agreed basis of valuation. (All calculations to the nearest rand). QUESTION THREE [35] Exe and Whye Mr X, the sole shareholder and managing director of Exe (Pty) Ltd, has been looking for an opportunity to expand his business. In a recent meeting with Mr. Y, the sole shareholder of Whye Trading (Pty) Ltd, it was agreed that as from 30 June 2020, Exe (Pty) Ltd would buy all of Mr Y's Shares in Whye Trading. They agree that the price paid for Mr Y's shares should be based on Whye Trading's free cash flows expected during the next three years ending 30 June 2021, 2022 and 2023, and thereafter a terminal value would be computed. Why Trading is financed entirely from equity, and Mr X intends to continue this policy following the acquisition. The parties have agreed that Whye Trading's free cash flow projections will be based on the following data: 1. Profit before Tax (PBT) Whye Trading's PBT figures for the last four years were: Years Ending 30 June PBT 2017 R100 000 2018 R110 000 2019 R132 000 2020 R171 600 These amounts are after deducting depreciation on existing equipment (refer to item 3, Equipment below). Projecting PBT for the years ending 30 June 2021 and beyond: PBT for 2021 is projected to grow at the average annual rate achieved since the end of 2017. PBT for 2022 should also grow at the same average annual rate, to be used for 2021, but is expected to be further boosted by 10% (i.e. the same growth rate for 2022 will be the average annual rate x 1.1). This additional growth in 2022 will result from the purchase on 30 June 2021 of new equipment costing R150 000. The anticipated useful life of this equipment is ten years. PBT for 2023 should continue to grow at the same average annual rate which was used to project PBT for 2021. The above projected growth in PBT is after allowing for all depreciation on existing and additional equipment. Assume a Terminal Value of R763 258 as at 30 June 2023 for free cash flows after 2023. 2. Taxation: An effective tax rate of 35% per annum is to be assumed and the Receiver of Revenue will allow the same depreciation deduction for tax purposes as is reflected in the accounting records. 3. Equipment: Whye Trading's existing equipment was purchased for R100 000 on 1 July 2016 and is expected to last another six years after 30 June 2020. Whye trading depreciates all equipment using the straight line method. As stated earlier, the purchase of additional equipment is planned for 30 June 2021. 4. Additional Working Capital: Net working capital at 30 June 2020 was R160 000. Growth in PBT is expected to require a similar growth in net working capital (i.e. the same growth percentages used to grow PBT). 5. Negative and positive free cash flows: Any positive free cash flow in Whye Trading will be absorbed by projects in Exe (Pty) Ltd, while any negative cash flow will be financed from internal funds in Exe (Pty) Ltd. 6. Cost of Equity: The cost of equity capital to be invested in Whye Trading is to be calculated from the historic rate of return show by quoted companies in the same industry of 19%, plus a premium of 0.25 on the historic return (0.25 x 19%) to account for additional risk. Required: Calculate the price payable at 30 June 2020 by Exe (Pty) Ltd for Mr Y's shares in Whye Trading (Pty) Ltd, in accordance with the agreed basis of valuation. (All calculations to the nearest rand)