QUESTION 1 (59 marks)

Mr. James Storm is an investment consultant employed at Standard Peak Ltd (“Standard Peak”). Each investment consultant of Standard Peak is allocated their own portfolio of existing and new clients. Accordingly, Mr James Storm has also been assigned a portfolio of clients to assist.

The following clients allocated to Mr James Storms currently have queries and require assistance:

CASE 1: MRS JANE DOW

Mrs Jane Dow has been offered to purchase non-redeemable, non-cumulative convertible preference shares with an issue price of R85 per share in Atom Ltd. These preference shares have a dividend rate of 4.62% per year, payable quarterly in advance. The conversion date is 31 July 2025, on which the preference shares may be converted into ordinary shares of Atom Ltd at a 12% discount to the prevailing market price of the ordinary shares as on that date. Mrs Jane Dow will be converting the preference shares to ordinary shares at that time. It is estimated that each ordinary of Atom Ltd will be trading at R57 on 31 July 2025. Furthermore, it is also estimated that no dividend is to be paid when the second preference share dividend is meant to be made but that the dividend payment will again resume thereafter. Similar preference shares to the Atom Ltd preference shares currently have a market yield of 8% per year.

CASE 2: MISS REGINA JACKSON

Miss Regina Jackson is interested in purchasing six (6) GHH Ltd 3-year R100 redeemable debentures at these debentures’ current market value. The debentures however have a call option attached to them, according to which GHH Ltd may redeem all these debentures after two (2) years. It is anticipated that GHH Ltd will exercise this right. The debentures offer 143 basis points above the Johannesburg Interbank Average Rate (“JIBAR”). Currently, the 12-month JIBAR yield is 8.95%. This yield is however expected to change to 8.82% in one years’ time. Similar debentures to these GHH Ltd debentures offer a yield to maturity of 11.77% per annum.

CASE 3: ACCELERATION LTD

Acceleration Ltd has 3 million ordinary shares in issue. Each ordinary share is reasonably valued at R1 120 and each share will be receiving a dividend of R55.40 within the next few days. Acceleration Ltd‘s business and resulting net profit after taxation are expected to grow annually by 8%. Acceleration Ltd intends to maintain the annual dividend declared to shareholders in the same ratio to the net profit after taxation, as it is currently.

CASE 4: MR BLESSING KHOSI

Mr Blessing Khosi is contemplating purchasing non-redeemable, cumulative preference shares in Beta-Delta Ltd. He, however, wants to establish a reasonable price to pay for each preference share. According to research performed on Beta- Delta Ltd and these preferences shares, the following events are anticipated:
• Each preference share will have an issue price of R50 attached to it.

• The preference dividend will be 11.8% per annum.

• The required rate of return for these preference shares is however 12.1%.

• Beta-Delta Ltd is planning to undertake a large project in four years’ time during which Beta-Delta Ltd is to launch a new product line. To have sufficient finances available to fund the product line launch, it is anticipated that Beta-Delta Ltd will not pay dividends during the third and fourth year from today. In the fifth year, Beta-Delta Ltd will again proceed with dividend payments.

REQUIRED:

1.1. Refer to CASE 1: MRS JANE DOW. Assist Mr James Storm in determining the value of each Atom Ltd preference share as on 30 April 2024 in order to inform Mrs Jane Dow what a reasonable price for each preference share will be, should she wish to purchase these preference shares on 30 Apil 2024.

Round to two decimals where applicable.(17 marks)

1.2. Refer to CASE 2: MISS REGINA JACKSON. Assist Mr James Storms in calculating the total purchase price that Miss Regina Jackson will have to pay
to acquire the six (6) GHH Ltd redeemable debentures.

