Unisa Module On Financial Ma

MAC4861/102/0/2020
NMA4861/102/0/2020
ZMA4861/102/0/2020
Tutorial letter 102/0/2020

ADVANCED MANAGEMENT
ACCOUNTING
MAC4861
NMA4861
ZMA4861
Year module
Department of Financial Intelligence

IMPORTANT INFORMATION
This tutorial letter contains important information

about your module
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ADVANCED MANAGEMENT ACCOUNTING
TUTORIAL LETTER 102 / 2020
TABLE OF CONTENTS PAGE
MODULE PURPOSE 4
INTRODUCTION AND OVERVIEW 4
PART 1 – STRATEGY, RISK MANAGEMENT AND FINANCING 8
LEARNING UNIT 1 STRATEGY AND GOVERNANCE 9

LEARNING UNIT 1.1 STRATEGY 11
LEARNING UNIT 1.2 CORPORATE GOVERNANCE AND INTEGRATED
REPORTING 20
LEARNING UNIT 2 RISK MANAGEMENT 24

LEARNING UNIT 2.1 RISK THEORY AND APPROACHES TO RISK
MANAGEMENT 26
LEARNING UNIT 2.2 RISK IDENTIFICATION AND DOCUMENTATION 30
LEARNING UNIT 2.3 RISK ASSESSMENT AND RESPONSES 35
LEARNING UNIT 3 COST OF CAPITAL AND CAPITAL INVESTMENT

APPRAISAL 41
LEARNING UNIT 3.1 WEIGHTED AVERAGE COST OF CAPITAL 43
LEARNING UNIT 3.2 CAPITAL INVESTMENT APPRAISAL – ISSUES IN
INVESTMENT APPRAISAL 49
LEARNING UNIT 4 SOURCES AND FORMS OF FINANCE 58

LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE 59
LEARNING UNIT 4.2 THE FINANCING DECISION 62
LEARNING UNIT 5 DIVIDEND DECISION 64

LEARNING UNIT 5.1 DIVIDEND DECISION 66
LEARNING UNIT 6 MANAGEMENT OF WORKING CAPITAL 67

LEARNING UNIT 6.1 MANAGEMENT OF WORKING CAPITAL 69
LEARNING UNIT 7 TREASURY FUNCTION 74

LEARNING UNIT 7.1 TREASURY FUNCTION 75
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TABLE OF CONTENTS (continued) PAGE
PART 2 – FUNCTION OF FINANCIAL MANAGEMENT 79
LEARNING UNIT 8 ANALYSIS AND INTERPRETATION OF FINANCIAL

AND NON-FINANCIAL INFORMATION 80
LEARNING UNIT 8.1 ANALYSIS AND INTERPRETATION OF FINANCIAL
AND NON-FINANCIAL INFORMATION 81
LEARNING UNIT 9 BUSINESSES IN DIFFICULTY 83

LEARNING UNIT 9.1 BUSINESSES IN DIFFICULTY 84
LEARNING UNIT 10 VALUATIONS 87

LEARNING UNIT 10.1 VALUATIONS 89
PART 3 – MERGERS & ACQUISITIONS AND BUSINESS PLANS 92
LEARNING UNIT 11 MERGERS AND ACQUISITIONS 93

LEARNING UNIT 11.1 VALUATION FOR PURPOSES OF M&A’s: SYNERGIES 95
LEARNING UNIT 11.2 OTHER CONSIDERATIONS 101
LEARNING UNIT 12 BUSINESS PLANS AND FINANCIAL PROPOSALS 107

LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS 108
INTEGRATED SELF-ASSESSMENT 109
INTEGRATED QUESTION 1 109

INTEGRATED QUESTION 2 109
TEST 1 (2019) – MAC4861/NMA4861/ZMA4861 110

TEST 1 (2019) – SUGGESTED SOLUTION 112
TEST 2 (2019) – MAC4861/NMA4861/ZMA4861 116
TEST 2 (2019) – SUGGESTED SOLUTION 119
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MODULE PURPOSE
This module is intended for students who are studying towards a Postgraduate Diploma in Accounting
Sciences (CTA Level 1) and ultimately towards the Certificate in the Theory of Accounting (CTA), a
prerequisite for the professional qualification of Chartered Accountant (SA) (registered with SAICA).
This module is therefore designed to help you develop the prerequisite competencies relating to
Management Decision Making and Control; as well as Strategy, Risk Management, and Financial
Management.
INTRODUCTION AND OVERVIEW

The purpose of this tutorial letter is to provide students with tutorial matter relating to Strategy, Risk
Management and Financial Management. This tutorial letter will build upon your prior knowledge and
introduce a few new concepts relating to strategy, risk and financing.
PRE-REQUISITES
The learning units contained in this tutorial letter build, to a large extent, upon prior knowledge obtained
in your undergraduate Management Accounting studies. It is therefore assumed that you have
achieved the necessary prior learning.
STRUCTURE OF THIS TUTORIAL LETTER
This tutorial letter is structured as three distinct parts, each containing a number of learning units. A
learning unit is the main study area within a part, and each learning unit is further divided into sub
learning units. You will find the outcomes, which you are required to achieve for each learning unit at
the beginning of each learning unit. Self-assessment activities are provided at the end of each learning
unit so that you can assess whether you have mastered the learning outcomes.
The parts of this tutorial letter are described below:
PART 1 – STRATEGY, RISK MANAGEMENT AND FINANCING (containing learning units 1-7)
PART 2 – FUNCTION OF FINANCIAL MANAGEMENT (containing learning units 8–10)
PART 3 – MERGERS AND ACQUISITIONS, AND BUSINESS PLANS

(containing learning units 11-12)
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CONTENT – THIS MODULE
The diagram below contains a schematic presentation of the content of this module.
MAC4861
Advanced Management Accounting
Strategy, Risk, Management

Planning and Management, Prior exams,
decision
general Financial questions and
making and
Management revision
control
Tutorial Tutorial Letter Tutorial Letter Tutorial Letter

letter 101
102 103 104
Tutorial
letters in the
3-series (3**)
Part 1 Part 2 Part 3
Learning units Learning units Learning units

1. Strategy and governance
2. Risk management 8. Analysis and 11. Mergers and
3. Cost of capital and capital interpretation acquisitions
investment appraisal of financial 12. Business
4. Sources and forms of and non- plans and
finance financial financial
5. Dividend decision information proposals
6. Management of working 9. Businesses
capital in difficulty
7. Treasury function 10. Valuations
TEST 1 TEST 2
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STUDY MATERIAL AND RESOURCES
Prescribed study material
The prescribed textbooks for this module are:
• Management and Cost Accounting (including Student’s Manual), 10th edition (Drury, C)
• Managerial Finance, 8th edition (Skae, FO.)
myUnisa resources
Please make use of myUnisa (https://my.unisa.ac.za) as it contains further resources to help you
master this module. The following resources are available on myUnisa (made available at appropriate
times during the year):
• your tutorial letters for this module

• tests and suggested solutions
• additional questions
• e-learning initiatives
• announcements containing information/updates relating to this module
Important note
This tutorial letter makes principle reference to the textbook Managerial Finance, 8th edition.
Supplementary literature/additional reading
You can use the bibliography at the end of each learning unit for additional reading for purposes of self-
enrichment.
General information and CTA news
For general information and CTA news please refer to the CTA Support Page, available from:
The CTA support page can be accessed from our CAS website landing page.
The short URL for this page is: www.unisa.ac.za/cas/cta
TESTS
The learning units assessed by Test 1 will cover predominantly (but not exclusively) the content of Part
1 (learning units 1–7); and Test 2 will cover predominantly (but not exclusively) the content of Parts 2
and 3 (learning units 8–12).
It is important to realise that the examination papers of this module will integrate between the various
learning units and disciplines. In preparation for the exam, you can therefore also expect some level of
integration in the tests.
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STUDY PROGRAMME
A study programme has been published in Tutorial Letter SASALL301. Please utilise this to plan your
studies.
We recommend that you allocate your time according to the following approximate allocation:
Part Learning Learning unit

unit no.
1 1 Strategy and governance 4%

2 Risk management 4%
3 Cost of capital and capital investment appraisal 12%
4 Sources and forms of finance 9%
5 Dividend decision 4%
6 Management of working capital 6%
7 Treasury function 6%
2 8 Analysis and interpretation of financial and non-financial information 10%
9 Businesses in difficulty 7%
10 Valuations 11%
3 11 Mergers and acquisitions 8%
12 Business plans and financial proposals 8%
Integrated self-assessment 11%
Total 100%
Note
If you struggle with any learning unit we strongly recommend that you allocate additional time – above
and beyond the total hours indicated.
CONCLUSION
We trust that the preceding sections will assist you in approaching your studies (linked to this tutorial
letter) in a methodical manner and with a greater level of understanding.
We hope you enjoy this part of your studies!
Regards,
Your Advanced Management Accounting lecturers

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PART 1: STRATEGY, RISK MANAGEMENT AND FINANCING
PURPOSE
The purpose of Part 1 is to reinforce and enhance your existing competencies related to
strategy, risk management and financing. Its purpose is further to assist you in applying your
knowledge to a scenario on an integrated basis.
The specific competencies referred to above relate to the development and evaluation of an
entity’s ability to make decisions and maximise its performance (including governance,
strategies, policies and resources). The competencies further relate to the management of
financial assets and the treasury function.
The purpose of the numerous activities and self-assessment activities included in this part is
also to enhance your pervasive qualities and skills – the professional qualities and skills that
chartered accountants are expected to bring to all tasks. These professional qualities include
ethical behaviour and professionalism, personal attributes, and professional skills.
The diagram below contains a schematic presentation of the content of this part.
Tutorial Letter 102

1. Strategy and governance 8. Analysis and 11. Mergers and
2. Risk management interpretation of acquisitions
3. Cost of capital and capital financial and non- 12. Business plans and
investment appraisal financial information financial proposals
4. Sources and forms of 9. Businesses in difficulty
finance 10. Valuations
5. Dividend decision
6. Management of working
capital
7. Treasury function
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LEARNING UNIT 1 – STRATEGY AND GOVERNANCE

LEARNING OUTCOMES
After studying this learning unit, you should be able to do the following:
• Demonstrate sound knowledge of the concepts of mandate and business model in the context of
an organisation.
• Critically review the appropriateness of an entity’s mission, vision, strategies and strategic plan.
• Critically reflect upon the internal and external influences on an entity’s strategy development.
• Evaluate an entity’s ability to manage organisational performance in accordance with its
strategies.
• Assess the alignment of management decisions with the entity’s vision, mission, values and
mandates.
• Understand and evaluate the business model of the entity in the context of the entity’s vision,
mission, values, mandate and overall objective
• Utilise analytical tools to assess the feasibility of strategies formulated.
• Discuss and critically review the strategic alignment of the financial function.
• Evaluate relevant structural and governance issues, including sustainability issues and integrated
reporting matters.
• Understand what the International Integrated Reporting Framework entails and its reference to
the various capitals within the organisation (financial, manufactured, intellectual, human, social
and human relationships and natural).
PRIOR LEARNING ASSUMED

In your undergraduate studies you have already mastered the learning outcomes indicated below. If
you want to refresh your knowledge, please refer to your undergraduate material and prescribed
textbook. For your convenience we provide textbook references.
Learning outcome Reference
Managerial Finance,
• Explain the function of financial management and the objective of the 8th edition
organisation. • Chapter 1 and 2
• Explain the strategic planning process (including the concepts of
strategy, mission, vision, goals, objectives, action plans and key
performance indicators).
• Identify key stakeholders of both private as well as public sector non-
profit entities.
• Describe the role of stakeholders and the relationship of the entity to
its stakeholders including the management thereof.
• Recommend appropriate strategic choices (considering risks and
opportunities).
• Assess the strategic focus of an organisation utilising tools such as
Porters Five Forces model, SWOT analysis and PESTEL
• Evaluate the implementation of strategy and performance
measurement against key performance indicators (KPIs).
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INTRODUCTION
For an entity to be successful it has to be guided by an overarching corporate strategy. In this regard,
the financial function could also add more value through a process of strategic alignment. In dealing
with the ‘bigger picture’, it is also important to realise that a firm functions within a greater context and
therefore also has to consider other stakeholders by means of appropriate corporate governance.
In this learning unit, we do not attempt to discuss all the different viewpoints and approaches; however,
the content of this learning unit is intended to enhance your existing knowledge of corporate strategy
and governance.
THIS LEARNING UNIT CONSISTS OF THE FOLLOWING:
LEARNING UNITS TITLE
LEARNING UNIT 1.1 STRATEGY
LEARNING UNIT 1.2 CORPORATE GOVERNANCE AND INTEGRATED REPORTING

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LEARNING UNIT 1.1 STRATEGY

1. Introduction
Author, Dale Littler points out that corporate strategy should address the fundamentals, ‘namely, the
“what,” “why,” “how,” and “when” of the organization’ (2011: no page number). In addition, when
contemplating the ‘bigger picture’, it is important to temper ambitions by means of appropriate corporate
governance.
In formulating a corporate strategy and in performing strategic analysis, firms frequently make use of
specific frameworks, including the following key models:
• SWOT analysis (analysis of a firm’s Strengths, Weaknesses, Opportunities and Threats).

• Porter’s five forces model (competitors; threat from substitute products; new entrants; bargaining
power of customers; and bargaining power of suppliers).
In this learning unit, we will explore: the development of strategy, selected strategic planning processes
and approaches, and the strategic alignment of the financial function. This learning unit is based on
sections of the following chapters from your prescribed textbook, Managerial Finance, 8th edition:
• Chapter 1 (Sections 1.2 to 1.6)

• Chapter 2 (Sections 2.1. to 2.6)
2. Content
The purpose of the content below is to supplement the information in the textbook in areas where it is
considered necessary. It in no way replaces or can be considered to be a substitute for the textbook.
It therefore remains imperative that you work through the textbook in detail.
2.1. Strategy development
Strategy involves outlining of long-term activities to achieve the purpose set out in the mission
statement and ultimately moving towards realising the vision. In developing the strategy of a company
it is also important to consider the mandate of the company. Mandate is defined as written authorization
and/or command by a person, group, or organization (the 'mandator') to another (the 'mandatary') to
take a certain course of action (Business Dictionary, 2017).
The extract below provides the mandate, vision, mission and strategy of Eskom, to assist in enhancing
your understanding of these fundamental concepts.
Mandate:
Eskom’s mandate is to provide electricity in an efficient and sustainable manner, including its
generation, transmission, and distribution and sales. Eskom is a critical and strategic contributor to the
South African government’s goal of security of electricity supply in the country as well as economic
growth and prosperity.
Vision:
Sustainable power for a better future.
Mission:
To provide sustainable electricity solutions to grow the economy and improve the quality of life of the
people in South Africa and the region.
Strategy:
To stabilise the business and to re-energise for longer term sustainability and growth.
(Eskom, 2017)
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2.1.1. Strategic planning processes and approaches
Various analytical models can be employed in strategic planning, of which SWOT analysis and
Porter's Five Forces are frequently used.
(a) SWOT analysis
See Table 1.1.1 for an overview of SWOT analysis, with examples.
INTERNAL FACTORS
Strengths Weaknesses
• Strengths are the virtues which enable the • Weaknesses are the factors that restrain the
entity to attain its mission. entity from fully realising its mission and
• Strengths are the foundation on which achieving its potential.
success can be built and sustained. • Weaknesses negatively influence the growth
• Strengths can be tangible or intangible. and success of the entity.
• Examples of strengths are: • Weaknesses are controllable and should be
reduced and removed, for instance new
✓ human competencies (the qualities and machinery can be purchased to overcome
behaviour of the employees, individually the problem of obsolete machinery.
and also as a team) • Examples of weaknesses:
✓ process capabilities
✓ huge financial resources ✓ insufficient research and development
✓ products and services (specific products facilities,
or an extensive product line) ✓ high employee turnover
✓ narrow product range
✓ huge debt
✓ complex decision-making process
✓ poor decision-making
✓ extensive wastage of raw materials.
EXTERNAL FACTORS
Opportunities Threats
• Opportunities typically arise from • Threats arise when circumstances in the
circumstances in the external environment external environment jeopordise the
that the entity can use to enhance their profits. success and profitability of the entity.
• Entities can obtain a competitive advantage • Threats cannot be controlled. A threat
by recognising and grasping opportunities as jeopordises the stability and survival of an
they arise. entity.
• Opportunities can arise from: • When threats combine with the weaknesses,
they compound the vulnerability of the entity.
✓ the market • Examples of threats are:
✓ competition
✓ industry/government ✓ strikes by workers in the industry
✓ technology ✓ technology that changes frequently
✓ increasing competition that results in
excess capacity
✓ price wars among competitors
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Table 1.1.1: An overview of SWOT analysis
(b) Porter's Five Forces
Porter's Five Forces model assumes that the competitive environment within an industry depends
on five forces that affect the entity's success. The five forces are illustrated in Figure 1.1.1 below.
Though the power of Porter’s Five Forces varies from industry to industry, these forces often have a
strong impact on an industry through their effect on the prices charged, costs, and the necessary capital
investment. Porter's model comes in handy when making strategic decisions because managers can
use it to analyse the industry's competitive structure.
Figure 1.1.1: The Five Forces That Shape Industry Competition (Source: Porter, 2008:4)
We will now discuss the five forces presented in the model.
i. Threat of new entrants
Potential competitors include entities that are not competing in the industry at present but have the
potential to do so. The entry of new competitors increases the capacity of the industry, creates
competition for market share, and lowers the current costs for customers.
The threat of entry by potential competitors is a function of barriers to entry. Higher barriers to entry
strengthen the position of the current players and make it more difficult for new ones to enter. Below
illustrates some of the factors affecting the barriers to entry:
• Brand loyalty
• Government regulations
• Customer switching costs
• Absolute cost advantage
• Established distribution channels (ease of distribution)
• Strong capital base
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ii. Strength of rivalry among current competitors
The competition for market share between entities in an industry is called rivalry. Intense rivalry among
well-known entities causes a great threat to profitability due to pressure on prices. Below are some of
the factors affecting the strength of rivalry:
• Demand conditions
• The competitive structure of the industry
• The amount of fixed costs
• The presence of global customers
• Absence of switching costs
• The growth rate of industry
• Extent of exit barriers
Barriers to exit are factors that prevent an entity from leaving (exiting) a market. If the cost of exiting
exceeds the cost (losses) of remaining in the market, it will be difficult for the entity to leave the market,
and it will likely continue to compete for market share. Below are some of the factors affecting barriers
to exit:
• Substantial investment in non-current assets

• High retrenchment costs
• Penalty clauses in supplier contracts
• Penalty clauses in rental agreements
iii. Bargaining power of buyers
In this context, ‘buyers’ are defined as the final consumers of a product/service or entities that deliver
the industry's product/service to the final consumers. Bargaining power of buyers refers to their
potential to bargain for lower prices. It also refers to the potential of buyers to demand from entities a
higher quality product/service and thereby raise production or service-delivery costs.
iv. Bargaining power of suppliers
In Porter’s model, ‘suppliers’ represent entities that supply inputs to the industry and have the potential
to raise the prices of these inputs (such as raw material or services) or the cost of an industry in a
number of other ways. Suppliers that have products with only a few alternatives or substitutes possess
strong bargaining power. The existence of strong suppliers usually results in high switching cost where
the supplier’s product forms a significant part of or input to the buyer's manufacturing process, since it
is usually expensive for an entity to adapt its production set-up to accommodate a different supplier's
product. Furthermore, each buyer tends to be less important to a strong supplier.
v. Threat of substitute products
Substitute products are described as alternative products that have the capability of effectively
satisfying customers’ needs, e.g. plastic bottles in lieu of glass bottles. Substitutes limit possible
monetary returns of an industry by setting a limit on the price that those entities can charge for their
product in an industry. The fewer close substitutes a product has, the greater is the chance for the
entities in the industry to raise their product prices and earn higher profits (all other factors being equal).
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2.2. Strategic alignment of the financial function
Author, Tomas Ambler described practical ways of aligning the financial function with strategy in a
2011-paper. This section, including Table 1.1.2 was compiled to a large extent based on information
contained in this paper. We therefore acknowledge the contribution made by this author.
Within the current context, the term “financial function” is meant to include not only the typical
bookkeeping, accounts and accounting functions, but also financial reporting, managerial accounting,
financial management, and the tax planning and compliance functions.
If we next consider the strategic alignment of the financial function, so described, we normally ask the
following questions:
• How can the financial function be better aligned to strategy?

• What inputs can the financial function offer that can be used in the development of strategy?
• How can the financial function help with the implementation of strategy?
Table 1.1.2 describes a number of practical ways of obtaining strategic alignment of the financial
function.
Corporate strategy: typical senior Suggestions for improved strategic alignment of the financial function
management input
Formulate the corporate strategy • Provide meaningful management information through synthesis of not only
internal data (typical), but also external data (consider e.g. political,
economic, social, technology, customer and supplier data)
Strategy development and recognition of • Timeously communicate expectations of constraints in capital and cash flow
capital constraints. Plan for additional • Forecast short and multi-year cash flow
sources of capital • Prevention of capital and cash flow shortfalls, where possible
• Determine the optimal sources and forms of finance, within the context of
optimum capital structure, for example, for a proposed investment
• Properly manage finances (including proper tax planning and tax
compliance) to prevent future constraints
Consider new product and market • Perform accurate and insightful capital investment appraisals
opportunities. Link these to internal • Recommend best ways of capital rationing
capabilities. Pursue investment
opportunities/best opportunities
Obtain and maintain a solid understanding • Provide meaningful management information, including accurate costing
of the firm’s core business information, e.g. by using activity-based costing (ABC) and proper data
analytic tools
• Determine where the greatest return on investment is generated (e.g.
products, customers and areas) and communicate to senior management
• Identify areas for improvement
• Develop a cause - effect relationships through a proper coding structure and
changes in the chart of accounts
Identify main goals, measures of success, • Remove out-dated performance measures, e.g. net divisional profit
and critical success factors (e.g. part of a • Prescribe superior performance measures considering the specific
Balanced Scorecard) circumstances, such as return on invested capital (ROIC), residual income
(RI), or Economic Value Added (EVATM)
• Promote incentives (financial and non-financial) that motivate goal
congruency and strategic alignment
• Timeously generate quality scorekeeping information
• Monitor progress
Compile action plans and recognise • Help to align resource allocation to strategy, by limiting finance and cash flow
organisational constraints constraints
Monitor action plans monthly • Use unique capabilities to promote and support the monitoring process
Create a link between multi-year strategy, • Facilitate the link between multi-year strategy, main goals, action plan
main goals, action plan timelines and timelines and operating budgets
operating budgets • Coordinate, compile and review the comparison between actual results and
the budget (the budget review automatically becomes a strategic review if
aforementioned link was properly made)
Share financial results with all employees • Facilitate and promote the sharing of financial results with the relevant role-
(to help top-down strategic alignment) players
Appointment of suitable senior financial • Train and promote financial staff to be strategic thinkers, not merely “bean
personnel counters”
Table 1.1.2: Ways of aligning the financial function with corporate strategy (Ambler, 2011 – adjusted)
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2.3. Analytical tools for assessing the feasibility of strategies
The following two analytical tools are examinable:
• Ansoff’s Product-Market Growth Matrix
The Ansoff Product-Market Growth Matrix is a tool created by Igor Ansoff with the aim of providing
entities with growth strategies. The following represents the four strategies that entities can pursue
to achieve product and market growth:
• Market penetration: Within this strategy growth is achieved without an entity deviating from its
original product market strategy i.e. growth can be achieved by increasing sales volumes to
existing customers or by making sales to new customers.
• Market development: This entails achieving growth by entering new markets.
• Product development: Growth is achieved by developing new products for the existing market.
• Diversification: This entails an entity simultaneously changing its product line and target
market.
It should be noted that practically most entities would follow several of the above strategies at
the same time.
• General Electric Corporation (GEC) Model
This model provides decentralised entities, with multiple business units, with a systematic
approach to determine the best manner in which to invest their cash. Instead of relying on the
projections of each business unit manager, the future performance of the business unit can be
assessed based on two key factors i.e. industry attractiveness and competitive strength. The
model is depicted graphically as follows:
Based on the above the following strategies are available when assessing each business unit:
Invest/Grow
A business unit will be in the “invest/grow” category if it has a high industry attractiveness and
the business unit is likely to do better than most of the other firms in the industry i.e. it is highly
competitive. A business unit in this category should be given as much money as it needs.
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Selectivity/Earnings
Business units in this category come secondary to those in the “invest/grow” category. So, the
amount of money spent on business units in the “invest/grow” category will determine how much
money is left over for business units in this category.
When allocating money to a business unit in this category, it is important to monitor earnings
closely, because if the business unit doesn’t improve then it may be better to invest money
elsewhere.
Harvest/Divest
A business unit will be in the “harvest/divest” category if it is in an unattractive industry and it is

