QUESTION TWO STATEMENT OF FINANCIAL POSITION As at 31 December 2020 ASSETS Plant and equipment 1 012 342 Land and buildings Current assets 1 032 Inventories 448 Trade receivables 564 20 Cash and cash equivalents TOTAL ASSETS 2 EQUITY AND LIABILITIES Stated capital (240 million shares in issue) 240 Non-distributable reserves 800 Retained income 64 580 Long-term liabilities 1 472 Trade payables Bank overdraft 230 TOTAL EQUITY AND LIABILITIES 2 Wellness Zone (Pty) Ltd operates health clubs in South Africa. The company was established more than twenty years ago by its executive directors and has grown to become a competitive health club. Wellness Zone (Pty) Ltd attempts to distinguish itself in the market through its friendly staff and competitive pricing. The company has recently entered into a contract with the government to allow government employees access to its clubs. Each Wellness Zone (Pty) Ltd health club has a similar layout and facilities that include cardiovascular equipment, free weight areas, circuit training, swimming pools and squash courts. The company is currently running an expansion project where it is planning on establishing a further eight new health clubs in the next ten months. The risk of the expansion project has been assessed to be consistent with the risk faced by the current projects. Wellness Zone (Pty) Ltd has a current weighted average cost of capital of 10% and it has a target weighted average cost of capital of 12%. The board of directors have [60] approached you, a valuations consultant, to perform a valuation of the company as one of Wellness Zone (Pty) Ltd's competitors would like to buy the company. The directors have provided you with the following audited financial information relating to Wellness Zone (Pty) Ltd. Note 1: Non-current liabilities comprise 8% bonds repayable at par on the 31 December 2020. STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2020 (R) Million Revenue Operating costs, excluding depreciation Depreciation on plant and machinery Interest payable Net profit before tax Tax Net profit after tax 1 639 1 225 152 205 The directors have provided the following forecast statements of financial position: FORECAST STATEMENT OF FINANCIAL 2021 2022 POSITION (R) (R) Million Million ASSETS Plant and equipment Land and buildings Current assets Inventories Trade receivables Cash and cash equivalents TOTAL ASSETS EQUITY AND LIABILITIES Stated capital (240 million shares in issue) Reserves Long-term liabilities Current liabilities 698 Trade payables 496 Bank overdraft 202 TOTAL EQUITY AND LIABILITIES 2 488 2 606 The board of directors have given you information regarding the forecast assumptions that need to be taken into account for the 2021 and 2022 years Revenue is anticipated to grow by 10% per annum until 2022. Cash operating costs are expected to be 75% of sales. It is expected that there will be no disposals of plant and equipment for the next two years. In 2022 the company is planning on purchasing new land which is expected to cost R10 million. No other purchases or disposals of land and buildings are expected to occur other than this purchase over the next 10 years. 1 063 342 1 083 470 592 21 2 488 240 970 580 1 116 352 1 138 494 622 22 2 606 240 1 053 580 733 521 212 Depreciation is anticipated to approximate 15% of year end net book value of plant and equipment. SARS allows wear and tear on the same terms as the depreciation policy of Wellness Zone (Pty) Ltd. The buildings that Wellness Zone (Pty) Ltd owns do not qualify for wear and tear from SARS. The company has taken a decision to keep the depreciation policy consistent with SARS and therefore no depreciation is provided on buildings. The bank overdraft is regarded as part of the permanent capital structure of the company. Interest on the bank overdraft is charged at 6% per annum, based on the overdraft balance at the beginning of the period. Any surplus cash on hand is not considered operational in nature. The company tax rate is 28% and is not expected to change. Ignore Capital gains tax. Additional information The PE ratio for a similar listed company is 10 and the long term future average earnings growth in the industry is forecast at 7%. The fair market value of land and buildings at 31 December 2020 is R380 million. Government bonds are priced to yield 6%. An appropriate beta for Wellness Zone (Pty) Ltd has been assessed to be 0.75. The average cost of equity for similar companies includes a market risk premium of 8%. . Free cash flow beyond 2022 is expected to grow at 5% per annum into the future. Included in the 2020 operating cost was an entertainment fee of R1 000 000 for entertaining government officials at a function where their contract was renewed for a period of 10 years. SARS does not allow this entertainment expense as a deduction. The yield to maturity on the long term loan and the bank overdraft is the same as the coupon rate. Required: 1 Explain the purpose of calculating the WACC and justify which is the appropriate rate for Wellness Zone (Pty) Ltd to use when evaluating the 2 Prepare the forecast statement of comprehensive income for 2021 and 2022 year. 3 Value the ordinary shares of Wellness Zone (Pty) Ltd at 31 December 2020 using the free cash flow to the firm approach. Commence your free cashflow with net profit before taz a price earnings based valuation a net asset valuation. Discuss the potential accuracy and limitations of each valuation performed. A detailed report is not required. 