MANAGEMENT COLLEGE OF SOUTHERN AFRICA (MANCOSA)

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Table of contents Question 1 2 3 Capital Budgeting techniques: ARR, PAYBACK and NPV Mergers and Acquisitions: Calculations and Evaluation Foreign risk management: Spot and Forward rate manipulations 4 Gearing: Revised EPS and Gearing for various funding sources Bibliography 17 11 Page No. 3 8 10

Question 1 1.1 ARR Depreciation = [cost scrap]/useful life = (3.6m 1m)/10 = R0.26m Therefore Average Profit = [total cash flows total depreciation]/useful life = Average Profit = 0.58m

Average Investment = [cost + scrap]/2 = = 2.3m

ARR

= Average proft/Average investment x 100 = 0.58m/2.3m x 100 = 25.22%

According to the ARR, the project should be accepted since the calculated value is more than required rate.

1.2 Payback period Year 0 1-3 Balance Cash flow -3,6m 3m 0.6m

Portion of year 4 =

= 7.2 in days become 0.2 x 30 = 6

Payback period is 3years 7 months and 6 days This makes the project acceptable because the maximum period is 5years 1.3 NPV Year 16 7 10 10 Total Present Value Investment Net Present value PVAF @ 18% 3.4976 0.9965 0.1911 1,000,000 600,000 1,000,000 Cash flow Present Value (R) 3,497,600 597,900 191,100 4,286,600 -3,600,000 686,600

According to the NPV technique, the project should be accepted because it gives a positive NPV

1.4 Investment Decision Report EVALUATION OF ICE-COATING MACHINE PROJECT Introduction The report summarises the results obtained from calculations made regarding the investment appraisal techniques. The report aimed at evaluating various capital appraisal techniques on a new icing-coating machine . Findings ARR The ARR calculated gave a figure of 25.22% which is higher than the standard 20%. This technique has an advantage of simplicity in calculation as well as understanding. However, it lacks ability to take account of time value of money. Payback Period The payback period shows that the project will restore the whole R3600000 initially invested in 3years 7month and 6days. This is a good time period considering that the company expect about 5years. The payback period is also simple to calculate and easy to understand but omits time value of money as well. In addition, this technique disregards all the cash flows after the cut-off date thus it does not give a comprehensive appraisal. Net Present Value The NPV method looks at positive or negative outcome. Positive is good while negative is bad. which came out positive showing that even when the future cash flows are discounted to the present time i.e. when the decision is made, the inflows surpass the outflows. The time value of money aspect is fully considered by discounting the cash flows. In addition the NPV technique uses all cash flows in its calculation.

Conclusion and Recommendations It can be concluded that capital investment appraisal is important in order to make an informed long term investment. There are several techniques that can be used they are not limited to the three above. We recommend that from a financial standpoint, the company should invest in the icingcoating machine.

1.5 Discounted Payback Period Year PVF/PVAF @ 18% 0 16 Balance 1 3.4976 -3,600,000 1,000,000 Cash-flow Present Value (R) -3,600,000 3,497,600 -102,400

0.3139

600,000

188,340

Portion of year 7 = 102,400/188,340 x 12 = 6.52 thus 0.52 x 30 = 16 Payback period = 6 years 6 months and 16 days This is above the required maximum limit of 5 years thus based on discounted Payback Period, the project is not acceptable!

Question 2 2.1 Seafoods P/E ratio = MPS/EPS 375/15 = 25 2.2 Exchange ratio = 8/5 = 1.6 2.3 Yes because they are getting more shares in Seaffood than in their present Fisheries. Each share in Fisheries is turning into 1.6 shares in Seafood thus it is a good offer. 2.4 Number of shares Seafoods = 150/0.25 = 600milion Fisheries = 40/0.50 = 80million 451/16.7= 27 Fisheries

Combined earnings = (600 x /0.167) + (80 x0.15) = 112.2million Plus synergy Total combined earnings 2.5 Number of shares to be issued = 1.6 x 80 = 128million 2.6 Total shares in the take-over = 600million + 128million = 728million 2.7 Combined EPS = 142.2/728 = 0.195 = 19.5cents
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= 30million = 142.2 million

2.8 Combined Market value = ((600 x 4.51) + ( 80 x 3.75) = R3006 million Plus Synergy Total Market value Combined MPS R30 million R3036 million = R3036/728 = R4.17 = 417cents

2.9 Combined P/E ratio Combined P/E ratio = Combined MPS/Combined EPS = 417/19.5 = 21.38 2.10 Benefits Fisheries = (417 x 1.6) 375 = 292cents There are positive gains for Fisheries shareholders thus it is an attractive offer

Question 3 3.1 1 Month forward rates Buy = 187.5 - 1.20 = 186.30 Sell = 192.40 - 1.10 = 191.30 3.2 The American dollar is depreciating against the European Euro 3.3 Euro cost of selling at spot rate = $350,000/192.40 = 1819.13 3.4 $ Receipt = 3,500,000/191.30 = $18295.87 3.5 1$ = R1.5280 1$ = 1.6240 Therefore, R1.5280 = 1.6240 thus /R cross rate = 1.063