not very competitive. There are two options for such business units i.e. to sell the business unit
or to harvest the business unit by investing short-term cash flows as far as possible to ensure the
business remains viable.
2.4. Key building blocks of an entity’s business model
A business model describes the rationale of how an organisation creates, delivers and captures value.
An entity’s business model is evaluated with the help of the following nine key building blocks:
• Customer segments
The customer segments building block defines the different groups of people or organisations an
enterprise aims to reach and serve. Customers comprise the heart of any business model. Without
profitable customers, no company can survive for long. In order to better satisfy customers, a company
may/should group them into segments with common needs, behaviours or other attributes.
• Value propositions
The value propositions building block defines the bundle of products and services that create value for
a specific customer segment. The value proposition is an aggregation, or bundle, of benefits that a
company offers customers. This could be the reason why customers choose one company over
another.
• Channels
The channels building block relates to the communication, distribution and sales channels utilised by
the company. This includes raising awareness among customers about new products, post-purchase
customer service and helping customers evaluate a company’s value proposition.
• Customer relationships
The customer relationship building block describes the type of relationships a company establishes
with customer segments. The following motivations apply to customer relationships: customer
acquisition, customer retention or increasing sales.
• Revenue streams
The revenue streams building block represents the cash a company generates from each customer
segment. The following two different types of streams exist: once-off customers and recurring revenue.
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• Key resources
The key resources building block describes the most important assets required to make a business
model work. Key resources can be manufactured, financial, intellectual, human or social and
relationship.
• Key activities
The key activities building block describes the most important activities a company must perform to
make its business model work. Activities differ depending on the type of business model e.g. for a
software company, the development of software is a key activity; this will however differ from a
computer manufacturer, where the supply chain of raw materials is important.
• Key partnerships
The key partnerships building block describes the network of suppliers and partners that makes the
business model work. Partnerships are forged for many reasons and have become a cornerstone of
many business models. Different types of partnerships can be distinguished; strategic alliances with
non-competitors, competition between competitors; joint ventures and buyer supplier relationships.
• Cost structure
The cost structure describes all costs incurred to operate a business model. The nature of the business
will determine whether it is a cost driven business (contain costs to drive value) or a value driven
business (spend what is necessary to get value).
(Osterwalder, A and Pigneur, Y. 2009.)
Activity 1.1.1
Search a website of at least one service and one manufacturing organisation of your choice. Identify
their mission, vision and values, and compare these with the characteristics presented in the discussion
above, regarding these concepts.
REQUIRED
In your opinion:
a. Does their mission statement define the core purpose of the entity?
b. Does their vision clearly communicate where the entity wants to go in the future?
c. Do their core values articulate the principles that the whole organisation should, in line with the
expectations of major stakeholders, comply with?
Feedback on Activity 1.1.1
Organisations have to state clearly their vision, mission statement and core values in order to
communicate their purpose. You should appreciate how entities respond differently to different
challenges.
For instance, the University of South Africa (Unisa) states its mission as ‘...a comprehensive, open
learning and distance education institution, which...in response to the diverse needs of society’. The
mission clearly expresses the purpose of its existence. The university aspires ‘[t]owards the African
university in the service of humanity’ (here, its vision clearly describes the desired future state of the
entity). Its strategic plan then sketches a further context, as follows: ‘Unisa espouses the values in the
Constitution of the Republic of South Africa: human dignity, the achievement of equality, and social
justice’.
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Activity 1.1.2
Attempt Practice Question 2-1 in the Managerial Finance (8th end) textbook
Solution to Activity 1.1.2
Find the solution after Practice Question 2-1.
Activity 1.1.3
Attempt Practice Question 2-2 in the Managerial Finance (8th ed) textbook
Find the solution after Practice Question 2-2. Visit the websites of the three companies for recent
updates.
Activity 1.1.4
Activity 1.1.5

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LEARNING UNIT 1.2 CORPORATE GOVERNANCE AND INTEGRATED

REPORTING
1. Introduction
The governing body of the entity, in the case of a company this will be the board of directors, is
accountable to the company and through the company to the stakeholders. Past corporate failures and
the separation of ownership and management of an entity are amongst some of the reasons that have
created the need for adequate and robust reporting. Such reporting will assist in ensuring stakeholders
are provided with adequate information on the governance present within organisations. The
governance principles relating to stakeholder’s relations with entities is contained in the King code of
Corporate Governance.
The King IV Code, which replaced earlier King Codes, was published in November 2016. The code
has been revised to, amongst others, bring it up to date with international governance codes and best
practice and increase compliance requirements and governance structures (KPMG, 2016). The
effective date of the implementation of King IV is financial years beginning 1 April 2017, with earlier
implementation encouraged.
The King IV Report defines corporate governance as ‘the exercise of ethical and effective leadership
by the governing body towards the achievement of the following governance outcomes: Ethical culture,
Good performance, Effective control, Legitimacy’ (IoD, 2016: 20).
King IV has introduced a change from the King III “apply or explain” basis to a “apply and explain” basis
for the application of the code. The code now contains 17 basic principles and the Institute of Directors
(“IoD”) lists the objectives of code as follows (IoD, 2016):
• Promote corporate governance as integral to running an organisation (delivering governance

outcomes such as ethical culture, good performance, effective control & legitimacy)
• Making the code accessible for a variety of sectors and organisations
• Corporate governance as holistic and interrelated and implemented in an integrated manner
• Encourage transparent and meaningful reporting
• Present corporate governance with ethical consciousness and conduct
King IV as in previous codes has a foundation in ethical and effective leadership. In addition,
supplementary schedules have been incorporated into the code, with the objective of giving
consideration to the various sector types (i.e. municipalities, non-profit organisations, retirement funds,
SME’s and state owned entities (IoD, 2016). For purposes of this course only sector supplements
relating to SME’s is required to be studied, whereby a basic knowledge is required.
The following principles, as well as the recommended practices, as contained in King IV should be
studied:
1. Ethical leadership
2. Organisation values, ethics and culture
3. Responsible corporate citizenship
4. Strategy implementation, performance
5. Reports and disclosure
6. Role of the governing body
7. Composition of the governing body
8. Committees of the governing body
9. Performance evaluations
10. Delegation to management
11. Risk and opportunity governance
12. Technology and information governance
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13. Compliance governance

14. Remuneration governance
15. Assurance (Financial report related)
16. Stakeholder inclusive approach
17. Responsibilities of shareholders
2. Content
2.1. King IV and integrated reporting
Integrated reporting requires more than just mentioning sustainability information, but must be
integrated with other aspects of the business process and managed throughout the year. King IV has
therefore introduced the notion of integrated thinking and requires the governing body to oversee the
publication of the following, for access by stakeholders:
• Corporate governance disclosures required in terms of King IV (see part 3: King IV Application
and disclosures)
• Integrated reports
• Annual financial statements and other external reports
An integrated report encompasses the following:
• an annual report
• statutory financial information and sustainability information
• sufficient information to record how the organisation has affected the economic life of the
community, both positively and negatively, and
• forward-looking information on how the board feels it can enhance the positive aspects and
negate the negative aspects
Activity 1.2.1
Answer Practice Question 1–4 in Managerial Finance (8th edition)
Feedback to Activity 1.2.1
Find the solution after the practice question in the textbook.
3. Self-assessment questions
Having now worked through all the relevant sections in the textbook, guidance and activities provided
by the two learning units, you should now be able to attempt the following self-assessment questions.
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QUESTION 1 5 MARKS (8 MINUTES)
Freaky Fashions LTD (“FFL”) is a South African retailer that sells fashionable clothing and sportswear.
Its shareholders consist of a large number of minority shareholders. The company has a strong focus
on cash and cash flow, and has decided to sell predominantly on a cash basis. The directors chose
this model as they believe that this differentiates it from its competitors, and because it further serves
as an easy source of funds for its continued growth and for dividend payments.
FFL currently generates 90% of its revenue stream from the retail of fashionable clothing and 10% from
sportswear. The management team of FFL have been exploring various investment opportunities to
increase net profit and expand operations and have requested the finance team to evaluate the
following opportunities:
Acquisition of Bargain Bags
Bargain Bags (Pty) Ltd (“Bargain Bags”) is an unlisted bag manufacturing entity that specialises in
the manufacturing of travel, sports and school bags. Its revenue is predominantly generated on a cash
basis. FFL is interested in acquiring 100% of Bargain Bags and has discovered during an agreed due
diligence exercise that Bargain Bags are currently experiencing a decline in turnover and liquidity and
are keen on restructuring their business. Since Bargain Bags already possesses the necessary
knowledge and skills, as well as the required infrastructure to manufacture sports and school bags,
FFL is of the opinion that taking over Bargain Bags would provide them with the opportunity to diversify
their product range. They will also use this as an opportunity to expand.
Fara clothing line
One of the directors of FFL, Mr Russell, worked in the clothing retail industry in the UK for a period of
10 years and has thus built strong relations with some of the large international fashion outlets. During
his recent visit to the UK he met with one of the directors, Mrs Kahn of a large international fashion
outlet “Fara”. During their meeting Mrs Kahn mentioned that Fara is considering expanding their
clothing line into South Africa. They are of the opinion that it will be a good idea to first retail their
clothing through South African outlets for a period of 5 years, as this will give them an indication of
whether it will be feasible to subsequently open Fara outlets in South Africa. Mr Russell saw this as an
opportunity and suggested that Fara consider retailing their clothing in FFL’s stores, since FFL has
years of experience as a clothing retailer and is quite in tune with the South African market.
REQUIRED Marks
(a) Discuss the advantages of FFL’s business strategy whereby they sell predominantly
on a cash basis. (5)
Note
The comprehensive scenario is adapted from Question 4 of the Question Bank PART 2
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Solution to Question 1
The following advantages arise from selling predominantly on a cash basis :
• During bad economic times FFL will not struggle to collect a large debtor’s book/bad trade
debt repayments. (1)
• FFL are likely to have large cash inflows and these can be utilised to expand (reinvest) or
reducing the need for financing (eg OD). (2)
• FFL are likely to have less legal compliance issues, specifically with regards to the National
Credit Act. (1)
• FFL can save costs as they wouldn't be required to spend large amounts on debtors, i.e.
statements, collections, etc. (1)
• FFL can offer cheaper prices to customers as credit risk and timing mark-ups do not need
to be added to the price of goods, i.e. cheaper than credit retailers. (1)
• FFL would have a better liquidity position as cash is received at the time of sale for the
majority of sales while purchases can be made on credit.
• Can pay suppliers cash or earlier and receive discounts. (1)
• Dividends can be paid regularly. (1)
• FFL are not likely to have any provision for bad debts, which may improve profits. (1)
Available (9)
Max (5)
BIBLIOGRAPHY AND ADDITIONAL READING
Ambler, TE. 2011. Aligning strategy and finance. Ann Arbor: Center for Simplified Strategic Planning
Ansof, I. 1957. Strategies for Diversification, Harvard Business Review, 35(5):113-124
Institute of Directors Southern Africa. (2016). King IV Report on Corporate Governance for South
Africa 2016. Available from:
http://c.ymcdn.com/sites/www.iodsa.co.za/resource/collection/684B68A7-B768-465C-8214-
E3A007F15A5A/IoDSA_King_IV_Report_-_WebVersion.pdf. [Accessed on 13/12/2016].
KPMG, (2016). King IV Summary guide. Available from:

https://assets.kpmg.com/content/dam/kpmg/za/pdf/2016/11/King-IV-Summary-Guide.pdf. [Accessed
on 13/12/2016].
Littler, D. 2011. Corporate strategy. [Online.] New York: Wiley-Blackwell. Available on a subscription
basis from: <http://www.blackwellreference.com> [Accessed 7 December 2011] McKinsey and
Company. 2008. Enduring Ideas: The GE–McKinsey nine-box matrix. This document is available from:
Osterwalder, A and Pigneur, Y. 2009. Business Model Generation. Amsterdam, The Netherlands
Porter, ME. 2008. On competition. Boston: Harvard Business School.
Skae, FO. 2017. Managerial Finance. 8th edition. LexisNexis: Johannesburg

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LEARNING UNIT 2 – RISK MANAGEMENT
LEARNING OUTCOMES
After studying this learning unit you should be able to do the following:
• Identify and evaluate opportunities and risks on an advanced level.

• Critically assess risks (including IT risks) and how they are managed.
• Understand and explain the critical components of an Enterprise Risk Management (ERM)
framework
• Evaluate an entity’s risk management programme.
• Recommend courses of action to help manage risks.
• Apply your theoretical knowledge relating to risk management to a given scenario, and provide
value added assessments and comments in this regard.

• Define risk in a business context. Managerial Finance, 8th

• Understand the objectives of risk management (including the edition:
values, accountability and authority relating thereto) • Chapter 3
• Understand the concepts of risk appetite, maturity and tolerance in
the context of risk management.
• Explain the risk management process (risk identification,
assessment, mitigation, monitoring and reporting).
• Implement and integrate risk management.
• Identify, analyse and assess risks
• Categorise the risks facing an entity.
• Suggest responses to the risks
• Document risks facing an entity in a risk register.
• Monitor and report on risks.
• Describe the functioning of Enterprise Risk Management (ERM).
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INTRODUCTION
A rational investor should expect a higher return on a higher risk investment. It is thus imperative to not
only quantify risk accurately, but at the same time, to manage risk so that the uncompensated risks
can be minimised.
Risk management is concerned with identifying, assessing and managing threats/risks resulting from
pursuing the entity's strategies. (The majority of the theory was addressed as part of your prior
learning.) You can obtain a better understanding of the theory by working through a sufficient number
of questions/case studies This learning unit will assist you in this regard.
LEARNING UNIT 2.1 RISK THEORY AND APPROACHES TO RISK MANAGEMENT
LEARNING UNIT 2.2 RISK IDENTIFICATION AND DOCUMENTATION
LEARNING UNIT 2.3 RISK ASSESSMENT AND RESPONSES

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LEARNING UNIT 2.1 RISK THEORY AND APPROACHES TO RISK

MANAGEMENT
1. Introduction
Everyone is exposed to risks in their day-to-day lives. In the financial world, one finds different types of
risk. Risks can arise from uncertainty, such as uncertainty about the future rand/dollar exchange rates,
possible project failures, possible legal liabilities, granting of credit, accidents, possible natural
disasters, possible fraud and error, and several other unknowns.
In the field of Management Accounting, the concepts of risk assessment and management are
pervasive. You have already encountered some of the related concepts before and will also encounter
others in subsequent learning units. For example, in assessing risk, the concepts of probability and
sensitivity have already been considered earlier as part of decision-making techniques. Risk will also
be considered when evaluating investment and financing decisions. Later you will also be reacquainted
with hedging techniques, which is a transaction that can lower or even eliminate risk in certain areas
(refer to learning unit 7 – Treasury Function).
This learning unit is based on sections of chapter 3 from your prescribed textbook, Managerial Finance,
8th edition.
2. Content
2.1. Risk and the business environment
The taking of risks allows the entity to be more competitive and to generate higher returns, e.g.
launching a new technologically advanced product even though there is uncertainty whether customers
will buy the new product. Benefits could be both financial, in the form of higher returns or reduced cost,
and intangible, such as gaining more valuable client information to be used for future products.
Risk-taking could also result in losses. However, greater risk should be balanced by a greater expected
reward. It is thus important for every entity to follow a strategic risk-management process. Here, value
could be added by controlling the probability of occurrence, the potential impact of unfortunate events,
and finally, by maximising the realisation of opportunities.
2.2. Risk Management Standards
The International Organisation for Standardization, a worldwide federation of standard setting bodies,
offers a generic standard (ISO31000) whereby risk management can be measured. According to this
standard, risk management should comprise the following five steps:
1. Establish the goals and context for risk management.

2. Identify risks.
3. Analyse risks and estimate the level of risk faced.
4. Evaluate and rank the risks.
5. Treat the risks through appropriate options.
Integral to these steps are communication and monitoring, which should be an on-going processes.
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2.3. Enterprise Risk Management (ERM) process
The Committee of Sponsoring Organizations of the Treadway Commission (COSO), a joint initiative
from the US, provides frameworks for several areas, including enterprise risk management. The ERM
framework is designed to assist companies in achieving their strategic, operational, reporting and
compliance objectives. Since the achievement of both strategic and operational objectives are subject
to external factors which can be beyond the control of the company, for such objectives ERM provides
reasonable assurance that management and the board of directors are made aware of the extent to
which the company is achieving its objectives (COSO, 2004).
Figure 2.1.1 offers a visual overview of the enterprise risk management process, as contained in one
of the COSO frameworks. Refer to Section 3.2 of the prescribed textbook for a discussion about each
of the elements of the framework.
Figure 2.1.1: Enterprise Risk Management (ERM) Integrated Framework (COSO, 2004)
2.4. Assessment of the entity’s stakeholders risk tolerance and its balance with opportunity
Good risk management allows businesses to exploit opportunities for future growth while protecting the
value already created. By aligning risk management to what the shareholders consider vital to the
success of the business, the shareholders are assured that what they value is protected.
This would occur in the following four stages:
• Establish what shareholders value about the company.

• Identify the risks around the key shareholder value drivers.
• Determine the preferred treatment for the risk.
• Communicate risk treatments to shareholders.
(CIMA Risk Management: 45)

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2.5. Risk maturity and risk management
Entities can make use of a risk maturity model to benchmark their current risk management practices
with the objective of improving thereon. Different industries develop varying models however a “generic
risk focused maturity model” has also been developed. This model contains the following four maturity
levels which organisation can use to benchmark themselves:
• Naïve: an entity would fall under this category when it is unaware of the need for risk management
and has no formal process in place in this regard.
• Novice: entities within this category are experimenting with the concept of risk management but
do not have formal risk management plans or processes in place.
• Normalised: entities within this category have built risk management into its routine business
processes and implement risk management in most of its projects
• Natural: entities within this category are proactive about risk management and implement it in all
aspects of their business
Entities should therefore firstly identify their current level of maturity based on the above. This should
then be followed by the identification of targets for improvement as well as the production of action
plans for improving risk management.
Activity 2.1.1
Assume you have sufficient capital to start a company that manufactures solar-powered vehicles. You
can either invest your money in this venture, or place it in a bank to earn interest.
Required
Illustrate the concept of risk versus reward by evaluating the risk-return relationship associated with
each option.
A company that manufactures solar-powered vehicles faces significant risks. These include:
• exposure to new technologies that changes quickly

• new and changing government standards and regulations
• difficulty in customers embracing the new technology
• a new market with plenty of unknown factors
Against this, if successful, the company making solar-powered vehicles could expect huge returns. The
vehicles may also help the planet with lower emissions. It may further qualify for government's support
and incentives.
In comparison, the risk of losing the money in the bank is very low, yet the potential return on the
investment is also low.
Activity 2.1.2
A newly established brewery hopes to establish itself as a leading player in the South African beer
industry with a number of new and unique beer brands.
Required
Identify what could be regarded as the entity's main ‘objectives’, with reference to the COSO risk
management framework (Figure 2.1.1).
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After considering the internal and external environment, the entity may define the following objectives:
a. Strategic objectives: Establish the entity as a leading player in the South African beer industry.
This could be done by identifying opportunities in the market and positioning the new brands in
such a way as to achieve sustained success.
b. Operations: Produce and deliver products of the highest quality in an efficient, effective and timely
manner.
c. Reporting: Providing reliable and timely information aligned with reporting standards and best
practices to enable stakeholders to analyse data and make sound business decisions.
d. Compliance: Comply with all legislative requirements for licensing, production, distribution,
branding, advertising, labour relations, taxation, and so forth.
Activity 2.1.3
Perform Practice Question 3-1 in Managerial Finance (8th edition).

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LEARNING UNIT 2.2 RISK IDENTIFICATION AND DOCUMENTATION

1. Introduction
In this learning unit we delve into the practical application of risk management by considering the
categories and types of risk, the tools available to identify risks, and the documentation thereof in a risk
register. The four categories highlighted in the COSO framework (Strategic, Operations, Reporting and
Compliance in Figure 2.1.1) could be used as the basis to identify different categories of risk.
2. Content
2.1. Types of risk
Risks could be classified into a multitude of categories. A list detailing risk types will seldom be
complete; however, we have endeavoured to identify a number of different risks in Figure 2.2.1 below.
Depending on our focus, we could add additional risks to this list, such as: country risk, market risk, as
well as systematic and unsystematic risk.
Business risks
Economic risks
Financial risk
Market risk
Types of risk
Social risk
Political risk
Information risk
Technology risk
Environmental risk
Compliance risk
Reputation risk
Figure 2.2.1 Various types of risk
We will now discuss some of these risk types.

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Business risk
This risk relates to business operations, people, processes, products and structure of the entity. This
includes product failure, fraud, loss of suppliers, key employees, business interruptions, etc. These
risks are generally within the entity's control and can be managed by introducing internal controls or
insurance.
Economic risk
Economic risks are inherent in the economy thus considered external to the business and include
inflationary pressures, unemployment rate and international policy. Other examples of economic risks
include:
• Product risk – When customer preferences change, your entity's sales may drop resulting in
losses, e.g. a sudden preference for leather handbags could result in reduced sales for handbags
made from plastic or other material.
• Stakeholder risk – stakeholders or investors may lose interest in your entity and hold back funds
for, say new investment projects. Employee strikes may disrupt and halt production resulting in
lost revenue.
Financial risk
Financial risk relates to the financial performance and position of an entity. Financial risks are also
linked to the entity's financial structure, i.e. the mix of equity and debt, lack of capital or overtrading.
The following are examples of financial risks:
• investment risk
• currency risk
• interest rate risk
• credit risk
• trading risks
These are risks that occur due to environmental, cultural and time differences between local and
international entities.
Technological risks
As part of technological risks, the failure of existing IT systems will impact negatively on productivity,
service delivery and, in extreme cases, even the sustainability of the entity itself. It could also entail
information security leaks or the risk associated with missing opportunities to not use (new/latest)
technology to enable or enhance business.
Environmental risk
We normally include as part of environmental risk:
• the risk related to climate change and risk of natural disasters (deemed to be external risks)
• the risk of damage by the entity or its processes to the environment, which may elicit fines and
penalties.
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Activity 2.2.1
A business entity in the courier industry, delivering packages and mail, has committed itself to specific
delivery times and destinations. The entity’s Chief Risk Officer highlighted the following:
• The entity's management has decided to work for two key customers in future. This has significant
benefits for the entity, as fixed contracts will guarantee work and an excellent revenue stream for
the next few years. However, one of the customers is already in financial distress and if the
business is lost it will be difficult to collect the money and will require marketing cost and time to
expand the customer base to the current levels.
• Drivers sometimes exceed the speed limit in an effort to get the work done quickly.
• A driver was recently caught delivering packages with the entity's vehicle for his own benefit. He
also accused other drivers of collecting money for their own benefit for work done with the entity's
resources.
• In an effort to save cost, the chief financial officer has decided to reduce the staff in the financial
department and not fill the positions before the end of the financial year when the financial
statements are drafted.
Required
Categorise the various risks faced by the entity and provide a reason for your classification.
Feedback on Activity 2.2.1.
• The decision to work for only two key customers increases the risk of future failure of the entity if
one of the key customers suffers financial losses or close down. This is a strategic risk, as it is
a long-term risk.
• Drivers exceeding the speed limit are breaking the law. This is a compliance risk.
• Drivers doing deliveries for their own benefit with the entity's resources are defrauding the entity.
This is an operational risk.
• The reduction in staff in the finance department could result in inaccurate and unreliable financial
information, which is a reporting risk.
Activity 2.2.2
Wakeup (Pty) Ltd is a coffee manufacturer based in South Africa. The entity's differentiating factor is
that it is currently the only importer of raw coffee beans from a small region in Ethiopia, an area offering
coffee beans with a unique flavour. These coffee beans are then roasted using a refined process to
produce an aromatic and well-rounded flavour. Wakeup (Pty) Ltd’s coffee is expensive and targets a
niche segment of the market.
Recent discussions took place between key stakeholders, namely the Chairman of the Audit Committee
(an independent non-executive director), Chief Executive Officer (CEO), Chief Financial Officer (CFO),
Chief Risk Officer (CRO) and key members of management, including the head of the legal department.
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The discussions revealed the following:
• The entity has a strong financial position to facilitate the financing of future projects.
• The entity has an excellent distribution network across South Africa.
• This distribution network is used to supply two large retailers with stores across South Africa.
• Only one of the retailers has placed their order for the next quarter.
• Based on market research, Wakeup's aromatic and rounded coffee blends will be very popular
in the fast growing Russian and Brazilian markets.
• The economic downturn in South Africa is a concern as expensive coffee is a luxury item and
there are inexpensive substitutes.
• Wakeup has a contract with an international company for the coffee beans to be shipped in
special containers from Ethiopia to South Africa. The shipping company has expressed concerns
about the growing number of pirate attacks off the Somalian coast, but has indicated that
alternative routes are not economically viable. The attacks have resulted in some cargo being
lost or stolen. It has also prevented the shipping company from achieving the specified delivery
dates.
• There is currently a legal dispute over the patent rights of the roasting process applied by
Wakeup, for one of its coffee blends.
• The company has a strong and stable base of employees with very good succession planning.
• Wakeup has a strong and recognisable brand in South Africa.
REQUIRED
Based on available information for Wakeup (Pty) Ltd:
a. Perform a PESTEL analysis.

