102 2020 0 Mac4862 PDF

MAC4862/102/0/2020
NMA4862/102/0/2020
ZMA4862/102/0/2020
Tutorial letter 102/0/2020

APPLIED MANAGEMENT
ACCOUNTING
MAC4862
NMA4862
ZMA4862
Year module
Department of Financial Intelligence

IMPORTANT INFORMATION
This tutorial letter contains important information

about your module
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APPLIED 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 AND GOVERNANCE 11
LEARNING UNIT 1.2 PUBLIC SECTOR 16
LEARNING UNIT 2 RISK MANAGEMENT 29

LEARNING UNIT 2.1 RISK MANAGEMENT 30
LEARNING UNIT 3 COST OF CAPITAL AND CAPITAL INVESTMENT

APPRAISAL 32
LEARNING UNIT 3.1 WEIGHTED AVERAGE COST OF CAPITAL 34
LEARNING UNIT 3.2 CAPITAL INVESTMENT APPRAISAL – ISSUES IN
INVESTMENT APPRAISAL 35
LEARNING UNIT 3.3 FOREIGN INVESTMENT 37
LEARNING UNIT 3.4 SCENARIO ANALYSIS AND MONTE CARLO SIMULATION 44
LEARNING UNIT 4 SOURCES AND FORMS OF FINANCE 47

LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE AND THE
FINANCING DECION 49
LEARNING UNIT 4.2 SOURCES AND FORMS OF FOREIGN FINANCE 51
LEARNING UNIT 4.3 QUANTITATIVE ANALYSIS OF FOREIGN FINANCE,
BASED ON DISCOUNTED CASH FLOW 53
LEARNING UNIT 5 DIVIDEND DECISION 60

LEARNING UNIT 5.1 DIVIDEND DECISION 61
LEARNING UNIT 6 MANAGEMENT OF WORKING CAPITAL 63

LEARNING UNIT 6.1 MANAGEMENT OF WORKING CAPITAL 64
LEARNING UNIT 7 TREASURY FUNCTION 66

LEARNING UNIT 7.1 THE TREASURY FUNCTION 67
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TABLE OF CONTENTS (CONTINUED) PAGE
PART 2 – FUNCTION OF FINANCIAL MANAGEMENT 69
LEARNING UNIT 8 ANALYSIS AND INTERPRETATION OF FINANCIAL AND

NON-FINANCIAL INFORMATION 70
LEARNING UNIT 8.1 ANALYSIS AND INTERPRETATION OF FINANCIAL AND
NON-FINANCIAL INFORMATION 71
LEARNING UNIT 9 BUSINESSES IN DIFFICULTY 73

LEARNING UNIT 9.1 BUSINESSES IN DIFFICULTY 74
LEARNING UNIT 10 VALUATIONS 75

LEARNING UNIT 10.1 VALUATIONS 77
PART 3 – MERGERS AND ACQUISITIONS AND BUSINESS PLANS 79
LEARNING UNIT 11 MERGERS AND ACQUISITIONS 80

LEARNING UNIT 11.1 VALUATION FOR PURPOSES OF M&As: SYNERGIES 82
LEARNING UNIT 11.2 OTHER CONSIDERATIONS 87
LEARNING UNIT 12 BUSINESS PLANS AND FINANCIAL PROPOSALS 93

LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS 95
INTEGRATED SELF-ASSESSMENT 96
INTEGRATED QUESTION 1 96
INTEGRATED QUESTION 2 96
TEST 1 (2019) – MAC4862/NMA4862/ZMA4862 97

TEST 1 (2019) – SUGGESTED SOLUTION 99
TEST 2 (2019) – MAC4862/NMA4862/ZMA4862 103
TEST 1 (2019) – MAC4861/NMA4861/ZMA4861 114

TEST 2 (2019) – MAC4861/NMA4861/ZMA4861 120
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MODULE PURPOSE
This module is intended for students who are studying towards a 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 topics. This tutorial letter will build upon your prior knowledge
and introduce a few new concepts relating to strategy, risk and financing; the function of financial
management; and also within mergers and acquisitions, and business plans.
PRE-REQUISITES
The parts and learning units in this tutorial letter build, to a large extent, upon prior knowledge obtained
in your undergraduate Management Accounting studies and in the post-graduate Advanced
Management Accounting module. 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.
MAC4862
Applied 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 8. Analysis and 11. Mergers and

2. Risk management interpretation acquisitions
3. Cost of capital and capital of financial 12. Business
investment appraisal and non- plans and
4. Sources and forms of finance financial financial
5. Dividend decision information proposals
6. Management of working 9. Businesses in
capital 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:
• Drury, C. Management and Cost Accounting (including Student’s Manual), 10th edition.
• Skae, FO. Managerial Finance. 8th Edition. LexisNexis: Johannesburg.
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

• tutorial letters of Advanced Management Accounting (MAC/NMA/ZMA4861) for this year
• 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, and
Tutorial Letters 102 Advanced Management Accounting (MAC/NMA/ZMA4861).
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. 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 predominately (but not exclusively) the content of Part
1 (learning units 1–7); and Test 2 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 CASALL301. Please utilise this to plan you
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 of the learning units we strongly recommend that you allocate additional time
above and beyond the total 90 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 Applied 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 as well as later
parts.
Tutorial Letter 102

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
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 further apply your knowledge and skills achieved
through your prior learning (see below) to a scenario, on an integrated basis. In addition, after studying
this learning unit, you should:
1. Be aware of and understand the public sector, including the applicable legal system and legal
framework.
PRIOR LEARNING ASSUMED

In your undergraduate and Advanced Management Accounting studies you have already mastered the
learning outcomes indicated below. If you want to refresh your knowledge, please refer to your
undergraduate material, prescribed textbook and MAC4861 Tutorial Letter 102/2020 (available under
‘additional resources’ on myUnisa). For your convenience we also provide textbook references.
Learning outcome Managerial

Finance,
8th edition
• Demonstrate sound knowledge of the concepts of mandate and • Chapter 1 and 2
business model in the context of an organisation. • MAC4861 TL102
• 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).
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 has to consider other stakeholders by means of appropriate corporate governance. The
content of this learning unit is intended to enhance your knowledge of corporate strategy.
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THIS LEARNING UNIT CONSISTS OF THE FOLLOWING SUB LEARNING UNITS:
LEARNING UNITS TITLE
LEARNING UNIT 1.1 STRATEGY AND GOVERNANCE
LEARNING UNIT 1.2 PUBLIC SECTOR

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LEARNING UNIT 1.1 - STRATEGY AND GOVERNANCE
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.
This learning unit is based on selected sections of the following chapter in 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. The impact of technology on strategy
The way in which business is conducted is evolving. Technology and industrialisation are amongst
some of the components which have played a role in this evolution.
This shift is across industries irrespective of the size of the entity, enabling entities to market their
product or service internationally and also source raw materials from suppliers around the world. With
this advanced technologies and interconnectedness there have also been significant advancements in
the financial sector providing access to capital markets globally. Various stock exchanges are now
accessible to most people with only bandwidth being a limiting factor. In most developing countries
there has been an expansion of the reach these platforms have. In addition, there is a significant growth
in the types of products available (in the form of foreign exchange contracts, options, contracts for
difference, etc.).
Entities are also utilising social media to communicate with customers and suppliers in real time
(Twitter, Facebook, and various other applications (apps)). This has enabled real time communication
which makes turnaround time shorter and enhances the customer experience. It has given the
customer a platform for raising complaints or compliments and therefore assists the entity in improving
their service. With the increased usage of smart phones by consumers, this form of communication
has become relatively wide reaching and has impacted most industries such as: banking, insurance,
flight bookings (on line bookings and on line check in), taxi (Uber) etc. The cost is relatively low with
entities encouraging the use of technology as this enables these entities to also save on costs (physical
rent is saved, electronic bookings save time and is more efficient thereby enhancing the customer
experience).
Industrialisation and the Fourth Industrial revolution has led to a trend in most industries to move
towards a mechanised environment which impacts both the manufacturing and non-
manufacturing/services industries. The internet of things has also influenced production processors
where assets are equipped with sensors that can capture, communicate and process data. This
provides the potential to create production distribution efficiencies, which benefits both manufactures
and customers alike. Studies have shown that the implementation of the Internet of Things could result
in significant cost savings thereby building efficiencies into an entities production process.
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It is however important to note that this shift has consequences that extend beyond increasing the
profitability of the entity to include aspects relating to efficiency, effectiveness and the long term
sustainability of entities or industries. One such aspect which was a theme in the World Economic
Forum (WEF) held in Davos in 2016, is that which relates to the use of the surplus labour which arises
from industrialisation. According to the WEF the impact of this aspect is currently unknown and needs
to be considered for both developing and developed economies due to the interconnectedness of the
global economy. Other risks associated with the extensive use of technology include: system failure,
fraud (internal and external), reliance on service providers etc. Technology security and business
continuity plans are therefore important in order for an entity to operate without unnecessary disruptions
and also provides assurance to its customers, suppliers and other users.
Refer to the link below for further information relating to the increased utilisation of technology and the
internet of things
http://www.mckinsey.com/business-functions/business-technology/our-insights/an-executives-guide-
to-the-internet-of-things
2.1.1. Robotic Process Automation (RPA)
In line with the topic of the internet of things and the Fourth Industrial revolution is RPM. According to
Ernst and Young (2016:2), RPA is the process whereby “a software or robot emulates human execution
of tasks via existing user interfaces: it captures and interprets existing applications, manipulates data,
triggers responses and communicates with other systems, it can be applied to existing applications
(without changing the current IT landscape).”
Various industries, including manufacturing, transportation, and medical industries make use of robots
to perform human driven tasks. RPA is now also becoming topical in the Finance world (Tucker, 2017),
its benefits include cost efficiency, minimising the risk of error, focussing skills on deriving value
creation etc. Some of the areas in which RPA can effectively be utilised within the finance space is:
1. Operational accounting (billing and collections, accounts receivable)

2. General accounting (allocations and adjustments, journal entry processing, reconciliations,
intercompany transactions etc.)
3. Financial and external reporting
4. Planning, budgeting and forecasting
5. Treasury processes
(Ernst and Young, 2016)
2.2. Corporate governance
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.
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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):
1. Promote corporate governance as integral to running an organisation (delivering governance

outcomes such as ethical culture, good performance, effective control & legitimacy)
2. Making the code accessible for a variety of sectors and organisations
3. Corporate governance as holistic and interrelated and implemented in an integrated manner
4. Encourage transparent and meaningful reporting
5. 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:
• Ethical leadership
• Organisation values, ethics and culture
• Responsible corporate citizenship
• Strategy implementation, performance
• Reports and disclosure
• Role of the governing body
• Composition of the governing body
• Committees of the governing body
• Performance evaluations
• Delegation to management
• Risk and opportunity governance
• Technology and information governance
• Compliance governance
• Remuneration governance
• Assurance (Financial report related)
• Stakeholder inclusive approach
• Responsibilities of shareholders
2.2.1. 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:
1. Corporate governance disclosures required in terms of King IV (see part 3: King IV Application
and disclosures)
2. Integrated reports
3. Annual financial statements and other external reports
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An integrated report encompasses the following:
1. an annual report
2. statutory financial information and sustainability information
3. 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 1.1.1
Answer Practice Question 1–4 in Managerial Finance (8th edition)
Feedback to Activity 1.1.1
Find the solution after the practice question in the textbook.
Activity 1.1.2
Activity 1.1.3
3. Self-assessment questions
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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QUESTION 1 11 MARKS (16.5 MINUTES plus reading time)
Perform the required part (c) of Question 1 (Medico Group), which can be found in the Question Bank
Part 2. The relevant required part is repeated below. (At this point it is not necessary to attempt to do
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
(c) Draft a formal report directed to the directors of MGSA, highlighting the results of:
2. An assessment of the current opportunities and threats that could be linked to
the group;
3. Shortcomings in the group’s current vision-statement, if any. (9)
Incorporate knowledge of the group and pharmaceutical industry in your answer, (2)
and specifically consider the South African context.
Solution question 1
Find the suggested solution to the relevant parts in the Question Bank.
QUESTION 2 9 MARKS (14 MINUTES plus reading time)
Perform the required parts (d) and (h) of Question 3 (Insimbi Limited), which can be found in the
Question Bank Part 2. The relevant required parts are repeated below. (At this point it is not necessary
to attempt to do 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
(d) Evaluate the circumstances of Insimbi Limited and the behaviour of Mr West from
an ethical and corporate governance perspective, and provide recommendations
for improvement. (5)
(h) List eight key areas recommended for inclusion in an Integrated Report. (4)
SOLUTION QUESTION 2
Find the suggested solution to the relevant parts in the Question Bank.
BIBLIOGRAPHY AND ADDITIONAL READING
Littler, D. 2011. Corporate strategy. [Online.] New York: Wiley-Blackwell. Available on a subscription
basis from: <http://www.blackwellreference.com> [Accessed 7 December 2011]
Skae, FO. 2017. Managerial Finance. 8th edition. LexisNexis: Johannesburg.
Tucker, I. 2017. Are you ready for your robots? [online]. Montvale: Strategic Finance. Available from:
http://sfmagazine.com/about-strategic-finance-and-ima/ [Accessed 27 August 2018].
Ernst and Young, 2016. Robotic process automation in the Finance function of the future [online].
United Kingdom: Ernst and Young. Available from:
https://www.ey.com/Publication/vwLUAssets/EY__Robotic_process_automation_in_the_Finance_fun
ction_of_the_future/$FILE/EY-robotic-process-automation-in-the-finance-function-of-the-future-
2016.pdf. [Accessed 27 August 2018].
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LEARNING UNIT 1.2 – PUBLIC SECTOR
1. Introduction
Since the public sector plays a pivotal role and has a major impact on the economy in South Africa,
and CAs(SA) play a prominent role and make a significant contribution to the public sector, it is
important for you to have a basic awareness and understanding of the public sector, including the
applicable legal system and legal framework.
The information provided within this Tutorial Letter provides you with a high level overview of the key
public sector legislation and how this legislation impacts the various aspects of Management
Accounting (i.e. Strategy, Risk Management and Governance, Financial Management and
Management Decision Making and Control).
After working through this content you should have an awareness and understanding of the high-level
principles relating to public entities. You are therefore not expected to know and apply the details.
Section 195(1)(b) of the Constitution states that public administration must be governed by democratic
values and principles, including the following:
✓ A high standard of professional ethics must be promoted and maintained;

✓ Efficient, economic and effective use of resources must be promoted;
✓ Public administration must be development oriented;
✓ Services must be provided impartially, fairly, equitably and without bias;
✓ People’s needs must be responded to, and the public must be encouraged to participate in policy
making;
✓ Public administration must be accountable;
✓ Transparency must be fostered by providing the public with timely, accessible and accurate
information;
✓ Good human-resources management and career-development practices to maximise
human potential must be cultivated.
✓ Public administration must be broadly representative of the South African people.
2. Content
2.1. Public Sector legislation
Legislation applicable to the public sector is very comprehensive. The notes included below therefore
provide you with a summary of public sector enabling legislation necessary to understand the public
sector.
The Constitution of the Republic of South Africa
The Constitution provides for, as part of the Bill of Rights, access to information held by the state that
is required for the protection of any rights and the right to administrative action that is lawful,
reasonable and procedurally fair. The Constitution provides for the enacting of legislation to give effect
to these rights (sections 32 and 33). Of particular importance to prospective CAs is chapter 13 of the
Constitution, relating to finance.
Section 213 requires that all money received by government be paid into a National Revenue Fund
that can only be used in terms of an appropriation by an Act of Parliament. The appropriation provides
for the equitable division of revenue raised by the three spheres of government and each province
receives an equitable share of that revenue. All money received by provincial government is paid into
a provincial revenue fund and the money can be withdrawn in terms of an appropriation by a provincial
act (section 226).
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The Constitution also provides for national legislation to prescribe the form, timelines and content of
national, provincial and municipal budgets (section 215). It further provides for the establishment of a
national treasury in each sphere of government that will introduce generally recognised accounting
practice, uniform expenditure classifications and treasury norms and standards (section 216).
It requires procurement of goods and services in accordance with a system that is fair, equitable,
transparent, competitive and cost effective (section 217).
The South African Reserve Bank is the central bank of the Republic and the primary objective of the
Bank is to protect the value of the currency in the interest of balances and sustainable economic growth
(section 224).
Refer to the following link for more information:

https://www.gov.za/documents/constitution/constitution-republic-south-africa-1996-1
Different pieces of legislation were enacted as a result of the Constitution, some of which are described
below.
The Public Finance Management Act (PFMA)
The PFMA is a key instrument for reform of financial management in the public sector in South Africa
and gives effect to various sections of the Constitution. The PFMA is positioned very high in the
statutory order, as clearly reflected in section 3(3) that states ‘in the event of any inconsistency
between this Act and any other legislation, this Act prevails’.
The objective of the PFMA, as described in section 2, is to secure transparency, accountability and
sound management of the revenue, expenditure, assets and liabilities of the institutions to which it
applies. The PFMA applies to departments, public entities, constitutional institutions, Parliament and
the provincial legislature (section 3).

