QUESTION 1 (40 marks)

Electrons-At-Work Ltd (“EAW’) is a South African electronic devices and accessories retailer with a nationwide footprint.

The entity is listed on the JSE AltX and has a 31 October financial yearend.

EAW purchases various electronic devices directly from international suppliers and then resells the devices locally at a predetermined mark-up on the cost price.

Upcoming purchase order
One of the international suppliers of EAW is a Japanese supplier called Dianhua Co. Ltd (“Dianhua”).

EAW will soon be placing another purchase order on 1 December 2023 at Dianhua for various cell phones to a total value of ¥ 428 000 (Yen 428 000).

EAW is an approved debtor of Dianhua and thus EAW is allowed to repay Dianhua in agreed portions on agreed dates: 20% of the total value of the order has to be paid when the order is placed, whereafter Dianhua will initiate the processing of the purchase order. The next 30% of the total value has to be paid on the date when the goods’ transporting ship departs from Japan and the remaining portion of the total value may be repaid 2 months after the transporting ship’s arrival at the designated harbour, which will be the Durban harbour in EAW’s case.

From past experience with Dianhua, EAW knows that from the time the order is placed at Dianhua, the transporting ship will depart after an average period of 30 days and then spend another 30 days at sea before arriving at the Durban harbour.

Finance option 1: Financer Ltd loan
EAW will have to obtain external finances to finance the upcoming Dianhua purchase. Financer Ltd (“Financer”) is a South African bank and will provide EAW with the best suited loan agreements for the Dianhua purchase. The interest rate will be set at 3.8% above the prime rate (annually compounding).

As EAW will not be required to pay Dianhua the whole total value when the goods are purchased, EAW will also not be taking out a loan to the total value of the purchase on the date the goods are purchased. EAW will acquire the loans from Financer on the same dates and to the same value as the payment dates and amounts to Dianhua.

EAW estimates that it will have sufficient internally generated funds, due to having sold the majority of the goods purchased and other sales, to repay Dianhua themselves on the date when the last portion of the repayment is due. Consequently, EAW will also be repaying Financer the full amount of the loan due to Financer on this date.

Finance option 2: Argent SW. loan
To ensure that EAW obtained the most competitive loan available, EAW has also evaluated the best interest rate and repayment terms available abroad. Argent SW. (“Argent”) is a Swiss bank that will also be willing to lend the required funds to EAW. EAW will acquire the total value in the same portions as the Dianhua repayment amounts due, however, seeing that Argent is based in Switzerland, EAW will have to acquire each portion a month before each payment to Dianhua’s due date.

Seeing that EAW will have sufficient internal funds available 2 months after the transporting ship’s arrival, EAW will also be repaying the total amount due to Argent on that date.

Exchange rates

Interest rates

Additional information:
• The current South African prime rate is 7.9% per annum.
• Ignore all taxation implications.

REQUIRED:

Calculate the total purchase price of cell phones to be ordered from Dianhua Co. Ltd in South African Rands (ZAR).
(7 marks)

Calculate the full repayment amount of the Financer Ltd loan in South African Rands (ZAR).

Assume that the repayment amounts to Dianhua Co. Ltd will be the following in sequential order of date of occurrence from first to last:
R12 500; R19 400; R27 800.
(9 marks)

Calculate the full repayment amount of the Argent SW. loan in Swiss Franc (CHF).

Assume that the repayment amounts to Dianhua Co. Ltd will be the following in sequential order of date of occurrence from first to last:
R12 500; R19 400; R27 800.
(12 marks)

The upcoming Dianha Co. Ltd purchase order itself will expose Electrons-At- Work Ltd to a certain type of financial risk.
Identify and explain this financial risk.
Supplement your answer by advising Electrons-At-Work Ltd on 3 (three) possible methods to mitigate this financial risk.
(12 marks)

QUESTION 2 (60 marks)

Magen Ltd (“Magen”) is a large food producer listed in the consumer sector of the Johannesburg Stock Exchange (“JSE”). The entity has a 30 June financial yearend.

Magen has various product lines that consist of daily and basic food items such as vegetables, canned foods, and cereals, amongst others.

Magen however does not have any candy product lines. This sector in the food industry is known to be lucrative and to overcome this shortcoming, Magen has identified an entity called Desertè Ltd (“Desertè”) that Magen is interested in acquiring.

Desertè owns and manufactures various candy products and has a 30 September financial yearend.

The following are the annual financial results of Desertè as at its financial yearend:

Note 1
The candy market sector grows by 2.2% annually on average. This trend is expected to continue in future periods. Desertè currently has a 17% market share in the candy market. This market share is expected to immediately increase to 25% when Magen acquires Desertè due to the business networks and resources of Magen which could be employed to Desertè’s advantage.

In three years’ time, the candy market is expected to have an increase in its annual growth to 3.3% which will then continue into the foreseeable future. At the same time, Desertè will also capitalise on this growth by increasing its candy market share to 30%.

Note 2
Should Magen acquire Desertè, Desertè’s gross profit margin is expected to increase by 5% due to cost savings. This improved gross profit margin is expected to then be maintained in all future periods.

Note 3
Included in operating expenses is depreciation to the value of R637 000. This depreciation is expected to decrease by 5% per annum for the following three years (the only percentage movement expected in depreciation for the following three years). Thereafter the depreciation is expected to reflect the capital cash expenditure each year.

The operating expenses are expected to steadily increase by 6% annually.

No other fixed asset movements are expected in the future besides an R440 000 planned equipment cash purchase in two years’ time.

Note 4
This amount is due to the profit on the sale of an investment in ordinary shares of Eva Ltd which Desertè had previously purchased. Consequently, Desertè no longer owns any shareholding in Eva Ltd.

Note 5
Desertè will maintain the entity’s net working capital in the same ratio to the turnover as currently, in future years.

Note 6
These long-term loans are the only non-current liabilities Desertè has. These long- term loans have a marginal cost of debt of 11.9% before tax.

Additional information:
• Desertè has 1 500 000 ordinary shares in issue from which R172 500 000 funds were obtained when issued. These are the only shares in issue.
• Long-dated RSA government bonds are currently offering yields of 8.8%.
• The food industry’s market premium is expected to be 2.4%.
• The betas in different sectors of the food industry do have noticeable differences as can be observed when comparing Margen’s 0.95 beta to Desertè’s beta of 1.23. Should these two entities however merge, the combined entity’s beta will be 1.16.
• Assume that all entities’ taxable income is the same as that entity’s earnings before interest and taxation.
• The South African Income Tax rate applicable to companies is 27%. No change in the tax rate is expected in the future.

REQUIRED:
Magen Ltd wishes to purchase all Desertè Ltd’s ordinary shares on 1 October 2023. Calculate the total current value of Desertè Ltd by using the Free Cash Flow method.

Should you omit an item intentionally from the Free Cash Flow value, provide a brief motivation.

Round to two decimal places where applicable. (60 marks)

Answers to Above Questions on Financial Management

Answer 1: The total purchase price of cell phones to be ordered from Dianhua Co. Ltd in South African Rands (ZAR) is calculated as follows:

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