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PESTEL analysis:
ANALYSIS CONSIDERATIONS
Political factors • The government stability in lucrative Russian and Brazilian markets
needs to be considered.
• Taxation policies in South Africa, Ethiopia and other potential markets.
The taxation policies of countries where significant competitors are
based should also be considered.
• Some governments and regions offer tax incentives/ grants, which could
facilitate new projects or expansion.
Economic factors • The sustainability of Wakeup's large customers is important when
identifying future risks.
• Other growing markets around the world offer the opportunity for
expansion.
• The economic downturn could result in reduced sales as unemployment
increases and people have less disposable income.
• Interest rate fluctuations could influence the cost of production.
• Exchange rate fluctuations could influence the competitiveness of
Wakeup's product pricing if it hopes to expand into international markets.
It could also increase the risk of more inexpensive substitutes in the
South African market.
Social factors • Lifestyle changes influence demand, that is when people work harder
and spend more time at work, it could influence the demand for coffee.
• Behaviour that is socially acceptable will drive demand.
• The influence of consumer protection movements, which seek to protect
consumers from dishonest packaging, advertising and guarantees. This
includes promoting healthier products.
• The effect of changes in demographics and increased urbanisation.
Technological • Government spending on new technologies.
factors • Advancements in the production process which could make it cheaper,
quicker and more cost effective.
• Advancements in the transport of goods and improvements to ensure
that goods remain dry and unscathed.
• The ability to apply technologically advanced production processes in
foreign markets needs to be considered.
Ecological factors • Environmental laws and regulations.
• By-products of the coffee production process and the cost and effect of
waste disposal.
• The sustainable management of the fertile land by the Ethiopian coffee
bean suppliers.
• Changing weather patterns could affect the supply of coffee, yields and
prices.
Legal factors • Foreign trade regulations regarding the unroasted/ raw coffee beans
(agricultural commodity) and the coffee (finished product).
• Laws and regulations including labour laws, product safety, and so forth.
• The entity is involved in a legal dispute over patent rights.
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LEARNING UNIT 2.3 RISK ASSESSMENT AND RESPONSES

1. Introduction
This learning unit focuses on a number of risk management processes, including the assessment of
risk, the responses to reduce or mitigate the risk, as well as the monitoring and reviewing of the process.
In this learning unit, risks are analysed by considering two dimensions, namely the impact (potential
damage or loss) and probability (likelihood of the event occurring). This analysis forms the basis for
determining how risk should be managed on both an inherent (gross) and residual (net) basis.
This learning unit is based on chapter 3 of Managerial Finance, 8th edition.
2. Content
2.1. Risk monitoring
Risk monitoring should involve continuous evaluation of the entity operations to ensure adequacy of
control measures and identify new risks, (Valsamakis, Vivian & Du Toit, 2010).
Methods available to monitor the effectiveness of the risk management process include the following:
• Loss management: Drawing up a summary of loss events, values and root causes.
• Key risk indicators: Set a specific risk threshold and highlight all the risks that breach the
threshold.
• Risk and control self-assessments completed by management: This is an analysis of
perceived strengths, risks, and weaknesses within the entity’s processes and the adequacy and
effectiveness of the controls designed to mitigate the risks and achieve entity objectives.
• Scenario management: This is a method to determine future risks, based on the views of experts.
Activity 2.3.1
The following three risks were identified as part of a brainstorming session facilitated by a risk analyst,
who is a member of a risk management department:
a. A foreign competitor will be introducing new technologies, which can result in the entity's products
becoming out-dated.
b. Employees of the company can enter into inefficient or wasteful contracts on behalf of the entity.
c. A fluctuation in currencies can have a negative effect on the price of imported raw materials. The
entity currently imports 2% of its raw material from Australia, but can buy the raw material from
local suppliers.
The following likelihood or impact ratings were attributed to each risk event:
a. New technologies to be introduced by a competitor –
• Probability: Will probably occur (4).

• Impact: The impact or consequence of the risk will threaten the survival or viability of the entity
(5).
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b. Inefficient or wasteful contracts –
• Probability: Can occur at some time and may be difficult to control (3).
• Impact: Will have a significant impact on the achievement of entity objectives or threaten the
continued operation of the entity (4).
c. A fluctuation in currencies –
• Probability: Can occur at some time and may be difficult to control (3).
• Impact: Limited effect and the impact or consequence of the risk can be dealt with by routine
operations as a small percentage of raw materials is imported and these can be sourced from
local suppliers (1).
REQUIRED
Populate the following selected fields of the risk register. Indicate the applicable risk type and
complete the inherent risk assessment.
Risk objective/category Risk type Risk description Inherent risk rating
Calculation of inherent risk ratings:
a. new technologies to be introduced by a competitor: 4 x 5 = 20

b. inefficient or wasteful contracts: 3 x 4 = 12
c. a fluctuation in currencies: 3x1=3
The following represents selected fields of the risk register after considering the above information.
RISK RISK TYPE RISK DESCRIPTION INHERENT

CATEGORY RISK RATING
Strategic risk Technology risk New technologies are set to be introduced. 20
Operational risk Entity risk Inefficient or wasteful contracts can be
entered into on behalf of the entity. 12
Financial risk Currency risk Fluctuation in currencies can have a negative
effect on the price of imported raw materials. 3
Activity 2.3.2
Consider the following risks and the corresponding inherent risk ratings and formulate suitable risk
responses if you assume that the entity's risk appetite is low:
RISK RISK TYPE RISK DESCRIPTION INHERENT RISK RE-

CATEGORY RISK RATING SPONSES
Strategic risk Technology New technologies are set to be
risk introduced.
20
Operational Entity risk Inefficient or wasteful contracts are
risk entered into on behalf of the company.
12
Financial risk Currency Fluctuation in currencies can have a
risk negative effect on the price of imported
raw materials.
3
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Legends:
Critical usually represented by the colour red

High usually represented by the colour orange
Medium usually represented by the colour yellow
Low usually represented by the colour green
The risk responses below were introduced to align the residual risk ratings with the company's low risk
appetite for these types of risks.
RISK RISK TYPE RISK DESCRIPTION INHERENT RISK RESPONSE

CATEGORY RISK
RATING
Strategic Technology New technologies are i. Obtain the rights to
risk risk set to be introduced. incorporate the new
20 technology into the
current products.
Operational Entity risk Inefficient or wasteful i. Draft a policy and
risk contracts can be procedure document for
entered into on behalf
12 contract management;
of the company. ii. Appoint a lawyer to
review and sign-off on all
contracts.
Financial risk Currency Fluctuation in i. Make use of hedging
risk currencies can have a instruments
negative effect on the
3 ii. Source products locally
price of imported raw
materials.
Activity 2.3.3
Visit www.mrpricegroup.com – Integrated Annual Report: risk governance and management and note
their expression of:
 risk appetite
 risk profile
 key business risks
 ERM
Activity 2.3.4
Review the integrated reports of 3 listed companies operating in different industries and take note of
the risks and mitigations disclosed by these companies.
Activity 2.3.5
Perform Practice Question 3-2 in Managerial Finance (8th edition).

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Activity 2.3.6
Mine Plats Limited (“MPL”) is a large mining company, listed on the JSE. Part of its mission is to create
value for all its stakeholders through safe, sustainable and responsible mining.
Given the nature of MPL ‘s operations they consider identifying and managing risk to be critical to the
success of their business. The risk management process within the company is ongoing and begins
with risk identification. Since risk management is embedded within all processes, risk is identified
across the Group; at business units, operations and projects. The identified risks are then assessed to
ascertain their causes, impact and likelihood of occurrence. This assessment assists in ranking and
prioritising the risks thereby enabling the risks to be appropriately managed.
Management is responsible for monitoring the progress of actions taken to mitigate key risks. The risk
management process is continuous and key risks are reported to the Audit Committee and
sustainability risks are reported to the Sustainability Committee.
The following represents an extract from one of the risk reports of MPL:
Strategic Priority Risk Mitigations

Commercial excellence Market conditions impact on • Future demand can be
Unlocking commercial the business. influenced across multiple
value by growing the The platinum price has been demand segments. To reduce
market and increasing weak during the year, risk, we have taken greater
sales revenue from all compounded by the continued responsibility for marketing and
metals. fall in demand for metal. We are stimulating demand.
also exposed through our • As a business, we ensure we
dependency on certain market have a detailed understanding
segments, e.g. of demand in the market and its
auto catalysts and diesel potential growth informs our
vehicles. strategy accordingly.
Sustainability Employee safety and health Various safety initiatives all
excellence Our safety performance has emphasise our commitment to
Creating sustainable steadily improved. Any inability zero harm:
value for all stakeholders to maintain this performance
would mean the threat of harm to • Ongoing focus on short-term
our employees. Our safety safety risks such as falls of
tolerance level remains at zero ground, underground transport
and moving machinery
• Moving towards mechanised
Uncontrolled discharge mining methods will eliminate
(water, gases, hydrocarbons many safety risks.
and waste)
A catastrophic release from one Potential events of this nature
of our sites could have material identified for each operational
safety, environmental, legal and site, and subject to detailed
regulatory, financial and analysis to identify site-specific
reputational consequences for key preventive and response
the business. controls. Measures instituted to
ensure these controls are
adequately designed, in place and
(Anglo American Platinum, performing as expected.
2015)
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REQUIRED
(a) Discuss the processes MPL has in place to manage risk.

(b) Evaluate whether the risk management process implemented by MPL is effective in responding
to the ever changing environment within which they operate.
(c) Evaluate whether MPL’s risk management programme is consistent with its mission and
strategies
(d) Discuss the potential implications for MPL if the company did not have an effective risk
management programme
Part a
The risk management process of MPL comprises the following:
• Risk identification: Risk is identified across the Group as risk is embedded within all processes.
• Risk assessment: MPL assesses its identified risks by determining their causes, impact and
likelihood of occurrence.
• Monitoring of risks: Management monitors the progress of risk mitigations
• Reporting on risks: Risk are reported on to the Audit and Sustainability Committees
Part b
The risk management processes described in part a are considered to be effective as they are
conducted on a continues basis and will therefore enable the company to identify new risks/ changes
to existing risks. Furthermore, risk management is embedded within all processes thereby enabling
MPL to identify risks across the Group and not only those at a strategic level.
Part c
MPL’s risk management programme seems to be consistent with its mission and strategies for the
following reasons:
• MPL’s mission centres around adding value by means of safe, sustainable and responsible
mining. Its risk management processes have identified risks relating specifically to sustainability,
including the safety of its employees and the release of waste and harmful gases.
• The identified risks are directly linked to the specific strategies of the company, per the risk report.
Part d
MPL would not be able to identify risks as they occur and therefore will not be in a position to adequately
manage the risks. This will negatively impact their ability to meet their strategic objectives and may
result in the loss of stakeholder confidence in the company.
After working through all the relevant sections in the textbook, guidance and activities provided by the
learning units, you should now be able to attempt the following self-assessment questions.
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Perform the required sub-part (a) of Question 4 (FFL), which can be found in the Question Bank. The
relevant required part is repeated below. (At this point it is not necessary to attempt to other parts of
the question; you should, however, take notice of the way in which all the various parts integrate and
relate to the scenario.)
REQUIRED Marks
(a) Identify and discuss the typical business risks that an entity operating in the clothing
retail industry in South Africa would be exposed to. Further advise the management
of FFL on the risk management techniques that could be implemented for each of the
risks identified.
Your answer should be presented in the following tabular format:
Risk identified Discussion of risk Risk management

(6) (6) (6) (18)
Solution Question 1
Find the suggested solution to the relevant part in the Question Bank.
BPP Learning Media. 2011. Performance strategy, strategic paper P3. 3rd edition. BPP Learning
Media: London.
CIMA. 2005. CIMA Official Terminology. 2nd edition. Elsevier : Oxford.
CIMA. 2011. CIMA Official Learning System. Paper P3 – performance strategy. 1st edition.
Elsevier: Oxford.
CIMA. 2014. CIMA Official Study Text. Paper P3-strategic level. Kaplan Publishing: United
Kingdom.
Committee of Sponsoring Organizations of the Treadway Commission (COSO). 2004. Enterprise

risk management – integrated framework. www.coso.org. [Accessed on July 2018]
COSO (2004). Enterprise Risk Management — Integrated Framework. COSO: Ridgecrest.

Hillson, A. 1997. Towards a Risk Maturity Model, The International Journal of Project and Business
Risk Management, 1(1):35-45.
Skae, FO. 2017.Managerial Finance, 8th edition. LexisNexis: Johannesburg.
Valsamakis, AC, Vivian, RW & Du Toit, GS. Risk management. 4th edition. Heinemann Publishers:
Sandton.
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LEARNING UNIT 3 – COST OF CAPITAL AND CAPITAL INVESTMENT APPRAISAL
LEARNING OUTCOMES
• Understand the concept of risk vs. return, including the underlying theory.
• Integrate multiple sources of knowledge to determine the fair value of different types/forms of
preference shares and debt, incorporating complications in discounted cash flow and relevant
income tax treatments.
• Analyse an entity’s cost of capital and capital structure.
• Calculate the weighted average cost of capital and the cost and value of its various components.
• Understand the circumstances in which a project specific cost of capital will be utilised, including
the calculation thereof.
• Differentiate between asset and equity betas, including the calculation thereof.
• Perform and evaluate an investment decision on an advanced level, utilising various capital
budgeting techniques.
• Address complications of an investment decision, including dealing with the effects of inflation,
risks, taxation, capital rationing and projects with different lifecycles.
• Evaluate the alternative of asset-specific finance.
• Perform sensitivity analysis upon an investment decision.
• Discuss the purpose and benefits of a post-investment audit.
• Recommend ways in which project and investment appraisal could be approached differently with
the aim of sustainable value creation.


• Analyse an entity’s cost of capital and capital structure on Managerial Finance
an intermediate level. (8th edition):
• Determine the fair value of different types of preference • Chapter 4 (sections 4.1-4.12)
shares and different forms of debt using a discounted cash • Chapter 5
flow method. • Chapter 6 (parts 6.1 to 6.5
• Calculate the weighted average cost of capital and the cost and 6.8)
and value of its various components. • Chapter 10
• Perform and evaluate an investment decision on an
intermediate level, utilising various capital budgeting
techniques
• Discuss and consider structural and governance issues,
as well as the qualitative factors, linked to an investment
decision.
• Evaluate the alternative of asset-specific finance on an
intermediate level.
• Identify and explain the various drivers of value, and
understand the interactions between these drivers, when
using a valuation method based on discounted cash flow.
• Critically discuss and consider qualitative factors, linked to
an investment decision.
• Understand the impact of sustainability factors on the
investment decision.
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• Provide advice regarding the following:
✓ the form of the transaction

✓ systems, information, confidentiality and disclosure
requirements
✓ due diligence procedures
✓ conflict of interest issues
INTRODUCTION
Capital investment appraisals are long-term decisions, where it will take several years to earn a return
on the capital investment made. The learning unit of capital investment appraisals integrates many
other management accounting learning units (including strategy, cost of capital and relevant costing),
and frequently serves as the precursor to the financing decision. It further integrates with the subject
of taxation.
The cost of capital is important as it directly affects the choice of investments. A too low cost of capital
could lead to the acceptance of investments earning insufficient returns; whereas a too high cost of
capital could lead to not accepting profitable investments.
Both cost of capital and capital investment appraisal have in the past frequently been examined in this
subject and also on the level of SAICA’s professional examinations. Thorough knowledge of these
learning units – on an advanced level – is therefore important.
LEARNING UNIT 3.1 WEIGHTED AVERAGE COST OF CAPITAL
LEARNING UNIT 3.2 CAPITAL INVESTMENT APPRAISAL – ISSUES IN INVESTMENT

APPRAISAL
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LEARNING UNIT 3.1 WEIGHTED AVERAGE COST OF CAPITAL
1. Introduction
The cost of capital is important as it directly affects the investment decision and the choice of
investments. The weighted average cost of capital (WACC) is the dominant indicator of the cost of
capital of an entity and is determined based on a weighted average of financing costs. Here, an entity’s
capital may consist of several forms of capital, including equity, preference shares and debt.
This learning unit is based on the following chapters in your prescribed textbook (Managerial Finance,
8th edition):
• Chapter 4: Capital structure and the cost of capital

• Chapter 5: Portfolio management and the Capital Asset Pricing Model
• Chapter 10: Valuations of preference shares and debt
2. Content
2.1. Weighted Average Cost of Capital
From your prior learning you should be able to calculate the weighted average cost of capital and its
various components on an intermediate level. Even though the basic formula and assumptions remain
intact, the calculation could be complicated to an extent – as illustrated in the sections indicated below.
Now study the following subsections in Managerial Finance (8th edition) and attempt the activities
included therein:
Chapter Subsection
4 4.1. to 4.12
5 5.1. to 5.7
2.2. Valuations of preference shares, debt and convertible instruments
In your undergraduate studies you were introduced to discounted cash flow methods and techniques,
and ways of valuing different types of preference shares and different forms of debt.
The sections you are going to study next will enhance your knowledge in this area and introduce further
complications, including the effect of some tax sections. It will also address the valuation of convertible
instruments, such as convertible debt.
Now study the following subsections in Managerial Finance (8th edition) and attempt the activities
included therein:
Chapter Subsection
10 10.1. to 10.4
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Activity 3.1.1
Attempt question 5.3 in chapter 5 of Managerial Finance, 8th edition.
Find the suggested solution after the question in the textbook.
Activity 3.1.2
Attempt question 5.6 in chapter 5 of Managerial Finance, 8th edition.
Activity 3.1.3
Refer to the example in subsection 10.3.5 of the Managerial Finance (8th edition) textbook. If you have
access to a computer with Microsoft Excel1, attempt this example using a spread sheet.
1
Microsoft and Excel are registered trademarks of the Microsoft Corporation, registered in the US and
other countries.
Below is a screenshot taken from Microsoft Excel®:
(Source: Skae and De Graaf, 2012 – used with permission.)

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This result was obtained by applying the following formulas:
Microsoft Excel® tips:
• Instead of displaying the solution to the formulas, you can display the formulas by simultaneously
pressing <Ctrl> and <~>. (To turn off this feature, repeat the same step.)
• When entering formulas you can save time by making used of absolute references, that is, making
use of the “$”-sign before a column and row reference in order to fix a certain cell’s position in a
formula, and then “dragging” that cell across in order to copy it. For example, we make use of an
absolute reference when referring to cell C8 (by typing $C$8) within the formula contained in cell
D13. We then “drag” cell C8 to the right, using the “+”panhandle, in order to copy it across row 13.
After working through all the relevant sections in the textbook, guidance and activities provided by this
learning unit, you should now be able to attempt the following self-assessment questions.
Finesse Footwear Limited (“Finesse Footwear” or “the company”) is a company operating in the
footwear industry.
The company’s directors are currently considering several projects which will expand the range of the
business activities undertaken by Finesse Footwear. The directors would like to use discounted cash-
flow techniques in their evaluation of these projects, but certain variables still have to be calculated.
Extract from the Statement of Financial Position as at the previous financial year-end:
31 December
2012
EQUITY and LIABILITIES R’000
Share capital and reserves

Ordinary share capital and premium 6 000
Other reserves 3 240
Redeemable preference shares 1 998
Interest-bearing liabilities 6 447
TOTAL EQUITY and LIABILITIES 17 685
Except for increases in reserves and as detailed below, no changes were made to the share
capital appearing in the Statement of Financial Position above.
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Additional information
• Finesse Footwear has an authorised ordinary share capital of 10 million shares, of which 5
million have been issued. A large block of ordinary shares were recently traded between non-
connected parties at a price of R3,00 per share. The company’s project analyst has estimated
the fair rate of return on ordinary capital at 18% (an Annual Percentage Rate [APR]).
• The redeemable preference shares were issued a few years ago at a par value of R10 per
share (200 000 shares are in issue). These shares are redeemable in three years’ time at a
premium of 15%. These preference shares carry a non-cumulative dividend that is payable
semi-annually (six months before the company’s financial year-end and at the company’s
financial year-end). The semi-annual dividend is calculated at 6% of the par value. A fair rate
of return for similar preference shares with a similar risk-profile is currently equal to 13%
(APR). The directors expect that all dividends will be declared and paid, except for dividends
in the final redemption year, owing to the pressure on cash flows in this year. (Section 8E of
the Income Tax Act will not apply.)
• The principle amounts on the interest-bearing liabilities have to be repaid in two tranches: in
2015 and 2016.
Required Marks
(a) Determine the fair value of ordinary shares on 1 January 2013 and highlight other 3
factors to be considered in this regard.
(b) Determine the fair value of the redeemable preference shares on 1 January 2013. 5
(c) Briefly discuss any potential problem areas and possible remedies linked to Finesse 5
Footwear’s current sources of finance and its future plans.
(Source: University of South Africa, MAC4861 Test 3 [2012] – updated, truncated and simplified)
Part (a)
Fair value of ordinary shares 01-Jan-13 Marks

Number of shares x price of recent investment
R
5 000 000 x R3,00 15 000 000 1
The fair value of ordinary shares on 1 January 2013 is equal to R15 million.
Other considerations:
• What is the background of the recent investment and level of investment? 1

• The background could affect the price, e.g. if the parties were connected persons,
which may not result in an arm’s length transaction. 1
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Part (b)
Fair value of redeemable preference shares Marks

31-Dec-12 /
01-Jan-13 30-Jun-13 31-Dec-13 30-Jun-14 31-Dec-14 30-Jun-15 31-Dec-15
Six-monthly
intervals 0 1 2 3 4 5 6
Preference dividend (6% x R2m) (120 000) (120 000) (120 000) (120 000) 1
0 0 1
Note: The non-

cumulative dividend is Note: The non-
not expected to be cumulative dividend is
paid for this 6 month also not expected to be
period paid for this 6 month
premium period
Redeemed (R2 000 000 x 1,15) (2 300 000) 1

(120 000) (120 000) (120 000) (120 000) 0 (2 300 000)
Discount rate = 13%/2 = 6.5% for a 6 month interval (13% per annum) [the fair or market rate] 1
0.9390 0.8817 0.8278 0.7773 0.7299 0.6853
Discounted
value (112 676) (105 799) (99 342) (93 279) 0 (1 576 268)
Fair value (1 987 364) (Factors or calculator steps show) 1
The fair value of the redeemable preference shares on 1 January 2013 is equal to R1 987 364.
Part (c)
Problem areas Marks Remedies Marks
• Cash outflows relating to existing 1 • Refinancing options should be 1

sources of finance coincides/are considered way in advance.
closely spaced (e.g. 2015 and 2016), • When refinancing, stagger the 1
and therefore exposes the company repayment terms/timing of
to significant cash flow pressure main cash outflows.
during this time.
• The company intends to increase the 1 • The company should 1

range of business activities, which determine an appropriate
may affect the existing business risk target capital structure by
and timing of cash flows. considering the current and
new business activities. When
investigating new sources and
forms of finance, consider this
target structure.
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QUESTION 2
Attempt Example Question 4-2 in chapter 4 of Managerial Finance (8th edition).
Solution to question 2
Refer to the suggested solution which appears after the question in the textbook.
QUESTION 3
Attempt Example Question 10-1 in chapter 10 of Managerial Finance (8th edition).
Refer to the suggested solution which appears after the question in the textbook
Skae, FO. 2017. Managerial Finance. 8th edition. LexisNexis: Johannesburg.