http://www.treasury.gov.za/legislation/PFMA/default.aspx
Treasury Regulations
National and provincial treasuries are key role players in the public finance management process
(PFMA, chapters 2 & 3). The National Treasury was established in accordance with the PFMA and is
responsible for financial and fiscal matters, including the budget preparation process, control over the
implementation of the national budget, monitoring the implementation of provincial budgets and
promoting and enforcing transparency and effective management. To perform these functions, the
National Treasury must prescribe norms and standards that are included in Treasury Regulations and
instructions.
Refer to the following links for more information:

http://www.treasury.gov.za/legislation/pfma/regulations/default.aspx
http://www.treasury.gov.za/legislation/pfma/TreasuryInstruction/default.aspx
The Municipal Finance Management Act (MFMA)
The MFMA is one of the important pieces of legislation relevant to local government. The objective of
the MFMA is described in section 2 and is to secure sound and sustainable management of the fiscal
and financial affairs of municipalities and municipal entities by establishing norms and standards and
other requirements in the areas of fiscal and financial affairs, revenues, expenditures, assets and
liabilities, budgetary and financial planning, borrowing, handling of financial problems in municipalities
and supply chain management.
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A student who understands the PFMA should be able to make the transition to understanding the
MFMA with relative ease.
Refer to the following links for more information:
http://mfma.treasury.gov.za/MFMA/Legislation/Local%20Government%20-
%20Municipal%20Finance%20Management%20Act/Municipal%20Finance%20Management%20Act
%20(No.%2056%20of%202003).pdf
The Division of Revenue Act
The Division of Revenue Act is published every year in compliance with section 214(1) of the
Constitution to provide for the equitable division of revenue raised nationally among the three spheres
of government. This includes the province’s equitable share of the provincial share of the provincial
revenue and other allocations to provinces, local government or municipalities from the national
government’s share of revenue.
The objective of the Act, as described in section 2, is to promote predictability and certainty in respect
of all allocations to provinces and municipalities, in order that provinces and municipalities may plan
their budgets over a multi-year period and thereby promote better coordination between policy,
planning and budgeting. The objective also includes promoting transparency and accountability in the
resource allocation process by ensuring allocations are reflected in the budgets of provinces and
municipalities and the expenditure of conditional allocations is reported on by the receiving provincial
departments and municipalities.

http://www.treasury.gov.za/legislation/acts/2014/Division%20of%20Revenue%20Act,%202014%20(
Act%20No.%2010%20of%202014).pdf.
Key features of this Act include the following:
Procurement legislation
Section 76(4)(c) of the PFMA provides that National Treasury should determine a framework for an
appropriate procurement and provisioning system that is fair, equitable, transparent, competitive and
cost effective. National Treasury has issued various documents to give effect to this requirement. The
policy strategy to guide
uniformity in procurement reform processes in government provided for devolved the responsibility
and accountability for procurement-related functions to accounting officers/authorities with the aim of
promoting uniformity in the various spheres of government with regard to the interpretation of
government’s preferential procurement legislation.
The former procurement and provisioning practices in government were replaced by a supply chain
management function and a systematic competitive procedure for the appointment of consultants as
an integral part of financial management. The Supply Chain Management Framework was published
in 2003 as part of Treasury Regulations in terms of section 76(4)(c) of the PFMA. Other relevant
legislation includes the Preferential Procurement Policy Framework Act, 2000 (Act 5 of 2000) and the
Preferential Procurement Regulations, 2001 that pertain to this Act.
http://www.treasury.gov.za/legislation/pfma/supplychain/Policy%20to%20Guide%20Uniformity%20in
%20Procurement%20Reform%20Processes%20in%20Government.pdf
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Public Audit Act (PAA)
The PAA Act is the key piece of legislation relevant to auditing and assurance in the public sector in
South Africa. Public sector auditors have an expanded mandate in that an audit includes the audit of
financial statements, compliance with laws and regulations, and the audit of performance against
predetermined objectives (sections 20(2)(c) and 28(1)(c)).

http://www.agsa.co.za/About/Legislation.aspx
2.1.1. Impacts of legislation on Management Accounting
In addition to the above public sector legislation, you need to understand how the public sector enabling
legislation impacts on the various aspects of Management Accounting (i.e. Strategy, Risk Management
and Governance, Financial Management and Management Decision Making and Control), this is
addressed in the sections that follow.
2.1.1.1. Strategy, Risk Management and Governance
Strategy
The public sector is bound by legislation and regulations resulting in many aspects of strategy, risk
management and governance components being included in legislative requirements. In the private
sector, achievement of the entity’s overall objectives involves the development and implementation of
strategies that take advantage of identified opportunities while minimising the damage that risks can
do to the achievement of organisational goals. This process is informed by the competitive
environment, the availability of sustainable resources and the importance of stakeholder relationships.
Collectively, this is communicated through the integrated report.
This process is echoed in the public sector, although cognisance is taken of the fact that the formulation
of strategies is driven by the constitutional and legislative mandates as well as policy priorities of
government and is performance driven rather than competitive driven.
The mandate of public institutions needs to inform the strategic focus areas with the emphasis on
service delivery. Strategic objectives are set for the strategic focus areas and performance indicators
and targets are defined to enable measurement of performance. Public sector institutions are required
to prepare strategic plans and annual performance plans that incorporate strategic outcomes,
objectives, indicators and targets. Ultimately the budgets of public institutions need to be aligned to the
strategic plans and strategic priorities of the particular institution so that the spending which takes place
allows the strategic objectives and strategic priorities to be addressed. Performance of government is
measured and monitored by the public and other stakeholders by way of actual against planned
performance and budgets.
The Treasury Regulations in section 3.2 require that the internal audit function assist the accounting
officer in achieving the objectives of the institution by evaluating and developing recommendations for
the enhancement or improvement of processes through which the objectives are established, the
achievement of objectives is monitored, accountability is ensured and corporate values are preserved.
A very unique legislative requirements related to strategy within the public sector is the requirements
to report on pre-determined objectives and that the information being reported is subjected to an audit.
Treasury Regulations require that annual reports include information about the institution’s efficiency,
economy and effectiveness in delivering programmes and achieving its objectives and outcomes
against the measures and indicators set out in the strategic plan.
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Risk Management
Risk management in the context of the public sector focuses on the importance of service delivery and
the identification and response to risks that could affect service delivery and compliance with laws and
regulations (given that the public sector is highly regulated).
Key focus areas for risk management in the public sector include procurement (supply chain
management) and contract management due to high levels of tender fraud and corruption.
Detailed legislation and guidance in these areas include: the PFMA Treasury Regulations 16A,
Preferential Procurement Policy Framework Act, Broad Based Black Economic Empowerment Act and
Supply Chain Management Regulations and related Practice Notes. Refer to the following links for
more information:
http://www.treasury.gov.za/legislation/pfma/supplychain/default.aspx
http://www.treasury.gov.za/legislation/pfma/practice%20notes/default.aspx
Another key risk area is the lack of performance or risks in terms of service delivery performance. The
Auditor-General issues a general report on the outcomes of the audits conducted every year after
completion of the audits. The general report includes reference to different risk areas, such as the
following:
✓ Quality of submitted financial statements

✓ Quality of submitted performance reports
✓ Supply chain management
✓ Financial health
✓ Human resource management
✓ Information technology.
Refer to the Auditor-General website (http://www.agsa.co.za/) to be informed about the identified risk
areas as part of the reporting on the outcomes of the audits completed each financial year.
Section 3.2 of the Treasury Regulations describes the requirements of internal control and the need
for the accounting officer to ensure that a risk assessment process is conducted regularly to identify
emerging risks. A risk management strategy, including a fraud prevention plan, must direct the work of
internal audit.
Governance
You should be aware of the governance structures within a public sector entity. There are different
governance structures in the public sector and various layers of governance structures exist. Functions
of government can be divided into the legislative authority, the executive authority and the
administrative authority, each of which are discussed below:
• The legislative authority
This is a legal political institution that makes, amends and repeals laws for the community. In South
Africa the legislative authority consists of the national sphere of government, vested in Parliament,
the provincial sphere of government vested in the provincial legislatures, and the local sphere of
government vested in municipal councils.
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• The executive authority
In South Africa this authority is entrusted to the President and the cabinet (Constitution of Republic of
South Africa, section 85). Cabinet members are elected political representatives and members of
Parliament. The President appoints one minister for each portfolio and decides on the membership of
the Cabinet. The President can inter alia appoint and dismiss ministers and have various other
functions and authority described in section 85, including to implement legislation, develop and
implement national policy, co-ordinate the functions of state departments, and prepare and initiate
legislation.
• The administration authority
This consists of the various administrative institutions or departments that need to execute the policies
and decisions of the legislature and the executive authority. Administration also consists of all
accounting officers, the chief financial officers, financial officers, internal auditors and other officials.
The roles and responsibilities of the different role-players are described below.
a) The accounting officer
The accounting officer (sections 36-43 of the PFMA) or the accounting authority (sections 49-57 of
the PFMA): Every department and every constitutional institution must have an accounting officer. The
accounting officer is the head of the department or the chief executive officer of a constitutional
institution. The appointment and roles and responsibilities of accounting officers are described in
sections 36‒41 of the PFMA. The following are some of the general responsibilities:
✓ To ensure effective, efficient and transparent systems of financial and risk management and
internal control are in place and are maintained (section 38(a)(i));
✓ To ensure a system of internal audit under the control and direction of the audit committee (section
38(a)(ii));
✓ To ensure an appropriate procurement and provisioning system that is fair, equitable, transparent,
competitive and cost effective (section 38(a)(iii));
✓ To ensure a system for properly evaluating all major capital projects prior to a final decision on the
project (section 38(a)(iv));
✓ To ensure the effective, economical and transparent use of resources (section 38 (b));
✓ To take effective steps to collect all money due and prevent unauthorised, irregular fruitless and
wasteful expenditure and losses resulting from criminal conduct and manage working capital
efficiently and economically (section 38(c));
✓ To take responsibility for management, safeguarding and maintenance of assets (section 38(d));
✓ To report to Treasury any unauthorised, irregular or fruitless and wasteful expenditure (section
38(g));
✓ To take effective and appropriate disciplinary steps against any official that contravenes the PFMA,
commits an act that undermines the financial management and internal control system or make or
permit unauthorised, irregular or fruitless and wasteful expenditure (section 38(h)).
The accounting officer is also responsible for budgetary control including reporting to the executive
authority any variances on the budget (section38).
The reporting responsibilities of the accounting officer include keeping full and proper records of the
financial affairs and preparing and submitting financial statements to the Auditor-General within two
months after the year end. Within five months after the year end the annual report for departments
must be submitted to the relevant treasury and the executive authority and those of constitutional
institutions to Parliament. The annual report and audited financial statements must:
• fairly present the state of affairs of the department, trading entity or constitution, its business, its
financial results and its performance against pre-determined objectives and its financial position
as at the end of the financial year; and
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• include particulars of any material losses through criminal conduct, and any unauthorised
expenditure, irregular expenditure and fruitless and wasteful expenditure and criminal or
disciplinary steps taken as a result thereof.
Reporting also includes monthly reporting on revenue and expenditure with an explanation of any
material variances and corrective steps taken.
b) The accounting authority
This should consist of a board or controlling body, or the chief executive officer if no controlling body
exists, and other officials at public entities have similar responsibilities to those described for the
accounting officers and other officials.
c) Chief financial officer
Each institution must have a chief financial officer who is directly accountable to the accounting officer
and assists the accounting officer in discharging the duties related to effective financial management,
including budgetary management, operation of internal controls and timely production of financial
reports.
d) Other officials
The responsibilities of other officials are also legislated, contrary to the private sector, and are
described in sections 44‒57of the PFMA. Some of these are as follows:
• To ensure the system of financial management and internal control is carried out in the area of
responsibility;
• To be responsible for the effective, efficient and economical and transparent use of financial and
other resources within the area of responsibility;
• To take effective and appropriate steps to prevent any unauthorised expenditure, irregular
expenditure and fruitless and wasteful expenditure, also with regard to the collection of revenue;
• To be responsible for management, including the safeguarding of assets and the management of
the liabilities.
e) Audit committee
Ultimately, those charged with governance need to account to various oversight bodies, including the
public accounts committees and the audit committees. Public sector audit committees are regulated
by national legislation including the PFMA, Treasury Regulations and the MFMA. The PFMA prescribes
the composition of the audit committee (with the focus on independence) and the frequency of meetings
(at least twice a year). The PFMA provides that Treasury may set additional regulations for audit
committees, their appointment and functioning. This is addressed in Treasury Regulation 3.1, in terms
of which an audit committee must operate in terms of a written terms of reference that needs to be
reviewed annually. Audit committees must review the following:
• The effectiveness of the internal control systems;

• The effectiveness of the internal audit function;
• The risk areas of the institution’s operations to be covered in the scope of external and internal
audits;
• The adequacy, reliability and accuracy of the financial information provided to management;
• Any accounting and auditing concerns identified as a result of internal and external audits;
• The institution’s compliance with legal and regulatory provisions;
• The activities of the internal audit function; and
• Its evaluation of the annual financial statements.
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In the annual report of the institution the audit committee must comment on the effectiveness of internal
control, the quality of the year’s management and monthly/quarterly reports. If a report from any source
implicates the accounting officer of fraud, corruption or gross negligence, the chairperson of the audit
committee must report this promptly to the relevant executive authority.
f) Internal audit
Another important component of governance is internal controls, including an internal audit function.
As indicated above, the accounting officer or the accounting authority is responsible for ensuring that
there is an effective, efficient and transparent system of internal control. The internal audit function
must assist the accounting officer in this regard by evaluating the controls for effectiveness and
efficiency and developing recommendations for improvement.
According to section 3.2 of the Treasury Regulations the requirements of internal control and internal
audit include the following:
• The accounting officer must ensure a risk assessment is conducted regularly to identify emerging
risks. A risk management strategy, including a fraud prevention plan, must direct the work of
internal audit.
• An internal audit function must be established.
• The purpose, authority and responsibility of the internal audit function must be formally defined in
an internal audit charter.
• An internal audit must be conducted in accordance with the standards of the Institute of Internal
Auditors.
• The internal audit function must complete a rolling risk-based three-year strategic internal audit
plan and an annual internal plan for the first year, indicating the proposed scope of each audit, and
report quarterly to the audit committee on performance against the annual internal audit plan.
• The internal audit function must be independent of activities audited and report directly to the
accounting officer.
• The internal audit function must co-ordinate with other internal and external providers of assurance
to ensure proper coverage, but limit duplication.
• Controls subjected to evaluation should include the information systems environment, reliability
and integrity of financial and operational information and the effectiveness of operations,
safeguarding of assets and compliance with laws, regulations and control.
2.1.1.2. Financial Management
Within government there has been a major focus on improving financial management. Treasury at a
national and provincial level has a critical role to play as part of the financial management process in
government as part of the responsibility to manage South Africa’s national government finances.
Supporting efficient and sustainable public financial management is fundamental to the promotion of
economic development, good governance, social progress and a rising standard of living for all South
Africans. Chapter 13 of the Constitution mandates the National Treasury to ensure transparency,
accountability and sound financial controls in the management of public finances.
The National Treasury’s legislative mandate is also described in chapter 2 of the PFMA, which
mandates the National Treasury to –
• promote government’s fiscal policy framework;