5 marks 10 marks 24 marks 13 marks 8 marks QUESTION TWO STATEMENT OF FINANCIAL POSITION As at 31 December 2020 ASSETS Plant and equipment 1 012 342 Land and buildings Current assets 1 032 Inventories 448 Trade receivables 564 20 Cash and cash equivalents TOTAL ASSETS 2 EQUITY AND LIABILITIES Stated capital (240 million shares in issue) 240 Non-distributable reserves 800 Retained income 64 580 Long-term liabilities 1 472 Trade payables Bank overdraft 230 TOTAL EQUITY AND LIABILITIES 2 Wellness Zone (Pty) Ltd operates health clubs in South Africa. The company was established more than twenty years ago by its executive directors and has grown to become a competitive health club. Wellness Zone (Pty) Ltd attempts to distinguish itself in the market through its friendly staff and competitive pricing. The company has recently entered into a contract with the government to allow government employees access to its clubs. Each Wellness Zone (Pty) Ltd health club has a similar layout and facilities that include cardiovascular equipment, free weight areas, circuit training, swimming pools and squash courts. The company is currently running an expansion project where it is planning on establishing a further eight new health clubs in the next ten months. The risk of the expansion project has been assessed to be consistent with the risk faced by the current projects. Wellness Zone (Pty) Ltd has a current weighted average cost of capital of 10% and it has a target weighted average cost of capital of 12%. The board of directors have [60] approached you, a valuations consultant, to perform a valuation of the company as one of Wellness Zone (Pty) Ltd's competitors would like to buy the company. The directors have provided you with the following audited financial information relating to Wellness Zone (Pty) Ltd. Note 1: Non-current liabilities comprise 8% bonds repayable at par on the 31 December 2020. STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2020 (R) Million Revenue Operating costs, excluding depreciation Depreciation on plant and machinery Interest payable Net profit before tax Tax Net profit after tax 1 639 1 225 152 205 The directors have provided the following forecast statements of financial position: FORECAST STATEMENT OF FINANCIAL 2021 2022 POSITION (R) (R) Million Million ASSETS Plant and equipment Land and buildings Current assets Inventories Trade receivables Cash and cash equivalents TOTAL ASSETS EQUITY AND LIABILITIES Stated capital (240 million shares in issue) Reserves Long-term liabilities Current liabilities 698 Trade payables 496 Bank overdraft 202 TOTAL EQUITY AND LIABILITIES 2 488 2 606 The board of directors have given you information regarding the forecast assumptions that need to be taken into account for the 2021 and 2022 years Revenue is anticipated to grow by 10% per annum until 2022. Cash operating costs are expected to be 75% of sales. It is expected that there will be no disposals of plant and equipment for the next two years. In 2022 the company is planning on purchasing new land which is expected to cost R10 million. No other purchases or disposals of land and buildings are expected to occur other than this purchase over the next 10 years. 1 063 342 1 083 470 592 21 2 488 240 970 580 1 116 352 1 138 494 622 22 2 606 240 1 053 580 733 521 212 Depreciation is anticipated to approximate 15% of year end net book value of plant and equipment. SARS allows wear and tear on the same terms as the depreciation policy of Wellness Zone (Pty) Ltd. The buildings that Wellness Zone (Pty) Ltd owns do not qualify for wear and tear from SARS. The company has taken a decision to keep the depreciation policy consistent with SARS and therefore no depreciation is provided on buildings. The bank overdraft is regarded as part of the permanent capital structure of the company. Interest on the bank overdraft is charged at 6% per annum, based on the overdraft balance at the beginning of the period. Any surplus cash on hand is not considered operational in nature. The company tax rate is 28% and is not expected to change. Ignore Capital gains tax. Additional information The PE ratio for a similar listed company is 10 and the long term future average earnings growth in the industry is forecast at 7%. The fair market value of land and buildings at 31 December 2020 is R380 million. Government bonds are priced to yield 6%. An appropriate beta for Wellness Zone (Pty) Ltd has been assessed to be 0.75. The average cost of equity for similar companies includes a market risk premium of 8%. . Free cash flow beyond 2022 is expected to grow at 5% per annum into the future. Included in the 2020 operating cost was an entertainment fee of R1 000 000 for entertaining government officials at a function where their contract was renewed for a period of 10 years. SARS does not allow this entertainment expense as a deduction. The yield to maturity on the long term loan and the bank overdraft is the same as the coupon rate. Required: 1 Explain the purpose of calculating the WACC and justify which is the appropriate rate for Wellness Zone (Pty) Ltd to use when evaluating the 2 Prepare the forecast statement of comprehensive income for 2021 and 2022 year. 3 Value the ordinary shares of Wellness Zone (Pty) Ltd at 31 December 2020 using the free cash flow to the firm approach. Commence your free cashflow with net profit before taz a price earnings based valuation a net asset valuation. Discuss the potential accuracy and limitations of each valuation performed. A detailed report is not required. 5 marks 10 marks 24 marks 13 marks 8 marks