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LEARNING UNIT 3.2 – CAPITAL INVESTMENT APPRAISAL – ISSUES IN

INVESTMENT APPRAISAL
1. Introduction
Capital investment appraisals are long-term decisions, where it will take several years to earn a return
on the capital investment made.
Here, it is important to take cognisance of the similarities and differences between capital investment
appraisals and business valuations. When assessing a proposed capital investment using discounted
cash flow methods (e.g. projecting cash flows and calculating a net present value or internal rate of
return), a capital investment appraisal displays many similarities to a business valuation (using, for
example, an enterprise discounted cash flow model, based on free cash flow). From your prior
knowledge, you should recall that a capital investment appraisal frequently assesses a project over a
fixed term (for example 5 years), where end-of-period cash flows should be accounted for (for example
the re-sell value of a machine). In contrast, a business valuation frequently accounts for a continuing
value using, for example, the Gordon Growth Model.
An investment decision can also be complicated by various factors, including the effects of inflation,
relevant costs and revenues, taxation, capital rationing and projects with different life cycles.
Often in the past, capital investment appraisals were made by considering only economic aspects. In
these enlightened times, however, appraisers are starting to consider other issues as well with the
ultimate goal of sustainable value creation.
This learning unit is based on the following chapters in your prescribed textbook:
Managerial Finance – 8th edition:
• Chapter 6: The investment decision (excluding section 6.9.)
2. Content
2.1. Sustainable value creation
Sustainable business practice looks beyond only the usual economical perspective, to also include
environmental and social considerations. Its intention is to support these multiple pillars in an effort to
help secure the ability of later generations/businesses to endure.
The demanding task of sustainable value creation will require the commitment of more than just a few
individuals; according to architect and sociologist, Robert Gutman, the responsibility falling upon
professionals is clear:
Every profession bears the responsibility to understand the circumstances that enable its
existence. (Quote, emphasis added)
In recognition of the importance of sustainability and governance, SAICA has placed strong emphasis
on these matters in its updated CTA curricula. You can therefore also expect coverage of this area in
your CTA assessments and in future professional exams – normally in terms of integration of these
learning units within a larger context.
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With this in mind, study the following extract from an exposure draft issued by the International
Federation of Accountants (IFAC) as Good Practice Guidance, entitled: Project and Investment
Appraisal for Sustainable Value Creation1. (Our comments and notes are included in square
brackets.)
As indicated below, project and investment appraisal include a wide range of capital investment
decisions, but also valuations of business organisations, for example, in the case of acquisitions and
disposals of subsidiaries.
2. Key Principles of Project and Investment Appraisal [an extract]
2.1 Project and investment appraisal refers to evaluations of decisions made by organizations on
allocating resources to investments of a significant size. Typical capital spending and investment
decisions include the following:
• Make or buy decisions and outsourcing certain organizational functions

• Acquisition and disposal of subsidiary organizations
• Entry into new markets
• The purchase (or sale) of plant and equipment
• Developing new products or services, or discontinuing them, or decisions on related research
and development programs
• The acquisition or disposal of new premises or property by purchase, lease or rental
• Marketing programs to enhance brand recognition and to promote products or services
• Significant programs of staff development or training
• Restructuring of supply chain
• Revision of distribution networks
• Replacing existing assets.
2.4 The key principles underlying widely accepted good practice... [include]:
D. A good decision relies on an understanding of the business and should be considered and
interpreted in relation to an organization’s strategy and its economic, social, and competitive
position.
F. All assumptions used in undertaking DCF [Discounted Cash Flow] analysis, and in evaluating
proposed investment projects, should be supported by reasoned judgment, particularly where
factors are difficult to predict and estimate. Using techniques such as sensitivity analysis to identify
key variables and risks helps to reflect worst, most likely, and best case scenarios, and, therefore,
can support a reasoned judgment.
G. A post-completion review or audit of an investment decision should include an assessment of the

decision-making process and the results, benefits, and outcomes of the decision.
3. Application Guidance on Implementing the Principles [an extract]
PRINCIPLE A
When appraising multi-period investments, where expected benefits and costs and related cash
inflows and outflows arise over time, the time value of money should be taken into account
[thereby suggesting the use of the Discounted Cash Flow method].
A5. Many decisions will involve sustainability elements, whether from an economic, environmental, or
social perspective, that may need incorporating into project appraisal and investment decisions.
1 Copyright © November 2012 by the International Federation of Accountants (IFAC). All rights reserved. Used
with permission of IFAC. Permission is granted to make copies of this work to achieve maximum exposure and
feedback.
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Where economic, environmental, and social impacts are important to decision making, information
flows, particularly on costs and resulting impact, should be explicitly required where possible. A
project or investment evaluation process should identify and incorporate such impacts where they
give rise to costs and benefits, which are often not viewed as being a component of direct
investment or operational costs. Therefore, these impacts are often referred to as “externalities”
but their inclusion with other relevant information enables an organization to better manage these
impacts and internalize the costs and benefits.
PRINCIPLE B
The time value of money should be represented by the opportunity cost of capital.
B6. Sustainability-related risks without an intergenerational dimension can be estimated and ranked,
and expected benefits and costs incorporated into the appraisal in the form of cash flows.
Incorporating sustainability into the cash flow analysis ensures that cash flows account for the
expected costs of not investing in a sustainable path. However, the choice of cost of capital
becomes more critical to a valuation decision the longer the time period for which the cash flows
occur. A criticism of discounting is that it places lower importance on the needs of future
generations and, therefore, has implications for intergenerational equity. For example, if seeking
to take account of environmentally linked deaths, to attribute a value today of 100 per death, a
discount rate of 10% would effectively mean that 10 deaths in year 25 were equivalent to one death
today.
Certain benefits and synergies relating to improved sustainability performance might be penalized
in a DCF analysis, particularly with larger outlay and longer payback periods.
PRINCIPLE C
The discount rate used to calculate the NPV in a DCF analysis should properly reflect the
systematic risk of cash flows attributable to the project being appraised, and not the systematic
risk of the organization undertaking the project.
C3. Where a risk adjustment takes place as an adjustment to the discount rate or to expected cash
flows, or combination of both approaches, it is important to avoid double counting or miscounting
risk. The danger of building up “additive models” for a variety of risk factors is over discounting for
risk. Risk can also be considered and analysed in a post-valuation adjustment through a sensitivity
analysis…for example, with the adjustment taking the form of a discount for potential downside
risk or a premium for upside risk.
PRINCIPLE D
A good decision relies on an understanding of the business and should be considered and
interpreted in relation to an organization’s strategy, and its economic, social, and competitive
position.
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D1. Decisions, especially those taken in a relatively high-risk environment, involve cash flow estimates
based on judgment. Hard and fast cash flows rarely exist. An investment and DCF analysis should
probe behind cash flow estimates to understand both the nature of a positive NPV and the source
of value over the opportunity cost of capital. Various aspects relating to environmental and social
performance can be particularly difficult to quantify, such as the valuation of ecosystem services.
However, opportunities and risks, and impact on strategy arising from issues such as climate
change, can be determined using estimates and qualitative criteria. In reality, the idea that
ecosystems might be of financial or economic value has conventionally been given little attention
in the “hard” measures that are used to assess and report on company performance. In the worst
case, undervaluing ecosystems may have served to undermine business performance by failing
to identify new cost-saving or revenue-generating opportunities, or to highlight potentially costly
liabilities.
Appendix A: Definitions [an extract]
Ecosystem services: (also referred to as “environmental services” or “ecological services”) the

benefits that people obtain from ecosystems. Examples include freshwater, timber, climate
regulation, protection from natural hazards, erosion control, and recreation. Corporate
ecosystem valuation is where both ecosystem degradation and the benefits provided by
ecosystem services are explicitly accounted for with the intention of informing and improving
business decision-making.
Activity 3.2.1
The extract from the exposure draft issued by IFAC, entitled: Project and Investment Appraisal for
Sustainable Value Creation, has reference.
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Required Marks
(a) Name the common term used to describe the impact of economic, environmental,
and social matters, where these result in costs and benefits, but where these are
not viewed as elements of direct investment or operational costs. (1)
(b) Discuss the downfalls of using a constant discount rate over time to discount
projects with long time horizons, in terms of sustainability-related risks. (3)
(c) Give two examples of ways in which discounted cash flow techniques could be
adjusted for it to place greater emphasis on environmental issues, especially where
these have possible cash outflow implications far in the future. (2)
(c) Complete the sentence: ‘Where a risk adjustment takes place as an adjustment to
the discount rate or to expected cash flows, or combination of both approaches, it
is important to avoid…’ (1)
(d) Supply two examples of how the under-valuation of ecosystems in project and
investment appraisals could ultimately undermine the performance of an entity. (2)
(e) List the other four parts of a Project and Investment Appraisal Decision Process,
other than the compilation of a Discounted Cash Flow model. (2)
(f) Give six examples of ecosystem services (3)
No specific solution is offered here as all answers are embedded in the extract from the exposure draft
provided.
2.2. Form of the transaction
A capital investment transaction can take place in varying forms, some of which are: percentage
ownership, assets versus shares, expansion through franchising, an alliance or joint venture.
These differing forms of transacting are further discussed below:
2.2.1. Expansion through franchising
Franchising refers to the process whereby the Franchisor grants the Franchisee the right to distribute
its products or services in return for a franchise fee and a percentage of monthly sales. This results in
the following risks and rewards:
➢ The expansion is funded by an external party.

➢ The franchisee has a direct interest in the business and is thus more likely to work harder and
be more motivated than an employee.
➢ The costs involved in developing a franchise are high.
➢ It is not easy to terminate a franchise.
2.2.2. Purchase shares in another company
This process is initiated with an offer by the acquiring firm. Should the shareholder accept the offer, the
shareholder will exchange his shares for cash and or securities. This results in the following risks and
rewards:
➢ Offeror can deal directly with the shareholders.

➢ Control can be obtained by purchasing less than 100%.
➢ No shareholders’ meeting required if total control is not the objective.
➢ `Existing leases and contracts stay in place.
➢ Employment contracts need not change.
➢ There may be stamp duty implications.
➢ The acquiring company becomes exposed to the risks of the company.
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2.2.3. Purchase the assets of another company
A company may choose to expand by purchasing the assets of another company rather than
purchasing shares in that company. This results in the following risks and rewards:
➢ The Companies Act prohibits a company from giving financial assistance to a buyer of its shares.
However, if an asset is purchased, the asset itself may be used as security for the loan.
➢ Marketable securities tax and stamp duties not payable.
➢ If assets are bought as a going concern, no VAT is payable.
➢ Interest on a loan to purchase assets would normally be tax deductible.
➢ Transfer duty on the assets purchased is payable and can be costly.
➢ Disposal of a major asset requires approval by ordinary resolution.
2.2.4. Joint ventures
This is when two or more companies make an agreement to do business in one specific area. They
share resources to pursue a common goal. This results in the following risks and rewards:
➢ It is an easy way to enter new markets.

➢ Access to better resources and expertise.
➢ Dissolution of a joint venture (JV) is simple.
➢ Costs to establish a joint venture is low.
➢ Failure of clear communication between management can result in many disputes.
➢ Objectives of parties to the joint venture are not always in line with one another resulting in
conflict.
➢ Different cultures and management styles usually becomes problematic.
2.2.5. Alliance
A strategic alliance is the sharing of resources for the benefit of all partners. It differs from a joint
venture with regards to formality and permanence of the agreement. A joint venture is a legal
relationship between the parties and usually results in the formation of a new business whereas a
strategic alliance entails an agreement (which is usually not legally binding) to combine resources
and information in order to achieve a specific goal. The risks and rewards of an alliance are as follows:
➢ It is not time consuming.

➢ Not very capital intensive.
➢ Breaking the alliance is much easier than a JV.
➢ The risk of sharing too much information resulting in an alliance partner becoming a competitor.
➢ Failure to clearly define the roles and responsibilities of each partner can be detrimental.
2.3. Due diligence investigations
A due diligence investigation refers to a detailed examination of the investment prior to the acquisition.
The aim of such investigations is to ensure that the acquiring company makes an informed decision.
The results of such procedures could lead to a change in the terms of the acquisition, or even a
cancellation of the transaction.
2.4. Systems, information, confidentiality and disclosure requirements
When performing a capital investment appraisal, it is important to ensure that the information utilised
to make the decision is reliable and is kept confidential. Furthermore, consideration should also be
given as to whether the entities current systems will be able to support the investment or will an upgrade
be required.
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2.5. Post-investment audit
It is important that firms compare actual results with the estimated cash flows used in the capital
budgets of projects and provide explanations for the differences. The main objective of a post-
investment audit is to improve the capital budgeting process.
A post-investment audit is useful to:
• monitor and improve the performance of projects subsequent to implementation;

• ensure that management work hard to achieve forecasts;
• provide valuable lessons for decision-making when it is time to evaluate further investments.
2.6. Conflict of interest issues (managers vs shareholders)
When considering a capital investment, managers may experience a conflict of interest between acting
in their own best interest and acting in the interest of the shareholders (which is their responsibility).
The transaction may not necessarily maximise shareholder wealth but the management will pursue the
opportunity in order to benefit themselves. It should be noted that such unethical motivation for a capital
investment is one of the key reasons for failed transactions. For this reason, amongst others, the pre-
and post-acquisition reviews are important procedures for consideration.
Activity 3.2.2
Attempt Question 6.3, in chapter 6 of Managerial Finance, 8th edition, without referring to the suggested
solution.
Compare your answer to the suggested solution in the textbook and establish reasons for differences.
Activity 3.2.3
Attempt Question 6.4, in chapter 6 of Managerial Finance, 8th edition, without referring to the suggested
solution.
Compare your answer to the suggested solution in the textbook and establish reasons for differences
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QUESTION 1 27 MARKS (41 MINUTES plus reading time)
Perform the required parts (a) to (e) of question 8 (BRAZILICA LIMITED), which can be found in the
Question Bank. The relevant required part is repeated below. (At this point it is not necessary to attempt
the other parts of the question; you should, however, take notice of the way in which all the various
parts integrate and relate to the scenario.)
REQUIRED Marks
(a) Calculate the current Weighted Average Cost of Capital of Brazilica Ltd and of
Sourpaulo Ltd, based on available information and using fair market values as the
weights. (17)
(b) Recommend which of the three companies of Brazilica Ltd, Sourpaulo Ltd and
Riojanero Ltd should pursue ‘Project Roupa’ when assessed quantitatively based on
earlier calculations and available information. (2)
(c) Discuss other factors to be considered by Brazilica Ltd, Sourpaulo Ltd and Riojanero
Ltd, before investing in ‘Project Roupa’, assuming it would be financially feasible for
all companies. (4)
(d) Supply two examples of how the under-valuation of ecosystems in project and
investment appraisals could ultimately undermine the performance of an entity. (2)
(e) Discuss the downfalls of using a constant discount rate over time to discount projects
with long time horizons, in terms of sustainability-related risks. (2)
Refer to the suggested solution to this part in the Question Bank.
Perform the required parts (a) and (b) of Question 11(ZIVA’S FASHION FANATICS LIMITED), which
can be found in the Question Bank. The relevant required part is repeated below. (At this point it is not
necessary to attempt the other parts of the question; you should, however, take notice of the way in
which all the various parts integrate and relate to the scenario.)
REQUIRED Marks
(a) Critically comment on the trainees’ conclusion, including the calculations provided to
substantiate his conclusion. (10)
(You are not required to reperform the Net Present Value analysis.
(b) Assume that the correct Net Present Value calculation of store option 2 resulted in
a positive NPV of R1 250 000. (4)
Calculate and conclude which store option will represent the best investment option
for ZFF.
(You should not make use of a profitability index).

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Correia, C, Uliana, DFE, and Wormald, M. 2011. Financial Management, 7th edition. Juta & Company.
Cape Town.
International Federation of Accountants (IFAC). 2012. Exposure draft: Project and Investment
Appraisal for Sustainable Value Creation. New York: IFAC
Skae, F O. 2017. Managerial Finance. 8th edition. LexisNexis: Johannesburg.

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LEARNING UNIT 4 – SOURCES AND FORMS OF FINANCE
LEARNING OUTCOMES
• Identify potential sources of funds on an intermediate level.

• Critically assess the suitability of different forms of finance to different types of business entities,
different types of assets financed and different intended purposes.
• Describe the role, characteristics, advantages and disadvantages of different sources of financing
to an entity after considering its strategies and objectives.
• Perform and evaluate a financing decision (incorporating the effect of tax, including section 24j of
the Income Tax Act).
• Explain the terms “project finance”, “securitisation”, “asset securitisation” and “syndication”.
• Apply common business vocabulary and terms in your discussions.
• Identifies the strengths and weaknesses of the financial proposal or financing plans.
• Review the alignment of a proposal or plan with strategic objectives.

Learning outcome Managerial

Finance,
8th edition
• Understand of the workings of capital and money markets. • Chapter 7
• Identification of possible markets and the most appropriate market.
• Understand the theory of capital structure and how it is impacted by the
financing decision.
• Identify potential sources of funds on a basic level.
• Describe the role, characteristics, advantages and disadvantages of different
sources of financing and suggest the most appropriate form of financing.
• Perform and evaluate a financing decision on an intermediate level.
• Develops a portion of a financial proposal or financing plan that is supported
by well-reasoned assumptions and up-to-date information.
• Understand the interaction between the investment and financing decisions.
INTRODUCTION
Finance represents the lifeblood that enables a business to grow, expand, thrive, and sometimes,
merely survive. Different sources and forms of finance exist – each with their own advantages and
disadvantages, and cost. Raising the correct form of finance is therefore a very important aspect for
any business enterprise.
LEARNING UNIT TITLE
LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE
LEARNING UNIT 4.2 THE FINANCING DECISION

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LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE
1. Introduction
Financing could come from various sources and could take on various forms, including debt, mezzanine
capital hybrid capital, and ordinary equity. Once you have a proper grasp of the various sources and
forms of finance available – and their typical characteristics and uses – you will better be able to assess
their suitability to a specific entity. The main aims of this learning unit are to enhance your existing
knowledge in this regard and to introduce a few additional concepts.
This learning unit is based on the following chapter in your prescribed textbook (Managerial Finance,
8th edition):
Chapter 7 – The financing decision (including Annexure A).
2. Content
Based on your prior learning you should be able to identify and evaluate potential sources of financing
on an intermediate level. You should also be able to assess the suitability of each form to an entity. In
this section we will further expose you to a list (though not totally complete) of different forms of finance
with their relating attributes.
The following represent some of the sources of finance:
a. Taking a company private
This relates to converting a public listed company to a private unlisted entity. Such a transaction/s
usually entails selling the shares of a company, at a premium, to a large private equity group. Given
the large amount of funds required for such a transaction the private equity investors usually utilise
debt funding to finance the transaction. The cashflows for the acquired company is then utilised to meet
the interest and capital payments on the debt. It is therefore important that the level of debt taken on is
not excessive as this may impact the availability of future funding for the acquired company.
One of the reasons that would motivate management and boards of directors to take a company private
is that it allows them to focus on the company’s long term strategy, and implementation thereof, as less
time is spend on compliance with regulatory requirements and satisfying the diverse needs of a large
variety of public investors.
b. A private placement
This is one way for an unlisted company to obtain a listing. Ordinary shares are sold directly to
institutional investors and no underwriting is required. The cost of a private placement is low and no
prospectus is necessary. It results in a strategic allocation of shares and the institutions may subscribe
later for more shares if required.
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c. Shareholder contributions
A company can raise finance by the issue of new shares which the public may take up. Share-issue
expenses have to be met from the finance raised.
A company may invite existing shareholders in a company to buy more shares through a rights issue.
This allows the company to raise more capital. Normally the subscription price to the rights issue will
be set lower than the current share price to encourage existing shareholders to take up the offer. If
current shareholders do not take up the rights issue their holdings will be diluted.
d. Venture capital
As small businesses grow they need further financing. A venture capitalist provides equity finance for
a share of ownership of a firm. The venture capital markets are less efficient than the public markets
as transaction costs are far higher and there are a small number of buyers and sellers. There are no
reporting requirements, and information is not freely available to all parties.
Now study the following in Managerial Finance (8th edition) and attempt the activities included therein:
Chapter 7: sections 7.1 to 7.9 (including Appendix 1)
2.1. Project finance, securitisation and syndication
Project finance (including public-private partnerships), securitisation and syndication represent

advanced concepts in finance. We briefly explain these concepts in this learning unit.
a) Project finance (including public-private partnerships)
Project finance is an industry term for the pool of finance that is assembled in order to finance large-
scale infrastructure and construction projects, as well as other public-private partnerships (PPP). It is
important to differentiate between this industry term and a business entity seeking finance for a specific
project: the latter type of projects tends to be much smaller and is usually not described as ‘project
finance’.
Project finance for large-scale projects often consists of debt and equity obtained from a multitude of
sources. Debt finance includes bond finance and debt from banks, developing finance institutions and
aid agencies. Investors, known as sponsors, often provide some equity financing. Often these sources
of finance are then supplemented by governmental grants. It is common practice to create a special
purpose entity for such a project; this entity then owns no other assets, except for the project. (This
may serve to ring-fence the sponsors in case of project failure.)
b) Securitisation
Securitisation is a practice whereby a business entity seeking debt finance may bypass a bank as
intermediary to issue a marketable security, such as a bill of exchange or a bond, directly to investors.
(Securitisation therefore removes the bank as intermediary)
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c) Syndication
Syndication is a process aimed at
• reducing the risk of each member of a syndicate, by spreading the risk over the collective
syndicate; or alternatively
• providing access to a high-value investment that would be out of reach for an individual investor
Several forms of syndication exist and we describe some of these below.
Syndicated loan
A syndicated loan is debt provided by a syndicate (or grouping) of lenders, which is usually co-ordinated
by a lead manager (The Economist, 1999).
Syndicated securities
Syndicated securities are issued by an entity and underwritten by a syndicate (or grouping) of financial
institutions, which is also usually co-ordinated by a lead manager (The Economist, 1999).
Syndication company
The common example of a property syndication company will be used to illustrate this concept.
Property syndication facilitates the investment in a property (often an expensive commercial property,
such as a shopping centre, factory or office building), by several investors, who combine their funds.
The property syndication company manages the investment and compensates investors (based on
rental income and capital growth). A well-managed property syndication company may provide real
benefits to investors, but several ill-fated examples exist, including Masterbond and, more recently,
Sharemax Investments.
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LEARNING UNIT 4.2 THE FINANCING DECISION
1. Introduction
The aim of the financing decision is to decide on the best available financing option for a proposed
investment – best not only in terms of cost (determined by calculating the net present cost or IRR), but
also fit (determined by considering various entity-specific factors).
This learning unit is based on selected sections of the following chapter in your prescribed textbook
(Managerial Finance, 8th edition):
Chapter 7 – The financing decision.
2. Content
Based on your prior learning you should be able to perform and evaluate a financing decision on an
intermediate level. These types of decisions could be complicated by a number of factors, including
taxation (specifically Section 24J of the Income Tax Act). Some of the further intricacies are explored
in this section.
Now study the following in Managerial Finance (8th edition) and attempt the activities included therein
(if any):
Chapter 7: sections 7.10 to 7.15 (including Appendix 1)
Attempt question 7-1 in chapter 7 of Managerial Finance, 8th edition.


