This assignment mostly covers work from topics 2 and 3 (study unit 7 to 12). Topic 1 is assumed prior knowledge.

Question 1 [30 Marks]

(Covers work mostly from topic 1 and study unit 7)

Checkbox Consulting has a client that requires advice regarding possible acquisitions in Zambia. The client is a large wholesale retailer that has operations in South Africa and in many other African countries. It wants to explore the idea of gaining a foothold in the Zambian retail market as it believes an upsurge in commodities is underway which will in turn boost the Zambian economy and consumer spending.

The client does not want to open their own store. They believe that to building up their brand from scratch will take too much time before they could reap possible benefits from it and therefore it was decided to purchase an existing retailer. Two possible targets have already been identified and you have been tasked with assisting the client in determining the value of both retailers. Potential offers have been discussed with both target firms.

The first retailer (referred to as company X from hereon) is listed on the Lusaka Stock Exchange (LuSE) while the second retailer (referred to as company Z from hereon) is a privately held firm. The client has handed over some information that was received in their initial discussions with both target firms to you as well as some of their estimations that they will base their decision on.

Company X:

Below is an abstract from the most recent (28 Feb 2017) financial statements of the firm:

(All statements and values are in Kwacha denoted as K)

Earnings available to ordinary shareholders K1500 million

Total assets K9000 million

Total liabilities K3000 million

Interest payment K300 million

Shares in issue at financial year end 2017 100 million

Market price per share at financial year end 2017 K55

Dividend per share K12,00

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Other relevant information obtained and gathered:

? The firm has a beta of 0,9 associated with its share price. This is similar to other listed retailers on the bourse.

? Recently, the firm considered issuing bonds to raise funds. Its bankers indicated that the firm could realistically issue 20 year, K10 000 bonds with an annual coupon of K2200 at a price of K9 000, from which an issuance fee of 1% would also need to be paid. This is in line with what similar companies could issue.

? The firm's current book value of its debt is similar to the market value of its debt.

? After the 28th of February 2017, but before the acquisition talks began, the firm issued another 10 million shares. The shares sold at a price of K60,00 before an issuance cost of 7%.

? Currently, the firms' shares are trading at K65,00.

? The company expects to maintain its current growth rate of 10% for the foreseeable future.

? The firm is asking your client K66,00 per share of its equity.

Your client indicated that they are not willing to pay a premium of more than 20% over the estimated value of the company X's share price to take control of the firm and this must be included in your analysis. However, if the ROE of company X is higher than its WACC, your client indicated that their premium can be increased to 23%.

Company Y:

Below is an abstract from the most recent (28 Feb 2017) financial statements of the firm:

(The management of the firm made their audited statements available to your client)

Net profit K800 million

Total assets K4000 million

Total liabilities K400 million

Interest payment K20 million

Dividend per share K7 500

Shares (equity shares of private shareholders) 100 000

Other relevant information obtained and gathered:

? The company can issue new debt on the same terms as their current debt.

? The firm is asking your client K40 000 per share of its equity.

? Your client uses the bond yield plus a risk premium method to estimate private firms' cost of equity and uses a premium equal to the market risk premium of 15%.

? The bond yield used for this analysis can be assumed to equal the firms book cost of debt.

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Your client is willing to pay a maximum premium of 5% over the estimated value of the share price of company Y as their investigations and research lead them to believe that the firm is not growing. However, if the ROE of company Y is higher than its WACC, your client indicated that their premium can be increased to 10%.

General information:

? The corporate tax rate is 35% for both firms

? The treasury bill rate is 21% and is assumed to be risk free.

? The market risk premium is 15%.

Required:

Analyse whether the prices offered by the respective companies, X and Y, are fair and advise your client whether it would be worthwhile to continue due diligence and discussions assuming that neither of the target firms are willing to change their asking prices.

Base your report on the following:

? Estimated share price using the dividend discount model (6)

? Estimated WACC (for both firms) (10)

? Profitability (ROE, ROA) (5)

? Analysis of estimated share price, profitability and allowable premium vs. asking price (5)

? Recommendation to the client (4)

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Question 2 [40 Marks]

This question is based mostly on study units 8, 9 and 10.