• coordinate macroeconomic policy and intergovernmental financial relations;
• manage the budget preparation process;
• facilitate the Division of Revenue Act, which provides for an equitable distribution of nationally
raised revenue between national, provincial and local government; and
• monitor the implementation of provincial budgets.
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The following provides an overview of relevant sections in the PFMA and Treasury Regulations related
to financial management:
• Revenue collection, cash collection and cash management
Government revenue includes taxes, sales, transfers, fines, penalties and forfeits, interest, dividends
and rent on land, as well as transactions in financial assets and liabilities. The PFMA (section 40)
requires the accounting officer to submit a report each month that include information on the actual
revenue and expenditure for the previous month and the amounts anticipated for that month. Within 15
days after month end, a report is issued to treasury and the executive authority on the information for
the month, with a projection of expected expenditure and revenue collection for the remainder of the
financial year; explanations on any material variances; and a summary of steps taken to ensure
projected expenditure and revenue remain within budget.
Section 7 of the Treasury Regulations describes the requirements for revenue management and
specifically to manage revenue efficiently and effectively by developing and implementing appropriate
processes to provide for identification, collection, recording, reconciliation and safeguarding of
information about revenue.
In terms of section 7 of the PFMA, the National Treasury must prescribe a framework for cash
management and section 15 of the Treasury Regulations include the frameworks for banking, cash
management and investments. As part of the control of the revenue funds each treasury is responsible
for the effective and efficient management of its revenue fund and ensuring sufficient money is in the
revenue fund to meet the appropriated expenditure and cash flow requirements. All revenue received
by a department must be paid daily into its paymaster-general (bank) account. Appropriated funds
requested by departments from Treasury must be in accordance with approved cash flow
requirements. At the end of the financial year, the accounting officer must surrender any unexpended
voted money to the relevant treasury. Treasury Regulations also prescribe the general principles for
banking and cash management, as follows:
• Collecting revenue when due and banking it promptly;

• Making payments no earlier than necessary;
• Avoiding prepayments for goods and services;
• Pursuing debtors to ensure amounts receivable are collected and banked promptly;
• Managing cash flow;
• Taking action to avoid locking up money, for example in unnecessarily high inventory levels;
• Performing daily bank reconciliations;
• Separating duties to minimise incidences of fraud.
• Expenditure management
The PFMA requires that the accounting officer should ensure effective, efficient, economical and
transparent use of the resources of the institution and prevent unauthorised, irregular and fruitless and
wasteful expenditure and losses resulting from criminal conduct. The accounting officer is responsible
for ensuring that the expenditure is in accordance with the vote of the department and should report
under-collection of revenue, shortfalls in budgeted revenue and overspending to the relevant treasury
(sections 38‒39).
Unauthorised expenditure includes overspending of the total amount appropriated per department or
expenditure not in accordance with its main purpose. If unauthorised expenditure is incurred,
Parliament or the provincial legislature must authorise the expenditure, otherwise funding allocated in
future years need to be utilised for the unauthorised expenditure (section 34 of the PFMA). Irregular
expenditure is expenditure, other than unauthorised expenditure, incurred in contravention of or not in
accordance with a requirement of any applicable legislation. Fruitless and wasteful expenditure is
expenditure that was made in vain that could have been avoided had reasonable care been exercised.
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The accounting officer must exercise reasonable care to prevent and detect these types of expenditure.
Where such expenditure incurs the necessary reporting should take place and the amount must be
disclosed as a note to the annual financial statements of the institution.
Section 8 of the Treasury Regulations require that the accounting officer must ensure internal
procedures and internal control measures are in place for payment approval and processing. The
controls should provide reasonable assurance that all expenditure is necessary, appropriate, paid
promptly and adequately recorded and reported. No amounts may be spent or committed without
obtaining the necessary approval. The Regulations also require all payments due to creditors to be
settled within 30 days from receipt of an invoice.
The PFMA further allocates responsibility to ensure a system for properly evaluating all major capital
projects prior to a final decision on the project to the accounting officer (section 38).
At the centre of government’s development plan is the provision of economic infrastructure to support
growth. Government planned expenditure on infrastructure is significant.
• Asset management
The PFMA allocates responsibility for the management, including the safeguarding and maintenance
of assets, to the accounting officer (section 38). Treasury Regulations require that the accounting
officer should ensure proper control systems exist and that preventative mechanisms are in place to
eliminate theft, losses, wastage and misuse. Stock levels should be optimum and at an economical
level. Processes and procedures should be in place for the effective, efficient, economical and
transparent use of the assets (section 10).
Treasury Regulation further require that the accounting officer take effective and appropriate steps to
collect money due timeously. Regulations also cover recovery of debts, writing off of debts and interest
payable on debts in section 11.
• Liabilities
The PFMA allocates responsibility for the management of the liabilities to the accounting officer (section
38).
The PFMA includes specific requirements on borrowing within government and places a limitation of
the ability to enter into loan agreements without prior approval (sections 66 and 71). With the exception
of entering into operating leases, the accounting officer of the department and other relevant staff can
be guilty of financial misconduct if financing agreements are entered into without the prior approval of
Treasury.
• Supply chain management
Extensive legislative requirements for supply chain management exist. The PFMA allocates
responsibility for ensuring an appropriate procurement and provisioning system that is fair, equitable,
transparent, competitive and cost effective to the accounting officer (section 38).
Section 16 of the Treasury Regulations covers the requirements for supply chain management and
states that the accounting officer must develop and implement an effective and efficient supply chain
management system that must be consistent with the Preferential Procurement Policy Framework and
provide for at least the following:
• Demand management
• Acquisition management
• Logistics management
• Disposal management
• Risk management
• Regular assessment of supply chain performance.
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The accounting officer must establish a separate supply chain management unit that can implement
the supply chain management system. The procurement of goods and services through quotations or
through the bidding process must be within the threshold value determined by National Treasury. The
supply chain management system must, in the case of procurement, provide for a bidding process that
includes ‒
• the adjudication of bids through a bid adjudication committee;

• the establishment, composition and functioning of bid specification, evaluation and adjudication
committees;
• the selection of bid adjudication committee members; and
• the approval of bid evaluations and/or adjudication committee recommendations.
The accounting officer must take reasonable steps to prevent abuse of the supply chain management
system and investigate any allegations against an official or other role player of corruption, improper
conduct or failure to comply with the supply chain management system.
2.1.1.3. Management Decision Making and Control
As part of Management Decision Making and Control, budgeting and monitoring are key elements that
will inform decision making and control.
Section 214(1) of the Constitution requires that a Division of Revenue Act determine the equitable
division of nationally raised revenue between national government, the nine provinces and the
municipalities every year. This process takes into account the powers and functions assigned to each
sphere of government. The Intergovernmental Fiscal Relations Act, 1997 (Act 79 of 1997)) prescribes
the process for determining the equitable sharing and allocation of nationally raised revenue. Section
214 of the Constitution requires that the annual Division of Revenue Act be enacted after factors in
sub-sections (2)(a) ‒(j) of the Constitution have been taken into account. These include national
interest, debt provision, the needs of national government, flexibility in responding to emergencies,
resource allocation for basic services and developmental needs, the fiscal capacity and efficiency of
provincial and local government, reduction of economic disparities, and promotion of stability and
predictability.
The national interest is encapsulated by governance goals that benefit the nation as a whole. The
National Development Plan, endorsed by Cabinet in November 2012, sets out a long-term vision for
the country’s development and includes 14 priority outcomes. The medium-term strategic framework
(MTSF) is adopted by Cabinet to give effect to the priority outcomes over the next five years. In the
Medium Term Budget Policy Statement, the Minister of Finance outlines how the resources available
to government over the medium-term expenditure framework (MTEF) would be allocated to help
achieve these goals.
Provincial and local government equitable share allocations are based on estimates of nationally raised
revenue. If this revenue falls short of the estimates within a given year, the equitable shares of
provinces and local government will not be adjusted downwards. Allocations are assured (voted,
legislated and guaranteed) for the first year and are transferred according to a payment schedule. To
contribute to longer-term predictability and stability, estimates for a further two years are published with
the annual proposal for appropriations. More information on the budget can be obtained from National
Treasury’s website
(http://www.treasury.gov.za/documents/national%20budget/2015/review/default.aspx).
Sections 26‒35 of the PFMA describe the budget requirements. Parliament and each provincial
legislature appropriate money for each financial year for the requirements of the state and provinces.
The budget must contain estimates of all expected revenue to be raised during the financial year,
estimates of current expenditure per vote and per main division within the vote, estimates of interest
and repayment on loans, estimates of capital expenditure per vote and main divisions within the vote
for the financial and future years, proposals for financing any anticipated deficit and the intentions
regarding borrowing and other public liability that will increase public debt.
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In February of each year, the Finance Minister tables the national budget in Parliament, at which the
Minister announces government’s spending, tax and borrowing. Once Parliament approves the budget,
it is adopted and becomes Parliament’s budget. The budget must include the projected revenue,
expenditure per vote and per main division and borrowing for the previous financial year and include
multi-year budget information.
The budget announces government spending for the next three financial years, that is, the years of the
MTEF. In contrast to the function-based process, the Appropriation Bill, tabled by the Minister of
Finance as part of the budget, is set out in terms of each budget vote. Generally, a vote specifies the
total amount of money appropriated to a national government department. Through the Appropriation
Bill the executive seeks Parliament’s approval and adoption of its national government spending plans
for the first year of the MTEF period. The abridged estimates of national expenditure publication is the
explanatory memorandum to the Appropriation Bill and contains detailed information regarding the
allocations to each national government vote.
Key performance indicators are included for each national government vote and entity showing what
the institutions aim to achieve by spending their budget allocations in a particular manner. This
information provides Parliament and the public with the necessary tools to hold government
accountable against the 14 outcomes set out in the MTSF.
Each public institution is also required to compile a strategic plan (called an integrated development
plan in the case of municipalities) and an annual performance plan (called a service delivery budget
implementation plan in the case of municipalities) that include strategic outcomes, objectives, key
performance indicators and targets. The requirements for planning and budgeting are included in
sections 5 and 6 of the Treasury Regulations.
These planning documents are used as a basis for monitoring performance through in-year reporting
(finance monthly and performance/non-financial quarterly) and annual reporting. This information
provides Parliament and the public with the necessary tools to hold government accountable against
the 14 outcomes set out in the MTSF and the objectives and targets set out in the plans.
2.1.2. Summary
The information above has provided an understanding of the key public sector legislation and how
this impacts on the:
• Strategy, risk management and governance;

• Financial management; and
• Management decision making and control of public sector organisations.
Please refer to the study material of your other modules for the impacts on:
• Accounting and external reporting;

• Auditing and assurance; and
• Taxation.
Activity 1.2.1
List the key enabling legislation a public sector entity would need to implement.
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• The Constitution of the Republic of South Africa

• The Public Finance Management Act (PFMA)
• Treasury Regulations
• The Municipal Finance Management Act (MFMA)
• The Division of Revenue Act
• Procurement legislation
• Public Audit Act (PAA)
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LEARNING UNIT 2 – RISK MANAGEMENT

LEARNING OUTCOMES
through your prior learning (see below) to a scenario, on an integrated basis.

Learning outcome References
• Identify and evaluate opportunities and risks on an advanced level. • Chapter 3

• Critically assess risks (including IT risks) and how they are managed. • MAC4861 TL102
• Understand and explains 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.
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.
Your prior learning for this learning unit included a fair amount of theory. 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 MANAGEMENT

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LEARNING UNIT 2.1 - RISK MANAGEMENT
1. Introduction
We have already noted that risks are relevant in everybody's day-to-day lives. In the financial world,
one finds different types of risk. Risks can come from uncertainty, such as uncertainty from 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 later 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 evaluatin1g 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.
2. Content
There is no additional content to be studied at this level. All content has already been addressed in
your prior learning. If you want to refresh your knowledge, please refer to the earlier section ‘Prior
learning assumed’.
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 2.1.1
List some risks that may be relevant to a South African entity manufacturing paper from tree pulp.
Assume that the entity exports to various clients in South America and Africa, and that the entity utilises
80% debt capital.
There could be numerous types of risks and the following are just a few examples that you could have
considered:
• environmental risks caused by air pollution from the paper mill (paper manufacturing plant)
• environmentalists may place pressure on the entity and cause restrictions on the cutting of trees if
a conscious effort is not made to ensure the sustainability of the water resources, fertile land,
natural forests and the biological system in the area
• the high level of gearing increases the financial risk and could place restrictions on future expansion
as loans require fixed repayments and are often secured by assets
• the entity exports to South America and other African countries, which increases currency risk as
contract values may change with currency fluctuations.
Activity 2.1.2
Perform Practice Question 3-3 in Managerial Finance (8th edition).

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QUESTION 1 (24 MARKS 36 MINUTES plus reading time)
Perform the required part (c) of question 3 (Insimbi 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
(c) For each of the risk factors indicated below, describe the reason why Insimbi Limited
may consider this a key risk factor and further suggest ways in which Insimbi could
mitigate these risk factors. In your answer you should make use of a table in the (24)
following format:
Risk factor Reason why this Mitigation
may represent a
key risk factor
• Regulatory, political and legal matters (2 marks) (2 marks)
• Inadequate supporting infrastructure (1 mark) (1 mark)
• Impact on the environment (2 marks) (2 marks)
• Foreign exchange (1 mark) (2 marks)
• Commodity price and demand (3 marks) (2 marks)
• Employees’ health and safety
(3 marks) (3 marks)
Solution to question 1
Find the suggested solution to the relevant part in the Question Bank.
Perform the required sub-part (a) of Question 15 (H Ltd Goup), which can be found in the Question
Bank. The relevant required part is repeated below.
REQUIRED Marks
(a) Identify and explain the key risks the H Ltd group faces with regard to its group
operations and describe ways, if any, in which the group could mitigate these risks. (40)
Find the suggested solution to the relevant part in the Question Bank.
Skae, FO. (2017). Managerial Finance, 8th edition. LexisNexis: Johannesburg.

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LEARNING UNIT 3 – COST OF CAPITAL AND CAPITAL INVESTMENT

APPRAISAL
LEARNING OUTCOMES
In addition, after studying this learning unit, you should be able to:
• recommend ways in which project and investment appraisal could be approached differently with
the aim of sustainable value creation
• perform and evaluate a foreign investment decision
• quantify the effect of specific scenarios on the net present value and/or internal rate of return of a
proposed investment
• describe how Monte Carlo simulation could help measure the impact of risk on a proposed
investment

Learning outcome Reference

Managerial Finance
(8th edition):
✓ Understand the concept of risk vs. return, including the • Chapter 4 (sections 4.1-
underlying theory. 4.12)
✓ Integrate multiple sources of knowledge to determine the fair • Chapter 5
value of different types/forms of preference shares and debt, • Chapter 6 (parts 6.1 to
incorporating complications in discounted cash flow and 6.8)
relevant income tax treatments. • Chapter 10
✓ Analyse an entity’s cost of capital and capital structure. • Management and Cost
✓ Calculate the weighted average cost of capital and its various Accounting, 9th edition:
components. Chapter 13
✓ Understand the circumstances in which a project specific cost • MAC4861 TL102
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.
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INTRODUCTION
Capital investment appraisals are long-term decisions, where it will take several years to earn a return
on the capital investment made. The topic of capital investment appraisals integrates many other
management accounting topics (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
LEARNING UNIT 3.3 FOREIGN INVESTMENT
LEARNING UNIT 3.4 SCENARIO ANALYSIS AND MONTE CARLO SIMULATION
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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 other 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 selected sections of 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
Activity 3.1.1
Attempt question 4.6 in Managerial Finance, 8th edition, without referring to the suggested solution.

Find the suggested solution after the question in the textbook.
Perform the required part (a) of Question 1 (MEDICO 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
REQUIRED Marks
(a) Calculate the weighted average cost of capital for MGSA as at 31 March 2013
based on available information and ignoring any effect of a possible merger or
acquisition. (14)
Refer to the suggested solution to this part in the Question Bank.