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Perform the required part (b) of Question 7 (The Entertainment Group) which can be found in the
Question Bank. The relevant required part is repeated below. (At this point it is not necessary to attempt
the other parts of the question; you should, however, take notice of the way in which all the various
parts integrate and relate to the scenario.)
REQUIRED Marks
(b) Evaluate the two loans from commercial banks considered as finance for the
outstanding balance on the theatres that are to be newly constructed. Your answer
should include:
(i) A determination of the most cost-effective loan by calculating the internal (11)
rate of return (IRR) of each;
(ii) A discussion of other factors to be considered in deciding between the two (4)
options.
(iii) Discuss the factors to be considered in evaluating whether to opt for a fixed
interest rate as opposed to a floating interest rate on either of the loans. (5)
(iv) Critically comment on the concerns that the shareholders of The
Entertainment Group have expressed regarding the other proposed
commercial bank loan-terms. (5)
Basson, D. 2007. ‘Playing bank-bank with other people’s money’, Auditing SA Summer 2007/8: 11-16.
Correia, C, Uliana, DFE, and Wormald, M. 2011. Financial Management. 7th edition. Juta & Company.
Cape Town.
The Economist. 1999. International Dictionary of Finance. London: Profile Books.
National Treasury (2004). PPP Practice Note Number 04 of 2004 ‘PPP Inception’. Pretoria: National
Treasury.

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LEARNING UNIT 5 – DIVIDEND DECISION
LEARNING OUTCOMES
• Identify factors affecting the dividend decision.

• Understand, at an intermediate level, the relevance and irrelevance theories and its impact on
dividend decisions.
• Identify and discuss the different methods and forms (including alternative forms) that an entity
may choose in paying dividends, on an intermediate level.
• Discuss the various factors to be considered before declaring a dividend / setting a dividend policy,
on an intermediate level.
• Evaluate the dividend decision, on an intermediate level.
• Recommend, on an intermediate level, the most appropriate method to distribute profits

Learning outcome Managerial Finance,

8th edition
• Identify basic factors affecting the dividend decision. • Chapter 14

• Understand, at a basic level, the relevance and irrelevance theories
and its impact on dividend decisions.
• Identify and discuss the different methods and forms (incl.
alternative forms) that an entity may choose in paying dividends on
a basic level.
• Discuss the various factors to be considered before declaring a
dividend/setting a dividend policy on a basic level.
• Evaluate the dividend decision on a basic level.
• Recommends, on a basic level, the most appropriate method to
distribute profits
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INTRODUCTION
A cash dividend is usually paid out of ‘free cash flow’ and thus management will not be able to use
these funds to invest in new projects; they may have to raise capital elsewhere. Since shareholders’
return on investment comprises both capital gain and dividends, the investors should be concerned
with the total return. This will be in line with management’s focus to maximise shareholders’ wealth.
(You should know that running a business on a sustainable basis also requires focus on other things –
including people and the planet.)
Surprisingly, successful companies display widely divergent dividend policies. Here, some companies
choose to pay strong or consistent dividends, whilst others choose to pay low dividends or none at all.
This then begs the question of whether the dividend decision actually affects the value of the company.
Yet, statutory requirements, shareholder preferences and the effect of taxation make this a more
complex matter. The ‘bird in the hand’ theory also predicts that shareholders will usually require a
higher rate of return from those companies with a fluctuating dividend policy as they perceive them to
be riskier. Put differently, companies with a stable dividend policy – all other things being equal – will
usually have a lower cost of capital relative to those with a fluctuating dividend policy.
This learning unit will explore the dividend decision further, including the different methods and forms
of dividends, and factors to be considered before setting a dividend policy.
LEARNING UNIT TITLE
LEARNING UNIT 5.1 DIVIDEND DECISION

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LEARNING UNIT 5.1 DIVIDEND DECISION
1. Introduction
The subject of this learning unit has already been introduced as part of the learning unit introduction.
This learning unit is based on the following chapter in your prescribed textbook (Managerial Finance,
8th edition): Chapter 14 – The dividend decision
2. Content
2.1. Dividend payment methods
Managers have to balance the need to maximise the value of a company with keeping shareholders
satisfied. Here management may choose different dividend policies and often consider shareholder
preference.
2.2. Dividend decisions in ‘perfect’ and imperfect markets
Where a company pays out a dividend, it may well have to raise an equivalent amount to finance its
new projects, e.g. by issuing new shares. The value of existing shares will be diluted by the value of
the dividend, implying that what has been gained on receipt of a cash dividend has been lost through
dilution of the value of shares. So, is a dividend policy relevant?
When it comes to the question of how a dividend policy affects the value of a business there are widely
divergent views. Miller and Modigliani argue that the dividend decision is irrelevant – in a ‘perfect
market’. Since the real world is anything but a ‘perfect’ market you may well ask yourself: why do I have
to know this? As is typical of many theoretical pursuits, there are many truths concealed in the detail.
There are also many insights to be gained from a study of both sides of a story.
2.3. Alternative forms of dividend payment
Dividends are not only paid in cash; many alternative forms of dividends exist. As you already know,
the following are the most common alternative forms:
• capitalisation issues / scrip dividends, and
• share buy-backs
After working through all the relevant sections in the textbook, guidance and activities provided by
this learning unit, you should now be able to attempt the following self-assessment questions.

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LEARNING UNIT 6 – MANAGEMENT OF WORKING CAPITAL
LEARNING OUTCOMES
• Analyse an entity’s accounts receivable, inventories, accounts payable and total working capital,
and suggest improvements.
• Calculate and evaluate the effect of changes in credit terms/policy.
• Analyse the entity’s financing of working capital and suggest improvements.
• Discuss the role of IT systems (incl Enterprise Resource Planning (ERP) and Customer
Relationship Management (CRM) systems) in working capital management.
• Assess an entity’s cash management and make recommendations for improvement (You can
exclude the Baumol and Miller-Orr models.)


Finance,
8th edition
• Analyse an entity’s accounts receivable, inventories, accounts payable Chapter 9

and total working capital, on an intermediate level, and suggest
improvements.
• Calculate and evaluate the effect of changes in credit terms/policy on an
intermediate level.
• Analyse the entity’s financing of working capital, on an intermediate level,
and suggest improvements.
• Assess an entity’s cash management and make recommendations for
improvement. (You can exclude the Baumol and Miller-Orr models.)
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INTRODUCTION
Working capital management, also known as short-term financial management, involves management
of the current assets and current liabilities of an entity. A business that fails to match decisions about
current assets and current liabilities, cannot survive in the long run. Working capital refers to current
assets and includes cash and short-term investments, inventory and accounts receivable. Businesses
may choose to finance their current assets through short-term or long-term finance. Use of long-term
finance may however reduce competitiveness, as a business may have less financial capacity for long-
term growth.
It is important to distinguish from current liabilities those that result from long-term decisions, for
instance, the current portion of long-term liabilities or short-term debt used to finance fixed assets.
Many businesses will have policies to determine target levels of each category of current assets and
financing thereof. A certain level of working capital is required for a business to operate efficiently. If
working capital levels are too low, the entity may face risk of out-of-stock situations, lost sales (credit
terms too strict or inventory not available) or inability to meet essential cash commitments. However, if
an entity holds too high working capital levels, it may not earn sufficient returns on such investment.
Working capital levels will also vary with changes in turnover and the inflation rate.
This learning unit is concerned with the range of skills required to manage working capital, including
ways in which it could be financed.
LEARNING UNIT TITLE
LEARNING UNIT 6.1 MANAGEMENT OF WORKING CAPITAL

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LEARNING UNIT 6.1 MANAGEMENT OF WORKING CAPITAL
1. Introduction
A later learning unit relating to analysis of financial information bears a close relationship with this
learning unit, the analysis and management of working capital. Working capital management involves
the management of current assets and current liabilities in terms of business policy guidelines. An
entity’s working capital policy will seek to balance the return generated from investment in the working
capital and exposure to associated risk. The challenge of setting up such policy is the forecasting of
working capital requirements.
This learning unit is based on the following chapter in your prescribed textbook
(Managerial Finance, 8th edition): Chapter 9 – Working capital management.
2. Content
Based on your prior learning you should have mastered most of the outcomes to an intermediate level.
The main purpose of this learning unit is thus to revise and expand your existing knowledge.
a) Accounts receivable management
When evaluating the creditworthiness of a potential customer, the following should be considered:
• collateral (security that may be given for the credit granted, if applicable)
• character (customer’s attitude towards payment)
• credit history (previous payment record)
• current financial position (consider a pay slip or Statement of Comprehensive Income)
• stability (how long at current address/job)
• general economic trends
Recall that a credit policy of an entity determines the following:
• credit allowed
• credit period
• discount offered
When evaluating the effect of a change in credit policy, you should consider the
• change in contribution (or gross profit) due to in-/decrease in sales

• change in bad debts
• change in the cost of the discount offered
• cost of financing working capital
• change in administration and other related costs
b) Accounts payable management
The management of creditors involves multiple facets, including: negotiating for favourable credit
terms, creating and maintaining good relationships with creditors, monitoring on-time payments to
creditors, and evaluating the cost of creditor financing.
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c) Inventory management
As you know, inventory is required for production (raw materials) and sales (finished products).
Inventory management requires planning as inventory does not spontaneously increase with an
increase in sales, as debtors do. As part of the planning process, the inventory policy must consider
the nature of the business and the environment in which it operates.
d) Cash management
Ways of relieving cash flow problems include the following:
• offering settlement discounts to debtors

• factoring debtors (although this is a drastic and expensive step)
• increasing the bank overdraft
• reducing inventory levels, thereby reducing holding costs
• extending creditor payments
• selling assets that are not earning sufficient returns
• enter into sale-and-leaseback agreements
• not paying dividends
• not undertaking (or extending) routine asset replacements
• negotiating with the SARS to pay off taxes due, over a specified period
• cost cutting
Activity 6.1.1
Ralphs Limited’s negotiated supplier credit terms are 2/10 net 30 (i.e. a 2% discount is offered for
payment within 10 days, otherwise payment must be made at the end of 30 days). Ralphs Ltd can obtain
a bank overdraft facility at a cost of 12% per annum.
Required
Advise Ralphs Ltd on whether it would be beneficial for them to take advantage of the supplier discount,
based on available information.
Cost of lost discount = Cash discount % x 365 days

100% – cash discount % t
= 2 x 365
100 – 2 30 - 10
= 37,2%
Where
t: time between discount period and payment date
Conclusion:
It would be beneficial for Ralphs Ltd to take advantage of the supplier discount as 12% per annum is
less than 37,2% per annum. (Both percentages represent nominal, annual percentage rates.)
Activity 6.1.2

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2.1. The role of IT systems in working capital management
IT systems can and often do play a crucial role in working capital management. Software tools range
from dedicated – sometimes customised – business software (such as Enterprise Resource Planning
and Customer Relationship Management systems), to end-user developed software (such as spread
sheets).
In this section we discuss some of the software solutions and the role they play in working capital
management.
Note:
The mention of a specific software package is merely for illustrative purposes and does not imply
endorsement. Software packages are subject to copyright laws and may further be subject to trademark
and patent laws.
a) Enterprise Resource Planning systems
Enterprise Resource Planning (ERP) systems aim to integrate all information flows and functions
(resources), across an organisation, into a single system. A successfully implemented ERP system
holds tremendous value to organisations – especially to bigger, more complicated organisations – in
that it may offer a single, on-time, integrated and efficient system, devoid of the multitude of problems
inherent to stand-alone systems.
An ERP system consists of separate modules – such as financial accounting, management accounting,
manufacturing, human resources, order-fulfilment, and sometimes also customer relationship
management (see below) – which all work together. All modules do not have to be installed
immediately, but could be added later as the need arises.
Examples of ERP software systems include SAP® and Sage®.
b) Customer Relationship Management systems
Customer Relationship Management (CRM) systems aim to improve ‘front-office services’ (client-facing
roles). It aims to achieve this through a holistic outlook of customers to help client-facing employees
make the right decisions in their various sales, marketing and customer-service fields. CRM systems
may represent a module of an ERP system or may function separately.
CRM systems may reduce costs and increase profitability through its organising of customer
relationship management, and by cultivating customer satisfaction and loyalty.
Examples of dedicated CRM systems include Microsoft Dynamics® CRM and Odyssey® CRM.
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c) Spreadsheet software
This range of flexible business tools is often end-user developed, but it is possible to build a more
formal and comprehensive solution – given the flexibility of this type of software. Spread sheet software,
e.g. Microsoft Excel®, can be used as part of the working capital management process in many ways,
including:
• the calculation of inventory, accounts receivable, and accounts payable days

• calculation of economic order quantities, and
• preparation of management information summaries and graphs
d) Internet tools and cloud-based solutions
Except for the obvious use of e-mail for communication with customers and suppliers, web browsers
and other cloud-based solutions enable companies to, e.g. engage in e-commerce. In terms of working
capital management, e-commerce enables companies to
• increase sales (by increasing its customer-base through B2C1 or B2B2 e-commerce)
• order inventory (by using B2B e-commerce)
• reduce accounts receivable (by offering internet payment solutions3)
• easily pay suppliers (through online banking solutions)
1
B2C e-commerce: B2C is an acronym for "business-to-consumer" and applies to any business or
organisation that sells its products or services to consumers over the Internet. When most people think
of B2C e-commerce, they think of Amazon.com, the online bookseller that launched its site in 1995
and quickly took on the world’s major retailers. In addition to online retailers, B2C has grown to include
services such as online banking.
2
B2B e-commerce: B2B is an acronym for "business-to-business" and differ from B2C in that
customers are other companies, while B2C customers are individuals. Overall, B2B transactions are
more complex and have higher security needs. Beyond that, there are two big distinctions:
• Negotiation: selling to another business involves bargaining over prices, delivery and product
specifications.
• Integration: companies selling to other businesses have to integrate with their customers' systems.
3
Internet payment solutions: companies such as WorldPay or Paypal enable thousands of businesses
to accept payments on the Internet. They normally accept credit and debit cards and bank transfers,
and accept most currencies.
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LEARNING UNIT 7 – TREASURY FUNCTION
LEARNING OUTCOMES
• Discuss the role of the treasury function.

• Integrate your knowledge of the workings of foreign exchange and interest rates.
• Identify risks related to foreign exchange and interest rates.
• Identify and discuss hedging techniques and risk management.
• Analyse various derivative instruments that are available to mitigate risks.
• Develop and evaluate risk management policies related to financial risk, at a basic level.
• Monitor risk exposure, taking into account changes within the entity and within the economy, and
recommend changes to risk management policies.
• Identify the need for and evaluate the usefulness of derivatives (including forward and future
contracts, swaps, put and call options).
• Set up different hedges and calculate the cost thereof (at an intermediate level).
• Suggest appropriate derivative instruments to manage the risk.
• Make use of the Black Scholes model to value options.
• Distinguish between the use of derivatives for purposes of hedging and speculation.

Learning outcome Managerial Finance,

8th edition
• Integrate your knowledge of the workings of foreign exchange and • Chapter 15
interest rates on an intermediary level. • Chapter 16
• Identify risks related to foreign exchange, interest rate, duration
choices, refinancing and liquidity, on an intermediary level.
• Identify and discuss hedging techniques and risk management on a
basic level.
• Develop and evaluate risk management policies related to financial
risk, at a basic level.
INTRODUCTION
The corporate treasury function fulfils multiple, important roles within most organisations. (The function
may be interwoven with the other duties of the financial manager for smaller entities.) The treasury
function is concerned with managing the entity’s payments, receipts and cash to make sure that the
entity has sufficient liquidity to meet its obligations, whilst simultaneously, managing currency, interest
rate and other financial risk. To fulfil these roles effectively requires a proper understanding of several
areas, including the functioning of foreign exchange markets and currency risk, as well as interest rates
and interest rate risk.
LEARNING UNIT TITLE
LEARNING UNIT 7.1 THE TREASURY FUNCTION

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LEARNING UNIT 7.1 THE TREASURY FUNCTION
1. Introduction
This learning unit aims to improve your existing knowledge of the functioning of foreign exchange
markets and currency risk, as well as interest rates and interest rate risk. It then uses this knowledge
to illustrate ways in which risk could be managed through hedges and derivatives.
8th edition):
• Chapter 15: The functioning of the foreign exchange markets and currency risk
• Chapter 16*: Interest rates and interest rate risk
* Please note that you are not required to know detailed calculations relating to interest rate swaps,
caps, floors and collars
2. Content
2.1. Foreign exchange markets and currency risk
The South African economy is fairly open and allows companies to trade within and with other
countries. Such transactions have to be settled in the foreign exchange markets. Due to the inherent
volatility in exchange rates these entities have to both understand the functioning of foreign exchange
markets and the nature of currency risk. For instance, where a South African company imports goods
from a US-based company, it will be exposed to the rand / dollar exchange rate when buying US dollars
in order to pay its US supplier.
In this section you will enhance your existing knowledge of the functioning of the foreign exchange
markets, currency risk, and how economic theories of purchasing power parity and interest parity
influence movements in the exchange rates. You will also learn hedging techniques and be exposed
to derivatives. Derivatives are simply financial contracts whose values derive from the value of some
other item, such as currencies.
Theories for determining forward exchange rates
You should know that countries with lower inflation rates will normally also have relatively low interest
rates and stronger currencies. In the indicated sections of the textbook you will be shown how interest
and inflation rate differentials affect the spot and forward exchange rates in the currency market
between two countries.
2.2. Risk management
The risk-management process involves identifying exposures to potential losses, measuring these
exposures, and the development of mitigation plans designed to manage, eliminate, or reduce risk to
an acceptable level. After risk management methods have been implemented, risk managers must
examine the risk management program to ensure that it continues to be adequate and effective. They
should periodically scan the environment to see whether the situation has changed in a way that affects
the nature or impact of the risk. The risk may have changed sufficiently so that the current mitigation is
ineffective and needs to be scrapped in favour of a different one. On the other hand, the risk may have
diminished in a way that allows resources devoted to it to be redirected.
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2.3. Black Scholes Model (Option pricing model)
The Black Scholes Model is a mathematical formula designed to price a call option as a function of the
following variables:
• Share price (S)

• Exercise price (E)
• Time to expiration (t)
• Standard deviation of return on share ()
• Risk free interest rate (R)
The Black Scholes formula is:
C = S x N (d1) – E x 𝑒−𝑅𝑡 x N (d2)
Where:
d1 = [ln (S/E) + (R +  /2)x t]
2
( x √t )
d2= d1 - ( x √t )
And where:
C = current option value

S = current share price
N (d) = the probability that a random draw from a standard normal distribution will be less than
(d).
E = exercise price
e = 2,71828 - the base of the natural log function
R = risk-free interest rate
t = time to maturity, in years
In = natural logarithm function
 = annualised standard deviation of the rate of return on the underlying asset.
Please note that you may be required to perform a basic calculation utilising the Black Scholes Model
when all input variables are provided. The formula will be provided to you in tests or exams.
The following table summarises the impact that an increase in each of the variables has on the option
price:
Increase to this variable Option price

Share price Higher
Strike price Lower
Time to expiration Higher
Standard deviation of return on share Higher
Risk free interest rate Higher
Activity 7.1.1
Let’s assume you would like to know the value of an option, with an exercise price of R80, to purchase
one share in company A. The current price of the shares is R70, and the option expires in three months.
Assuming that the share pays no dividends, the standard deviation of the shares returns is 60% per
year, and the risk-free rate is 8% per year.
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Required: Calculate that the value of the option.
2
d1 = [ln (70/80) + (0.08+ 0.6 /2)x 3/12]
(0.6x√0.25)
= (-0.13 + 0.07)/0.3
= -0.2
d2 = -0.2 - (0.6x√.25 )
= -0.5
N (-0.20) = 0.4207*
N (-0.50) = 0.3085*
*Value is obtained from cumulative normal distribution table.
Thus, the value of the call option is:
C = 70 x .4207 – 80 x 2.71828−0.0.8 (0.25) x 0.3085

= 29.45- 80 x 0.98 x 0.3085
= R 5.26
* Values are obtained from a cumulative normal distribution table which will be provided in tests and
exams.
After working through the relevant sections in the textbook and the material provided in this learning
unit, you should now be able to answer the self-assessment questions.
QUESTION 1
Attempt Practice Question 15-3 in chapter 15 of Managerial Finance, 8th edition.
QUESTION 2

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QUESTION 3
Firer, C, Ross, S, Westerfield, R & Jordan, B. 2012. Fundamentals of Corporate Finance. 5th South
African edition. United Kingdom: McGraw-Hill Education (UK) Limited.
Hiller, D, Grinblatt, M & Titman, S. 2012. Financial Markets and Corporate Strategy. Second
European edition. United Kingdom: McGraw-Hill Education (UK) Limited.
Reference for Business (2014). Risk Management (online). This document is available from:
http://www.referenceforbusiness.com/management/Pr-Sa/Risk-Management.html#ixzz3KoakMrXs.

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PART 2 – FUNCTION OF FINANCIAL MANAGEMENT

PURPOSE
The purpose of Part 2 is to reinforce and enhance your existing competencies related to the
function of financial management, and to assist you in applying your knowledge to a scenario
on an integrated basis.
The specific competencies referred to above relate to the analysis of the entity’s financial
situation, advisory services to a financially troubled business, and estimating the value of a
business.
This part also develops and applies specific competencies referred to in Part 1. In addition,
the purpose of the numerous activities and self-assessment activities included in this part is
also to enhance your pervasive qualities and skills – the professional qualities and skills that
Chartered Accountants are expected to bring to all tasks. These professional qualities include
ethical behaviour and professionalism, personal attributes, and professional skills.
The diagram below contains a schematic presentation of the content of this part, as well as earlier
and later parts.
Tutorial letter 102

1. Strategy and governance 8. Analysis and 11. Mergers and
2. Risk management interpretation of acquisitions
3. Cost of capital and financial and non- 12. Business plans and
capital investment financial information financial proposals
appraisal 9. Businesses in
4. Sources and forms of difficulty
finance 10. Valuations
capital
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LEARNING UNIT 8 – ANALYSIS AND INTERPRETATION OF FINANCIAL

AND NON-FINANCIAL INFORMATION
LEARNING OUTCOMES
• Clearly distinguish between the different objectives and areas of analysis (including the
ratios/calculations suitable to the different areas).
• Perform financial analysis, interpret results and draw conclusions as to an entity’s present and
future financial situation (at an advanced level).
• Analyse and interpret non-financial information.
• Identify and incorporate the influence of the entity’s competitive, economic, social, political and
internal environment upon your results.
• Integrate your knowledge of sustainability, environmental, social and governance factors as
part of your analysis.

textbook. For your convenience we also provide textbook references.