Cereals Pty(Ltd) is has to replace a machine that is used to make a pulp out of grain fibres which is used in their main product, cereals. The current machine is not acceptable in terms of industry good practice anymore and needs to be replaced. The management of the firm has identified two new possible machines that can be used, but are unsure of the financial implications of acquiring any one of the two machines. You have been tasked with determining the acceptability of the two respective machines in terms of financing costs. This will assist the management of the firm as they can then have objective information regarding which of the machines to investigate further and to discuss further with possible suppliers. You have been given permission to ask for any information from other employees at the firm.

Some general information was e-mailed to you by the bookkeeper:

? The current machine has been written off but there is already a committed buyer who has agreed to pay R50 000 for the old machine which he wants to sell as scrap metal.

? The company is taxed at 28%.

? The machines are always depreciated on a straight- line basis over the usable life of the project.

? Quotes from an installer have already been obtained. It will cost R1000 000 to install either machine.

? The company has always had such machines on their books and they need to be replaced at the end of their life. One can say that they are continually renewable projects.

The financial manager of the firm e-mailed you the following:

All of our projects are evaluated to take inflation and risk into account. For inflation, we adjust by using the real return of return and we also adjusting for risk by using a risk adjusted discount rate (RADR) based on the coefficient of variation (CV) of the cash flows.

A risk adjustment is always made as follows:

If the CV is smaller than 0,5, the risk premium is multiplied by 0,8

If the CV is larger than 0,5 but smaller than 0,75, the risk premium is kept as is.

If the CV is more than 0,75, the risk premium is multiplied by 1,5.

Where the risk premium refers to WACC minus the risk free rate

The WACC of the company is 15%, the risk free rate is 8%, inflation is 6% and the market risk premium is 6%. Excess funds can be re-invested at 12%. The company is established and has a beta of 0,9 which it also uses in evaluating core projects.

When evaluating multiple projects, we compare net present value (NPV), internal rate of return (IRR), modified/ multiple internal rate of return (MIRR) and equivalent equal annuities

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(EEA) as well as payback period. All of this information is passed on to decision makers so that they can start evaluating all projects that will at least offer acceptable returns.

Cash flows of the respective machines have been estimated as follows:

Cash flows

Machine 1 (R000's)

Machine 2 (R'000's)

Purchase price

3000

4000

Sales generated per year

2500

3500

Variable costs associated

50% of sales

40% of sales

Fixed costs associated with the machine

200

500

Increase in net operating working capital

500

1000

Economic lifespan

5 years

4 years

Residual value at end of economic life

1500

1400

The sales generated per year were determined as follows:

Hint: The values above should be used in the determination of relevant cash flows, the values below are for the CV calculation.

All values in R'000's.

Machine 1

Machine 2

Cash flow

Probability

Cash flow

Probability

1020

0.1

450

0.2

2560

0.8

3800

0.7

3500

0.1

7500

0.1

Required:

Determine the:

1. Relevant cash flows (6)

2. Discount rates to be used (8)

3. NPV's (2)

4. IRR's (2)

5. MIRR's (4)

6. Payback periods (2)

7. EEA's; (4)

and making use of the given information, evaluate the acceptability of the two projects. Report regarding which one of the two machines would financially be better than the other, taking into account the information at hand only. Refer to your calculations and findings in your report. (6)

Include in your report NPV (and only NPV) analysis with inflation adjusted cash flows instead of the real rate of return and explain why it is more accurate than using the real rate of return only (this must be done over and above what the CFO expects, so it must be done in addition to using the real rate of return). (6)

Number your calculations as set out above and use the number to refer to your calculations in your report. Use number 8 for the calculation of the inflation adjusted cash flows and 9 for the NPV's

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Question 3 [15 Marks]

This question is based mostly on study unit 11.

