HIGHER EDUCATION PROGRAMMES

Academic Year 2024: January - June

Summative Assessment 1: Principles of Strategy, Risk and Financial
Management Techniques (HFMN230-1)
NQF Level, Credits: 6, 12
Weighting: 60%
Assessment Type: Examination
Stationery: Black/blue pen/calculator
Pass requirement: 50%
Examiner: E. Slabbert
Educator E. Slabbert
Due Date: 4 June 2024
Total: 100 marks
Duration: 3 hours

Instructions:
1. This examination script consists of 19 pages, including the cover sheet. Ensure that you
have all the pages.
2. This examination consists of Essay-Type questions.
3. No answers in pencil will be marked.
4. Consult the HE Invigilated Assessment Event Rules carefully.
5. Answer all questions.
6. Show all calculations.
7. The SAICA Competency Framework Reference at the end of a question is for
recordkeeping and will inform you which SAICA Competency is covered in the question.
8. Good Luck!

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QUESTION 1 (54 marks)

Assume the Giraffe Ltd and Rhino Ltd cases below are separate case studies.

Giraffe Ltd
Giraffe Ltd (“Giraffe”) is a leading hospitality entity with hotels ranging from luxury to
budget hotels which are located across South Africa. Giraffe has a capital structure of
56%:44% debt-to-equity.

Giraffe will be undertaking a construction project in the future during which a theatre
and related entertainment rooms will be built at some identified Giraffe luxury hotels.
To finance this construction project, Giraffe will be utilising the entity’s internal
available funds from the retained earnings.

As Giraffe is not listed on the Johannesburg Stock Exchange (“JSE”) and therefore
the equity beta of the entity is not readily available. Horison Ltd (“Horison”) is a similar
hotel and entertainment entity, operating in the same industry as Giraffe. Horison is
listed on the JSE in the consumer services sector, where it can be observed that an
equity beta of 1.35 is applicable to Horison. From research conducted on Horison, it
was determined that Horison has a capital structure of 123%.

The average return offered in the accommodation sector is 13.7% while the long-term
RSA government bonds offer a return of 8.4%.

A South African Income Tax rate of 27% is applicable to companies.

Rhino Ltd
Rhino Ltd (“Rhino”) is one of South Africa’s largest tourism and leisure entities which
assets include 16 wildlife and other resorts.

Rhino is listed on the JSE in the consumer services sector through which the entity
has issued a total of 42 000 000 ordinary shares to date.

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Rhino’s earnings per share (“EPS”) on 31 May 2024 is R39 and the Price - Earnings
ratio (“P/E ratio”) of the entity is 2.6.

The entity has a dividend policy of 18% of earnings for the ordinary shares and wishes
to continue to meet this policy. Further, Rhino expects a growth rate of 5.2% annually
for the entity and, consequently, the earnings of the entity as well.

Rhino also has 13% corporate bonds with a par value of R110 in issue. There are
28 500 000 such bonds in issue with a maturity date in 4 years times and a current
trading price of R107 per bond. The interest of these corporate bonds is paid semi-
annually in advance.

Additionally, Rhino wishes to issue 41 000 000 non-redeemable preference shares

through the JSE platform. The JSE will however charge a floatation cost of R0.90 per
preference share, to facilitate the issuing of these preference shares. These non-
redeemable preference shares will have an issue price of R50 each and a coupon rate
of 12.6%. Assume the issue price to be reflective of an accurate current value per
preference share.

Assume today is 31 May 2024.

A South African Income Tax rate of 27% is applicable to companies.

REQUIRED:

1.1. Assist Giraffe Ltd in determining the cost of Giraffe Ltd’s retained earnings.
Round to two decimals where applicable.
(12 marks)

1.2. Briefly explain why retained earnings are considered to have a cost (of capital)
for an entity.
(2 marks)

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1.3. Assist Rhino Ltd in determining the required rate of return of the ordinary
shares as on 31 May 2024.
Round to two decimals where applicable.
(8 marks)

1.4. Assist Rhino Ltd in determining what the current required rate of return of the
non-redeemable preference shares will be if these prefence shares were to
be issued today.
Round to two decimals where applicable.
(7 marks)

1.5. Assist Rhino Ltd in determining the annual required rate of return of the
corporate bonds after taxation as on 31 May 2024.
Round to two decimals where applicable.
(12 marks)

1.6. Assist Rhino Ltd in determining the entity’s weighted average cost of capital
(“WACC”), after the non-redeemable preference shares have also been issued.

Assume the following required rates of return:

Ordinary shares 13.2%
Non-redeemable preference shares 14.9%
Corporate bonds 12.5%

Round to two decimals where applicable.

(13 marks)

Competency Framework Reference:

PERFORMANCE MEASUREMENT FOR MANAGEMENT AND OTHER
C1
INTERNAL USERS OF FINANCIAL INFORMATION
Uncertainty, volatility or inaccuracy, and consideration of qualitative
C1.4
factors in decision-making

Perform sensitivity and scenario analyses on key variables affecting the

a)
financial outcome of the decision, and interpret the result of the calculation

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 Incorporate the possibility of various outcomes into the decision-making
b)
process, including the use of probabilities and expected values
Assess alternatives and recommend a course of action, considering both
c) quantitative and qualitative factors, and whether the proposed decision is
consistent with the organisation’s strategic objectives and plans

C2 FINANCING DECISIONS
C2.2 Sources of funds
Demonstrate knowledge of basic corporate funding arrangements, including
a)
how measures in capital and money markets function