Finance,
8th edition
• Identify the different objectives and areas of analysis (including the • Chapter 8
ratios/calculations suitable to the different areas).
• Perform financial analysis, interpret results and draw conclusions as to an
entity’s present and future financial situation (an intermediate level).
• Analyse and interpret non-financial information at an intermediate level.
INTRODUCTION
The first step towards a better understanding of this learning unit is comprehension of the objective
of financial analysis and interpretation. This objective is to supply the users of an enterprise’s financial
and non-financial information with meaningful information, to equip them to make informed decisions.
Users include all stakeholders of the entity, such as the entity’s own management, investors,
financiers, suppliers, employees, consumers, as well as the government and general public.
Decisions made by these users include economic decisions (the reason for the traditional focus on
the analysis of financial information), but also decisions linked to sustainability, environmental, social
and governance factors (one of the reasons why, these days, non-financial information is starting to
assume more weight).
LEARNING UNIT 8.1 ANALYSIS AND INTERPRETATION OF FINANCIAL AND NON-

FINANCIAL INFORMATION
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LEARNING UNIT 8.1 – ANALYSIS AND INTERPRETATION OF FINANCIAL

AND NON-FINANCIAL INFORMATION
1. Introduction
In this learning unit we further explore an important function of financial management, which involves
the analysis and interpretation of financial and non-financial information.
Financial information is analysed, in part, to asses both business and financial risk. This includes: (1)
the calculation and comparison of ratios and other calculations within the entity over time; (2)
comparison of ratios and other calculations of the entity with the industry/similar entities; and (3) the
discussion of, and conclusion on, the calculated ratios.
8th edition):
• Chapter 8: Analysis of financial and non-financial information

• Chapter 11: Business and equity valuations
2. Content
2.1. Financial analysis and interpretation
Financial analysis and interpretation require a multitude of skills based on a sound working knowledge
of the various ratios and other calculations.
This will require the following:
• memorisation of the various ratios / other calculations – per area of analysis (you have to
know these per area as they will NOT be provided in the tests or examinations)
• a proper working knowledge and understanding of what is meant by each ratio / other
calculations, especially when compared to a benchmark such as the same ratio / calculation
for an earlier year, a similar company, or industry
• interrogation of your knowledge of the aforementioned areas, in order to interpret and
conclude upon your analysis
Most of the necessary knowledge for this area has already been achieved as part of your prior
learning. Now study the following subsections in Managerial Finance (8th edition) and attempt the
activities included therein:
Chapter Subsection
8 8.1 to 8.5 (excluding 8.3.5 to 8.3.6)
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2.2. Analysis and interpretation of non-financial information
Analysis and interpretation of non-financial information involves similar skills to those applied in the
context of financial information. However, analysis and interpretation of non-financial information also
requires an understanding of the non-financial information areas themselves, including sustainability,
and environmental, social and governance matters. In this regard, you have already obtained the
necessary knowledge of the Integrated Report and KING IV in Learning Unit 1.2, and in your prior
learning.
The Balanced Scorecard is a framework that addresses both financial and non-financial areas.
Originally developed by authors Kaplan and Norton, this performance measurement framework
focuses on four key business areas: financial, internal business processes, customer, and learning
and growth. Next, you are required to further your knowledge of this area by studying the following
subsections in Managerial Finance (8th edition):
Chapter Subsection
8 8.3.5 to 8.3.6
Activity 8.1.1
Work comprehensively through the Financial analysis example (8.3.4.3) in Managerial Finance
(8th edition).
3. Self-assessment question
Attempt question 8-1 in chapter 8 of Managerial Finance, 8th edition, without referring to the suggested
solution.
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LEARNING UNIT 9 – BUSINESSES IN DIFFICULTY
LEARNING OUTCOMES
• Identify tools that can be utilised to measure performance of an organisation.

• Identify and advise financially-troubled businesses (at a basic knowledge level).
• Identify the tax implications of the possible courses of action.
• Suggest appropriate means of refinancing a business.
• Prepare a preliminary analysis of the sources of the financial difficulty, the severity of the situation
and the potential for the success or failure of the recovery plans, including appropriate course of
action.
• Understand the business rescue principles as set out in the Companies Act.
• Integrate your knowledge of business performance measurement tools and ways of business
restructuring (at a basic level), in attempting an integrated question.
INTRODUCTION
Business entities may find themselves in financial distress for a multitude of reasons. One of the
functions of financial management is to assist such businesses in some way, usually in the form of
sound advice and with assistance in using some of the tools at their disposal. Here, businesses could
restructure/reorganise themselves within the guidelines of the Companies Act; they could enter into
voluntary liquidation; or restructure by means of divestiture, or an absorption or amalgamation with
another entity.
Restructuring in the form of disinvestment may help in dealing with financial distress, but may also
form part of a strategy of ‘best-practice parenting’. According to this strategy, holding companies
should display a superior means of ‘parenting’ the subsidiary and, if not possible, it should then
consider divesting. Here, the level of ‘difficulty’ in which the subsidiary finds itself necessitates a
broader reading.

LEARNING UNIT 9.1 BUSINESSES IN DIFFICULTY
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LEARNING UNIT 9.1 - BUSINESSES IN DIFFICULTY

1. Introduction
This learning unit focuses on businesses encountering some sort of difficulty and how this should be
managed. The two key avenues available to businesses in difficulty are reorganisation or liquidation.
This learning unit is based mainly on the following chapter in your prescribed textbook (Managerial
Finance, 8th edition):
• Chapter 13: Financial distress
2. Content
2.1. Businesses in difficulty
Several financial indicators were developed to predict the chances of business failure. These include
the:
• Z-score model
• K-score model
• A-score model
Regarding these models, it is more important for you to understand the various considerations and
indicators of problems, rather than calculating the scores using these models.
Note: Formulas will be provided if these scores have to be calculated. (As indicated, other ratios and
calculations indicated in learning unit 8.1 – Analysis and interpretation of financial and non-financial
information – will not be provided.)
For instance, the A-score model contains some useful indicators of typical problems in companies that
might lead to business failure. Some of the key characteristics of a firm in financial distress include:
• weak governance structures

• weak accounting structures
• mistakes, including excessive borrowing
• symptoms of problems, including employees having low morale
The three biggest mistakes that often contribute to failure is: overtrading, gearing and taking on big
projects.
In addition, it is important that you understand the essence of financial distress. Financial distress is a
condition where a company cannot meet, or has difficulty paying off its financial obligations to its
creditors as it falls due and payable. The chance of financial distress increases when a firm has high
fixed costs, illiquid assets, or revenues that are sensitive to economic downturns.
Now work through the example within section 8.3.4.3 – section VII in your prescribed textbook
(Managerial Finance, 8th edition):
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2.2. Business recovery and restructuring
Often, even though businesses find themselves in difficulty, they may possess some valuable
characteristics (i.e. sound management, an innovative product, etc). Sometimes, it is these valuable
characteristics that should be utilised to assist them in recovering from their difficulty.
A constructive way of dealing with a business in financial difficulty is to reorganise the business.
Reorganisation is the restructuring of a failing firm in an attempt to continue operations as a going
concern, and may involve any/all of the following:
• reconstructing the financial structure of the firm/refinancing the firm

• introducing a flatter management structure
• closing down non-profitable operations and products
• divestitures, i.e. selling non-profitable assets, divisions, subsidiaries, etc.
Indicators that a reconstruction is required are often linked to the failure indicators in section 2.1.
above, but in this case, the business organisation should also have good prospects for the future.
The numerous considerations of a reorganisation are considered in the textbook. These include
conditions; structures; related accounting entries; and legal requirements, including requirements for
business rescue.
2.3. Refinancing a business
Refinancing refers to replacing the existing financing with new financing. The new sources of funds
are used to pay the existing debt of the company. Refinancing could include, amongst others,
increasing the maximum amount of the facility, changing the forms of finance used or obtaining
finance from a different source.
It is important to note that refinancing should only be undertaken once a complete cost/benefit
analysis of all financing options available was undertaken.
In learning unit 1.4 (Sources and forms of finance) you have already learned about the various
potential sources of funds, and the role, characteristics, advantages and disadvantages of each.
2.4. Tax implications
The corporate rules, which are covered in sections 41–47 of the Income Tax Act, should be
considered. Section 44 specifically deals with transactions relating to an amalgamation and section
47 specifically deals with transactions relating to liquidations.
2.5. Business rescue principles in terms of the Companies Act
The business rescue regime is an attempt to provide an alternative to liquidating a near-insolvent

company. A directors’ resolution that declares that the company is in dire financial straits is required
An independent person (called a ‘practitioner’) must also be appointed. The business rescue
practitioner has the duty to investigate the company’s affairs and then decide whether or not there is
any reasonable prospect of rehabilitating the company. If the practitioner decides that there is such a
prospect, he must then prepare a business plan. After the business plan is approved by the
company’s creditors (and shareholders, if their rights are affected) the practitioner must then oversee
its implementation.
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Business rescue is a system to temporarily protect a company against the claims of creditors so that
the business can be restructured and thereafter sold for maximum value as a going concern, thus
giving creditors and shareholders a better return than they would have received had the company
been liquidated. A successful business rescue procedure therefore does not necessarily require that
all creditors be paid in full or that all shareholders retain their investment.
.
Activity 9.1.1
Which of the following alternatives would together indicate a high risk of business failure?
(a) a company with a Z-score of 1,2 and an A-score of 30

(b) a company with a Z-score of 1,2 and an A-score of 22
(c) a company with a Z-score of 2,2 and an A-score of 25
(d) a company with a Z-score of 3,0 and an A-score of 30
Suggested solution (a)
(a) Yes. Z-scores less than 1,8 shows a high risk of short term failure and A-scores greater than
25 indicate that a company is likely to fail.
(b) No. Z-scores less than 1,8 shows a high risk of short term; however, A-scores less than 25
indicate that a company is not in danger of failing.
(c) No (not a high risk). Z-scores between 1,8 and 2,99 indicate that a company is at a potential risk
of failing and an A-score of 25 or less indicate that a company is not in danger of failing.
(d) No. A-scores greater than 25 indicate that a company is likely to fail; however, Z-scores greater
than 2,99 show a low risk of failing
QUESTION 1 (8 MARKS 10 MINUTES)

Attempt Practice Question 13-1 in Managerial Finance (8th edition).


Find the solution after the practice question in the textbook

Steyn, C. and Everingham, G. (2011). The New Companies Act Unlocked. South Africa: Siber Ink
Skae, FO. Managerial Finance. 8th Edition. LexisNexis: Johannesburg.
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LEARNING UNIT 10 – VALUATIONS

INTRODUCTION
The exercise of valuing something has preoccupied humankind for ages. Even in early times, the
practice of bartering required the exchange of one commodity for another, based upon a perception
of the value of each. For example, using bartering, one might have exchanged livestock for a certain
amount of salt. (Remarkably, salt used to be a valuable commodity.)
In most regards, today’s complex economic environment is far removed from the trading practices of
old. However, people today have an even stronger need to value some things, or – more precisely –
to have them valued. As a Chartered Accountant you may one day perform professional valuations
of several of the tools of the modern economy, including preference shares, debt, equity, and of
business enterprises. Yet, even if you don’t offer this service directly in the future, your skill set will
demand a good understanding of valuation principles.
In this learning unit you will learn a couple of additional models of valuation, but mainly, you will be
enhancing your prior learning. Many students struggle with this important learning unit precisely
because they are attempting to refine knowledge in this area that is not strong to begin with (akin to
building a house on sand). If you are one of these students, we strongly encourage you to allocate
extra time to this learning unit in order to first ‘cement’ your prior learning (indicated below), before
attempting the further learning presented in this learning unit.
LEARNING OUTCOMES
• Perform a valuation of convertible securities

• Display an understanding of the complexities and uncertainties underlying the various valuation
approaches, methodologies, methods and models suitable to business and equity valuations.
• Use a range of skills to perform, and professionally present, advanced business and equity
valuations using the following valuation methodologies/methods/models: (1) price of recent
investment, (2) net assets, (3) earnings multiples (several), (4) market price multiples, (5)
Gordon Dividend Growth Model, and (6) models based on free cash flow.
• Discuss the various considerations and recommend ways in which an entrepreneur could
prepare for the sale of his/her business.
• Identify the critical assumptions and facts that underlie the valuation estimate.

In your undergraduate studies you have already mastered the learning outcomes indicated below.
Please refer to your undergraduate material if you want to refresh your knowledge. (Current textbook
references are also provided for your convenience.)
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Finance
8th edition
• Critically reflect on the various valuation approaches, methodologies, methods Chapter 11
and models suitable to business and equity valuations.
• Explains the shortcomings of the various valuation methodologies
• Perform valuations of various instruments (i.e. equity, and preference shares
and debentures and bonds)
• Discuss qualitative factors relating to valuations.
• Use a range of skills to perform business and equity valuations using the
following valuation methodologies/methods/models:
(1) Earnings
(2) Net assets
(3) Free cash flow
(4) Gordon Dividend Growth Model
LEARNING UNIT 10.1 VALUATIONS

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LEARNING UNIT 10.1 VALUATIONS
1. Introduction
A successful Advanced Management Accounting student is required to display advanced knowledge

and engagement in the topic of Management Accounting.
With such high expectations, it is understandable that the learning unit of valuations is an important
one and also one that has been examined numerous times in the past. Not only does this learning
unit bring together several important building blocks of Management Accounting (think of the time
value of money, discounted cash flow, risk assessment, and several others), it is also an ideal way to
test insight and to test your knowledge within a particular context. Valuations, in turn, then serves as
a building block for other learning units (think of ‘mergers and acquisitions’, for example).
This learning unit adds to your prior knowledge in this area and is based mainly on the following
chapter in your prescribed textbook (Managerial Finance, 8th edition):
• Chapter 11 – Business and equity valuations
To help you track your overall progress, combined revision of prior learning and new study required
for this learning unit will be based on the following chapter and sections in Managerial Finance (8th
edition):
Chapter Subsections Excluding
11 All • Section 11.6.5.1 (f), the McKinsey Convergence Value-driver

formula (this will be covered in CTA level 2)
• 11.6.6 Model based on EVA®/MVA (as a valuation model per se,
this will be covered in CTA level 2)
2. Content
The purpose of the content below is to supplement the information in the textbook in areas where it
is considered necessary. It in no way replaces or can be considered to be a substitute for the
textbook. It therefore remains imperative that you work through the textbook in detail.
2.1. Preparing for a sale
There often comes a time when an entrepreneur wants to sell his/her business. An entrepreneur may
have been very successful in starting and growing a business, but oftentimes he/she is very uncertain
of how to prepare for its later sale. (These arguments are more relevant to owners of unlisted, private-
equity businesses.) Here, a chartered accountant often assists with invaluable advice; it is thus
important for you to learn about the various considerations in this regard.
An entrepreneur could decide to sell his/her business using several avenues. In a 2013 online
publication2, Investec, a specialist bank, described the most prominent exit strategies in this area as
• selling to another market player

• selling to a private equity firm
• transferring ownership to employees, management or family
• listing the business through an initial public offering
2For a specific reference refer to the Bibliography and Additional Reading-section at the end of this learning
unit, or use a search engine to search for ‘preparing for sale, site:investec.co.za’.
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When preparing for a successful sale, an entrepreneur should obtain proper professional advice and
further ensure that certain key areas are given the appropriate attention.
Here, Investec (2013)1 highlights the importance of
• clean and consistent accounting records

• clear and well-documented agreements, governing key relationships (such as exclusive
distribution rights)
• a clear understanding of the various drivers of value, for purposes of a business valuation
• a clear understanding of the components of a business and how they dynamically interact with
other components where a portion of the business will be retained (also for purposes of a
business valuation)
• strong legal agreements, such as shareholder agreements
In addition, an entity should ensure proper compliance with tax laws.
2.2. Assumptions and facts that underlie the valuation estimate
2.2.1. Risks related to sustainability
Sustainability (environmental, social and governance) risks and opportunities should be integrated
into traditional equity valuation techniques to show how a company’s revenue, earnings and cash
flows could be impacted by global sustainability issues.
For example, there could be an additional risk for a mining company if it has operations in areas of
water scarcity. This additional risk could cause a decrease in the value of the company. On the other
hand, sustainability opportunities could cause an increase in the value of the company. For example,
if a utilities company has exposure to an expanding green energy market or “smart energy”
technology.
2.2.2. Growth strategies and growth prospects
Growth is a key driver of corporate valuation. Some firms are positioned to achieve growth through
product innovation or by merging with or acquiring other firms while other firms have already reached
the maturity phase and cannot continue to stay in a high growth bracket due their size, market share
or the maturity of their products. Investors are willing to pay more for firms with a well-defined growth
strategy and financial policies that are consistent with these strategies and therefore high growth
entities trade at higher multiples than low growth entities. In some industries, however, investors are
less willing to pay for EPS growth that is driven by cost cutting, share repurchases and tax planning,
as opposed to revenue growth.
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Perform practice question 11-1 in the Managerial Finance (8th edition) textbook.
Perform parts (a) and (b) of practice question 11-4 in the Managerial Finance (8th edition) textbook.
Perform the required parts of practice question 11-5 in the Managerial Finance (8th edition) textbook.
Investec Bank (2013). Preparing for sale (online). Investec Bank: Johannesburg.
JP Morgan (2010). Understanding the new growth paradigm: Opportunities to create value in an
anemic growth environment (online). This document is available from:
https://www.jpmorgan.com/directdoc/cfa_nov2010.pdf
Skae, FO. 2017. Managerial Finance. 8th Edition. LexisNexis: Johannesburg.
Thomson Reuters (2014) . EXECUTIVE PERSPECTIVE: Morgan Stanley incorporates sustainability

into equity analysis. (online). This document is available from:
http://sustainability.thomsonreuters.com/2014/09/10/executive-perspective-morgan-stanley-
incorporates-sustainabilty-equity-analysis.
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PART 3 – MERGERS AND ACQUISITIONS AND BUSINESS PLANS
PURPOSE
The purpose of Part 3 is to reinforce and enhance your existing competencies related to
the evaluation of mergers and acquisitions and the development of business
plans/proposals. In addition, its purpose is to assist you in applying your knowledge to a
scenario on an integrated basis.
This part also develops and applies specific competencies referred to in Parts 1 and 2. In
addition, the purpose of the numerous activities and self-assessment activities included in
this part is also to enhance your pervasive qualities and skills – the professional qualities
and skills that chartered accountants are expected to bring to all tasks. These professional
qualities include ethical behaviour and professionalism, personal attributes, and
professional skills.
The diagram below contains a schematic presentation of the content of this part as well as earlier
and later parts of this tutorial letter.
Tutorial Letter 102

1. Strategy and 8. Analysis and 11. Mergers and
governance interpretation of acquisitions
2. Risk management financial and non- 12. Business plans and
3. Cost of capital and financial information financial proposals
capital investment 9. Businesses in
appraisal difficulty
4. Sources and forms of 10. Valuations
finance
capital
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LEARNING UNIT 11 – MERGERS & ACQUISITIONS (M&A’s)
LEARNING OUTCOMES
• Analyse the risks and financial implications of a merger, acquisition, proposed start-up, strategic
alliance or divestiture, including:
✓ the strategic context

✓ behavioural implications
✓ legal implications
✓ pricing considerations
✓ impact of synergy
✓ financing considerations
✓ management buy-outs
✓ Black Economic Empowerment (BEE)
✓ post-acquisition review
✓ industry regulation
✓ environmental, social and governance implications
• Based on the analysis, suggest
✓ the form of the transaction

✓ financing options and terms
✓ due diligence procedures
✓ systems, information, confidentiality and disclosure requirements
✓ conflict of interest issues
✓ key risks and rewards
• Use a range of skills to perform advanced valuations for purposes of mergers & acquisitions
(M&As), using various valuation methodologies/methods/models and incorporating the effect of
synergies.

textbook. For your convenience we also provide textbook references. It is also essential to have
mastered the outcomes of learning unit 10 (Valuations) before attempting this learning unit.

Finance,
8th edition
• Identify ways the ownership of an entity can be restructured (e.g.
buyouts, takeovers, restructurings) • Chapter 12
• Explain some of the issues that can arise from a change in control
(changes to structure, due diligence, risks, etc.)
• Analyse the risks and financial implications of a merger, acquisition,
proposed start-up, strategic alliance or divestiture on a basic level.
• Based on the analysis, make certain suggestions regarding the proposed
transaction/agreement on a basic level.
• Perform a valuation for mergers.
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INTRODUCTION
The business of mergers and acquisitions is an unforgiving business; whereby massive amounts of
money are either spent or lost. As a chartered accountant you may well be involved in these
transactions, in some capacity or another. This learning unit therefore conveys important concepts
that will lay the necessary groundwork in your studies but possibly also in your future area of
specialism.
LEARNING UNIT 11.1 VALUATION FOR PURPOSES OF M&As: SYNERGIES
LEARNING UNIT 11.2 OTHER CONSIDERATIONS

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LEARNING UNIT 11.1 VALUATION FOR PURPOSES OF M&As: SYNERGIES

1. Introduction
Valuation for purposes of M&As builds to a large extent on the concepts already addressed in the
learning unit of Valuations (learning unit 10). It incorporates a phenomenon that is not only
extraordinary, but also very elusive – a synergy effect. If achieved, this effect has a combined effect
greater than the sum of the parts. This implies that a planned M&A could achieve synergy through
the combination of previously disparate entities, through resulting efficiencies (such as economies of
scale), cost savings and other revenue enhancing effects.
Importantly, synergy should not be used by dealmakers merely as a vague justification for a
transaction; integration between the entities should be properly planned and managed, sources of
value should be clearly described and the synergy value determined in advance. The important step
of valuing synergy is the focus of this learning unit.
8th edition):
• chapter 11
• chapter 12
2. Content
2.1. Corporate restructuring background
Business entities often restructure their operations, assets, financial or legal structure – in a process
called corporate restructuring (refer to figure 11.1.1) – with the aim of becoming more successful or
to better serve their corporate strategy.
Instead of growing organically, a firm can sometimes achieve faster growth, especially in a new
market, by expanding through a merger with or acquisition of another firm. Sometimes, changing
circumstances, including a changing economy and changing strategies, dictate that a firm divest itself
of certain subsidiaries or interests.
As explained, there are various forms of corporate restructuring; however, this learning unit focuses
on what is probably the most common: mergers and acquisitions.
2.2. M&As, or a creature by another name?
The business of M&As is not only a merciless business, whereby massive amounts of money are
either spent or lost, but also one going by several names. Here, the term ‘mergers’ usually refers to
deals where two business enterprises take near equal stakes in each other’s businesses; the term
‘acquisitions’ basically refers to the purchase of a business enterprise. To complicate matters, a
merger is sometimes described as an ‘amalgamation’, and an acquisition is sometimes referred to as
a ‘takeover’. On the other hand, financial accountants prefer the universal term of ‘business
combinations’.
The exact technical distinction between these terms have become blurred and is therefore of lesser
importance for purposes of this learning unit. Here we will refer mainly to the term M&As and may
use the terms ‘merger’ and ‘acquisition’ interchangeably.
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Finally, two further terms have to be introduced. An ‘acquirer’ represents the business enterprise that
purchases or acquires (through a bidding process) another enterprise, which is known as the ‘target’.
Note
The distinction between horizontal, vertical and conglomerate forms of corporate restructuring is
important. These classifications have already been introduced as part of your prior learning.
Corporate restructuring
Expansion Disinvestment
Divestitures
Merger Acquisition Reverse Joint arrangements

takeover - Joint Venture
- Joint operations
Figure 11.1.1 Forms of corporate restructuring
2.3. The synergy effect
As long ago as 1965, Igor Ansoff, a distinguished author and mathematician, eloquently captured the
meaning of synergy between different organisations. He described it as the:
2 + 2 = 5 effect
Coming from a mathematician we know that there has to be some deeper meaning to this otherwise
nonsensical equation. In fact, the extra “1” contained in this equation is generated through the
efficiencies generated by the working together of two (previously separate) organisations. In other
words, it is generated through a synergy effect.
Importantly, studies show that synergy in the case of M&As is by no means guaranteed. Studies
further show that in successful cases, synergies frequently accrue to only the target business
enterprise’s shareholders, mainly due to the payment of outsized M&A premiums by the acquirer
(Sirower, ML & Sahni, 2006).
2.4. Valuation of for purposes of M&A: Synergies
Business and equity valuations form a very important part of M&As. In this area you would draw
heavily from the range of specialist skills mastered in the learning unit of Valuations (learning unit 10).
In performing a valuation for purposes of M&As, you may represent either the acquirer, or the target,
or otherwise, act as an independent appraiser.
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As a result, you may have to determine (1) a minimum price of the target (normally to be considered
by the target organisation), (2) a maximum price of the target (payable by the acquirer without them
destroying value by overpaying), or (3) a fair market value of the target (when acting as an
independent appraiser).
Here, the following guidelines apply:
• When determining a minimum value of the target organisation, all synergies are usually
disregarded.
• When determining a maximum value, all specific (unique) synergies that may exist between the
target and the acquirer are usually quantified and included in the maximum price.
• Finally, if determining a fair value of the target organisation, only synergies that could exist in
general (also with other acquirers) are quantified and included in the fair market value – unique
synergies are disregarded here. The reason for this is because competition between different
bidders will create a market for the synergies that are achievable by more than one potential
bidder.
Note
We could quantify synergies using a number of valuation methodologies, methods or models.

