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You are currently in the process of reviewing two investments namely Dalmatia Limited and Roma Limited. Below are the calculations that you have performed so far:

Risk and Return Calculations:

Dalmatia

Probability Return Mean

Probability (return –

mean) ^2 Variance

0.65 10.00 6.50 0.65*((10-10.7)^2) 0.32

0.35 12.00 4.20 0.35*((12-10.7)^2) 0.59

10.70 ό

2 0.91

Standard Deviation 0.95

Roma

Probability Return Mean

Probability (return –

mean) ^2 Variance

0.65 22 14.30 0.65*((22-14.30)^2) 38.54

0.35 -2 -0.70 0.35*((-2-13.60)^2) 92.99

13.60 ό

2 131.53

Standard Deviation 11.47

Covariance and Correlation Calculations:

Probability

(Return NF – Mean NF) x (Return SL x Mean

SL) Covariance

0.65 (10 – 10.70)*(14.30- 13.60) -0.49 -0.32

0.35 (12 – 10.70)*(-2 – 13.60) -20.28 -7.10

Covariance of

Returns -7.42

Correlation = Covariance/SD of NF x SD of SL = -7.42 / (0.95 x 11.47) = -0.68

The following additional information is available:

• Risk free rate is 3%

• Market Return is 12%

• Market standard deviation 25.2

• Covariance of NF shares in relation to the market is 25.2

• Covariance of SL shares in relation to the market is 39.6

• All calculations must be rounded to two decimal points.

Financial for Decision-Making October 2020 Assignment Page 3 of 17

1.1 Determine the expected return and risk of a portfolio with

Dalmatia and Roma where 40% of the portfolio is invested in

Dalmatia and 60% is invested in Roma. You must also

discuss whether you such portfolio should be invested in and

why.

The following formula should be used to determine the risk of

the portfolio:

(16)

1.2 Calculate the required return for Dalmatia using the Capital

Asset Pricing Model (CAPM) and discuss whether you would

invest in such share.

Use the following formula to calculate Beta:

(9)

[25 marks]

Financial for Decision-Making October 2020 Assignment Page 4 of 17

QUESTION 2

Read the case study/ scenario below and answer the questions based

on the case study.

Gecko Limited (GL) is a company that is in the fast moving consumer goods market

(FMCG). The company is listed on the Johannesburg Securities Exchange (JSE) in order

to raise capital from different sources to expand operations. GL has analysed an

investment into a new computer platform from the 2021 year onwards. Below is the net

present value analysis (NPV) for the proposed investment prepared by the CFO of the

company:

2021 2022 2023 2024

Notes R R R R

Turnover 1 18 000 000 18 000 000 18 000 000 18 000 000

Operating costs 1 -4 500 000 -4 500 000 -4 500 000 -4 500 000

Opportunity cost 2 -1 000 000 -1 000 000 -1 000 000 -1 000 000

Supply licence agreement

instalments -800 000 -800 000 -800 000 -800 000

Operating cost savings 300 000 300 000 300 000 300 000

Cost platform lease 3 -480 000 -480 000 -480 000 -480 000

Depreciation -700 000 -700 000 -700 000 -700 000

Interest on long-term loan 4 -897 536 -712 469 -503 344 -267 032-

Provision for changes in

legislation 5 – – – -2 500 000

Net cash flows 9 922 464 10 107 531 10 316 656 8 052 968

Notes:

• GL’s Chief Financial Officer (CFO) expects that revenue and operating costs

will increase by inflation (around 6%) year on year. However, the CFO is of the

opinion that the net present value should be prepared using real amounts, not

nominal, and as a result has not included the effects in the revenue or

operating costs above.

• The opportunity cost represents annual instalments in terms of the supply

licence agreement, to which GL will no longer be entitled.

• GL is currently in a lease agreement with OPCO SA (Pty) Ltd. The annual

instalments on the lease are R480 000 per annum. The lease agreement was

entered into on1 March 2017 and will conclude in 2022. As the platform rented

will be necessary to expand into this market, it has been included in the

analysis above.

• GL obtained a long-term loan of R15 million on 1 January 2010 to finance

various operations. The long-term loan is repayable in 25 equal annual

instalments, which commenced on 31 December 2010. The loan bears interest

at a fixed rate of 13% per annum. The loan agreement provides that the loan

cannot be repaid earlier than the agreed repayment profile.