A2.3 Implementing strategy

Assess the risk tolerance of the entity’s stakeholders’ and its balance with
d)
opportunity

I Ethics, values and attitudes

I1 Personal ethics

III1 Self-development
III2 Adaptive mind set and agility

Y1 Analytical/critical thinking
Y2 Integrated thinking

Y3 Problem solving

X6 Self-management

W1 Computational thinking
a) Decomposition of problem into smaller sub-problems

b) Find patterns (similarities, shared characteristics) among the sub-problems

c) Determine relevant characteristics and discard irrelevant characteristics

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QUESTION 2 (46 marks)

Livra (Pty) Ltd (“Livra”) is a courier and transport entity that provides services
nationwide across South Africa. Livra’s business has grown significantly over the last
few financial periods, and consequently, a need for an additional delivery truck to
Livra’s current delivery truck fleet exists.

Livra prefers to incorporate the delivery truck brand and model, Kiha Z118 in the
entity’s delivery truck fleet, as the entity has found these delivery trucks to be reliable,
load capacity sufficient and economical on fuel usage. A Kiha Z118 delivery truck
(hereafter referred to as “Kiha Z118”) has a purchase price of R654 500 in the free
market.

After evaluating Livra’s current capital structure and comparing it to the optimal capital
structure for the entity, Livra’s directors decided to finance the acquisition of a Kiha
Z118 with a debt – either by means of a loan or lease.

Debt financing option 1: Loan

Financer Bank is willing to extend the necessary funds to Livra through a four (4) year
loan with an interest rate of 11.7% quarterly compounding attached to the loan. Equal,
annual repayment instalments will be required, payable in advance.

Should Livra wish to borrow the funds and acquire right of ownership of Kiha Z118,
Livra will be required to pay for service and maintenance themselves.

According to Livra’s property, plant and equipment policy, vehicles and thus Kiha
Z118, are to be depreciated over three (3) years on the straight-line basis. Kiha Z118
vehicles qualify under section 11 (e) of the South Africa Income Tax for a wear-and-
tear allowance. Section 11(e) requires the diminishing balance method to be applied,
but for ease’s sake (and exclusively for the purpose of this scenario), the straight-line
method may be used. Further, section 11(e) allows for a 4-year wear-and-tear
allowance period.

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Debt financing option 2: Lease

Omnis Ltd (“Omnis”) is an entity that extends leases for various assets to outside
parties.

Kiha Z118 can be leased from Omnis over a four (4) year period for R138 500 payable
semi-annually in arrears.

According to the lease agreement, the service and maintenance cost of Kiha Z118 is
included in the lease payments.

In order to purchase the Kiha Z118 when the lease comes to an end, a payment of
R37 000 can be made to Omnis. It is Livra’s intention to proceed with such an
acquisition, should Livra opt for lease financing.

Additional information:
• From market research and past experience, it is known that Kiha Z118 trucks
require annual service and maintenance for which amounts to R63 000 per
annual service.
• The South African Income Tax rate applicable to companies is 27%.
• Livra is required to complete and submit tax assessments annually at the end
of each year to the South African Revenue Services (‘SARS”).
• Livra’s target weighted average cost of capital (“WACC”) is 12.9%. Livra
ensures that all financing decisions made are made in line with this.
• Livra’s cost of debt before tax is 12.3%.
• Once the four (4) year anniversary has been reached, Livra will dispose of this
Kiha Z118 for a residual value of R49 300.

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REQUIRED:

2.1. Draft a loan amortization schedule for Option 1, the loan offered by Financer
Bank to Livra (Pty) Ltd.
(13 marks)

2.2. Advice Livra (Pty) Ltd whether the entity should finance the Kiha Z118
acquisition by entering into the lease or the loan agreement. Support your
advice by determining the Net Present Cost (NPC) of both options separately.
(34 marks)

Round to two decimals where required.

Competency Framework Reference:

C2.1 Cash management

Assess alternative cash management solutions in the market and consider
d)
these in relation to the organisation’s strategic objectives
C2.2 Sources of funds
Evaluate possible sources of funding available to the organisation taking into
consideration its size and stage of development (e.g., crowd sourcing for
b) start-up businesses) and identify the most appropriate sources of funding to
achieve its business strategies and objectives, including value creation for
stakeholders
Recommend appropriate funding arrangements after consideration of related
c) consequences, costs, benefits, implications for operational and future
financing decisions and tax, and other legal implications
C3.1 Capital investment appraisal
Review investment appraisals in accordance with the strategic objectives of
b) an organisation, including value creation for stakeholders and other non-
financial considerations.

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 To evaluate the alternatives for asset-specific finance: Analyse the cost of
c) asset-specific finance such as a loan, instalment sale and lease, as
alternatives to the organisation’s usual method of financing acquisitions

I Ethics, values and attitudes

I1 Personal ethics

III1 Self-development
III2 Adaptive mind set and agility

Y1 Analytical/critical thinking
Y2 Integrated thinking

Y3 Problem solving

X6 Self-management

X8 Emotional intelligence
Exercise self-awareness and self-discipline; Apply self-reflection and self-
a) awareness skills and techniques to ensure continuous learning and growth.
Accept constructive feedback from others.
Show persistence and resiliency in pursuing goals despite obstacles and
c)
setbacks

W1 Computational thinking
a) Decomposition of problem into smaller sub-problems

b) Find patterns (similarities, shared characteristics) among the sub-problems

c) Determine relevant characteristics and discard irrelevant characteristics

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FORMULA SHEET:

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