However, we normally value synergy using a discounted cash flow method.
Activity 11.1.1
Bidder Ltd (“Bidder”) is seeking accelerated growth through the acquisition of compatible, external
business organisations.
In this regard, a committee of Bidder, tasked with identifying suitable candidates for acquisition, has
suggested the purchase of Target Ltd (“Target”) – a company in a different, but compatible industry.
In case of a takeover of Target by Bidder the following specific synergies and related costs are
expected:
• 50 employees of Target would immediately be made redundant at an after-tax retrenchment cost

of R1,2 million.
• Annual post-tax wage savings are expected to be R750 000 (at current prices). Future wage
increases would have grown at double the inflation rate for next year and at a rate equal to
inflation for years thereafter.
• Some land and buildings of Target would be sold for R800 000 (after tax) and do not need to be
replaced (the combined entity will have sufficient office space).
• Fixed advertising and distribution cost savings of R150 000 (before tax) would be saved in the
next year and for each year thereafter.
• Legal and other acquisition-related cost at present value are expected to amount to R3 million
(after tax).
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The following additional information is available:
• The weighted average cost of capital of Target has been estimated at 18%.
• The income tax rate is 28%.
• The current rate of inflation is 5% per annum and is expected to remain at approximately this
level in the foreseeable future.
• Unless otherwise mentioned, all fixed expenses will grow by inflation only.
• The intrinsic equity value of Target has been estimated at R20 million (this value was determined
using an income approach and excludes all possible synergies).
• If a company, other than Bidder, were to acquire Target, it is expected that only 40% of the net
synergy benefit will be realised.
Required Marks
(a) Calculate the value of all specific synergies, after associated costs, between Bidder and (10)
Target, based on available information.
(b) Determine a minimum selling price which Target may consider. (1)
(c) Determine a maximum bid price which Bidder may offer. (1)
(d) Determine the fair value of Target. (2)
(e) Critically discuss reasons why Bidder should consider offering less than the maximum (5)
bid price (determined in part (c)) for Target and recommend a more suitable bid price.
(Source: UNISA, TOE408W, test 3 [2011] – updated, truncated and adjusted)
Notes
Part
(a) Make sure that costs are subtracted and savings are added.
- Ensure that you include the costs/savings in the correct period.

- Remember to apply Gordon Growth Model where future growth applies. Only applicable
if there is constant growth.
(b)-(d) Before continuing with this learning unit, make sure you understand how synergies affect the
maximum, minimum and fair value price.
(e) Discussion questions are common. Take time to see how these are answered.
Part (a) Present value of synergies and related cost

Year 0 Year 1 Marks
Wage savings and associated cost R R
• Employees – retrenchment costN1 (1 200 000) (1)

• Wage savings for Year 1 (R750 000 x (1+ (2 x 5%)) 825 000 (1)
• Wage savings for years after Year 1:
Apply the Gordon Growth ModelN2
P0 = Cf1/(WACC-g), adjusted for the appropriate year:
P1 = Cf2/(WACC-g)
= R825 000 aboveN3 x (1,00 + 0,05) 6 663 462 (2)
(18% – 5%) (1)
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Year 0 Year 1 Marks
Land and buildingsN1 800 000 (1)
Advertising and distribution
Apply the Gordon Growth Model

P0 = Cf1/(WACC-g)
= R150 000N4 x (1 – 28%) 830 769 (1)
(18% – 5%) (1)
Legal and other costN1 (3 000 000) (1)
Totals (2 569 231) 7 488 462
Discount factors (for a rate of 18%) 1,000 0,847 (1)

(Mark awarded for using discount factors or
financial calculator – calculations shown)
Discounted values (2 569 231) 6 342 727
Total present value of specific synergies, after associated

costs 3 773 496
(Figures may not total correctly due to rounding.)
Notes
N1
This figure is already after-tax and already a present value.
N2
We can apply the Gordon Growth Model only where constant growth is expected (in this case:
inflation growth only, from Year 2).
N3
This figure is already after-tax.
N4
We do not increase the R150 000 by inflation here as it already represents the saving in one
year’s time.
Part (b) Minimum selling price
This will equal the intrinsic value of Target (excluding all possible synergies): R20 million. (1)
Part (c) Maximum bid price
This will equal the intrinsic value of Target plus the value of all specific synergies (net of associated
cost): (R20 000 000 + R3 773 496, calculated in part (a)) = R23 773 496. (1)
Part (d) Fair market value of Target
This will equal the intrinsic value of Target plus the net value of synergies obtainable by more than
one potential acquirer: (R20 000 000 + (3 773 496 x 40%)) = R21 509 398. (2)
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Part (e) Critical discussion
Bidder should seriously consider offering less than the maximum bid price (R23 773 496) for Target,
for the following reasons –
• The nearest other bidder is likely to offer no more than the fair market value: R21 509 398
(determined in part (d)), since no synergies above the 40%-level would be available to it. (1)
• The specific synergies between Bidder and Target relate mainly to the reduction in duplicated
facilities and staff. (1)
• Since Bidder will contribute to this benefit (for example, through use of its facilities or staff by the
combined entity), the specific synergy benefit should be shared. (1)
• If Bidder pays the maximum price of R23 773 496 (determined in part (c)), including the full price
of all net synergies, it would be paying for the full synergy benefit (to Target’s shareholders) and
none of the specific synergy benefits would accrue to its shareholders (Bidders existing
shareholders). (1)
Recommend a suitable bid price
The eventual bid price will be a matter of negotiation, but it is recommended that Bidder bids less
than the maximum price (R23 773 496 from part (c)), closer to the minimum price (R20 million from
part (b)), likely to end up close to the fair market value (R21 509 398 from part (d)). (1)
(Source: Unisa, TOE408W – adapted)
Attempt question 11–4, required part (c), in Managerial Finance (8th edition):
The suggested solution can be found after the question in the textbook.
Perform the required part (b) of Question 9 (X-Factor Holdings) which can be found in the Question
Bank. The relevant required part is repeated below.
REQUIRED Marks
(b) Recommend a maximum bid price in Australian Dollar that Countryside could offer for (21)
a 70% shareholding in Bedazzled as at 30 June 2013. Support your recommendation
by calculating a value using a method based on a forward EV/EBIT multiple and the
available information.
Motivate the appropriateness of this valuation method, the recommended price, the
components of your calculation, and any adjustments made.

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LEARNING UNIT 11.2 OTHER CONSIDERATIONS

1. Introduction
Befitting the complicated nature of M&A’s, these transactions normally involve numerous specialists,
at great expense. As a chartered accountant, you may assist in this process and therefore also require
a good working knowledge of some of the other M&A considerations. In this learning unit we will
address some of these, including funding considerations, Black Economic Empowerment (BBBEE)
considerations, post-acquisition reviews, and due diligence investigations.
8th edition):
• Chapter 12
2. Content
2.1. The form of the transaction
Expansion can occur in various different forms, some of which are discussed below:
Expansion through franchising
Franchising refers to the process whereby the Franchisor grants the Franchisee the right to distribute
its products or services in return for a franchise fee and a percentage of monthly sales. This results
in the following risks and rewards:
➢ The expansion is funded by an external party.

➢ The franchisee has a direct interest in the business and is thus more likely to work harder and be
more motivated than an employee.
➢ The costs involved in developing a franchise are high.
➢ It is not easy to terminate a franchise.
Purchase shares in another company
This process is initiated with an offer by the acquiring firm. Should the shareholder accept the offer,
the shareholder will exchange his shares for cash and or securities. This results in the following risks
and rewards:
➢ Offeror can deal directly with the shareholders.

➢ Control can be obtained by purchasing less than 100%.
➢ No shareholders’ meeting required if total control is not the objective.
➢ Existing leases and contracts stay in place.
➢ Employment contracts need not change.
➢ There may be stamp duty implications.
➢ The acquiring company becomes exposed to the risks of the company.
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Purchase the assets of another company
A company may choose to expand by purchasing the assets of another company rather than
purchasing shares in that company. This results in the following risks and rewards:
➢ The Companies Act prohibits a company from giving financial assistance to a buyer of its
shares. However, if an asset is purchased, the asset itself may be used as security for the loan.
➢ Marketable securities tax and stamp duties are not payable.
➢ If assets are bought as a going concern, no VAT is payable.
➢ Interest on a loan to purchase assets would normally be tax deductible.
➢ Transfer duty on the assets purchased is payable and can be costly.
➢ Disposal of a major asset requires approval by ordinary resolution.
Joint ventures
This is when two or more companies make an agreement to do business in one specific area. They
share resources to pursue a common goal. This results in the following risks and rewards:
➢ It is an easy way to enter new markets.

➢ Access to better resources and expertise.
➢ Dissolution of a joint venture (JV) is simple.
➢ Costs to establish a joint venture is low.
➢ Failure of clear communication between management can result in many disputes.
➢ Objectives of parties to the joint venture are not always in line with one another resulting in
conflict.
➢ Different cultures and management styles usually becomes problematic.
Alliance
A strategic alliance is the sharing of resources for the benefit of all partners. It differs from a joint
venture with regards to formality and permanence of the agreement. A joint venture is a legal
relationship between the parties and usually results in the formation of a new business whereas a
strategic alliance entails an agreement (which is usually not legally binding) to combine resources
and information in order to achieve a specific goal. The risks and rewards of an alliance are as follows:
➢ It is not time consuming.

➢ Not very capital intensive.
➢ Breaking the alliance is much easier than a JV.
➢ The risk of sharing too much information resulting in an alliance partner becoming a competitor.
➢ Failure to clearly define the roles and responsibilities of each partner can be detrimental.
2.2. Funding considerations
The manner in which M&A transactions are funded is an important consideration as it could affect
market sentiment and in some cases, even the success or failure of the deal. There are a number of
factors which need to be considered when making this decision; these are detailed within the following
subsection in Managerial Finance (8th edition):
Chapter Subsection
12 12.4 Funding for mergers and acquisitions
2.3. Industry regulation
Companies which are controlled in terms of the Banks Act, the Long-Term Insurance Act and the
Short-Term Insurance Act need approvals, respectively, from the Minister of Finance or the Registrar
of Banks, the Registrar of Non-Banking Financial Institutions, i.e. the Executive Officer of the Financial
Services Board (FSB) for any change in control in such companies.
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Approval is needed from the Department of Mineral Resources for a change of control in any
companies that hold mining or prospecting rights. In certain industries, such as mining, one of the
factors that is taken into account in granting approval for a change of control is the level of
shareholding by previously disadvantaged South Africans in the target, post-acquisition.
Other industries also have industry specific regulations and statutes such as the telecommunications
industry and the gambling industry, where approval may be required for a change of control.
2.4. BEE transactions
Over the past decade or so, BEE credentials have become an increasingly large motivation for
business entities to engage in a merger or acquisition transaction, since it directly affects ownership.
Broad-Based Black Economic Empowerment (B-BBEE) is driven by both legislation and regulation,
in the form of the B-BBEE Act, No. 53 of 2003, which empowers the Minister of Trade and Industry
to issue Codes of Good Practice, and publish Transformation Charters. The process of B-BBEE works
in collaboration with other acts and regulations, including those in the areas of Employment Equity
and Preferential Procurement.
The Codes of Good Practice prescribe a Generic Scorecard with certain targets and weights.
However, there are also Transformation Charters, which considers particular industries and their
unique activities and circumstances (normally resulting in a slightly different permutation of targets
and weights when compared to the Generic Scorecard).
The Generic Scorecard considers the ownership of an entity as an important area, but since its goal
is to promote broad-based empowerment, it has a much wider scope. As the Generic Scorecard also
forms the basis of most other Charters, it is important for you to know the different criteria. As indicated
below, the Generic Scorecard has five elements, each allocated a certain weighting (indicated in
brackets below). The Scorecard includes bonus points, so it is possible to achieve more than 100
points.
1. Ownership (25)
2. Management control (19)
3. Skills development (20)
4. Enterprise and supplier development (40)
5. Social-economic development ( 5)
(DTI, 2019)
Business entities have to be assessed annually by an accredited Verification Agency, which issues a
B-BBEE verification certificate indicating the scorecard information and assessment result in the form
of a contributor-rating. Depending on the score, an entity will be rated from a Non-Compliant
Contributor (the lowest rating), to a Level Eight Contributor (just above the lowest rating), all the way
up to a Level One Contributor (the highest rating for entities achieving more than 100 points) (DTI,
2019)
Many large South African companies aim to achieve the requirements relating to ownership by
disposing of a large proportion of their shares to black shareholders. The problem with such
transactions is that often financing becomes an issue as the black shareholders do not have sufficient
funds to pay for these shares and thus a number of creative arrangements are developed to assist in
financing these BEE transactions.
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2.5. Post-acquisition review
Although conducting a formal post-acquisition review is not always performed, it is a vital stage within
the merger/acquisition process. This review not only enables an assessment of the transactions
success (allowing them to take any corrective action, if possible), it can also improve the strategy and
execution of subsequent merger/acquisition transactions.
As a result, companies engaging in merger/acquisition transactions will do well by developing such

teams to conduct such reviews. Team members should have a good understanding of the company,
the objectives/goals of the merger or acquisition as well as the risks pertaining to the transaction.
As part of this process, such a team – often referred to as a post-acquisition review team – can compare
certain key indicators before and after an acquisition. These indicators include:
• return on assets
• profitability
• earnings per share
• price-earnings ratio
2.6. Due diligence investigations
A due diligence investigation refers to a detailed examination of the target company prior to the merger
or acquisition. The aim of such investigations is to verify/audit, amongst others, the financial, legal and
operational information of the target company so as to ensure that the acquiring company makes an
informed decision.
These procedures are usually carried out by a special team who have experience in this field, and
consist of employees of the acquiring company and some experts if necessary. The results of such
procedures could lead to a change in the terms of the proposed merger or acquisition, or even a
cancellation of the transaction.
2.7. Systems, information, confidentiality and disclosure requirements
The compatibility of the information and computer systems, between the two companies, should be
considered as a part of the due diligence procedures.
The due diligence process will give the acquiring company access to detailed financial and other
business information relating to the target company. A confidentiality agreement is normally signed in
order to protect the interests of the target company.
The information that is required to be made public in relation to a merger or acquisition is regulated by
the JSE Listings Requirements (for listed entities) and the Companies Act (which includes the Takeover
Regulations).
Disclosure of the following is normally required:
• consideration payable
• the asset that is being acquired
• special dealings (arrangements)
• the effect on listing
• conditions and timing
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2.8. Conflict of interest issues (manager’s vs shareholders)
When entering into a negotiation for a potential merger/acquisition transaction, managers may
experience a conflict of interest between acting in their own best interest and acting in the interest of
the shareholders (which is their responsibility). This usually occurs when, for example the manager
sees the merger/acquisition transaction as an opportunity to advance his/her career (by being involved
in a larger corporation or an industry which he/she may have an interest in). The transaction may not
necessarily maximise shareholder wealth but management will pursue the opportunity in order to
benefit themselves. It should be noted that such unethical motivation for a merger/acquisition is one of
the key reasons for failed transactions. For this reason, amongst others the pre- and post-acquisition
reviews are important procedures for consideration.
Activity 11.2.1
As part of a growth strategy, JD Ltd recently merged with one of its competitors. However, since the
merger there have been numerous problems, including the compatibility issues with the two companies’
accounting software packages, lawsuits from former employees claiming to be unfairly dismissed, and
an investigation by the Competition Commission. Mr Brice Larken, a majority shareholder, regrets not
seeking your firms’ (CWC’s Consulting) consulting assistance earlier as these matters are now causing
him sleepless nights.
Required:
Recommend to Mr Brice Larken the procedure that CWC’s Consulting function should have performed
in order to identify possible issues and risks prior to the merger and acquisition.
Provide further details of the steps included in such a procedure and describe how these steps could
have assisted JD Ltd with identifying these issues and risks, in advance.
(Source: UNISA, DIPAC26 exam [2011] – updated, truncated and adjusted
N1: The information in the scenario highlighted the issues being experienced i.e. compatibility of software, law suits from employees
and approval from the Competition Commission.
Students were thus required to use this information to develop steps that would identify the issues prior to the merger and thus
prevent them from occurring.
Your firm’s consulting function could have assisted JD Ltd by performing a due diligence
investigation prior to the merger and acquisition, as follows:
• The first step is identification, where information is gathered and risks are identified. By
performing this step JD Ltd would have identified the initial risks prior to the merger.
It would in this case have included reviewing minutes of management and board meetings – this
may have identified the issues which now have come to the fore.
• The second step is the consideration of legal aspects, compatibility issues (business, culture,
ITC, etc) contractual aspects and insurance. By performing this step JD Ltd could have
obtained legal advice with regards to the dismissal of certain employees and could have avoided
the lawsuits from employees claiming to have been dismissed unfairly. This step would have also
assisted to ensure that approval is first obtained from the Competition Authorities before the
merger is pursued.
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• The third step includes the summarising and analysing of all the financial data. This step would
assist in further identifying JD Ltd’s exposure to risk and includes a comparison between old and
new insurance policies.
• Step four only occurs after the merger and acquisition is finalised and includes visiting the
new location and streamlining compatibility and administration issues. This step would have
assisted JD Ltd to successfully plan and budget for the integration between the two accounting
software packages.
(Source: UNISA, DIPAC26 – adapted)
Ansoff, IH. (1965). Corporate Strategy. New York: McGraw-Hill.
Bowman Gilfillan (2013) Getting the Deal Through: Mergers and Acquisitions. This document is
available from: http://www.bowman.co.za/FileBrowser/ArticleDocuments/Getting-the-Deal-Through-
MergersandAcquisitions.pdf London: Law Business Research Ltd Research
Correia, C, Uliana, DFE, and Wormald, M. (2011). Financial Management, seventh edition. Juta &
Company Cape Town
Department of Trade and Industry (DTI). (2019). Codes of Good Practice On Broad Based Black
Economic Empowerment. Available from: <https://www.bbbeecommission.co.za/wp-
content/uploads/2019/06/42496_31-5_Amended-Statement-000-300-and-400.pdf> (accessed
11 September 2019). DTI: Pretoria
Sirower, ML and Sahni, S. (2006). Avoiding the “synergy trap”: practical guidance on M&A decisions
for CEOs and boards, Journal of Applied Corporate Finance, 18(3):83–95.

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LEARNING UNIT 12 – BUSINESS PLANS AND FINANCIAL PROPOSALS
LEARNING OUTCOMES
• Interrogate your knowledge of the purpose and audience of a business plan/proposal in their
preparation, on a basic level.
• Develop new business plans and financial proposals.
• Analyse existing business plans and financial proposals.
• In preparing business plans and financial proposals, identify and address:
o the business strategy and strategic plan

o strengths and weaknesses of the plan
o the resources needed
o sources of financing
o anticipated costs and recoveries (including its calculation)
o all assumptions made.
• Critically review all assumptions made.
INTRODUCTION
The idea for a start-up business entity often sees the light on the back of a napkin. Likewise, new
growth ideas for an existing business are often born through informal discussion. But ideas are useless
unless put into action. A business plan represents the detailed, long-term roadmap whereby these
ideas could be implemented. A related but separate document is the financial proposal.
LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS

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LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS
1. Introduction
A business plan represents the detailed, long-term roadmap whereby new business ideas could be
implemented. Put differently, a business plan is a plan of where a business idea wants to go and how
it is planning to get there. It is a sales document, selling ideas to potential debt and equity investors. It
can be used at various stages of the organisation’s life. The document can also be used as a planning
and control instrument by the involved parties.
A related but separate document is the financial proposal. A financial proposal is not the same as a
business plan; it is a request for money based upon a business plan. As a finance professional you
may well one day be instrumental in the compilation of these important documents; it is thus important
for you to understand the content of these documents and the processes involved.
2. Content
This learning unit brings together knowledge of several different areas, which is then drawn from to a
large extent in compiling a new business plan/financial proposal, or in analysing these documents. The
textbook illustrates this process in detail and describes some additional considerations.
Now study the following subsections in Managerial Finance, 8th edition, chapter 2, and attempt the
activities included therein:
• Chapter 2: Sections 2.7 to 2.9
The activity below, the self-assessment questions provided later in this learning unit, and the integrated
self-assessment at the end of this tutorial letter will help you to apply your knowledge.
Activity 12.1.1
Attempt question 2-7 contained in Managerial Finance, 8th edition, without referring to the suggested
solution.
The suggested solution can be found after the question in the textbook.

.
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INTEGRATED SELF-ASSESSMENT
After studying the learning units covered in this tutorial letter the next important step is to practise the
application of the acquired knowledge on an integrated level. You can use the integrated questions
contained in this part as self-assessment.
We strongly recommend that you attempt these questions under simulated examination conditions.
Then, after completion, compare your answer to the suggested solution and establish reasons for
differences. (If necessary, revisit the learning units contained in this tutorial letter, your prior study
material and / or Managerial Finance, 8th edition.)
Remember to make notes summarising the reasons for your mistake(s). Further indicate on a summary
sheet of questions performed during the year, whether you need to revisit some of these questions, or
sections of the questions, later.
Now attempt the following integrated questions as well as the relevant test of 2018, which is presented
below.
INTEGRATED QUESTION 1
Perform question 18 in the Question Bank (APEX ASISST).
Suggested solution integrated question 1
Find the suggested solution in the Question Bank.
INTEGRATED QUESTION 2
Attempt question 10 (‘Oscar Limited ‘), which appears in the question bank.
Suggested solution integrated question 2
Find the suggested solution in the question bank.

