University of Fort Hare

Together in Excellence

NKUHLU DEPARTMENT OF ACCOUNTING

FINANCIAL MANAGEMENT 2A
AFM 211E
______________________________________________________________________

MOCK EXAMINATION SOLUTION

ASSESSOR: Mr SM Msakatya

QUESTION TOPICS COVERED MARKS

1 Risk and Return 21

2 Financial Statements Analysis 36

3 Time value of money 6

4 Valuations 25

5 Cost of Capital 27

TOTAL 115
QUESTION 1 21 MARKS

State of the Economy Probability of State of the Economy Return

Boom 30% 30%
Normal 50% 22%
Recession 20% 10%

1. A 
0.09+0.11+0.02 = 0.22

2. D
Probability Deviation Deviation x Deviation Variance
30% 8% 64 19.2
50% 0 0 0
20% -12% 144 28.8
48%

3. B
σ = √48
= 6.93%

4. B

Z = x- x¯ 
σ
= 20 – 24 
8
= -0.5
Therefore 0.5- 0.1915
= 30.85
Part B

Probability of Return Return

State of the Economy State of the
Economy
Mancity Liverpool
Boom 10% 40% 20%
Normal 60% 30% 16%
Recession 30% -20% 14%

Other Share Information:

Mancity Liverpool
Rand value invested R4 000 R6 000
Beta of shares 1.8 0.7
Standard deviation 23.70% 1.70%
Variance 0.0564 0.000276

1) e 

Probability of Return Re Return Re

State of the Economy State of the
Economy Mancity Liverpool
Boom 10% 40% 4.00% 20% 2.00%
Normal 60% 30% 18.00% 16% 9.60%
Recession 30% -20% -6.00% 14% 4.20%
16.00% 15.80%
 
Expected Return portfolio Portfolio Beta

=(0 .4*0.16)+(0.6*0.158) =(0 .4*1.8)+(0.6*0.7) 

0.1588 1.14 

2) a 

Set calculator to Stat 1 Mode

Insert
4 (x,y) 2 Enter
18 (x.y) 9.6 Enter
-6 (x,y) 4.2 Enter
RCL r = 0.76

QUESTION 2 36 MARKS

(1) 2015 2014 Marks

a. Current assets (a) 4,120,000 2,940,000

Current liabilities (b) 2,200,000 1,200,000
Current ratio (a) / (b) 1.87 2.45 1+1

Cash + Mark Sec + Acc rec + Short-

b. term notes + Pre-paid exp. (a) 1,520,000 1,340,000
Current liabilities (b) 2,200,000 1,200,000
Acid-test ratio (a) / (b) 0.69 1.12 1+1

c. Sales (all credit) (a) 16,000,000 12,000,000

Average receivables (b) 1,050,000 750,000 1
Accounts receivable turnover (a) / (b) 15.2 16.0 1+1
In days = 365 days / turnover times 24.0 22.8
d. Cost of goods sold (a) 12,929,600 9,600,000
Average inventory (b) 2,100,000 1,520,000
Inventory turnover ratio (a) / (b) 6.16 6.32 1+1

Average sale period:

365 / inventory turnover 59.28 57.79 1+1

e. Total liabilities (a) 3,700,000 2,700,000

Shareholders' equity (b) 4,300,000 3,900,000
Debt-to-equity ratio (a) / (b) 0.86 0.69 1+1

Net income before interest and taxes

f. (a) 1,130,400 884,000
Interest expense (b) 180,000 180,000
Times interest earned (a) / (b) 6.28 4.91 1+1

g. Net income after tax (a) 648,000 480,000

Total assets (b) 8,000,000 6,600,000
Return on assets (a) / (b) 8.10% 7.27% 1+1

h. Net income after tax (a) 648,000 480,000

Total sales (b) 16,000,000 12,000,000
Net income to sales 4.05% 4.00% 1+1

i. PE ratio 1
Not enough info to calculate for the company
but it is an indicator more for investors that
provides information about future prospects.

20

Report to: Bank Directors

From: A Student 2
Date: May 2016 present

Strengths, weaknesses and recommendations

The company has improved its profit margin from last year. This is attributable to an
increase in gross margin, which is offset somewhat by an increase in operating 1
expenses. In both years the company's net income as a percentage of sales equals or 1
exceeds the industry average of 4%.
Although the company's working capital has increased, its current position actually has 1
deteriorated significantly since last year. Both the current ratio and the acid-test ratio 1
are well below the industry average, and both are trending downwards. Given the 1
present trend, it will soon be impossible for the company to pay its debts as they
become due.