Question 3.1 (3 Marks)

A small manufacturing business recently realised that it needs to lower its investment in working capital (measured by the cash conversion cycle). Currently its DIO (days inventory outstanding) is 50, its DSO (days sales outstanding) is 60 and its DPO (days payables outstanding) is 7. The owner of the business indicated that he is of the opinion that due to raw material requirements and fluctuations in production, a lowering of inventory is not possible. How would you recommend he takes action to lower his CCC?

Question 3.2 (4 Marks)

Tilapia Canneries Ltd wants to estimate the amount of funds they will require to fund their operations in 2018. The company has total assets of R50m, liabilities of R30m, a net profit margin of 10% on sales of R600m with a dividend pay-out ratio of 50%. All assets and liabilities are considered spontaneous and increase in line with increases in sales. It is expected that sales will grow by 25% in the coming year. Estimate the funds the firm will require in 2018.

Question 3.3 (8 Marks)

BigBox Ltd is a medium sized firm that manufactures boxes. The firm is busy with sales forecasting for 2018. Over the past seven years, the company has mostly seen substantial growth and the management of the firm wants to get an idea of what sales they can expect over the coming year. They are of the opinion that the firm will continue to grow steadily as it regularly gets stable government contracts. Over the past seven years, it sales were as follows:

BigBox Ltd. sales 2011 - 2017 (R'000 000's)

2011

2012

2013

2014

2015

2016

2017

35

45

42

55

62

78

86

At the moment, there is a discontinuity between management and the accountant of the firm. The management have been basing their estimations in the average growth per year (average of percentage growth every year) of 16,94% while the accountant has been making estimates based on the average total growth to date (2017 sales in relation to 2011 sales, divided by the six growth periods) which leads to an expected growth rate of 24,29%. The management tasked you to come up with a better estimation of sales for 2018.

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The accountant also indicated that the firm does not have an objective idea regarding the variability of the growth in sales, in other words, they do not know how likely the measures they have will be to deviate from the expected value or average sales amount. He asks that you also calculate the standard deviation of the past sales so that they can have an idea of how large an expected deviation from the estimation may be.

Required:

Evaluate the past sales and use regression analysis using your HP10BII+ calculator or any other suitable tool, to create a report and estimation as required. Discuss:

? How the regression was done (2 Marks)

? The slope of the regression (2 Marks)

? Forecasted sales for 2018 (3 Marks)

? The standard deviation of the estimation (1 Mark)

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Question 4 [15 Marks]

This question is based mostly on study unit 12.

Question 4.1 (5 Marks)

Shocks Ltd sells shock absorbers to mechanical workshops on credit only. The management of the company estimated that it could increase sales by offering better credit terms. Currently, the days sales outstanding (or average collection period) is 25 days. It is expected that this will change to 30 days under the new standards. Sales are expected to increase from R100m to R110m. No discounts are offered and bad debts are negligible. The company can borrow short terms funds at a rate of 10% and has a gross profit margin of 15%. Would it be worthwhile for the company to change its credit terms?

Question 4.2 (10 Marks)

Vegetables (Pty) Ltd is currently forecasting its short-term financing needs and it requires your assistance in determining its needs for financing and the possible costs thereof. The following information has been gathered and passed on to you.

The bookkeeper pulled an aging report from the system and determined that 30% of sales were paid for in the same month that the sales were made, 20% was paid one month later and the remainder two months later (all sales were on credit).

The company had a cash balance of R300 000 at the end of June.

The company has access to a R10 000 000 revolving credit facility (line of credit) at a cost of 12% interest per year. No administrative fees are applicable.

All purchases are paid one month in arrears.

Sales from March, April, May and June were as follows:

March

April

May

June

R600 000

R700 000

R500 000

R800 000

Expected sales for June, July, August and September are as follows:

June

July

August

September

R450 000

R550 000

R900 000

R1000 000

Purchases amount to 60% of sales every month and other costs amount to R600 000 per month including depreciation of R100 000 per month.

Required:

Draw up a cash budget for the company for June to September and determine how much the requisite short-term financing by way of the revolving credit facility will cost (in rand) over this period, if utilised. Also provide a brief report on how much financing will be required in every month, the associated cost of financing for that month, as well as the total cost of financing over the period under review.