Question 1

1. Any 5 business risks that Mercado (Pty) Ltd is exposed to:

* risk of earnings volatility due to exchange rate fluctuations
* risk of exchange rate losses
* risk of product obsolescence/expiry
* risk that demand for luxury expensive items drops with economic downturn
* risk associated with a limited range of products for a specific market
* risk of low customer loyalty due to large range of local substitutes available / high competition Any 5 valid business risks, max 5 marks 5

2. Sources of finance:
* retained income
* new issue of equity
* loan
* new issue of debentures
* new issue of prefs 5

3. Management believes all debt is bad due to the cost of interest.

This is an incorrect perspective on debt because:
*debt is a cheaper form of finance than equity
*debt can be used to fund new assets to generate returns
*this in turn boosts Return on equity
*debt creates a tax shield because interest is tax deductible unlike dividends
Management's decision to repay the debt ahead of schedule has put unneccesary cashflow pressure on the entity. Evaluate validity & completeness
Repaying the debt prematurely has also eliminated the above-mentioned benefits associated with debt. of students anwer, max 5 marks 5

4. 2021 2020
Net profit margin = (70 / 3 790) 1,85% 1,80% *Net profit margin is slightly higher in 2021. Decreased profitability 1
is not the cause of the overall decrease in ROE.
Total asset turnover = (3790 / 2 530) 1,50 1,61 *Sales generated for every R1 of assets has decreased by 10c in 2021. 1
Decreased operating efficiency has contributed to the decreased ROE.
Financial leverage multiplier = (2 530 / 1 350) 1,87 2,15 *The equity multiplier has reduced. 1
*This is due to the repayment of debt.
ROE 5,19% method 6,23% *Debt is offering less leverage in 2021. 1
*This is the main reason for the reduction in ROE in 2021.
* Shareholders earned R1,04 less per R1 of equity than in 2020.
*The reduced ROE is a negative indicator, which is not attractive to
shareholders/investors.
Evaluate validity & completeness
2021 2020 of students discussion, max 6 marks for discussion 6
(given)
5. Inventory holding pd in days = 365 / (2 500/830) 121 128 *The decrease in holding period is not significant. Goods are non- 1
perishable so 4 months holding is satisfactory considering the business
is reliant on shipping systems to obtain stock & avoid stock-out. 1
Receivables coll prd in days = 365 / (3 790/1110) 107 89 *Collection period was already too long and has got worse by 18 days.
This is caused by relaxing credit procedures to encourage sales 1
despite pandemic. This is a big threat to cash flow management.
Payables pmt period in days = 365 / (2 500/800) 117 75 * Collection period has been pushed out by 42 days.
Management is using creditors as a finance source by stalling payments.
Such a long pmt period is unsustainable - creditors will impose interest
or cut credit line which may damage business operations.
NWC cycle = 121+107-117 111 method 142 *Cycle has shortened overall 1
but this is largely due to the unsustainable extension on payables pmt
period.
*Cycle indicates that cash is tied up for over 3 months. This is too long.
Current ratio = (2 000 / 840) 2,38 3,3 *The current and quick ratios are suitable since both indicate that 1
current liabilites can be met in the short term, however since debtors
comprise more than half of CA, this is still a concern as cash is not readily
Quick ratio = ((2 000-830) / 840) 1,39 0,68 available if creditors take a stand. 1
*Despite a reduction in the NWC cycle and suitable current and quick
ratios, the receivables collection period and payables pmt period
evidence a deterioration in cash management in 2021.
Evaluate validity & completeness
of students discussion, max 9 marks for discussion 9

6. *offer customers an early settlement discount.

*offer customers a discount for cash sales.
*reduce extent of cash tied up in stock by ordering smaller quantities more often.
*arrange extended payment terms with suppliers, which may include interest terms similar to an overdraft facility with a bank.
*obtain a revolving credit facility with a bank if the interest is cheaper than that of creditors. Any 3 valid strategies, max 3 marks 3

7. Mercado's Earnings for 2021 70000

Price earnings ratio of Foodies Ltd 25

Adjusted down for
*lack of ready market / transferability -2 (any reasonable adjustment allowed) 1
*smaller business, lack of widespread reputation -2 (any reasonable adjustment allowed) 1
=Reasonable PE multiple 21

Value of total shareholding 1470000 method 1

Value of 50% shareholding 735000 method 1
8.
NAV of Mercado on 31 Dec 2021 = 2530 - 340 - 840 1350000
50% of NAV 675000 method 1

Purchase price as a % of book value of Mercado 109%

Conclusion: Yes, Franco would have been pleased since he received more than the book value of the business. 1

9.
Ordinary shares 410000 55% 0,15 0,08 2
Loan 340000 45% 0,11 0,05 2
750000 WACC = 0,13 1

cost of debt = 15%(1-28%)

Cost of equity = D1/P0 + g
= ((20000/100000)*1,07)/4,1) + 0,1 OR = ((20000/100000)*1,07)/4,1) + 0,07*
*This alternative was allowed because the Neatness and legibility 1
constant growth rate differed to the expected Logical argument and clarity of expression 1
growth in Y1
Total Q1 56
 inflation 0,07
1. Y0 Y1 Y2 Y3
Capex - 345 000 2
Proceeds on sale of fridge 40 000 1
Investment in NWC - 500 000 500 000 2
Pre-tax operating cash flows: - 105 000 720 000 585 504 427 838
Class revenue 1 440 000 1 232 640 988 416 1,5 1,5
Variable costs - 576 000 - 493 056 - 395 712 1,5 1,5
Forgone yoga revenue - 144 000 - 154 080 - 164 866 2
Utensils - 55 000 correct column 1
Other setup costs - 50 000 correct column 1
Tax @ 28% - 151 200 - 131 741 - 87 595 1
Net annual cash flows - 910 000 568 800 453 763 840 243 1
PV factor (@ 12%) 1 0,893 0,797 0,712 1
PV - 910 000 507 882 361 740 598 085
NPV 557 707 1