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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 (e.g. 5 years), where end-of-period cash flows should be accounted for (e.g. 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 lifecycles.
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 textbooks:
Managerial Finance – 8th edition:
• Chapter 6: The investment decision
2. Content
self-assessment at the end of this tutorial letter will help you to apply your knowledge
3. Self-Assessment questions
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Perform the required parts (a) (b) and (c) of Question 2 PART B (D&S TEC), 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 weighted average cost of capital (WACC) of D&S TEC at 31 March
2012 based on the target structure. (6)
(b) Without further calculations, explain the impact that a new bank loan, to finance the
investment, will have on D&S TEC’s
(i) cost of equity (2)

(ii) cost of debt; and (2)
(iii) weighted average cost of capital. (2)
(c) Use the discounted cash-flow model to determine what the resale value of the
computer and other equipment will need to be, to achieve a required return of 19%.
Your answer should include detailed calculations and indicate key assumptions or
items omitted from your evaluation.
(i) Calculations (14)

(ii) Assumptions (3)
International Federation of Accountants (IFAC). 2012. Exposure draft: Project and Investment
Appraisal for Sustainable Value Creation. New York: IFAC

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LEARNING UNIT 3.3 – FOREIGN INVESTMENT
1. Introduction
An appropriate capital investment decision can only be made after considering several quantitative and
qualitative factors. Quantitative appraisal of a proposed capital investment usually requires forecasting
of investment-related and associated cash flows, which is then discounted at an appropriate risk-
adjusted discount rate based on WACC. This process is complicated further when involving a foreign
investment as we then have to consider additional factors, such as country risk and different currency
units.
This learning unit is based on the following chapter in your prescribed textbook:
Managerial Finance – 8th edition

Chapter 6: The investment decision, part 6.9
2. Content
2.1. Quantitative analysis of a local capital investment decision
In performing a quantitative appraisal of a proposed local investment, we usually calculate the net
present value (NPV) of the projected investment-related and associated cash flows (excluding finance-
related cash flows), by discounting the cash flows using an appropriate risk-adjusted discount rate.
Then, once all quantitative and qualitative factors have been considered, a capital investment decision
is made. (These concepts are described in detail in the textbook.
Next we consider additional considerations when contemplating the discount rate for foreign
investment.
2.2. Country risk
According to author, Luis Pereiro (2002), country risk represents the combined risk from the following
country-specific risk components (with examples in brackets):
• Currency risk and the risk resulting from inflation, including devaluation and volatility in the local
currency (think of the volatility of South African rand a few years ago and of the recent devaluation
in several emerging market currencies against benchmark currencies).
• The credit risk of the government, including the possibility of defaulting on international debt funding,
such as government bonds (think of the euro-crisis, and recent changes in the perceived credit risk
of Greece and Portugal).
• Social or political problems (think of recent events in Syria and Egypt).
• Possibility of government expropriation and nationalisation of private assets (think of recent events
in Zimbabwe and Bolivia).
• Potential barriers to free capital flow in and out of the country (think of South Africa).
Pereiro (2002) adds that country risk is relevant where investment is not diversified geographically,
either through practical limitations, due to countries restraining investors from entering and exiting (for
example, South African exchange control partially restrains investors in this regard), or willingly, where
investors choose to invest only in a single country and therefore effectively choose not to diversify
geographically.
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Next we consider ways of adjusting for the effects of country risk as part of foreign investment appraisal.
Although little consensus exists amongst experts as to the best technique to use for the adjustment of
country risk, numerous techniques have been described, with various levels of complexity. (Complex
techniques for the adjustment of country risk fall beyond the scope of the curriculum.)
We recommend that you study the techniques described in this section rather than section 6.9, entitled
“International capital budgeting”, as in the prescribed textbook.
In this section we discuss two basic techniques that are commonly used; both are based on the Capital
Asset Pricing Model. (This discussion is adapted from descriptions by Correia [2011], Pereiro, [2002]
and Damodaran [2009].)
a) Technique 1
This technique allows for the adjustment of country risk in components: partially at the level of projected
cash flows and partially at the discount rate.
Apply the following steps in evaluating a foreign investment:
1. Estimate future cash flows in the foreign currency.

2. Convert to local currency (rand) using forecasted spot exchange rates for each year. (This step
accounts for the effect of currency risk and is similar to the one used in analysing foreign finance.
Refer to learning unit 4.2 in this regard.)
3. If available, add or deduct the incremental insurance premium (in rand, as obtained from Lloyds
of London, for example) to account for the difference in political risk, expropriation risk, etc. (If the
foreign country has a higher risk than South Africa then the incremental insurance premium should
be deducted; if a lower risk then the incremental premium should be added.)
4. Determine/obtain the discount rate for the investor company (in South Africa, based on rand) and
adjust for foreign country risk factors not incorporated in step 3.
5. Adjust the local discount rate (South African, based on rand) for the effect of improved
geographical diversification benefits, if any. (This may result in a lowering of the rate.)
6. Further adjust the local discount rate (South African) for undiversified investment-specific risks,
not accounted for as part of the forecasted cash flows.
7. Determine the net present value by discounting the cash flows (in rand) using the adjusted local
(South African) discount rate.
b) Technique 2
This technique allows for the adjustment of country risk mainly at the level of the discount rate, where
it incorporates a “country risk premium”.
Country risk premium
A country risk premium is the additional return required over a benchmark risk-free rate, due to the
effects of incremental country risk. A country risk premium is often calculated based on the spread of
a sovereign bond (belonging to the country of investment) over a benchmark bond (often taken as US
T-Bonds or German Bonds), both with the same monetary denomination (thus normally US dollars or
euro) and both with a similar maturity date close to the life expectancy of the proposed investment.
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One way of determining this spread is to refer to the rating allocated to the country’s debt by one of the
rating agencies and then to refer to the published spreads relative to the US T-bond, for instance.
Tables 3.1 and 3.2 provide an indication of these bond-spreads. (Spreads are indicated in basis points;
100 basis points equals 1%. We do not provide a more recent representation because US corporate
bond spreads in recent times approached their widest on record due to the international financial crisis,
making later figures less representative.)
Activity 3.3.1
Determine the country risk premium of a proposed 10-year investment in Brazil, using the information
in Table 3.3.1. Assume that the credit rating of Brazil’s sovereign debt is rated at BBB.
The country risk premium of a proposed investment in Brazil is calculated as follows: A 10 year BBB
rated bond has a spread of 292 basis points compared to US T-bonds (per Table 10.3.1), or 2,92%,
which equals the Brazilian country risk premium over the US.
Steps in applying technique 2
Apply the following steps in evaluating a foreign investment using this technique:
1. Estimate future cash flows in the foreign currency.
2. Convert to a benchmark currency (US dollar or euro) using forecasted spot exchange rates for
each year.
3. Determine a risk-adjusted discount rate (US dollar or euro-based) as follows:
WACCfi = (Kd x d%) + (Ke x e%)
Where:
WACCfi= The weighted average cost of capital for the proposed foreign investment
Ke = Cost of equity
Kd = After-tax rate of return on debt capital (sometimes increased by the after
tax country risk premium [Rc]
d% = The debt component in the target capital structure, or debt capital as a
percentage of the sum of the debt and ordinary equity capital (based on
market values)
e% = The equity component in the target capital structure, or ordinary equity
capital as a percentage of the sum of the debt and ordinary equity capital
(based on market values)
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Calculation of Ke
This sum equals the (US dollar or euro denominated) risk free rate of the foreign country
Ke = (Rfg + Rc) + ß (MRP) + Ri
Where:
Rfg = Global risk free rate (for example equal to the yield on a US T-bond or
German Bond with a maturity date close to the life expectancy of the
investment)
Rc = Country risk premium (for example calculated based on the spread of a
sovereign bond [belonging to the country of investment] over a benchmark
bond, both denominated in the same currency and both with the same
maturity date)
ß = Representative Beta coefficient
MRP = Representative equity market risk premium
Ri = Premium for undiversified investment-specific risks, not accounted for as
part of the forecasted cash flows.
4. Determine the net present value by discounting the cash flows (in US dollar or euro) using the (US
dollar or euro) risk-adjusted discount rate.
5. Convert the net present value to rand using the current spot rate.
Table 3.3.1: Yield spread over US T-bond by bond rating, May 2009 (Bloomberg)
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The general meaning of credit rating opinions is summarised below:
AAA Extremely strong capacity to meet financial commitments. Highest Rating.

AA Very strong capacity to meet financial commitments.
A Strong capacity to meet financial commitments, but somewhat susceptible to
adverse economic conditions and changes in circumstances.
BBB Adequate capacity to meet financial commitments, but more subject to adverse
economic conditions.
BB Less vulnerable in the near term but faces major on-going uncertainties to adverse
business, financial and economic conditions.
B More vulnerable to adverse business, financial and economic conditions but
currently has the capacity to meet financial commitments.
CCC Currently vulnerable and dependent on favourable business, financial and economic
conditions to meet financial commitments.
CC Currently highly vulnerable.
C Currently highly vulnerable obligations and other defined circumstances.
D Payment default on financial commitments.
Additional “+” or “-” ratings are sometimes indicated for finer classification.
Table 3.3.2 Meaning of credit rating opinions (Standard & Poor’s, 2018)
Activity 3.3.2
Attempt the following illustrative example and compare your answer to the suggested solution.
Foreign investment
Assume you are the financial manager of a large South African firm who is contemplating an investment
in Brazil.
You have already gathered or estimated the following information:
• The investment has a life expectancy of 3 years.
• Forecasted net cash flows per annum: Million Million Million Million
Years from now 0 1 2 3
Forecasted net cash flows
(currency: Brazilian real) (4) 3 5 7
• Rates
1 USD 8.13 ZAR Spot

1 USD 1.83 BRL Spot
1 USD 2.10 BRL Forward rate (1 year)
1 USD 2.31 BRL Forward rate (2 years) - estimated
1 USD 2.49 BRL Forward rate (3 years) - estimated
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Acronyms used:
USD = US dollar
BRL = Brazilian real
ZAR = South African rand
• Yield on a note with a maturity close to that of project life-expectation

US treasury note 1.2%
• International equity market risk premium 5.0%
• Brazilian bond spread relative to US treasury 2.9% (Based on credit ratings)
• Information specific to the Brazilian investment

o Beta coefficient (estimated) 2.0
o Undiversified investment-specific risk 5.0%
• Other information
o Value of international diversification (rand [million]) 1 (Estimated)
REQUIRED Marks
Perform a quantitative analysis of the proposed Brazilian investment to determine if the
investment will yield a positive net present value. (10)
Investment in Brazil Marks

0 1 2 3
BRL (million) cash flows (4,00) 3,00 5,00 7,00
Forward exchange rates (USD1 = BRL_) 1,83 2,10 2,31 2,49
USD (million) cash flows (2,19) 1,43 2,16 2,81 (1)
Foreign discount rate

Ke = (Rfg + Rc) + ß (MRP) + Ri
= (1, 2%+2, 9%) [1] + 2(5%) [1] + 5%[1] Marks as indicated in square brackets, total: 3
= 19,1%
19,1% 1,000 0,840 0,705 0,592 (1)
Factors or calculator steps shown
Discounted values (USD

[million]) 2,20 (2,19) 1,20 1,53 1,66 (1)
Spot exchange rate (1USD =
ZAR_) 8,13
Converted to ZAR (million) 17,92 (1)

Value of international
diversification (ZAR [million]) 1,00 (1)
Net present value of Brazilian
investment (ZAR [million]) 18,92
Note: figures may not total due to rounding.

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Correia, C et al. 2011. Financial Management. 7th edition. Juta & Co: Cape Town.
Damodaran, A. 2009. Strategic Risk Taking: A Framework for Risk Management. New York:
Pearson Prentice Hall.
Pereiro, LE. 2002. Valuation of companies in emerging markets. New York: John Wiley & Sons.
Skae, FO. 2017. Managerial Finance. 8th edition. LexisNexis: Johannesburg
Standard & Poor’s. 2018. S&P Global Ratings Definitions [Online.] New York: Standard & Poor’s.
Available from: < https://www.standardandpoors.com/en_US/web/guest/article/-
/view/sourceId/504352> [Accessed 5 July 2018].
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LEARNING UNIT 3.4 - SCENARIO ANALYSIS AND MONTE CARLO SIMULATION
1. Introduction
Traditional discounted cash flow techniques used to evaluate a proposed investment, attempt to
capture the effects of risk and uncertainty into a single figure – a single net present value (NPV) or
internal rate of return (IRR) for the investment. Yet these techniques incorporate several variables,
each subject to a degree of uncertainty. In consequence, by attempting to capture the effects of overall
risk and uncertainty into a single figure, these techniques do not fully highlight the potential effects
these may have. (Traditional discounted cash flow techniques are described in detail in the textbook).
To help address this weakness, an appraiser can employ certain techniques that shed greater light on
the effects of risk and uncertainty. Two such techniques are scenario analysis and Monte Carlo
simulation.
This learning unit is based on the following chapters in your prescribed textbook:
Managerial Finance – 8th edition

• Chapter 6: The investment decision, part 6.7
2. Content
2.1. Scenario analysis
Scenario analysis is an extension of sensitivity analysis performed on a capital investment appraisal.

Firstly, a brief summary of sensitivity analysis: Here we change a single variable in the analysis (whilst
keeping the other constant or independent) and note the outcome on the appraisal, such as the effect
on the investment’s net present value (NPV) or internal rate of return (IRR). We can also plot the results
on a sensitivity graph.
With scenario analysis we determine the outcome of an investment appraisal for different scenarios
(often in three levels, such as best-case, worst-case and intermediate-case). In contrast to sensitivity
analysis, here we have the luxury of assuming interdependence of variables. For example, under a
worst-case scenario, if we assume a smaller market share we can also lower the expected selling price
of the product.
2.2. Monte Carlo simulation
Monte Carlo simulation was developed by nuclear physicists to help solve complex problems
incorporating a fair degree of uncertainty. Practitioners in managerial finance later realised that it would
be helpful also in performing capital investment appraisals, specifically for proposed investments
incorporating a large degree of uncertainty.
A Monte Carlo simulation utilises a computer programme (Microsoft Excel® or a dedicated software
programme) to generate a large number of scenarios (similar to those described in the preceding
section), given probabilities for inputs. A random number is then generated for each of the uncertainties
that, in turn, is input into a formula to generate an outcome for a single scenario. This is then repeated
for thousands of scenarios.
Before we explore the intricacies of Monte Carlo simulation, let’s assume that regular discounted cash
flow analysis was performed on two investments. Further assume that this analysis revealed an
expected internal rate of return (IRR) of 9,2% for Investment X and an IRR of 10,3% for Investment Y.
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Based on these internal rates of return only, a financial manager will typically choose Investment Y,
due to its higher IRR (if this is in excess of the company’s weighted average cost of capital).
A paper on risk analysis in capital investment, written by David Hertz as long ago as 1964, highlights
the additional insight that could be obtained through Monte Carlo simulation. Table 3.4.1 shows the
results of a Monte Carlo simulation performed by Hertz for two proposed investments, Investment X
and Investment Y, based on thousands of scenarios. If assumptions are aligned, the peak of the
distribution plotted for each investment should equal the results of a regular discounted cash flow
analysis. (Notice that the peak of the distribution plotted for Investment X equals the 9,2% IRR
described earlier and likewise, the distribution plotted for Investment X equals the 10,3% IRR described
earlier.) However, Monte Carlo simulation offers additional insight into the two investments. For
example, Table 3.4.1 reveals the following:
• Investment X has a one-in-twenty chance of a negative IRR, and a one-in-fifty chance of an IRR in
excess of 30%.
• Investment Y has a one-in-ten chance of a negative IRR, and a one-in-hundred chance of an IRR
in excess of 30%.
Table 3.4.1 Results of a Monte Carlo simulation: Various possible internal rates of return for two
proposed investments (Hertz, 1964:96)
Activity 3.4.1
Assume you are the financial manager of the company considering the two investments for which a
Monte Carlo Simulation was performed in Table 3.4.1. Further assume that the company has a
weighted average cost of capital equal to 9%, with enough funds only for a single investment.
Would you recommend Investment X or Y, given the following information?
1. The company is neither risk averse nor an extreme risk taker and aims to maximise expected
returns from investments.
2. The company is risk-averse and wants to avoid a loss-making investment where possible.
3. The company favours an investment with a greater possibility of becoming a “shooting star” (by
offering great returns).
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1. Investment Y. This investment has the higher expected internal rate of return (10, 3% per annum
vs 9,2%).
2. Investment X. The expected internal rates of return of the two investments do not differ
considerably (9,2% vs. 10,3%) and Investment X has half the chance of incurring a loss (1/20 vs
1/10 chance).
3. Investment X. The expected internal rates of return of the two investments do not differ
considerably (9,2% vs. 10,3%) and Investment X has double the chance of earning an exceptional
return of 30% per annum (1/50 vs 1/100 chance).
QUESTION 1 45 MARKS (68 MINUTES)
Attempt question 6-6 in chapter 6 of Managerial Finance, 8th edition, without referring to the suggested
solution. Compare your answer to the suggested solution and establish reasons for differences.
Compare your answer to the suggested solution in the textbook and establish reasons for differences.
Hertz, DB. 1964. ‘Risk analysis in capital investment’, Harvard Business Review, 42(1): 95–106.