• The amount for the provision has been reliably estimated by the CFO.

Financial for Decision-Making October 2020 Assignment Page 5 of 17

Additional Information:

• The tax rate is 28%.

• The nominal return on equity rate (6%) has been used to discount these cash

flows. The CFO has not used the WACC rate as he is of the opinion that the

only providers of capital that require a return are the shareholders. The

Weighted Average Cost of Capital (WACC) rate is 10%.

• The initial cost of investing in this new market is R50 million and it is expected

that the annual net cash flow on the project will be R10.5 million from 2025

onwards.

Critique the net present value calculation prepared by the CFO of

GL. Your answer should make use of the following table:

Issue Explanation

(25)

[25 marks]

Financial for Decision-Making October 2020 Assignment Page 6 of 17

QUESTION 3

Read the case study below and answer the questions based on the

case study.

Green-Orr Limited (GOL) is a retailer of various fast-moving consumer

goods (FMCG’s).

Due to the COVID-19 pandemic the entity has experienced reduced

operating margins and liquidity concerns. As part of their process to

manage liquidity concerns, they have considered factoring their accounts

receivable (debtors’ book). Below is an extract from the notes to GOL’s

financial statements as at 31 July 2020:

Description 2020 (R)

Trade Debtors 2 000 000

Provision for Doubtful Debts (150 000)

Prepayments 200 000

Trade and Other Receivables 2 050 000

GOL has approached DBC Bank for assistance with the factoring

transaction. Below is a brief summary of the bank’s terms:

1.) DBC will give 80% of the value of accounts receivable as at 31 July

2020 to GOL. The remaining 20% will be recovered by DBC and

paid over to GOL.

2.) The fee is 7.5% of the accounts receivable amounted stated

above.

In order to manage GOL’s cash flow more effectively, the CFO has

expressed interest in using the Miller-Orr model. GOL invests its surplus

cash at an annual rate of 7.5% and incurs R150 per transaction on buying

and selling short-term securities. The expected daily cash balances and

their probability distributions are as follows:

Cash (R) Probability

80 000 15%

90 000 40%

100 000 45%

The acceptable lower limit of cash holding is R20 000.

3.1 In terms of International Financial Reporting Standards

(IFRS) 9: Financial Instruments, discuss how accounts

receivable should be measured in GOL’s financial

statements. In addition, provide the initial journal entry

(debit/s and credit/s) if GOL decided to enter into the

(14)

Financial for Decision-Making October 2020 Assignment Page 7 of 17

factoring transaction.

3.2 Based on management’s forecast and using the Miller-Orr

Model, calculate the target cash level GOL should hold in

order to allow for effective management of their cash flows.

Below is the formula for Miller-Orr:

Optimal return point =

(

3√3 x cost per order x variance of daily cash balances)/(4 x

daily interest rate on marketable securities)

+

Lower cash limit (11)

[25 marks]

Financial for Decision-Making October 2020 Assignment Page 8 of 17

QUESTION 4

Read the case study below and answer the questions based on the

case study.

Gymogae (Pty) Limited (Gymogae) is a multi-national conglomerate.

Gymagoe is in the process of calculating their WACC rate for the 2020

financial year and has complied the following information:

• Ordinary Shares

Dividend declared for 2020 R250 000.

The dividend yield of Gymogae is estimated to be 11%.

There are 100 000 ordinary shares in issue.

• Preference Shares

You are currently in the process of reviewing two investments namely Dalmatia Limited and Roma Limited

These are 10% preference shares convertible into ordinary shares

in 2022. The offer for conversion is one ordinary share for every

four preference shares held.

It is estimated that these preference shares have a market rate of

18%.

The book value of the preference shares is R4million and the price

per preference share is R5.

• Debentures

These debentures are non-convertible and non-redeemable.

The debentures current yield to maturity is 20%.

The market value of the debentures is R14million.

Additional Information:

• Extract from the statement of comprehensive income:

2019 2018 2017

R R R

Profit after tax 650 000 601 800 557 200

• The tax rate is 28%.

Calculate the Weighted Average Cost of Capital (WACC) of

Gymogae Ltd. You are currently in the process of reviewing two investments namely Dalmatia Limited and Roma Limited