Conclusion: Accept the project since NPV > 0 1

Tax calculation:
Pre-tax operating cash flows: 615 000 585 504 427 838 1
Wear & Tear new capex - 115 000 - 115 000 - 115 000 method 1
Forgone Wear & Tear fridge 30 000 1
Recoupment fridge 10 000 1
Taxable income 540 000 470 504 312 838
Tax @ 28% 151 200 131 741 87 595 method 1
Layout 1
 Workings:
Revenue per Participants Variable costs
Variable revenues and costs person per year per person
Y1 R500 2 880 -200
Y2 R535 2 304 -214
Y3 R572 1 728 -229

Forgone yoga revenue R100 x 40 people x 3 times per month x 12 months

Capex investment:
Ovens 20000 11 220 000
Fridge room 125 000
Total new capex 345 000
Annual W&T 115 000

2. Initial outflow - 910 000

Recovered in Y1 568 800 1
Subtotal - 341 200
Recovered in Y2 453 763

Payback period = 1 year and 9,02 months method 1

Conclusion: Management should proceed since the payback period is within the acceptable limit of 3 years. 1
3. The agency problem:
An agent is someone who contracts on behalf of a principal.
The CEO, Harold Mkize is the agent of The Beauty Spot.
An agency problem occurs when a conflict of interest arises.
Such a conflict arises when a decision that is good for the business, conflicts with that which is good for the agent, or vice versa.
In this case, Harold is faced with a decision that will benefit him (the discount on coffee machine) but will not necessarily
be in the best interests of the company as cheaper suppliers may be available for the kitchen equipment.
Harold has a duty as a director of The Beauty Spot to put the best interests of the company ahead of his own.
If he accepts the discount he will be contravening the ethical principles contained in the Code of professional conduct of professional accountants.
Appropriate response:
Harold should disclose the conflict of interest to the other directors
and exclude himself from executive team that chooses the supplier.
If the same supplier is chosen, Harold can accept the discount since he did not make the selection. Evaluate validity & completeness
of students discussion, max 6 marks for discussion 7
4. Investment fund balance (annuity due):
PMT 10000 per month in advance 1
interest rate 0,12 per annum compounding annually 1
n 60 12 mths x 5 years 1
FV = Total saved after 5 years = 824864 1

If the student calculates an ordinary annuity, the answer will be 816697 Award 3 marks (i.e. 1 mark penalty)

5. Behavioural finance:
Personal bias can cloud one's judgement and negatively affect the decisions taken on behalf of the company.
In the ethical conflict discussed above, Harold experienced personal bias that was driven by the prospect of a personal financial benefit.
Wrt the share investment, Harold displays personal bias when he expresses his choice to invest in Skin Deep (Pty) Ltd.
He allows his personal feelings and attitudes (excitement, optimism, gut feeling) to direct a decision for the business without diligent investigation.
His strong feelings prompt him to behave in a dominant manner, expressing that the decision has been made by him alone.
This is dangerous because strong emotions can affect sound reasoning and judgement (such as when forecasting anticipated returns) and can ultimately lead to p
Similarly, Doreen allows her prior bad experience investing in a start-up company to mar any possibilty of a future investmnet in a fledgling business.
This could be to her detriment as she may lose out on a good investment by waiting to see if a company succeeds.
Evaluate validity & completeness
of students discussion, max 7 marks for discussion 7
6. Analysis of Skin Deep (Pty) Ltd method method method method 4
Deviation
Probability Rate of return Deviation squared Variance Standard
(a) (b) (b-5%) (c) (a x c) deviation
(axb)
10% -15% -2% -20% 4,000% 0,400%
20% 0% 0% -5% 0,250% 0,050%
40% 5% 2% 0% 0,000% 0,000%
20% 10% 2% 5% 0,250% 0,050%
10% 25% 3% 20% 4,000% 0,400%
Mean return = 5% 0,900% 9,49% 4
accuracy

Comparative information Skin Deep Porefect

Mean return 5% 11%
Standard deviation 9,49% 14%
Coefficient of variation 1,90 1,27 2

Explanation of the result: Porefect exhibits less risk per unit of return than Skin Deep. 1
Conclusion: Porefect should be selected. 1

7. Z score calculation:
Z score = =(10-11)/14
Z score = -0,07 method 1

Reading from Z score table: The area to the left of the z score = 0,47210 of the full bell which has a total area of 1.
This means that the probability that Z<-0,07 is 47,21%. method 1
Conversely, it means that the probability that Z>-0,07 is 52,79%.
Interpretation: This can be interpreted to conclude that there is a 52,79% chance of a return from Porefect that is
greater than 10%. method 1
Conclusion There is more than a 50% chance of achieving a return above 10% per annum from Porefect.
method 1
8. A risk averse investor requires higher reward for exposure to higher risk. He seeks the least risk per equivalent unit of return. 2

Neatness and legibility 1

Logical argument and clarity of expression 1

Total Q2 64