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LEARNING UNIT 4 – SOURCES AND FORMS OF FINANCE AND FOREIGN

FINANCE
LEARNING OUTCOMES
After studying this learning unit, you should be able to do the following:
• Further apply your knowledge and skills achieved through your prior learning (see below) to a
scenario, on an integrated basis.
• Detail the most prominent forms of foreign finance available to business entities in South Africa
and, for each, further detail the typical business users, sources of finance or investors, and
associated requirements.
• Determine the most appropriate form of finance for a South African business entity, given a specific
narrative, by performing appropriate calculations for various financing options (including foreign
finance) and consideration of other relevant factors.


Finance,
8th edition
Sources and forms of finance
• Identify potential sources of funds on an intermediate level. • Chapter 7,

• Critically assess the suitability of different forms of finance to different types including
of business entities, different types of assets financed and different intended Appendix 1
purposes. • MAC4861
• Describe the role, characteristics, advantages and disadvantages of TL102
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.
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INTRODUCTION
Finance (funding) represents the lifeblood that enables a business to grow, expand, thrive, and
sometimes, merely survive. Raising finance is therefore a very important aspect for any business
enterprise. The aim of the financing decision is to decide on the best 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).
LEARNING UNIT TITLE
LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE AND THE FINNACING
DECISON
LEARNING UNIT 4.2 SOURCES AND FORMS OF FOREIGN FINANCE
LEARNING UNIT 4.3 QUANTITATIVE ANALYSIS OF FOREIGN FINANCE, BASED ON
DISCOUNTED CASH FLOW
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LEARNING UNIT 4.1 SOURCES AND FORMS OF FINANCE AND THE

FINANCING DECISON
1. Introduction
The subject of this learning unit has already been introduced as part of the introduction above.
This learning unit is based on the following chapter in your prescribed textbook (Managerial Finance,
8th edition):
• Chapter 7: The financing decision
2. Content
2.1. Alignment with strategic objectives
Successful development of strategy requires a clear understanding by the strategic planning team of
perceived future capital limitations. If the strategy being formulated exceeds those limitations, the need
for additional sources of capital becomes itself a strategic issue and the process of considering
strategic alternatives begins.
2.2. Interaction between the finance and investment decisions
The financing decision normally takes place after a capital investment appraisal, where the investment
appraisal indicated that a particular investment should be made (usually accompanied by a positive
net present value).
The only exception is where there is a particular cheap form of finance available and this form of finance
is directly linked to the particular investment (e.g. a favourable leasing option of a particular asset). In
this case the finance decision can influence the outcome of an investment decision, because here the
cheap finance and asset are intricately linked. In such a case the favourable asset-specific finance can
provide an additional advantage, which may turn a capital-investment decision’s negative net present
value, into a positive.
Perform the required part (f) of Question 3 (Insimbi Limited) which can be found in the Question Bank.
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REQUIRED Marks
(f) Determine if Insimbi Limited’s proposed bond issue would represent a cost effective
form of debt finance to the company (for 8 marks), and critically evaluate the
appropriateness of the bond issue on matters besides cost, by considering the
company’s circumstances and operating environment (for 4 marks). You are
required to show the full impact of income tax in your calculations. (12)

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LEARNING UNIT 4.2 - SOURCES AND FORMS OF FOREIGN FINANCE
1. Introduction
Raising finance is a very important aspect for any business enterprise. In deciding on a form of finance,
an enterprise should consider several factors, including the following:
• suitability to the type of business and/or asset financed

• true cost
• impact on cash flow
• constraints associated with the form of finance, including the effect of debt covenants
• impact on the overall risk profile
• how it pairs with existing finance
• availability
The present financial crisis has not only restricted the access to finance for many business entities, but
placed renewed focus on the risk of using excessive debt finance.
For the new, smaller business it is often a case of using whatever form of finance is available, at
whatever cost. In contrast, a larger business – with a track record – can often apply more of the
knowledge and skills highlighted in this learning unit, to secure the right form of finance, at the right
time, and at the right cost. Under certain circumstances, foreign finance will provide the right match to
such a business enterprise.
In this learning unit we explore the specialist field of foreign finance, as it applies to the South African
business entity.
Now study the following subsections in Managerial Finance (8th edition) and attempt the activities
included therein (if any):
Chapter Subsection
7 7.16 Foreign Finance
2. Content
Foreign finance is increasingly important to the larger business entity, especially firms earning foreign
income and those with operations in other countries. However, when contemplating the use of foreign
finance, it is important that a business consider not only the related benefits (e.g. natural hedging
opportunities and diversification of the sources of finance), but also the additional risks (e.g. foreign
exchange exposure).
2.1. Sources and forms of foreign finance
Notwithstanding the effects of the financial crisis, several forms of finance are nonetheless available to
the South Africa business, from several sources – local and foreign. It is important to place sources
and forms of foreign finance within the greater context of the financing field. The more common forms
of foreign finance include debt financing in the form of:
• foreign currency loans

• medium-term notes, issued in a foreign currency
• foreign bonds
• eurobonds
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Sources of foreign debt finance include:
• South African development finance institutions (DFIs), such as the Industrial Development
Corporation (IDC)
• foreign DFIs
• foreign banks
• foreign institutional and retail investors
Certain foreign investors may also invest directly in the equity of South African businesses, which is
referred to as “foreign direct investment”.
2.2. Detailed description of specific forms of foreign finance
a) Foreign bonds
A foreign bond is a bond issued by an entity to investors in a foreign country, in the currency of that
foreign country. For example, foreign bonds, may be issued by a South African business to investors
in the UK bond market, in pound sterling (Emery, Finnerty & Stowe, 2007). Foreign bonds may also
be listed on foreign securities exchanges in order to promote their liquidity on the secondary market.
b) Eurobonds
Eurobonds represent bonds issued by an entity to European investors, denominated in a currency

other than that of the entity’s home country or country of issue (Levinson, 2006). For example, a South
African business may issue euro-denominated Eurobonds to investors in the UK. Eurobonds are
frequently denominated either in euro, US dollar or Swiss francs. (The name Eurobond is derived from
the European investors to which it is issued, not the euro currency). Eurobonds are frequently listed
on the London Stock Exchange and is subject to less regulation as it is issued only to institutional
investors, not retail investors (London Stock Exchange, no date).
2.3. Uses of foreign finance
Foreign finance is used predominately by large companies, for the following reasons:
• To obtain access to finance, where local sources of finance is limited.

• To diversify the sources of finance.
• To refinance existing debt.
• Foreign finance may be more affordable than local finance.
• To act as a natural hedge, where the company earns foreign income.
2.4. Additional considerations when using foreign finance
A South African business using foreign finance has to take cognisance of additional considerations,
including:
• Foreign exchange risks and associated cost of hedging this risk.

• South African Reserve Bank requirements.
• Credit rating agency reviews and ratings (This is normally only required where credit risk is not
intrinsically assessed by the debt provider, such as a foreign bank. An example where it may be
necessary is before a foreign bond issue; this function is then typically performed by one of the
three main rating agencies, which are Standard & Poor’s, Fitch and Moody’s.)
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LEARNING UNIT 4.3 - QUANTITATIVE ANALYSIS OF FOREIGN FINANCE,

BASED ON DISCOUNTED CASH FLOW
1. Introduction
The aim of the financing decision is to decide on the best financing option for a particular investment,
as planned by a particular business. In choosing the best financing option several factors have to be
considered, including:
1. Financing options: what are the available options, including foreign finance options?
2. Capital structure: does the business have capacity for more debt; how close is the business to its
optimal (target) capital structure; and is there an opportunity to move closer to the target level?
3. Cost considerations: which viable financing option is the most cost effective?
4. Impact: what is the impact of each viable choice of finance on the business (e.g. the impact on
control, and the impact of conditions and debt covenants)?
5. Matching: is there a proper match between expected investment cash inflows and finance cash
outflows?
6. Other benefits: does the financing option allow for other benefits, such as the opportunity to form
a natural hedge to foreign exchange risk? (For example, a company earning income from foreign
operations in US dollar, for instance, may opt to also take out a foreign loan denominated in US
dollar.)
2. Content
2.1. Determining the most cost-effective form of finance
When comparing the cost of several viable financing options, it is important to compare like to like.
Therefore, a financial manager should attempt to compare the cost of different financing options where
these have similar conditions, security requirements and covenants. If the options are not directly
comparable in this way, these factors should be adjusted for in the calculation (which may involve a
great deal of subjective adjustment, which in turn, will reduce the reliability of the results).
In deciding on the most cost-effective form of finance, you should calculate and compare the following
for each viable finance option
• the net present cost/ internal rate of return of the associated finance-related cash flows (including
the implications of taxation), using an appropriate risk-adjusted discount rate;
This process is fairly simple when comparing, for example, different loan options denominated in rand.
However, foreign debt finance introduces further complications as foreign finance exposes a business
to the effect of foreign currency movements, which normally have an additional cash flow implication.
We therefore have to incorporate the effect of expected foreign currency movements into the
discounted cash flow analysis.
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a) Determining the net present cost / internal rate of return of foreign debt finance
When a South African business wishes to incur foreign debt finance, an evaluation of this financing
option will require certain adjustments to be made, including adjustment for the effects of changes in
exchange rates and foreign exchange risk.
Author, Luis E Pereiro (2002), detailed adjustment methods that can be used when evaluating foreign
debt finance in a book on valuation in emerging markets. Although this publication is written from a US
perspective, the methods are equally relevant in a SA perspective. More specialised methods are
available, but the description in this section is based on the simplified method described by Pereiro
and we therefore acknowledge the contribution made by this author.
A financial manager of a South African business, determining the net present cost (NPC) or internal
rate of return (IRR) of foreign debt should preferably make use of the following method.
Suggested method
(This method is adjusted for a SA perspective and slightly adapted. According to this method the effects
of changes in exchange rates and foreign exchange risk are incorporated in the exchange rates used
to convert the foreign currency to the home currency.)
You should apply the following steps:
1. Project the financing-related cash flows in the foreign currency.
2. Project the applicable taxation effect of the financing cash flows, but express as a foreign currency.
3. Total the financing-related cash flows.
4. Convert the total cash flows into rand using a forecast spot exchange rate at each time interval,
based on (in order of preference):
a. Forward exchange rates published by banks (normally only available for a 12-month horizon
and only for major currencies).
b. Relative interest rates, using the International Fisher Effect, based on this formula:
(ZAR/FC)t = (ZAR/FC)0 x (1+rt)t

(1+rFt)t
Where:
(ZAR/FC)t = the exchange rate of South African rand compared to the
foreign currency at time t
(ZAR/FC)0 = the current spot exchange rate
rt = the spot South African interest rate at term t (often determined based
on the yield to maturity of an appropriate South African government
bond)
rFt = the spot foreign country interest rate at term t (often determined
based on the yield to maturity of an appropriate foreign government
bond)
(Variables in italics are usually provided in an examination.)
5. Determine the NPC by discounting the forecast total rand-converted cash flows using an appropriate
discount rate (usually the risk-adjusted after-tax cost of new debt); or determine the IRR based on
the initial rand-equivalent loan advance and forecasted total rand-converted cash flows.
(We demonstrate the use of this method in the activity below.)

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b) Quantitative analysis of foreign finance: other important procedures
In cases where a business elects not to hedge the foreign exchange risk or is unable to do so, it is
important to perform additional procedures to explore the effects of risk and uncertainty. These
procedures may include:
• sensitivity analyses, based on changes in the forecast spot exchange rates

• allocating probabilities to different outcomes such as “optimistic”, “expected” and “pessimistic” to
weigh the effect of uncertainty on forecast cash flows (refer to learning unit 3.4 for more detail on
this technique)
• a Monte Carlo simulation (refer to learning unit 3.4 for more detail on this technique)
Activity 4.3.1
Construction and mining group
The management of a construction company, listed on the JSE recently approved the investment in a
R770 million mining fleet by a subsidiary company (Newco).
This investment will allow the group to enter the contract mining market.
The management has been in discussions with various parties regarding the financing of this fleet. The
company has received two proposals but has not yet made a final decision on which option to pursue.
Details of the proposals are as follows:
1. A loan by the group’s usual commercial bankers
The bank is prepared to advance a five-year loan of R770 million to Newco, secured by means of a
notarial bond over the fleet. The loan will bear interest at an effective annual rate of 8,65%. (This is
deemed to be Newco’s pre-tax cost of new debt.)
2. €70 million Eurobond
The second alternative is that Newco issue a €70 million Eurobond. The Eurobond will be secured by
means of a notarial bond over the fleet. The bond will have a fixed coupon of 5,65% per annum payable
annually in arrears. The Eurobond will be listed on various European bond exchanges. The bond will
be redeemable five years after issue at the par value of €70 million.
Other market information:
• The current R : € exchange rate is 11,00 : 1,00.

• The 12 month forward R : € exchange rate published by a bank is 11,70 : 1,00.
• Recent data on government bonds are as follows:
Maturity date Latest yields

(years from now) South Africa Eurozone
2 years 6,3% 0,4%
3 years 6,5% 0,5%
4 years 6,8% 0,8%
5 years 7,0% 1,1%
You can assume that:
• Newco’s tax rate is 28% per annum.

• No other hedging instruments are available to Newco.
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REQUIRED Marks
(a) Determine the most cost-effective form of finance to be used by Newco to finance the
fleet investment. (10)
(The example is based on the 2011 Qualifying Examination, Part 2, question 2: updated, adapted and
requirement changed [SAICA, 2011].)
Determination of net present cost (NPC) and internal rate of return (IRR) Marks
A loan by the group’s usual commercial bankers
As the loan’s effective annual rate of 8,65% per annum is equal to Newco’s pre-tax cost of new debt
(kd before tax), this rate will dictate the loan’s NPC and IRR. (NB: This is a specific condition with a
specific outcome).
kd of Newco = 8,65% x 0,72 = 6,228%. (1)

Therefore:
IRR/YR of this loan = 6,228%; and
NPC of this loan = (R770 000 000) (equal to the loan amount advanced, but negative)
Due to the lack of transaction fee and other complicating factors, a simplified calculation has been
shown in the suggested solution for the SA taxation effect.
Students should specifically refer to Tutorial Letter 102 of MAC4861 (available under Additional
Resources on myUnisa) to ensure they are up to date with the impact of Section 24J of the Income
Tax Act on the financing decision. In this regard, you should let the wording in the required-section and
the number of allocated marks guide you towards using a “short” or “long” approach. The superior
approach, when there is a transaction fee involved, is the long approach as described in chapter 7 of
the prescribed textbook.
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Eurobond Year 0 1 2 3 4 5 Marks

Interest (EUR) 5.65% (3 955 000) (3 955 000) (3 955 000) (3 955 000) (3 955 000) (1)
SA taxation effect (28% on interest) (stated in EUR) 1 107 400 1 107 400 1 107 400 1 107 400 1 107 400 (1)
Redeem bond (EUR) (70 000 000) (1)
Finance-related cash flows (after tax) (EUR) 0 (2 847 600) (2 847 600) (2 847 600) (2 847 600) (72 847 600)
Forecast spot exchange rate (see below) 11,70 12,33 13,09 13,86 14,61
Finance-related cash flows (after tax) (ZAR) 0 (33 316 920) (35 110 908) (37 275 084) (39 467 736) (1 064 303 436) (1)
IRR/YR 10.16%C5 Calculator steps shown (1)

NPC, discounted at: 6.228% 1,0000 0,94137 0,88618 0,83422 0,78532 0,73927 (1)
Discount factors / calculator steps shown
NPC (911 379 616) 0 (31 363 595) (31 114 588) (31 095 792) (30 994 611) (786 811 030)
Note: your answers may differ due to rounding differences.
Determination of forecast spot exchange rate (ZAR/EUR):
Current spot rate (ZAR/EUR)0 = 11,00

Forward exchange rate (ZAR/EUR)1 11,70 not available not available not available not available (1)
Based on relative interest rates (ZAR/EUR)t 12,33C1 13,09C2 13,86C3 14,61C4
Increase in exchange rate 6,4% 5,4% 6,2% 5,9% 5,4%
(11,70-11,00) (12,33-11,70)
Example calculation 11,00 11,70
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Conclusion Marks
The loan by the group’s usual commercial bankers will represent the most cost
effective form of finance, as it has the lower NPC (compare its NPC of –
R770 000 000 to – R911 379 616 of the Eurobond) and the lower IRR (compare (1)
6,228% to 10,16%).
Calculations
Calculation 1 – 4 based on:
(ZAR/EUR)t = (ZAR/EUR)0 x (1+rt)t

(1+rFt)t
C1
(ZAR/EUR)2 = 11,00 x (1+6,3%)2)/(1+0,4%)2 = 12,33 (1)
C2
(ZAR/EUR)3 = 11,00 x (1+6,5%)3)/(1+0,5%)3 = 13,09 (1)
C3
(ZAR/EUR)4 = 11,00 x (1+6,8%)4)/(1+0,8%)4 = 13,86 (1)
C4
(ZAR/EUR)5 = 11,00 x (1+7,0%)5)/(1+1,1%)5 = 14,61 (1)
Calculation 5: Calculator steps (e.g. HP10bII) -
1 P/YR
CF0 CF1 CF2 CF3 CF4 CF5

770 000 000 (33 316 920) (35 110 908) (37 275 084) (39 467 736) (1 064 303 436)
IRR/YR = 10,16%
Available marks 13
Maximum marks 10
Focus notes
• The effect of changes in foreign exchange (or associated hedging costs) often has a significant
impact on the NPC/IRR of a financing option.
• When determining the forecast spot exchange rates, we make use firstly of published forward
exchange rates and, where this is not available, we use the effect of relative interest rates applying
the International Fisher Effect, as shown.
• A simple reasonability check to the forecast spot exchange rates is to compare the difference
between the interest rates in the two currency zones for a specific year to the increase in the forecast
exchange rate for that year; these two percentages should be comparable, but not necessarily equal
to one another. (For example, the difference in the yield percentages for year 5 is 5,9%
[7,0% - 1,1%], the increase in the forecast exchange rate for year 5 is 5,4%.)
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Perform the required parts (b) (c) (d) and (e) of Question 21 (Cloth Group) which can be found in the
REQUIRED Marks
(b) Calculate and determine which debt instrument (euro denominated bond or the
syndicated loan) will be the most cost effective way for Cloth Group Ltd to raise
medium-term finance. (15)
Ignore all tax implications.