Round to two decimals where applicable. (11 marks)

1.3. Refer to CASE 2: MISS REGINA JACKSON. State the formal name given to an interest rate that is dependent on a reference rate as its basis. (2 marks)

1.4. Refer to CASE 3: ACCELERATION LTD. Calculate the rate required by each ordinary shareholder of Acceleration Ltd. (5 marks)

1.5. Refer to CASE 3: ACCELERATION LTD. Briefly explain, based on

Acceleration Ltd ‘s ordinary shares only, whether Acceleration will be able to

list on the Johannesburg Stock Exchange (“JSE”) main board. (3 marks)

1.6. Refer to CASE 3: ACCELERATION LTD. State the term used for the required rate of return of equity holders, such as Acceleration Ltd ‘s ordinary shareholders. (2 marks)

1.7. Refer to CASE 4: MR BLESSING KHOSI. Assist Mr James Storm in determining a reasonable price that Mr Blessing Khosi should be willing to pay for each Beta-Delta Ltd preference share if the shares are purchased today. (14 marks)

1.8. Assume that one long-term debt instrument (“Debt 1”) has a credit rating of ‘B’ according to both Standards & Poor’s (“S&P”) as well as Moody’s.

Another long-term debt instrument (“Debt 2”) has a credit rating of ‘BBB’ according to S&P and ‘Baa’ according to Moody’s.

Seperately for Debt 1 and Debt 2, interpret the meaning of each debt instrument’s rating and explain the difference between the credit ratings.

QUESTION 2 (41 marks)

Youth (Pty) Ltd (“Youth”) is a dermatological practice in Cape Town’s Central Business District. The entity employs specialised, well-trained dermatologists, and the majority of its client base is middle to high-income earners. Currently, Youth is considering introducing a new product range to be sold in its practice. The entity is deciding between two product ranges, “Bright” and “Elastic”.

While Bright will be an affordable skincare range, Elastic will be more expensive but offers more benefits to the user as it has more proteins and minerals. Consequently, choosing Elastic as the product range to be introduced is riskier, whilst it is known that Bright will be bought by customers. Elastic may not be as successful amongst the customers due to the higher price. However, should Elastic succeed, the returns to Youth will be higher due to the higher selling price and consequential profit.

In order to perform an evaluation of which product range to choose, Youth has conducted research on the probability of each product range’s success and the returns they will receive in each of the various outcomes.

PRODUCT LINE: BRIGHT

A sensitivity analysis and market research have been conducted which delivered the following results: Should the Bright product line fail, a loss of 14.8% will be experienced. The chance of this product line failing is 8.6%. However, should it be successful above average a 56.1% return will be obtained and, if highly successful, a 68.2% return. The chances of these are 57.2% and 24.2% respectively. In the case of the Bright product line achieving average success, a 51.5% return will still be obtained.

PRODUCT LINE: ELASTIC

The sensitivity analysis and market research for this product line indicated the following: Should this product be successful above average, a 77.4% return will be received. The chance of this is 33.6%. If the product line is only average in this success a 59.8% return will be generated of which the chance is 30.1%. In the extreme cases of a failure or a high success, the outcomes will be a loss of 19% and a return of 80.5% respectively. A 21.2% probability can be assigned to the first and 15.1% to the latter.

REQUIRED:

2.1. Calculate the return that Youth (Pty) Ltd could expect from the Bright product line and Elastic product line, respectively. (8 marks)

2.2. Calculate the risk that Youth (Pty) Ltd can expect from the Bright product line and Elastic product line, respectively. (21 marks)

2.3. The directors of Youth (Pty) Ltd pointed out that the research indicated that the Elastic product line will generate a return of 59.8% even if it only achieves an average success, whereas the Bright product line will only generate a 51.5% return if the same outcome prevails.
Advise the directors of Youth (Pty) Ltd as to what the chances are of the Bright product line generating a return of 59.8% (6 marks)

2.4. Indicate the range in which the Elastic product line’s return could be expected to fall within, should the directors require to know with 99.7% accuracy what the actual return will be. Assume the Elastic product line’s variance was calculated as 16% and the expected return as 53.5% (6 marks)

Answer to Above Questions on Financial Management

Answer 1: The value of each Atom Ltd preference share as on 30 April 2024 is calculated as follows:

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