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TEST 1 (2019)
QUESTION 1 40 MARKS
Piper Industrials Limited (Piper) is listed on the Johannesburg Stock Exchange. Piper is the leader in
the field of industrial mining supplies and is at the forefront of innovate advancements. Piper’s business
model includes showcasing and supplying the latest products at mining indabas and industrial shows.
Piper has showed interested in expanding into the solar power sector which has been identified as a
key focus area by the government.
Piper uses a state of the art stock management system. Inventory with a limited shelf life are tracked,
identified and scrapped on a regular basis. They also have stringent quality control procedures in place
to ensure all products sold are safe. The mining industry in which Pipers products are used is governed
by strict rules and regulations. Employees using these products need to be trained on an ongoing basis.
To remain competitive, Piper send their own staff on regular training and also train and provide
refresher courses to its clients.
Piper’s summarised statement of financial position as at 31 December 2018:

R’m
Shareholder’s Equity 2 452

Non –current liabilities
Preference shares 600
Long-term debt 950
Total equity and liabilities 4 002
Additional information:
• Shareholders equity consists of 500 million issued ordinary shares. These shares were originally
issued at R 2.00 per share and are currently trading at R 6.86 per share. Shares are actively traded
on the stock exchange and Piper’s cost of equity is 14%.
• The 10% irredeemable preference shares were issued at R 10 per share. The current market price
of similar irredeemable preference shares is R 12,50.
• The long-term debt relates to a loan obtained from SVB bank on 1 January 2017, for R1,6 billion
with a 11.5% fixed interest rate. The term of the loan is five years, and is repayable annually in
arrears in five equal annual instalments and cannot be traded in the open market. Similar market
related long-term debt can currently be raised at 12% per annum. The loan qualifies as an
instrument and is deductible for tax purposes in terms of Section 24J of the Income Tax Act.
• The corporate tax rate is 28%.
Possible expansion:
The financial director of Piper is of the opinion that the group should expand into the solar power sector.
He is proposing that the board considers the acquisition of a manufacturing plant, in order to
manufacture the Bopper Solar Panel (BSP). The engineering and marketing departments supplied the
following information regarding the proposed solar panel:
• The cost of the plant (including commissioning) is R 58 million. This will be paid for at the start of
the first year of the project.
• The BSP product is expected to have a 4-year product lifespan.
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• It is estimated that 10 000 units a year of BSP will be sold during the first three years of production.
However demand is expected to drop to 8 000 units during the final year of production.
• The BSP will be marketed at R 15 000 per unit in the first year. In the second year this price will
increase to R 17 000, and it will increase every year thereafter by 12 % per annum.
• Direct all-inclusive costs per BSP will be R12 000 per unit in the first year of production. This cost
will increase by 10% in the second and third year of production. In the fourth and final year of
production this cost will only increase by 5%.
• Working capital requirements will be R 1.6 million at the end of the first year. This will increase to
R 1.8 million in the second year and will peak in the third year at R 2.0 million. At the end of the
fourth year only 75% of the outlay will be recovered and the balance absorbed into the existing
business.
• For the purpose of this evaluation, the Directors have stipulated a Weighted Average Cost of
Capital of 16%. The policy of the group is to apply a hurdle rate of 2.25% for investment appraisal
purposes.
• South African Revenue Services will allow an allowance on the manufacturing plant of 40% in
the first year and 20% over the next three years.
• The group applies the same policy for depreciation as for wear and tear.
• At the end of the life of the plant (4-years) it will sold for R 1 million.
REQUIRED Marks
(a) Calculate the actual Weighted Average Cost of Capital Piper Industrials Limited
(Piper), based on current market values, as at 31 December 2018.
Round all calculation to the nearest R’m. 14 14
(b) What qualitative factors should Piper consider when deciding on whether they
should supply solar panels. 6 6
(c) Advise Piper whether they should invest in the Bopper Solar Panel (BSP)
manufacturing plant based on a Net Present Value investment technique. 13
Round all calculations and working to the nearest R’000.
Communication, logic and layout 1 14
(d) Explain the current initiatives undertaken by Piper that will mitigate the risks
identified below:
i. The sale of unsafe supplies. 2

ii. Strong competition. 3
Communication: logical argument 1 6
TOTAL 40
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TEST 1 – SUGGESTED SOLUTION (2019)
(a) Calculate the actual Weighted Average Cost of Capital (WACC), based on current market
values, as at 31 December 2018.
Comments:
• It is important to read the Required carefully, in this case it indicated that calculations should
be rounded to the nearest Rand million. Many students did not do this, this wastes time and
increases the chances of making errors.
• Many students were unable to calculate the market value of the loan:
✓ Firstly, since loan is repayable in instalments, it is logical that the FV will be zero and since
PV, I/YR and N are provided, you should deduce that you would need to calculate the
PMT.
Market value of Equity Cost of Equity
✓ Secondly the market value of the loan represents the present value of future cash flows
500 X R6.86 = R3 430 1 r/w 14% 1 r/w
i.e. the 5 year loan was incurred in 2017 therefore at the end of 2018 only 3 years are
500 000 000 x 6,86= 3 430 000 000 1 r/w
remaining, making it only necessary for your market value calculation to project cash flows
for the remaining 3 years.
✓ Lastly S 24 J refers to the tax on the interest portion of the repayment, therefore you would
need to calculate the interest portion of the annual repayment and then only the tax on the
interest is a relevant cash flow.
Market value of Preference shares Cost of Preference shares
Number of preference shares 10% x 10/12,5

60 (600/10) = 8% 1 r/w
60 x R12, 50
= R 750 1 r/w
60 000 000 x 12,50 = 750 000 000 1 r/w
Market value of long-term loan Cost of long-term loan
R'm 12 x 0.72
PV 1 600 = 8.64% 1 r/w
I/YR 11,50% 1r/w
N 5 1rw
FV 0
PMT R -438,37 1c
The marks for the calculator inputs above v=can only be awarded if PMT is calculated
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2019 2020 2021

R'm R'm R'm
Payments (438,37) (438,37) (438,37)

Tax on interest 28% 34,20 24,01 12,66 1c
S24J accrual amount (A=BXC) 122,13 85,76 45,21 2r/w
Pre-tax yield to maturity (B) 11,50% 11,50% 11,50%
Adjusted initial amount (C) 1 062,01
Adjusted initial amount (C) 745,77
Adjusted initial amount (C) 393,16
Adjusted initial amount (C)
Total cash flows -404,17 -414,36 -425,71
Kd (12*0.72) 8,64% 1r/w
NPC (1 055,11) 1c
Alternative to S24J interest calculation
Calculator inputs must be shown

3INPUT 2ndF Amort = interest of 122,13
WACC
Instrument Market Value Proportion Cost Weighted

Equity 3 430 65,52% 14% 9,17%
Preference Shares 750 14,33% 8% 1,15%
Loan 1 055 20,15% 8.64% 1,74%
5 235 100% 12,06%
1 r/w 1c
MAX 14
(b) What are the qualitative factors Piper should consider when deciding on whether they should
supply solar panels.
• Does the group have the knowledge and capabilities for the solar power industry? (1)
• What is the lifespan of a solar power panel? (1)
• What after sales service is required for the solar power products? (1)
• Will the group issue a guarantee on solar power products
• Is there potential to expand further into the solar power industry? (1)
• The product has a low carbon emission footprint, this could be used to the benefit
of the group (1)
• Does this new venture fit with the current business line? The rest of the activities is vastly
different from current operations (1)
• It might distract management from keeping focused on the main business of the group. (1)
• What are competitor products like? (Strong or weak). (1)
• Is there capacity in the market for the group’s product? (Chinese products have flooded the
market).
• Can solar power panels be recycled? (1)
• Consider repeat business (1)
MAX 6
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(c) Advise Piper whether they should invest in the BSP manufacturing plant based on a Net
Present Value (NPV) investment appraisal.
Comments:
• Once again, it is important to pay attention to the rounding instruction, as explained
above.
• The signage of the cash flows are important and need to be consistent income or
increases in income should be represented by inflows and costs or increases in costs
should be represents by out flows
• It is important to perform a separate tax calculation wherein you include all taxable income
and expenses. Please note only the tax impact of wear and tear is relevant and therefore
wear and tear should only be included in the tax calculation and not the NPV analysis.
0 1 2 3 4
R'000 R'000 R'000 R'000 R'000
Cost of plant (58 000) 1r/w

Sale of plant 1 000 1r/w
Working capital required (1 600) (200) (200) 1r/w
Recoupment of working
capital (2m*0.75) 1 500 1r/w
Sales 150 000 170 000 190 400 170 600 Calc 1
Cost of sales (120 000) (132 000) (145 200) (121 968) Calc 2
Tax (1 904) (7 392) (9 408) (10 509) Calc 3
Total cash flows (58 000) 26 496 30 408 35 592 40 623
Discount rate (16 + 2.25) 18,25% 1r/w
NPV R28 455 1c
Since the NPV is positive, Piper should invest in the manufacturing plant 1
Calc 1: Sales
1 2 3 4
Units 10 000 10 000 10 000 8 000
Selling price 15 000 17 000 19 040 21 325
150 000 000 170 000 000 190 400 000 170 600 000 2r/w
Calc 2: Cost of sales
1 2 3 4
Units 10 000 10 000 10 000 8 000
Cost price 12 000 13 200 14 520 15 246
120 000 000 132 000 000 145 200 000 121 968 000 2r/w
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Calc 3: Tax calculation
1 2 3 4
Sales 150 000 170 000 190 400 170 600 1/2r/w
Cost of sales -120 000 -132 000 -145 200 -121 968 1/2r/w
Sale of plant 1 000 1/2r/w
Wear and tear -23 200 -11 600 -11 600 -11 600 1r/w
Working capital write off -500 1r/w
Taxable income 6 800 26 400 33 600 37 532
Tax@28% -1 904 -7 392 -9 408 -10 509 1
MAX 13
Communication, logic and layout: 1
MAX 14
(d) For each of the risks identified below, explain the current initiatives undertaken by Piper that
will aid in mitigating the risk.
iii. The sale of unsafe supplies.
iv. Strong competition.
Comments:
It is important to read the Required carefully, in this case the Required did not ask to explain the
risks nor suggest mitigations but rather explain the initiatives Piper already has in place to
mitigate the given risks.
Risk. Attempted mitigation
The sale of unsafe supplies. Piper has an advanced stock management system whereby supplies
with a limited shelf life are tracked, identified and scrapped. This
limits the risk of the sale of unsafe supplies. (1)
Piper has stringent quality control procedures in place to ensure all

products manufactured are safe. (1)
Strong competition. The group is the leader in the field and tries to be innovative by
ensuring its supplies the very latest products. (1)
The group show cases and supplies its latest products at mining
indabas and industrial shows. (1)
Piper send their own staff on regular training ensuring that staff are
well trained and are able to effectively assist customers. (1)
Piper gives training and refresher courses to its clients enabling
them to comply with the strict safety regulation governing their industry.
(1)
MAX 5
Communication, logical argument: 1
MAX 6
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TEST 2 (2019)
QUESTION 1 40 MARKS
Khuselo (Pty) Ltd is a company that manufactures and installs vehicle-tracking devices and performs
tracking services for various clients in South Africa. Customers who purchase devices from Khuselo
can choose to subscribe for tracking services with Khuselo or any other service providers. Khuselo has
been in operation for the past 10 years and has chosen to remain an unlisted entity.
The following financial information of Khuselo has been correctly prepared by their Management
Accountant:
Extract of Statement of Profit or Loss of Khuselo (Pty) Ltd for the periods ended 30 March
Note 2019 2018 Change
R'000 R'000 %
Revenue 1 300 562 1 125 600 15,54%

Device sales revenue 585 253 450 240 29,99%
Subscription revenue 1 715 309 675 360 5,92%
Cost of Sales (702 303) (675 360) 3,99%
Gross profit 598 259 450 240 32,88%
Common size analysis

2019 2018
Revenue 100,00% 100,00%
Device sales revenue 45,00% 40,00%

Subscription revenue 55,00% 60,00%
Cost of Sales 54,00% 60,00%
Gross profit 46,00% 40,00%
1. Subscription Revenue
2019 2018 Change
Number of subscribers 425 779 375 200 13,48%

Average Annual Revenue per subscriber R 1 680,00 R 1 800,00 -6,67%
Proposal from Izinga Ltd (Izinga)

Izinga manufactures and supplies various mechanical parts for motor vehicles to distributors across
Southern Africa. Izinga have communicated to Khuselo that they would like to initially acquire a 60%
interest of the existing equity in Khuselo. After a year they would then like to acquire the remaining
40% equity interest and merge Khuselo and Izinga. Izinga plans on financing the acquisition of Khuselo
by means of a share exchange.
Equity valuation of Khuselo
Ms. Sheshisa Nqamulela, the Management Accountant of Khuselo, took the initiative to prepare the
following calculation of the equity value of Khuselo, based on the earnings multiple method of valuation:
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Value of Equity = Profit After Tax X Price Earnings Ratio
Value of Equity of Khuselo = 247 961 000 X 11 = R2 727 571 000 ≈ R2.73 billion.
Where:
• 2019 Profit After Tax = 2019 Profit After tax of Khuselo = R247 961 000
• 2018 Profit After Tax = 2018 Profit After tax of Khuselo = R182 380 000
• Price Earnings Ratio = 2019 Price Earnings Ratio of Izinga Ltd = 11,00
Forecast Financial Information of Khuselo

The CFO of Khuselo compiled the following projected financial information to prepare for the possible
negotiations with Izinga Ltd.
Notes 2020 2021 2022
R'000 R'000 R'000
Capital expenditure (i) 10 000 25 000 36 000

Depreciation and amortisation 35 000 45 000 57 000
Interest expense (ii) 56 000 56 000 56 000
Investment Income (iii) 23 307 23 307 23 307
Tax expense (iv) 99 731 112 642 129 364
Profit after tax 256 452 289 650 332 650
Notes to the forecasted financial information:
(i) Capital expenditure represents the planned capital spend on additions to

property, plant and equipment.
(ii) Interest expense relates to a long-term loan which has a market value of R 500 million.
(iii) Khuselo invests excess cash, after considering the operational requirements
and capital investments, in short-term deposits. This cash is expected to earn a pre-tax rate of
11,00% per annum.
(iv) The tax expense is based on projected taxable income.
Working Capital requirements

2019 2020 2021 2022
R'000 R'000 R'000 R'000
Current Assets 232 015 256 000 352 620 421 560
Current Liabilities 220 125 218 490 326 360 369 665
Additional information
• The current inflation rate is 6,00% and is expected to remain the same for the foreseeable future.
• Khuselo’s target debt-equity ratio is 25,00%.
• Khuselo’s pre-tax cost of debt is 12,50%.
• The beta co-efficient of Khuselo is currently estimated at 1,15.
• The current annual yield on long-term government bonds is 6,25%, while the basket of listed
companies in the same sector of Khuselo’s operation has averaged 16,25% per year.
• Assume a corporate tax rate of 28% for all periods.
• Khuselo expects its cash flows to grow at a stable rate of 6,00% per annum from 2023 onwards.
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REQUIRED MARKS
Sub- Total
total
(a) Comment on the financial performance of Khuselo (in terms of revenue
and gross profit) for the 2018 and 2019 periods. 8
[Note: No calculations are required]
Communication skills: clarity and logic of arguments 1 9
(b) (i) Calculate the fair market value of a 60% equity interest in Khuselo
as at 30 March 2019, using a free cash flow method of valuation 18
and the provided information.
[Note: Provide detailed calculations for all inputs and round to the
nearest R’000. The starting point of your valuation should be profit
after tax].
Communication skills: presentation and layout 1
(ii) Identify and discuss the potential errors in the valuation performed by
Ms Nqamulela [Note: No calculations are required]. 4
(iii) Advise the shareholders of Khuselo of the advantages of receiving

payment by means of a share exchange. 4 27
(c) Discuss key initiatives that can be implemented by Izinga after its merger
with Khuselo to increase the merger’s chances of success. 4
TOTAL 40
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TEST 2 – SUGGGESTED SOLUTION (2019)
(a) Comment on the financial performance of Khuselo (in terms of revenue and gross profit)
for the 2018 and 2019 periods.
Comments:
• Student’s discussions were limited; remember the length of your discussion should be guided
by the mark allocation
• Most students were unable to provide insightful comments i.e. linking movement to inflation,
commentary of the change in the mix of subscriptions and device sales, reasons for the
movements etc.
• Please note that with questions like these it is important to ask yourself, based on the
information provided, what value added interpretations and conclusions can be made.
Revenue performance
Revenue improved 1
The total company revenue has increased above the inflation rate, 1
Thus revenue has grown in real terms. 1
This improvement in revenue is largely driven by the increase in revenue from device 1
sales (29.9%)
The selling price per device has increased 1
This is supported by the increase in the number of subscribers (13.48%) 1
The subscription revenue increase (5,92% v 29,99%) was lower due to reduced 1
subscription fees charged to customers compared to 2018 (R 1 680 vs. R 1 800)
This could be an attempt by Khuselo to increase the number of subscribers. 1

The composition of revenue between subscriptions and devices sales changed as 1
a result of a higher increase in device sales revenue compared to subscription revenue.
Gross profit performance
Gross profit has improved 1
The improvement in gross profit (32,88%) is due to significantly lower increase in cost
of sales (3,99%) compared to increase in revenue (15,54%). 1
The increase in cost of sales is lower than the increase in inflation, 1
Therefore cost of sales is decreasing in real terms and enhancing gross profit growth. 1
The minimal nominal increase in cost of sales could be due to scale economies in 1
producing and selling more devices and servicing more subscribers.
Khuselo is therefore effectively managing its costs. 1
This is evidenced by the decrease in the cost of sales to revenue from 60,00% to 1
54,00%, resulting in gross profit percentage improvement from 40,00% to 46,00%.
MAX 8
Communication skills: clarity and logic of arguments 1
MAX 9
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b (i) Calculate the fair market value of a 60% equity interest in Khuselo as at 30 April 2019, using a
free cash flow method of valuation and the provided information.
Comments:
Students performed poorly within this section, the following points are to be noted:
• You were required to include a calculation of WACC as it is required as a discount rate and
sufficient information was provided to perform the calculation.
• Movements in working capital represent cash flows and are relevant, as they are required to
sustain the business.
• Non-operating income and expenses such as interest expense and investment income are
excluded as the instruments to which they relate are valued separately and deducted/added
to the enterprise value. Therefore the market value of these instruments would need to be
calculated, if not provided.
• Depreciation is not a cash flow but an accounting entry, therefore it should be excluded. Also
important to note is that there are no tax implications for depreciation.
• In the final year of projections i.e. 2022, a continuing value, taking into account expected
growth, must be calculated based on the principle of Gordons Growth model.
Calculations
Calc 1: WACC
Debt-equity ratio 25,00%
Debt =25/125 20,00%
Equity =100/125 80.00% 1r/w
Pre-tax cost of debt 12,50%
12,50% X 0,72 9,00% 1 r/w
Ke = Rf + B(Rm – Rf 17,75% 2 r/w
= 6,25% + 1,15(16,25%-6,25%)
= 6,25% + (1,15 * 10,00%)
Weight Cost WACC
Debt 20,00% 9,00% 1,80%

Equity 80,00% 17,75% 14,20%
100,00% 16,00% 1c
Calc 2: Continuing Value
= FCF2022 X (1+g)
(WACC – g)
= (351 554*1.06) 1c
(16%-6%) 1c
= 3 726 472
Calc 3: Market value of Investment
23 307/11%
= 211 882 1r/w
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0 1 2 3
2019 2020 2021 2022
R'000 R'000 R'000 R'000
Profit after tax 256 452 289 650 332 650

Interest 40 320 40 320 40 320
Reverse: Interest expense 56 000 56 000 56 000 1 r/w
Tax implication (15 680) (15 680) (15 680) 0.5c
Investment income (16 781) (16 781) (16 781)
Reverse: Investment Income (23 307) (23 307) (23 307) 1 r/w
Tax implication 6 526 6 526 6 526 0.5c
Subtotal 279 991 313 189 356 189
Reverse: Depreciation and Amortisation 35 000 45 000 57 000 1 r/w
Changes in working capital (25 620) 11 250 (25 635)
Current Assets (23 985) (96 620) (68 940) 1 r/w
Current liabilities (1 635) 107 870 43 305 1 r/w
Capital expenditure (10 000) (25 000) (36 000) 1 r/w
Free Cash Flow of the Firm 279 371 344 439 351 554
Continuing Value (Calc 2) 3 726 472
Net Cash Flows 279 371 344 439 4 078 026
Discount rate :16% (Calc 1) 1c
Operating Enterprise Value 3 109 430 1c
Market Value of Other Assets (Calc 3) 211 882 0,5c
Total Enterprise Value 3 321 312
Less: Market Value of Debt (500 000) 1 r/w
Total Value of Equity 2 821 312
Marketability discount (5%) (145 864) 1c
Adjusted Value of Equity 2 675 448
60% Value of Equity 1 605 269 1c
ALTERNATIVE
Profit before tax 356 183 402 292 462 014

Reverse: Interest expense 56 000 56 000 56 000 1 r/w
Reverse: Investment Income (23 307) (23 307) (23 307) 1 r/w
EBIT: Earnings Before Interest and 388 876 434 985 494 707
Tax
Tax charge (108 885) (121 796) (138 518)
Tax per income statement (99 731) (112 642) (129 364)
Reverse: Tax benefit on interest charge (15 680) (15 680) (15 680) 0.5c
Reverse: Tax on investment income 6 526 6 526 6 526 0.5c
Subtotal 279 991 313 189 356 189
MAX 18
Communication skills – l presentation and layout: 1
MAX 19
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b(ii): Discuss the potential errors in the valuation performed by Ms Nqamulela
1 Maintainable earnings were not utilised to perform the valuation i.e. earnings were
not adjusted for non-market related items, abnormal/extraordinary items etc. 1
2 The valuation is based on only the 2019 earnings, these earnings may not be truly
representative of Khuselo’s maintainable performance. 1
3 Maintainable earnings should be calculated considering whether there is a trend in
historical earnings and if not a weighted average should be calculated. 1
4 The valuation is based on the PE ratio of a vehicle spare parts manufacturer, this
may not be appropriate as this company is different to that of a vehicle tracking
company. 1
5 The PE ratio used is not adjusted to match the risk profile, size, shares marketability,
management and operations of Khuselo. 1
MAX 4
b(iii) Advise the shareholders of Khuselo of the advantages of receiving payment by

means of a share exchange.
1 Reaping benefits of long-term share price growth and future dividends in the merged
company. Since the shareholders will continue to have a financial interest in the company
there is potential to share in the increased earnings and market share value. 1
2 Reaping the synergistic benefits in the merged company. 1
3 Diversification benefit that the merged firm presents to shareholders thus reducing
investment risk. 1
4 Tax advantages: Capital gains tax is deferred with a share exchange 1
5 Khuselo shareholders will hold shares in a listed entity, making their shareholding
more marketable 1
Any valid point 1
Maximum marks 4
(c) Discuss the key measures that can be implemented by Izinga Ltd after the merger with
Khuselo to increase the merger’s likelihood of success.
1 Stakeholder management/change management: engaging with affected stakeholders

to consult with them and ensure their needs and interests with respect to the merger are 1
catered for.
2 Uniform employee policies: kickstart a process to ensure policies applicable within the
merged company are the same for employees coming from Khuselo and Izinga
(remuneration, working conditions etc). 1
3 Standardization of processes and systems (operating model): ensure the ways of
doing things and processes followed are standardised within the merged company. 1
Promote the same organisational culture through-out the merged organisations to
ensure same vision, mission and values are promoted and lived within the merged
organisation. 1
4 Proper management of possible staff layoffs (retrenchments, down-sizing, right-
sizing) in the merged firm to avoid poor staff morale, litigation and costly exercises. 1
5 Enhance efficiency and eliminate duplicated functions. 1
6 They may need to train staff to ensure they have the requisite knowledge and skills. 1
Any valid point 1
Maximum marks 4

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MAC4861/102/0/2020

Tutorial letter 102/0/2020

Department of Financial Intelligence

This tutorial letter contains important information

ADVANCED MANAGEMENT ACCOUNTING

TUTORIAL LETTER 102 / 2020

TABLE OF CONTENTS PAGE

INTRODUCTION AND OVERVIEW 4

PART 1 – STRATEGY, RISK MANAGEMENT AND FINANCING 8

LEARNING UNIT 1 STRATEGY AND GOVERNANCE 9

LEARNING UNIT 2 RISK MANAGEMENT 24

LEARNING UNIT 3 COST OF CAPITAL AND CAPITAL INVESTMENT

LEARNING UNIT 4 SOURCES AND FORMS OF FINANCE 58

LEARNING UNIT 5 DIVIDEND DECISION 64

LEARNING UNIT 6 MANAGEMENT OF WORKING CAPITAL 67

LEARNING UNIT 7 TREASURY FUNCTION 74

TABLE OF CONTENTS (continued) PAGE

PART 2 – FUNCTION OF FINANCIAL MANAGEMENT 79

LEARNING UNIT 8 ANALYSIS AND INTERPRETATION OF FINANCIAL

LEARNING UNIT 9 BUSINESSES IN DIFFICULTY 83

LEARNING UNIT 10 VALUATIONS 87

PART 3 – MERGERS & ACQUISITIONS AND BUSINESS PLANS 92

LEARNING UNIT 11 MERGERS AND ACQUISITIONS 93

LEARNING UNIT 12 BUSINESS PLANS AND FINANCIAL PROPOSALS 107

INTEGRATED SELF-ASSESSMENT 109

INTEGRATED QUESTION 1 109

TEST 1 (2019) – MAC4861/NMA4861/ZMA4861 110

INTRODUCTION AND OVERVIEW

STRUCTURE OF THIS TUTORIAL LETTER

The parts of this tutorial letter are described below:

PART 2 – FUNCTION OF FINANCIAL MANAGEMENT (containing learning units 8–10)

PART 3 – MERGERS AND ACQUISITIONS, AND BUSINESS PLANS

CONTENT – THIS MODULE

Strategy, Risk, Management

Tutorial Tutorial Letter Tutorial Letter Tutorial Letter

Part 1 Part 2 Part 3

Learning units Learning units Learning units

STUDY MATERIAL AND RESOURCES

Prescribed study material

The prescribed textbooks for this module are:

• your tutorial letters for this module

Supplementary literature/additional reading

General information and CTA news

Part Learning Learning unit

1 1 Strategy and governance 4%

We hope you enjoy this part of your studies!

Your Advanced Management Accounting lecturers

PART 1: STRATEGY, RISK MANAGEMENT AND FINANCING

Tutorial Letter 102

Part 1 Part 2 Part 3

Learning units Learning units Learning units

LEARNING UNIT 1 – STRATEGY AND GOVERNANCE

PRIOR LEARNING ASSUMED

Learning outcome Reference

THIS LEARNING UNIT CONSISTS OF THE FOLLOWING:

LEARNING UNITS TITLE

LEARNING UNIT 1.1 STRATEGY

LEARNING UNIT 1.2 CORPORATE GOVERNANCE AND INTEGRATED REPORTING

LEARNING UNIT 1.1 STRATEGY

• SWOT analysis (analysis of a firm’s Strengths, Weaknesses, Opportunities and Threats).

• Chapter 1 (Sections 1.2 to 1.6)

2.1. Strategy development

2.1.1. Strategic planning processes and approaches