(c) Identify and describe the key factors that Cloth Group Ltd should consider in
evaluating which debt instrument to issue. (6)
(d) Assuming that Cloth Group Ltd elected to enter into the syndicated loan agreement,
discuss the key factors and issues that Cloth Group Ltd should consider in
evaluating whether to change from a floating interest rate to a fixed interest rate. (5)
(e) Briefly describe the concept of asset-backed securitisation and indicate what
benefits, if any, could accrue to Cloth Group Ltd from securitising its trade (5)
receivables.
Solution to Question 1
Emery, DR, Finnerty, JD and Stowe, JD. 2007. Corporate Financial Management. 3rd edition. New
Jersey: Pearson Education.
Levinson, M. 2006. Guide to Financial Markets.4th Edition. London: The Economist.
London Stock Exchange (LSE). No date. A practical guide to listing debt in London. London: London
Stock Exchange.
Pereiro, LE. 2002. Valuation of companies in emerging markets. New York: John Wiley & Sons.
Skae, FO and De Graaf, A. Foreign Finance. Prepared for a future publication in Managerial Finance.
Unpublished.
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PART 1 LEARNING UNIT 5 – DIVIDEND DECISION
LEARNING OUTCOMES
through your prior learning (see below) to a scenario, on an integrated basis, as well as incorporate tax
considerations.

Learning outcome Managerial Finance,

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

• Understand, at an intermediate level, the relevance and irrelevance • MAC4861 TL102
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
INTRODUCTION
Surprisingly, successful companies display widely divergent dividend policies. Here, some companies
choose to pay strong, consistent dividends whilst others choose to not pay any dividends at all. This
may lead one to predict that dividend policy is irrelevant. Yet, statutory requirements, shareholder
preferences and the effect of taxation make this a more complex matter. Besides, regardless of the
policy, you can never please everyone: somewhere, somehow there is likely to be a disgruntled person
in the form of a shareholder, an employee, a director, or… (fill in the blank).
This learning unit refers to inter alia some of 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
8th edition):
• Chapter 14: The dividend decision
2. Content
2.1. Tax implications
In terms of the Income Tax Act, dividends tax is payable on the distribution of profits at a rate of 20%
and share-holders will thus effectively receive 80% of the declared dividend.
Specific exclusions in terms of the Income Tax Act should be considered.
Activity 5.1.1
Attempt question 14-2 in chapter 14 of Managerial Finance, 8th edition.
Solution to Activity 5.1.1
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Perform the required part (d) of Question 1 (Medico Group) which can be found in the Question Bank.
REQUIRED Marks
(d) Discuss the benefits and limitations of MGSA’s current dividend policy. (4)

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LEARNING UNIT 6 – MANAGEMENT OF WORKING CAPITAL
LEARNING OUTCOMES
1 PRIOR LEARNING ASSUMED


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

and total working capital, and suggest improvements. • MAC4861 TL102
• 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.)
INTRODUCTION
Working capital management involves the management of current assets and current liabilities with the
aim of maintaining these at efficient levels. But what do we mean by efficient levels? To paraphrase a
fairy tale, these levels are not too low, not too high, but just right. Why is this important? Maintaining
levels of working capital that are too high are expensive (it may generate insufficient returns) and it
may negatively affect the entity’s cash flow; levels that are too low may result in lost opportunities. 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
This learning unit is based on selected sections of the following chapters in your prescribed textbook
(Managerial Finance, 8th edition): Chapter 9: Working capital management.
2. Content
Activity 6.1.1
Attempt question 9-3 in chapter 9 of Managerial Finance, 7th edition, without referring to the suggested
solution.
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.
Perform the required parts (c) and (e) of Question 14 (Ithemba Engineering) which can be found in the
REQUIRED Marks
(c) Estimate and conclude on the impact that the introduction of the proposed
settlement discount for customers could have on the profits and cash flows of
Ithemba. (12)
(e) Discuss how Ithemba should account for the 10% settlement discount that the
Board of Directors is considering. (4)

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Perform the required part (k) of Question 1 (Medico Group) which can be found in the Question Bank.
REQUIRED Marks
(k) Critically assess MGSA’s credit policies and procedures in respect of trade
receivables, supporting where appropriate your comments with calculations. (12)

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LEARNING UNIT 7 – TREASURY FUNCTION
LEARNING OUTCOMES


Finance,
8th edition
• Discuss the role of the treasury function. • Chapter 15

• Integrate your knowledge of the workings of foreign exchange and • Chapter 16
interest rates. • MAC4861
• Identify risks related to foreign exchange and interest rates. TL102
• Identify and discuss hedging techniques and risk management.
• Analyse various derivative instruments that are available to mitigate risks
• Develop and evaluates 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.
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 is based on the following chapters in your prescribed textbook (Managerial Finance,
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
learning assumed’. 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 7.1.1
Attempt question 15-5 in chapter 15 of Managerial Finance, 8th edition, without referring to the
suggested solution.
Activity 7.1.2
suggested solution.
Activity 7.1.3
suggested solution.
Solution to Activity 7.1.3
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Perform the required part (i) of Question 1 (Medico Group) which can be found in the Question Bank.
REQUIRED Marks
(i) Explain, with supporting calculations, how the currency option could be used to
hedge against exchange rate movements with regard to the machine purchased for
the production of ZDT. (8)
In your answer you should make use of the quoted rates and premiums. Assume a
spot rate in the currency market of ZAR10,9/€1 on the strike date.
QUESTION 2 7 MARKS (11MINUTES plus reading time)
Perform the required part (b) of Question 14 (Ithemba Engineering) 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
REQUIRED Marks
(b) Explain how forward and option contracts could be used to hedge Ithemba’s current
and future exposure to movements in foreign currencies. (7)
Skae, FO. 2017. Managerial Finance.8th edition. LexisNexis: Johannesburg.

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2 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

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
finance difficulty
5. Dividend decision 10. Valuations
capital
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LEARNING UNIT 8 – ANALYSIS AND INTERPRETATION OF FINANCIAL

AND NON-FINANCIAL INFORMATION
LEARNING OUTCOMES


8th edition
• Clearly distinguish between the different objectives and areas of • Chapter 8
analysis (including the ratios/calculations suitable to the different • MAC4861 TL102
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, and environmental,
social and governance factors as part of your analysis.
INTRODUCTION
Analysis and interpretation of information are important functions of financial management. These tasks
are essential as they form the basis for a better understanding – an understanding that could then be
used for several purposes. Perhaps unsurprisingly, the traditional focus of these endeavours was on
financial information; however, these days, non-financial information is starting to assume more weight
– specifically, where this relates to matters of sustainability, and environmental, social and governance
factors.
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 the
calculation and comparison of ratios within the entity over time, within the industry/similar entities as
well as the discussion of, and conclusion on, the calculated ratios.
The wider scope of this topic also requires analysis and interpretation of non-financial information,
including information on sustainability, and environmental, social and governance matters. Additional
material on the integrated report and KING IV in Learning Unit 1.1, and in your prior learning.
8th edition):
• Chapter 8: Analysis of financial and non-financial information
2. Content
At an applied management accounting level, students should not expect too many marks solely for
being able to calculate a ratio. More important is to understand and interpret the ratio, trend and cash
flows which are supported by possible and credible reasons for unexpected variances. A discussion of
an entity’s financial position must be logical and structured and should add value and should not only
indicate an increase or decrease in the ratio.
3. Self-Assessment question
Attempt question 8-2 in chapter 8 of Managerial Finance,8th edition, without referring to the suggested
solution.

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Perform the required part (b) of Question 3 (Isimbi) 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
REQUIRED Marks
(b) Analyse (for 18 marks) and interpret (for 16 marks) the performance of Insimbi
Limited for the year 2012, including a comparison with the market/competitors, in
the following three categories: Operational, social and environmental. (You are not
required to address the effect of fluctuations in the exchange rate for this part.) (34)

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LEARNING UNIT 9 – BUSINESSES IN DIFFICULTY
LEARNING OUTCOMES

3
Finance,
8th edition
• Identify tools that can be utilised to measure performance of an organisation • Chapter 13

• Identify and advise financially-troubled businesses (at a basic knowledge • MAC4861
level). TL102
• 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 financial difficulty, the severity
of the situation and the potential for the success or failure of the recovery
plans.
• 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 these businesses, in the form of sound advice and with
assistance in using the appropriate 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 with 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
8th edition):
• Chapter 13: Financial distress
2. Content
The activity below and the integrated self-assessment at the end of this tutorial letter will help you to
apply your knowledge.
3. Self-assessment question
suggested solution.

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LEARNING UNIT 10 – VALUATIONS
LEARNING OUTCOMES
In addition, after studying this learning unit, you should be able to
• use a range of skills to perform, and professionally present, business and equity valuations using
a model based on EVA®/MVA


Finance,
8th edition
• Perform a valuation of convertible securities • Chapter 11:
• Display an understanding of the complexities and uncertainties • MAC4861
underlying the various valuation approaches, methodologies, methods TL102
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.
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INTRODUCTION
Valuations is not only fascinating, but pervasive: it incorporates several principles learnt in preceding
learning units and further serves as a springboard of knowledge to later learning units. In order to
master the learning outcomes of this learning unit, you will thus require a strong foundation in your prior
learning and the preceding learning units included in this tutorial letter, including, but not limited to: the
cost of capital, capital investment appraisal and sources and forms of financing. In turn, this learning
unit of valuations will serve as an introduction to further, more advanced learning units, such as mergers
and acquisitions.
As a Chartered Accountant you may one day perform professional valuations, but even if you don’t,
your skill set will still demand a good understanding of valuation principles.
In this learning unit you will learn a couple of new methods/models of valuation, but mainly, you will be
dealing with more complex valuations. In short, you will be enhancing and applying your prior learning.
LEARNING UNIT 10.1 VALUATIONS

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LEARNING UNIT 10.1 - VALUATIONS
1. Introduction
A successful Applied Management Accounting student is required to display advanced knowledge and
engagement in the topic of Management Accounting. In addition to this demanding requirement, you
will also have to show that you are able to apply your knowledge to complex scenarios (as implied by
the title of the course).
2. Content
The content within this learning unit builds on the concepts introduced in your prior studies and in the
preceding learning units of this tutorial letter. Some new concepts and valuation models (i.e.
EVA®/MVA.) will also be learnt.
This learning unit 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, be advised that combined revision of prior learning and new
study required for this learning unit will be based on all subsections of this chapter (i.e. no subsection
is to be excluded; Appendix 2 of chapter 11 is for noting only, but the valuation outlines in Appendix 1
of chapter 11 may be very helpful).
Perform the required parts of practice question 11-2 in the Managerial Finance (8th edition) textbook.
Perform the required parts of practice question 11-3 in the Managerial Finance (8th edition) textbook.

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Perform the required parts (e) and (g) 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
(e) Identify five key valuation issues applicable to the valuation of South African business
entities that are to be considered specifically given the current economic crisis. (5)
(g) Determine the fair value of the enterprise of Movies (Pty) Ltd as at 31 August 2010
based on the information and projections provided by the directors, and other relevant
information of this company, using a discounted cash flow approach.
Marks will be allocated as follows:
(i) Calculation of a weighted average cost of capital. (7)

(ii) Determination of value by calculating free cash flows. (7)
Refer to the suggested solution to this part in the Question Bank

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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 Part 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
parts.
Tutorial Letter 102

3. Cost of capital and financial and non- 12. Business plans
capital investment financial information and financial
appraisal 9. Businesses in difficulty proposals
4. Sources and forms of 10. Valuations
finance
5. Dividend decision
capital
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LEARNING UNIT 11 – MERGERS AND ACQUISITIONS (M&A’s)
LEARNING OUTCOMES
‘additional resources’ on myUnisa). It is also essential to have mastered the outcomes of learning unit
10 (Valuations) before attempting this learning unit.

Finance,
8th edition
• Analyse the risks and financial implications of a merger, acquisition, • Chapter 12

proposed start-up, strategic alliance or divestiture, including: • MAC4861 TL
102
• 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.
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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 an extraordinary phenomenon with a
combined effect greater than the sum of the parts – a synergy effect.
8th edition):
• Chapter 11
• Chapter 12
2. Content
o 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 topic of valuations (learning unit 17). 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.
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 value of the target (normally 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 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.
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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).
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 (10)
and 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 (5)
maximum 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)
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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 825 000 (1)
(1+ (2 x 5%))
• 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)
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 3 773 496

associated costs
(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.
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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)
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)
✓ Self-Assessment questions
Perform the required parts (b) (c) (d) and (f) of Question 9 (X) Factor Holdings which can be found in
the Question Bank. The relevant required part is repeated below.
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REQUIRED Marks
(b) Recommend a maximum bid price in Australian Dollar that Countryside could offer
for 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. (21)
Motivate the appropriateness of this valuation method, the recommended price, the
components of your calculation, and any adjustments made.
(c) Describe some of the factors that would influence the eventual purchase price
that Countryside is likely to pay for Bedazzled (excluding the effect of synergy) (3)
(d) Draft a formal letter to the directors of Countryside, describing the risks to the
company paying for acquisition synergy-benefits, without first performing detailed
supporting calculations and without creating a roadmap to its realisation. (3)
(e) Describe the limitations of a valuation method based on (any) earnings multiple, in
the case of Bedazzled. (3)
(f) Indicate the potential sources of synergy should Countryside acquire Bedazzled.
Incorporate knowledge of these companies and general knowledge of the clothing
industry in your answer. (6)

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LEARNING UNIT 11.2 OTHER CONSIDERATIONS

1. Introduction
Befitting the complicated nature of M&A, 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
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.
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.
▪ If the assets of the target are encumbered as security, consent by the holders of the security is
not required.
▪ 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
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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.
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)
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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.
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 later 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:
(a) return on assets

(b) profitability
(c) earnings per share
(d) 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).
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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
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.
Perform the required part (h) of Question 1 (Medico Group) which can be found in the Question Bank.
The relevant required part is repeated below.
REQUIRED Marks
(h) Draft a memo to the management accountant of MGSA discussing:
✓ Possible reasons why the Acti-Pharm acquisition may not be successful. (5)
✓ The advantages and disadvantages of carrying out a post-acquisition review
with regard to the purchase of an interest in Acti-Pharm. (3)

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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
Ltd
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.
Skae, FO. 2017. Managerial Finance. 8th Edition. LexisNexis: Johannesburg.