1
The drain on the cash accounts of the company seems to be a result mostly of a large
build-up in accounts receivable (aggressively acquiring customers) and inventory 1
(increased product lines).

The average collection period has increased by 4.6 days since last year, and is now 9 1
days above the industry average.

Many of the customers are not taking advantage of the discount being offered by the 1
company, since the average collection period is 27 days while collection terms are 2/10, 1
n/30.

This could suggest financial weakness on the part of these customers, or sales to 1
customers who are poor credit risks. Perhaps the company has been too aggressive in 1
expanding its sales.

The inventory turnover was only 5 times this year as compared to over 6 times last year.
It takes three weeks longer for the company to turn its inventory than the average for the 1
industry (71 days as compared to 50 days for the industry average). This suggests that 1
inventory levels are higher than they need to be. This could however also be 1
attributable to the increased number of product lines.
Decision:

The loan should be approved on the condition that the company take immediate steps to
1
get its accounts receivable and inventory back under control. This would mean more
1
rigorous checks of creditworthiness before sales are made and perhaps declining credit
to slow-paying customers.

It would also mean a sharp reduction of inventory levels to a more manageable size. 1
If these steps are taken, it appears that sufficient funds could be generated to repay the
1
loan in a reasonable period of time.

Note - marks will also be awarded for a decision to decline the loan, provided the
explanation is logical and makes sense.
TOTAL 19

MAX 14
Question 3

(a) PV = -50 000

i = 4 /12 
PMT = 0
FV = 75 000
COMP n = 121.84 
= 121.84 / 12
= 10.15 years

(b) PV = -50 000

i = 4 /12
PMT = -500
FV = 75 000
COMP n = 35.39 
= 35.39 / 12
= 2.95 years
Question 4

(a) 22

Asset
Property (Given) 1
3,500,000.00
Cash (Given) 1
1,500,000.00
Ordinary Share Calc 1 1
Holdings 1,000.00 12,000.0 12,000,000.00
0
Calc 2 11 500 1
100.00 1,150,000.00
Debentures Calc 3 3839 2
2,000.00 7,678,000.00
0.
25,828,000.00 5

20% portion 1
5,165,600.00

Calculation 1 -
Investpr0
Dividend
1,200.00
Interest 0.1
Value 2
12,000.00

Calculation 2 - Choice Investment

N 1 2 1
FV 550 605 2
I 10 10 1
PV 500 500
(a) (b)
Dividend growth
model

Value = D
(1+g)/(k-g)
= 605 3
(1+0.05)/(0.1- 12 705
0.05)

N 2 0.
5
FV 0.
12 705 5
I 10 0.
5
PV 10 500
(c)
PV = 11 500 (a + b + c) 1

Calculation 3

N 15 0.
5
PMNT 1
400.00
I 9 0.
5
FV 2240 1
PV 3839

PV = 3839

(b) 3
Economic Value 1
Add
Free Cash Flow 1
Price Multiples 1
Question 5

a) Calculate the cost of retained earnings using the

(i) CAPM Risk free rate + (Return on market – Risk free rate) X Beta
= 8% + (15% - 8%) x 1.42 = 17.94% (2)

(ii) GORDON GROWTH RATE

Dividend (1 + g) + Growth rate
Share price

=10.50x40% (1.10) + 10% (1)

85.80
= 17.03% (1)
b)
Share capital
MV = R65.70 (1)
Cost = 17.94% (1)

Preference shares
MV = 11.5%/12.5% x R110 (1)
= R101.20 (1)
Cost = 12.5% (1)

Debentures
MV
N I PV PMT FV
6 (½) 14.5% (½) ? 15.20 (1) 104.50 (1)
PV = 104.68 (1)
Cost 14.5% (1-0.28) = 10.44% (1)

Long term loan

MV
N I PV PMT FV
5 (½) 12% (½) ? 175 000 (1) 1 250 000(1)
PV = 1 340 119.40 (1)
Cost = 12% (1-0.28) = 8.64% (1)

Market values Weight Cost WACC

Share capital 16 425 000 56.43% (½) 17.94% 10.12% (1)
(65.70x250 000)
(1P)
Preference shares 5 060 000 17.38% (½) 12.5% 2.17% (1)
(101.20x50 000)
(1P)
Debentures 6 289 800 21.61% (½) 10.44% 2.26% (1)
(104.68x60 000)
 (1P)
Long term loan 1 340 119 4.58% (½) 8.64% 0.40% (1)
Total 29 105 919 100% 14.95%