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Question 4 4.1 Operating profit = PBIT (Profit Before Interest and Tax) Additional Operating profit = 32.8% x 10,000,000 = 3,280,000 4.2 EPS = Earnings available for Ordinary shareholders/ Number of shares in issue = 5,778,000/10,000,000* = R0.58 *Number of shares = 5,000,000/0.5 = 10,000,000 4.3 Gearing = Total Debt/ Total Equity = 12,000,000/22,020,000 x 100 = 54.49 or 54% 4.4, 4.5 and 4.6 Revising the Income statement Ordinary share Financing Preference share financing Long-term Loan financing

R000 Current operating profit Additional operating profit 11 170 3 280 14 450

R000 11 170 3 280 14 450

R000 11 170 3 280 14 450

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Interest: Current Interest Additional interest (10,000,000x15%) Profit Before Tax Tax (35%) Profit After Tax Preference dividend (14% x 10,000,000) Earnings due to ordinary shareholders Ordinary Dividend : Existing New
A

2 280 -

2 280 -

2 280 1 500

12 170 4 259.5 7 910.5 7 910.5 2 500 862.069 4 548.431

12 170 4 259.5 7 910.5 1 400 6 510.5 2 500 4 010.5

10 670 3 734.5 6 935.5 6 935.5 2 500 4 435.5

Retained earnings for the year

Ordinary dividend per share = 2,500/10,000 = 0.25

Therefore dividend for the O/S financing = 13,448,276 x0.25 = 3,362,069

Number of ordinary shares issued 10,000,000/R2.90 = 3,448,276 Share premium = (R2.90 R0.50) = R2.40 per share Total share premium = R2.40 x 3,448,276 Ordinary share capital (R0.50 x 3,448,276) Total = R 8,275,862 = R 1,724,138

R 10,000,000

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Revised Balance (Extract) Ordinary share Financing R Shareholders funds Ordinary shares (50c) : Existing New Share premium: Existing New Retained Earnings: Prior years (12,060 3,278) Current year Total Equity Long term- Liabilities Debentures, 19% due 2020 Unsecured loan, 15% Total Debt Number of ordinary shares Existing New Total 10,000,000 10,000,000 10,000,000 3,448,276 12,000,000 12,000,000 12,000,000 - 10,000,000 33,290,431 22,752,500 23,177,500 5,000,000 1,724,138 4,960,000 8,275,862 8,782,000 4,548,431 5,000,000 4,960,000 8,782,000 4,010,500 5,000,000 4,960,000 8,782,000 4,435,500 Preference share financing R Long-term Loan financing R

12,000,000 12,000,000 22,000,000

13,448,276 10,000,000 10,000,000

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4.4 Ordinary Share financing EPS = 7910500/13448276 = R0.59 Gearing = Total Debt/ Total Equity = 12,000,000/33290431 x 100 = 36% 4.5 Preference Share financing EPS = 6510500/10000000 = R0.65 Gearing = Total Debt/ Total Equity = 12,000,000/22752500 x 100 = 53% 4.6 Debt/Long term loan financing EPS = 6935500/10000000 = R0.69 Gearing = Total Debt/ Total Equity = 22,000,000/23177500 x 100 = 95%

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4.7 Report Optimal Financing Option Table of contents Executive summary Introduction Discussions Conclusion and Recommendations

Executive Summary The report aimed at evaluating three financing options to raise funds from external sources for Blue Bay Industries. The options under consideration were ordinary shares, preferences shares and long term loan. Each alternative form of financing was evaluated in terms of impact on EPS and gearing. From the results, it was found that Preference shares yield better EPS and gearing than the other two forms thus it was the recommended source of finance. Introduction The report summarises the three options available to raise R10000000. The first option is issuing ordinary shares at R2.90 each, the second option will be issuing 14% preference shares and lastly the third option is 15% unsecured long term loan. The options were analysed in terms of impact on EPS and Gearing. Discussions The data shows that ordinary share financing dilutes shareholding thus reducing the EPS while reducing gearing because the equity base increases. The number of
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shareholders increases thus it may have negative impact on ownership and control issues as decisions may take longer to make when the shareholders are too many. Preference shares have fixed dividend which is non-tax deductible but because it does not increase number of ordinary stock, it follows that it improves EPS. Gearing under preferred stock is also low since the gearing formula required for this question does not include preference shares as part of debt. Other authors would want to have the preference share capital as part of total debt (Dransfield, 2001:351; Patra, 2005: 272). Finally, the loan finance creates an interest obligation which is tax deductible thus reduces the tax expense of the company and the resulting tax shield was enough to result in higher earnings per share since number of shareholders did not change. The major drawback of the loan financing option is the increase in gearing that come with it which makes the company vulnerable and less attractive for investors. Conclusion and Recommendations It can be concluded that capital structure and financing must look beyond EPS and gearing because other things like dilution, future obligations and the ease with which the company can acquire the desired finance through the various forms also play an important role. We recommend that from a financial standpoint, the company should raise funds through the issue of 14% preference shares.

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Bibliography Dransfield, R. (2001). Business for foundation degrees and higher awards. New York: Heinemann. Patra, K. (2005). Accounting and finance for managers. Delhi: Sarup & Sons.

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