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LEARNING UNIT 12 – BUSINESS PLANS AND FINANCIAL PROPOSALS
LEARNING OUTCOMES
After studying this learning unit, you should be able to further apply your knowledge and skills
achieved through your prior learning (see below) to a scenario, on an integrated basis.

It is important to realise that this learning unit relies heavily on the learning outcomes achieved in prior
learning units, including the function of financial management, strategy, risk management, sources of
finance, valuations, and the treasury function. It is thus important that you have achieved the necessary
learning outcomes before attempting this learning unit.

8th Edition
• Interrogate your knowledge of the purpose and audience of a
business plan/proposal in their preparation, on a basic level. • Chapter 2:
• Develop new business plans and financial proposals. Sections 2.7 to 2.9
• Analyse existing business plans and financial proposals. • MAC4861 TL102
• In preparing business plans and financial proposals, identify and
address:
o the business strategy and strategic plan

o strengths and weakness 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.

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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. 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 your business plan. As a finance professional you
may well one day be instrumental in the compilation of these important documents.
LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS

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LEARNING UNIT 12.1 BUSINESS PLANS AND FINANCIAL PROPOSALS

1. Introduction
This learning unit is based on the following subsections in Managerial Finance, 8th edition, chapter 2:
• Chapter 2: Sections 2.7 to 2.9
2. Content
3. Self-assessment question
Perform the required part (m) of Question1 (Medico Group) which can be found in the Question Bank.
REQUIRED Marks
(m) Draft a memo to the management accountant of MGSA describing matters to be
included in the business proposal under the headings of:
• Industry analysis (3)

• Risk and risk management (2)
Skae, FO. 2017. Managerial Finance. 8th edition. Lexis Nexis: Johannesburg.
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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 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 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 tests of 2018, as presented below.
Integrated question 1
Perform question 6 in the Question Bank (RAPS GROUP LIMITED).
Solution to Integrated question 1
Find the solution in the Question Bank.
Integrated question 2
Perform question 5 in the Question Bank (CASEYWALKERCARMICHAEL SOUTH AFRICA LIMITED).
Solution to integrated question 2
Find the solution in the Question Bank

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TEST 1 (2019)
QUESTION 1 40 MARKS
Ignore Value-Added Taxation
BACKGROUND
Decadent Chocolates Pty Ltd (DC) is a private company that was founded in the early 1990’s in South
Africa by Mr. Williams, who learnt the art of making chocolate in Belgium. Mr. Williams was always
passionate about chocolate making and only uses the finest ingredients in his creations. It didn’t take
a long time for consumers to be impressed with Mr. Williams chocolate making skills and DC quickly
grew into a successful company. Customers appreciate how creative DC is in making chocolate, even
after being in operation for so many years, and trust the quality of their products.
CHANGES TO THE BUSINESS STRATEGY
Two years ago Mr. Williams became ill and handed over the management of DC to his son, Marc.
During this period Marc spent time gaining an understanding of DC’s business operations, processes
and procedures. He indicated that he now knows the business well enough and plans on implementing
changes to the business strategy. Marc would like for DC to utilise technology more within their
manufacturing processes as it is not necessary for them to spend so much of time hand crafting
chocolates when this work can be done by a machine. He is of the opinion that customers will not know
the difference and there is therefore no reason to tell them about the change.
Marc is quite excited about the use of machinery in the manufacturing process as this will enable DC
to increase its output which is in line with his vision. He is therefore trying to secure a contract with X
Ltd, a listed company within the hospitality and food service industry. Marc has heard from one of his
friends, Phillip, that X Ltd is looking for a new chocolate supplier that can fulfil their large demand at a
reasonable price. Phillip works for X Ltd and Marc has persuaded him, by gifting him and his family
with a weekend away, to provide him with confidential information regarding the quotes some of the
chocolate suppliers have provided X Ltd. Marc believes that this will assist him in ensuring that DC
provides X Ltd with the most “appropriate” offer. Marc is determined to secure X Ltd as a customer and
is willing to do whatever it takes, including utilising cheaper ingredients to ensure the contract is
profitable. He feels that since DC products are trusted and the company has a good reputation, X Ltd
will grant him the contract, if his price is reasonable.
Marc, together with the Operations Manager, have performed some research regarding chocolate
manufacturing machinery and have found a machine which they consider appropriate for DC. The
machine costs R800 000 and can be utilised for a period of 4 years. A capital allowance for taxation
purposes of 25% can be claimed on the machine and it is expected to have no value after 4 years. It
will cost DC R13 200 a year, in real terms, to maintain the machine.
FUNDING OPTIONS
The Financial Manager presented the following two funding options to Marc:
Option 1
Obtain a loan from DC’s bank for R 800 000 for a period of 4 years (2020-2023). Transaction costs
amount to 2.5% of the value of the loan and is payable immediately. The loan will bear interest at 3.5%
above the prime interest rate and is repayable, in arrears, in equal annual instalments, comprising
capital and interest. The loan qualifies as an instrument and is deductible for taxation purposes in terms
of Section 24J of the Income Tax Act.
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Marc is concerned about the risk relating to this option carrying a variable interest rate but the Financial
Manager has indicated that there are instruments that can mitigate this risk.
Option 2
Lease the asset for a period of 4 years, at an annual cost of R250 000 in 2020 and escalating by a
nominal rate of 6% annually. The lessor will bear the maintenance costs.
ADDITIONAL INFORMATION
1. The South African corporate tax rate is 28%.
2. South Africa’s prime interest rate is 10,25% and is expected to remain the same.
3. The South African inflation rate is 5,1%.
REQUIRED Marks
Sub- Total
total
(a) Determine the most cost effective funding option for Decadent Chocolates
based on the Internal Rate of Return of each option. 18
Communication: Presentation and layout 1 19
(b) (i) Discuss the factors that should be considered in deciding between a
fixed interest rate and a variable interest rate. 5
(ii) List four derivative instruments that can be utilised to hedge against
interest rate volatility. 2
(iii) Explain to Marc what entering into an interest rate swap agreement
would entail and how it can be utilised to hedge against increasing
interest rates. 7 14
(c) Comment on Marc’s behaviour from an ethical point of view and the potential
impact this could have on DC. 6
Communication: logical argument 1 7

TOTAL 40
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TEST 1 – SUGGESTED SOLUTION (2019)
1. DetermineRthe most cost effective funding option for DC.

PV 800 000 1/2r/w
I/YR 13,75% 1/2r/w
N 4 1/2r/w
FV 0 1/2r/w
PMT R -273 157,93 1c
Please note that marks for calculator inputs above are only given if PMT is calculated.
Option1 2019 2020 2021 2022 2023
Present value 800 000 1/2r/w
Issue costs -20 000 1/2r/w
Tax on issue costs 5 600 1/2r/w
Payments -273 158 -273 158 -273 158 -273 158 1c
1c for x
Tax on interest 28% 30 800 24 518 17 373 9 245 by 28%
S24J accrual amount (A=BXC) 110 000 87 566 62 047 33 019 2r/w
Pre-tax yield to maturity (B) 13,75% 13,75% 13,75% 13,75%
Adjusted initial amount (C) 800 000
Total cashflows 780 000 -236 758 -248 640 -255 785 -263 913
After tax RR 10,76% 1c
Alternative to S24J interest calculation
Calculator inputs must be shown
1INPUT 2ndF Amort = interest of 110 000 (1/2r/w)

2INPUT 2ndF Amort = interest of 87 566 (1/2 r/w)
3INPUT 2ndF Amort = interest of 62 047 (1/2 r/w)
4INPUT 2ndF Amort = interest of 33 019
ALTERNATIVE (1/2 r/w)
1INPUT 2ndF Amort = interest of

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The following cash flows can be included in Option1 but then should not be included in
Option 2 (Refer to shaded area in Option 2):
Maintenance costs (13,873) (14,581) (15,324) (16,106)

1r/w
1c for x by
Tax @28%
59 884 60 083 60 291 60 510 28%
Maintenance costs (13,873) (14,581) (15,324) (16,106)
1/2r/w
Wear and tear (200 000) (200 000) (200 000) (200 000) 1r/w
Option 2 2019 2020 2021 2022 2023

Present value 800,000 1r/w
Lease payments -250,000 -265,000 -280,900 -297,754 2r/w
Maintenance savings 13,873 14,581 15,324 16,106 1r/w
Taxation 10,116 14,117 18,361 22,861 1c 28%
Lease payments -250,000 -265,000 -280,900 -297,754 1/2r/w
Maintenance savings 13,873 14,581 15,324 16,106 1/2r/w
Wear and tear forfeited 200,000 200,000 200,000 200,000 1r/w
Total cashflows 800,000 -226,011 -236 302 -247,215 -258,787
IRR 7,91% 1c
The most cost effective option is the lease 1c
Commentary:
The following applies to the loan:
1. Since the 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
2. Many students don’t seem to understand what S24 J entails an how it is accounted for. 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 in calculating IRR
The following applies to the lease:
3. It is important to read the information carefully to know when escalation/inflation

MAX 18applies
4. Since with the lease, maintenance costs are not incurred, these costs represent a saving
that is relevant when comparing the two alternatives. Based on the same principle, the tax
benefit of wear and tear is forfeited. However, it is important to note that 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 IRR analysis
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(i) Discuss the factors that should be considered in deciding between a fixed interest rate and a
variable interest rate.
(ii) List four derivative instruments that can be utilised to hedge against interest rate volatility.
(iii) Explain to Marc what entering into an interest rate swap agreement would entail and how it can
be utilised to hedge against increasing interest rates.
(i)
1. The differential cost between the two rates: (1)

The fixed rate is traditionally higher that the variable rate. (1)
2. Certainty that comes with a fixed interest rate: (1)
Will the company be able to meet their loan obligations should interest rates increase? (1)
3. Are there any hidden fees/costs with the fixed interest rate? (1)
4. Consider the timespan of the funding (long term vs short term) (1)
5. Historical trends and future projections regarding movements in variable interest rates:
(1)
interest rates have been fairly stable with the prime interest rate staying constant at 10.25
since July 2017 until March 2018 when it was cut by 25 basis points to 10%. (1)
MAX 5
Commentary:
Once again it is important to read the required carefully. In this section you were required to
discuss the factors to consider in deciding between fixed and variable rates. Many students limited
(ii) discussion to explaining what a fixed and variable rate is rather than how you would go about
their
choosing between the two rates and therefore performed poorly within this section.
1. Forward rate agreements (½)

2. Interest rate futures contracts (½)
3. Interest rate option contract (½)
4. Interest rate swap agreements (½)
5. Interest rate cap (½)
6. Interest rate floor (½)
7. Interest rate collar (½)
MAX 2
(iii)
Since DC has a variable interest rate loan but wants a fixed interest rate, they would need to
identify a suitable counterparty to the swap agreement that has a fixed rate loan but would prefer
a variable interest rate. (1)
This counterparty would typically be a related party or a Bank. (1)
The counterparties to the swap agreement would need to agree on the following:
1. fixed interest rate (½)

2. variable interest rate (½)
3. notional amount (½)
that will apply to the agreement

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DC and the counterparty will then swap cash flows (but not legal obligations per the original loan
agreements) in terms of their swap agreement (1)
DC would therefore be exchanging its payments at a fixed rate applied to a notional amount, for
a series of receipts determined at a variable interest rate. (1)
Should interest rates increase, the receipts received by DC from the counterparty will also
increase and this can be used by DC to service the increased interest cost on their original
loan with their Bank. (1)
Both parties must benefit from the swap agreement and therefore the overall gain is shared
between the counterparties (1)
MAX 7
Commentary:
The majority of students do not know what an interest rate swap is and how it works. It is important
for students to have an understanding of how and when the various derivate instruments are used.
This is adequately explained in the prescribed textbook.
(c) Comment on Marc’s behaviour form an ethical point of view and the potential impact this
could have on DC.
1. Marc intends on changing the manufacturing process from hand crafted to machine
manufactured without informing customers, (1)
2. He also is willing to utilise cheaper ingredients to secure a contract (1)
3. this is unethical as he is not being transparent with his customers/misrepresenting DC’s
products (1)
4. He is breaching the trust that customers have in DC’s products (1)
5. Marc has obtained confidential information from his friend in exchange for a gift (1)
6. He is gaining an unfair advantage over other suppliers (1)
7. This amounts to a bribe which is unethical and illegal (1)
Impact:
The potential impact of the above described unethical behaviour could be as follows:
In the long term customers may lose confidence in DC’s products (1)
this will not only lead to financial loss (½)
but also reputational damage and (½)
also potential legal action (½)
MAX 6
Communication: logical argument 1
MAX:7
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TEST 2 (2019)
QUESTION 1 40 MARKS
Ignore the impact of section 8 of the Income Tax Act

PART A
Ukuzwa Ltd trading as UKU, is in the broadcast sector, specialising in content distribution for television
and Video on demand (VoD). UKU was formed in 1994 and listed on the Johannesburg Stock
Exchange (JSE) in 2000.
Extract of the Statement of financial Position of UKU as at 28 February 2019
Notes 2019 2018
R’000 R’000
Share Capital 1 750 500

Retained Earnings 134 928 126 753
Non-redeemable preference shares 2 1 000 1 000
Total Equity 136 678 128 253
Non-Current liabilities
Long-term borrowing 4 6 000 8 000
Current Liabilities
Overdraft 3 613 1 412
Trade Creditors 2 451 3 137
Short-term portion of long-term borrowings 4 2 000 2 000
Accrued Interest 917 1 146
Current tax payable 490 392
Total Liabilities 12 471 16 087
Notes
1. Ordinary share capital as at 28 February 2018 comprises 5 000 000 shares at 10c per share.
The closing market price on 28 February 2018 was R55 per share. On 1 June 2018 UKU
announced a 25c per share bonus share issue, to existing shareholders, at a ratio of 1:10. In
December 2018 UKU issued a further 500 000 shares at 25c per share, all these shares were
taken up. The closing price of the shares as at 28 February 2019 was R 65 per share.
2. Non-Redeemable preference shares were issued on 30 June 2015, consisting of

1 000 000 shares with a nominal value of R1 per share. The shares carry a fixed dividend of
11%, which is payable annually arrears. The required rate of return on these shares is 8%.
3. UKU has an overdraft facility of R5 million with Digital Bank, which is utilised to fund operational
requirements.
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4. On 1 March 2017 UKU obtained a loan for R140 million from Digital Bank. The loan bears
interest at 12.5% per annum (pre-tax). The capital is expected to be settled in equal annual
instalments, in arrears, over a period of 5 years. Similar loans bear interest at a rate of 13.25%
(pre-tax). This loan qualifies as an instrument and is deductible for taxation purposes in terms
of Section 24J of the Income Tax Act.
Potential Acquisition
In the past UKU has grown organically, however from 2015 its strategy has been to diversify its portfolio
and acquire content creation companies. During the current year (2019) UKU approached, one of these
content creation companies, Umalusi (Pty) Ltd (UMA), to purchase 51% of their shares for R 50 million.
UMA is a television content creation company that focuses on South African movies. The company
was incorporated in 2011 by Kagiso, a film student, with the mission of telling untainted South African
stories in native languages. UMA focuses on a wider market, compared to most of its competitors as
their movies are translated into the nine official languages.
Extract of profit or loss and other comprehensive income for the year ended 28 February of
UMA (Ltd):
Notes 2019 2018 2017
R’000 R’000 R’000
Revenue 1 100 251 80 250 78 992

Cost of Sales (75 188) (60 188) (59 244)
Gross Profit 25 063 20 062 19 748
Operating Expenses 2 (11 278) (9 028) (4 937)
Operating profit 13 785 11 034 14 811

Other Income 3 42 55 55
Finance Costs 4 (180) (203) (225)
Profit before tax 13 647 10 886 14 641
Notes
1. UMA's accountant erroneously included profit on sale of equipment in the revenue account for
the period ended 28 February 2019. The cost of the asset was R500 000, the carrying amount
at the date of sale R150 000 and the proceeds on sale amounted to R600 000.
2. Operating expenses include the following:

(i) Entertainment expenses of R420 000 for 2019 and R120 000 for 2018. SARS requested
supporting documents for these expenses, but the accountant was unable provide this as
they did not represent business related expenditure (private in nature).
(ii) Depreciation on filming equipment of R 800 000 for 2019; R1 000 000 for 2018 and
R1 200 000 for 2017. Depreciation should be calculated at a rate of 25% per annum on
cost but UMA has calculated it at 20% per annum on cost.
(iii) Salaries include payments to Kagiso’s wife, who is not an employee of UMA, of R870 000
per annum.
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3. Other income relates to fair value adjustments on speculative investments. The market value
of the investments as at 28 February 2019 is R1 500 000.
4. Finance costs relates to interest on long term borrowings.
Additional Information
5. The average capital gearing ratio for the industry in which UKU operates is 40%.
6. UKU’s working capital management has been poor compared to industry standards, as the
debtors cycle is 60 days and the creditor’s cycle is 30 days.
7. UKU has been paying dividends consistently since 2001. Based on their strategy to expand
through acquisition, the company announced during 2018 that they will not pay a dividend
during the current and future financial years. The share price decreased significantly as a result
of this news. In order to rectify the situation UKU announced a rights issue.
8. The earnings yield of a similar JSE listed company as UMA is 9%.
9. The size of the similar JSE listed company is on average twice the size of UMA, and these
organisations have a higher cash holding than UMA.
10. In 2019 UMA received an award for its advanced level of innovation by the National Film and
Video Foundation (NFVF).
REQUIRED MARKS
Sub- Total
total
(a) 1. Calculate the capital gearing ratio of UKU as at 28 February 2019. 11
2. Recalculate UKU’s capital gearing ratio assuming UKU funds the

acquisition of UMA by means of a loan, 1
Assume the market value of the new loan to be R38 720 000.
3. Discuss the impact the new loan will have on UKU’s capital gearing
ratio. 5
Communication skills- logical argument 1 18
(b) Calculate the fair market value of a 51% shareholding in UMA as at

28 February 2019. Utilise the P/E multiple method of valuation. 16
Communication skills- layout and structure 1 17
(c) Discuss the factors that could possibly limit UKU and UMA from realising
post-merger synergies. 5
TOTAL 40
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(a)
(i) Calculate the capital gearing ratio of UKU as at 28 February 2019.
(ii) Assuming UKU obtain the R 50 million loan from Digital Bank, calculate the impact this
will have on UKU capital gearing ratio. Assume the market value of the new loan to be
R 38 720 000
(iii) Discuss the impact this will have on this will have on UKU’s capital gearing ratio.
Commentary:
Most students lost marks due to the following mistakes:
Calculation of capital gearing ratio:
• Capital gearing ratio should be based on market values, some students used book
values.
• The formula for calculating capital gearing ratio is Market Value of Debt / Enterprise
Value, where Enterprise Value = Sum of Market Value of All Capital (i.e. Debt + Equity +
Preference Shares).
o Some students confused the capital gearing ratio with the debt-equity ratio.
o Other students included items that do not form part of the permanent capital
structure (e.g. current liabilities and bank overdraft).
• The capital gearing ratio is a percentage (%).
Discussion of impact of debt financing on capital gearing ratio
• Many students failed to discuss the impact,

• The discussion had to centre around how the capital gearing ratio will change because of
debt financing and what impact will this change have on the business
Valuation of loan: present value of future cash flows

Many students made the following principle errors:
• Not applying sec24J interest deduction on which the interest tax shield is calculated for
inclusion (tax cash flows) in the analysis (3 marks).
• Not calculating the annual payment (PMT) for inclusion in the cash flow analysis (4
marks).
• Some students valued the loan in 2017. The required value was for 28 Feb 2019 thus
only future cash flow until the end of the loan term (from 2020 to 2021) had to be
included in the analysis.
• Not accounting for tax: Remember that after tax cash flows should be discounted at an
after-tax discount rate (3 marks).
Valuation of equity: market capitalization method

Some students valued the shares at their issue prices instead of the current market value of
R65.
Valuation of preference shares

The preference shares were NON_REDEEMABLE, thus students had to value using the
formula:
Market Value = Annual Coupon in Rands / Annual Market Rate of Return on Similar Preference
Shares.
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(i)
Market value of Debt
Marks should only be awarded if PMT is calculated
R'000
PV 140,000 0.5 r/w
I/YR 12.50% 0.5 r/w
N 5 0.5 r/w
FV 0 0.5 r/w
PMT R -39,320 1c
2019 2020 2021 2022

R'000 R'000 R'000 R'000
Payments (39,320) (39,320) (39,320) 1C
Tax on interest 28% 3,277 2,311 1,223 1C
S24J accrual amount (A=BXC) 11,704 8,252 4,369 2r/w
Pre-tax yield to maturity (B) 12.5% 12.5% 12.5%
Adjusted initial amount (C) 93,633
Total cashflows 0 (36,042) (37,009) (38,097)
Discount rate (13.25*0.72) 9.54% 1r/w
NPC 92,731 1C

Calculator inputs must be shown 2r/w
Market Value of Equity using Market Capitalization Method (R’000)
R’000
Market Value (MV) of Share Capital 2019
Opening Balance: Number of shares issued 5 000
Bonus Shares Issue 500
Share issue 500
Closing Balance: Number of shares issued 6 000 1r/w
Market Price per share R 65
Market Value of Equity R 390 000 1c
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Market Value (MV) of Non-redeemable preference shares (R’000)

𝑁𝑜𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 𝑋 𝐶𝑜𝑢𝑝𝑜𝑛 𝑅𝑎𝑡𝑒
𝑀𝑎𝑟𝑘𝑒𝑡𝑉𝑎𝑙𝑢𝑒 =
𝑀𝑎𝑟𝑘𝑒𝑡 𝑅𝑎𝑡𝑒
𝑅 1 000 𝑋 11%
= = 𝐑 𝟏 𝟑𝟕𝟓 𝟏𝐫/𝐰
8%
Bank overdraft not included in capital gearing ratio calculation 1r/w
Capital gearing ratio before acquisition

𝑪𝒂𝒑𝒊𝒕𝒂𝒍 𝑮𝒆𝒂𝒓𝒊𝒏𝒈 𝑹𝒂𝒕𝒊𝒐 =
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡
𝑀𝑉 𝑜𝑓 𝐷𝑒𝑏𝑡 + 𝑀𝑉 𝑜𝑓 𝐸𝑞𝑢𝑖𝑡𝑦 + 𝑀𝑉 𝑜𝑓 𝑃𝑟𝑒𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑆ℎ𝑎𝑟𝑒𝑠
92 731
=
92 731 + 390 000 + 1 375
= 19% 1C
MAX 1
MAX 11
(ii)
Capital gearing ratio post debt financing of acquisition
92 731 + 38 720
=
92 731 + 38 720 + 390 000 + 1 375
= 25% 1C
Alternative to new capital gearing ratio
92 731 + 38 720
=
92 731 + 50 000 + 390 000 + 1 375
= 24,61% ≈ 25% 1C
MAX 1
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(iii)
Discuss the impact the new loan will have on UKU’s capital gearing ratio.
Capital gearing ratio after the loan caused the gearing ratio to increase from 19% to 25%.
Indicating an increase in financial risk 1
Although UKU’s ratio has increased, it is still lower than the industry average of 40%.
1
This may be an indication that the industry is optimally geared and has invested in
profitable projects, whereas UKU had a lower financial risk appetite, as in the past the
1
focus has been on organic growth rather than acquisitions.
The proposed debt funding is significantly higher (77% = 38 720 / 50 000) than the
current gearing ratio (19%) and industry standard (40%). 1
The increase in financial risk will increase the expected return on equity as investors
will expect a higher rate for the higher financial risk. 1
UKU may find it difficult to fulfil capital and interest repayments for the following 1
reasons: ½
Existing long term loans have recently been granted (i.e. they are at inception), UKU
would therefore have to make interest and capital repayments on this loan for 3 more ½
years. ½
UKU may be experiencing cash flow problems as their working capital management is
poor ½
UKU’s decision to replace dividend with a rights issue could also be indicative of cash
flow problems
UKU has to pay 11% divided annually on the non-redeemable shares
Other valid point MAX 1
Communication Skills: logical argument 1

MAX 6
Commentary:
Most students lost marks in the discussion question due to:
• Listing factors instead of discussing

• Not benchmarking /comparing the ratio to industry
• Not focusing their discussion on the impact the loan will have on:
o gearing ratio
o financial risk
o required return to shareholders
o cash flows
Students are advised to study the required carefully and thoroughly to determine what has been
asked and plan their solution accordingly to improve their performance in future assessments.
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(b)
Calculate the fair market value of a 51% shareholding in UMA as at 28 February 2019, based on
the P/E multiple method of valuation
Commentary:
Determination of maintainable earnings
Many students did not normalise the earnings to arrive at sustainable maintainable earnings:
• Most students did not remove the profit on sale of fixed asset from revenue to determine
maintainable revenue.
• Many students did not calculate the normalised maintainable gross profit of 25% to
remove the impact of incorrect accounting entry (recognition of profit on sale of fixed
asset in revenue) to determine maintainable gross profit.
• Adjustment for non-core business expenses (payment of salary to wife of business owner
and reversal of entertainment expenses) were performed incorrectly, instead of being
reversed they were double counted.
• Correction of accounting depreciation understatement.
• Conclude on appropriate maintainable earnings to be used for valuation: In this scenario
the earnings did not show an upward trend, thus weighted average earnings had to be
used in the valuation.
Determination of maintainable price earnings ratio
Many students did not:
• Correctly convert the earnings yield to earnings multiple.

• Students also confused earnings yield (i.e. %) to earnings multiple (i.e. number of times).
This distinction is essential in valuations:
o Value of equity = Maintainable Earnings X PE Ratio

o Value of equity = Maintainable Earnings ÷ Earnings Yield
Equity value calculations
Most students did not adjust for the following on the equity value:
• Non-core assets (R1,5million) that had to be valued separately.

• Marketability discount since UMA is an unlisted equity.
• Control premium to account for value of control because majority is being value (i.e.
greater than 50% of control).
• Calculation of equity value being at 51%.
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Calculate Maintainable Earnings for UMA
2019 2018 2017

Revenue 100 251 80 250 78 992
Adjustment for profit on sale of Asset
(450)
(600-150) 1r/w
Adjusted Revenue 99 801 80 250 78 992
Cost of Sales (74 851) (60 188) (59 244)
Gross Profit at 25% 24 950 20 062 19 748 1c for 25%
Operating Expenses (11 278) (9 028) (4 937)
Adjustments
Decrease Entertainment 420 120 1r/w
Increase Depreciation from 20% to
25%. (200) (250) (300)
2019: (8 000 / 20% X 25%) - 8 000 1r/w
Decrease Salaries 870 870 870 1 r/w
Adjusted Operating expenses (10 188) (8 288) (4 367)
Operating profit 14 762 11 774 15381
Finance Costs (180) (203) (225) 1r/w
Taxation @ 28% (4 083) (3 240) (4 244) 1c
Profit after tax 10 499 8 331 10 912
Maintainable earnings have no trend therefore weighted average 1
Weight 3 2 1
Weight* PAT 31 497 16 662 10 912
Sum of Weight* PAT 59 071
Sum of Weight 6 1r/w

Weighted Average 9 845 1c
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Alternative Solution: Starting at Profit before tax
2019 2018 2017

R'000 R'000 R'000
Reverse: Non-recurring items
Reverse: once-off profit on sale of assets (450) 1r/w
Impact of reversal on cost of sales 337 1C
Normalisation of gross profit @ 25% (113)
Accounting error correction (200) (250) (300) 1r/w
Reverse: Current Depreciation 800 1 000 1 200
Charge: Correct Depreciation (1 000) (1 250) (1 500)
Reverse: Non-core business items
Reverse: entertainment expense 420 120 1r/w
Reverse: Kagiso's wife salary 870 870 870 1r/w
Reverse: Other income (42) (55) (55) 1r/w
Normalised profit before tax 14 582 11 571 15 156
Taxation @ 28% (4 083) (3 240) (4 244) 1C
Maintainable profit after tax 10 499 8 331 10 912
Maintainable earnings have no trend, therefore use weighted average 1r/w
Weights 3 2 1
Weightings 31 498 16 662 10 912
Sum of Weightings 59 072
Sum of Weights 6 1r/w
Weighted Average 9 845 1C
Calculations: Alternative Solution
Normalisation of Gross profit (113)

Reverse: Current Gross profit (25 063)
Adjusted Gross profit @ 25% 24 950 = 99 801 X 25%
Adjusted Sales (100 251 - 450) 99 801
Reduced sales (450) = 600 - 150

Reduced cost of sales 337 = 75 188 - (99 801 * 75%)
Effect on gross profit (113)
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Adjust the comparator P/E multiple
Earnings yield percentage 9%

P/E Multiple (1/9) 11 1r/w
Adjustments to Price Earnings Ratio

Size of the JSE comparator is twice that of UMA - 1
Innovation of UMA + 1
Access to markets + 1
UMA has less cash holdings than comparator - 1 4 Max
UMA has less controls (salaries for relatives) -
Other Max1 1
Adjusted PE multiple 10
Value of 51% equity share holding of the entity

Maintainable earnings 9 845
Adjusted P/E multiple 10
98 450 1c
Add Market Value of Investment 1 500 1r/w
99 950
Add Control Premium @ (99 950*5%) 4 998 1c
Less Marketability of discount (99 950* 7%) (6 997) 1c
Value at 100% 97 951
Value at 51% 49 955 1c
MAX 16
Communication skills- layout and structure: 1
MAX 17
(c)
Discuss the factors that can hinder UKU and UMA from realising post-merger synergies
UKU and UMA although in the same industry have different objectives and therefore 1
different business/operating models. (UMA is a content creation organisation and UKU
is a distributor). Obtaining alignment may be challenging.
UKU's management skills might not be the best fit for UMA (Culture Difference). 1
UMA's employees may be threatened by the acquisition and UMA may lose skilled
employees, making it difficult for the organisation to realise expected benefits. 1
Financial information of UMA may not be accurate and therefore not in line with UKU’s
expectations as the information is based on non-audited financial statements. 1
The integrity of UMA’s management may be problematic and hinder performance as
they seem to be inflating business expenses. 1
UMA's financial systems, processes and reporting may not be at a standard required
by the JSE, thereby requiring UKU to incur additional costs to improve this 1
Economic climate (unfavourable change in interest rates, taxes, growth) negatively
impacting customer base. 1
Any valid point MAX 1
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MAC4861 - 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.
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• The BSP product is expected to have a 4-year product lifespan.

• 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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(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)
Total cash flows -404,17 -414,36 -425,71
Kd (12*0.72) 8,64% 1r/w
NPC (1 055,11) 1c
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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MAC4861 - 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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MAC4861 - 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
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Calc 3: Market value of Investment
23 307/11%
= 211 882 1r/w
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

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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MAC4862/102/0/2020

Tutorial letter 102/0/2020

Department of Financial Intelligence

This tutorial letter contains important information

APPLIED 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 29

LEARNING UNIT 3 COST OF CAPITAL AND CAPITAL INVESTMENT

LEARNING UNIT 4 SOURCES AND FORMS OF FINANCE 47

LEARNING UNIT 5 DIVIDEND DECISION 60

LEARNING UNIT 6 MANAGEMENT OF WORKING CAPITAL 63

LEARNING UNIT 7 TREASURY FUNCTION 66

TABLE OF CONTENTS (CONTINUED) PAGE

PART 2 – FUNCTION OF FINANCIAL MANAGEMENT 69

LEARNING UNIT 8 ANALYSIS AND INTERPRETATION OF FINANCIAL AND

LEARNING UNIT 9 BUSINESSES IN DIFFICULTY 73

LEARNING UNIT 10 VALUATIONS 75

PART 3 – MERGERS AND ACQUISITIONS AND BUSINESS PLANS 79

LEARNING UNIT 11 MERGERS AND ACQUISITIONS 80

LEARNING UNIT 12 BUSINESS PLANS AND FINANCIAL PROPOSALS 93

TEST 1 (2019) – MAC4862/NMA4862/ZMA4862 97

TEST 1 (2019) – MAC4861/NMA4861/ZMA4861 114

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

1. Strategy and governance 8. Analysis and 11. Mergers and

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 Applied 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 Managerial

THIS LEARNING UNIT CONSISTS OF THE FOLLOWING SUB LEARNING UNITS:

LEARNING UNITS TITLE

LEARNING UNIT 1.1 STRATEGY AND GOVERNANCE

LEARNING UNIT 1.2 PUBLIC SECTOR

LEARNING UNIT 1.1 - STRATEGY AND GOVERNANCE

• Chapter 1 (Sections 1.2 to 1.6)

2.1. The impact of technology on strategy

2.1.1. Robotic Process Automation (RPA)

1. Operational accounting (billing and collections, accounts receivable)