FMA101 Financial Management Study Guide

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The information below was taken from a financial ratio analysis prepared by Canned Foods Ltd to assess its financial performance for 2019. Sales revenue R50 000 000 Gross profit margin 65% Operating profit margin 40% Net profit margin 6% Return on total assets 16% Return on ordinary shareholders’ equity 18% Total asset turnover 4% Average collection period 58 days Number of days in a year 365 Use the ratios and other information provided to calculate the rand value for the following accounts: 1.3.1. Gross profit 1.3.2. Cost of goods sold 1.3.3. Operating profit 1.3.4. Operating expenses 1.3.5. Profit available to ordinary shareholders 1.3.6. Total assets 1.3.7. Total shareholders’ equity Show all calculations.

WELCOME

Welcome to Financial Management (FMA101) for the Bachelor of Business Administration degree. Southern Business School wishes you success in studying this subject and trust that you will find it a most enjoyable and very useful learning experience!

TUTORIAL LETTER 1

ASSIGNMENT 01

Question 1 [33]

• The management of Globe Travel (Pty) Ltd extracted the following information from the accounting records for the financial year ending 30 June 2020:

Depreciation	R25 000
Administration expenses	R220 000
Sales	R3 450 000
Sales expenses	R180 000
Cost of goods sold	R2 550 000
Lease expense	R40 000
Interest expense	R30 000
Dividends on preference shares	R35 000
Dividend per ordinary share	R0.50
Number of ordinary shares in issue	900 000
Tax rate	28%

 

Required:

Use the information provided to calculate the earnings per share (EPS) and the net profit margin.

Show all calculations. (12)

• You are a business journalist reporting on the financial performance of companies. In a recent interview with the CEO of an engineering company, the CEO stated that the company is performing very well at present and because it is using the most modern engineering technology while at the same time keeping its inventory levels low. The CEO stated that the use of state-of-the-art technology coupled with low inventory levels will soon result in the company achieving high profit levels.

The CEO presented the following ratio analysis to support his statements:

	2017	2018	2019	2020
Current ratio	1.30	1.70	1.90	2.10
Quick ratio	1.20	0.80	0.50	0.40

 

Required:

Do you agree with the CEO’s statement about profits? Use the information provided in the table to explain your answer.  (14)

• The information below was taken from a financial ratio analysis prepared by Canned Foods Ltd to assess its financial performance for 2019.

Sales revenue	R50 000 000
Gross profit margin	65%
Operating profit margin	40%
Net profit margin	6%
Return on total assets	16%
Return on ordinary shareholders’ equity	18%
Total asset turnover	4%
Average collection period	58 days
Number of days in a year	365

 

Required:

Use the ratios and other information provided to calculate the rand value for the following accounts:

• Gross profit
• Cost of goods sold
• Operating profit
• Operating expenses
• Profit available to ordinary shareholders
• Total assets
• Total shareholders’ equity

Show all calculations. (7)

Question 2 [32]

Dagmar Suppliers Ltd wants to do a scenario analysis to assess possible profitability for 2021. The company will consider three different sales scenarios. The pessimistic prediction of sales is R840 000, the most likely sales are R1 125 000 and the most optimistic prediction of sales is R1 350 000.

Dagmar’s statement of comprehensive income for 2020 is as follows:

Dagmar Suppliers Ltd

Statement of comprehensive income for the year ended 31 December 2020

	Rand
Revenue	950 000
Less: Cost of sales	446 500
Gross profit	503 500
Less: Operating expenses	326 250
Operating profit	281 250
Finance cost	45 000
Profit before tax	177 250
Less: Income tax	53 175
Profit for the year	124 075

 

Required:

• Apply the percentage-of-sales method to the statement of comprehensive income for 2020 to develop the pessimistic and optimistic pro-forma statements of comprehensive income for 2021. Use the table format below to prepare your answers. (18)

Items	2020	% of sales	Pessimistic	Optimistic

• Explain why the percentage-of-sales method could result in an overstatement of profits for the pessimistic scenario and an understatement of profits for the optimistic scenario. (14)

Question 3 [21]

The chief financial officer (CFO) of Quinn Logistics wants to determine the value of its shares using the free cash flow method. The CFO calculated the free cash flows for the period 2015– 2019 as follows:

Quinn Holdings: Free cash flows 2015–2019

Year	FCF2015–2019
2015	650 000
2016	720 000
2017	775 000
2018	825 000
2019	880 000

 

Additional information:

·         FCF growth after 2019 to infinity	5%
·         Weighted average cost of capital (WACC)	11%
·         Market value of debt	R4 200 000
·         Market value of preference shares	R1 200 000
·         Number of ordinary shares issued	200 000

 

Required:

Apply the free cash flow method to the information provided by the CFO to calculate the value of an ordinary share of Quinn Holdings.

Show all calculations and round off all values to the nearest whole number.

 

Question 4 [38]

Sky Explorations Ltd is a company that provides aerial scanning services using drones. The company intends to expand its services by purchasing an additional drone. The survey team of the company researched the suppliers of drones and has narrowed down its preference to two drones from which it needs to select one. The two drones are the Stellar drone and the Bigeye drone.

With the assistance of the financial manager, the survey team prepared the following table with the expected internal rates of returns for both drones together with the probabilities of these returns. Sky Explorations requires a 15% return on its investment.

Stellar		Bigeye
Internal rate of return (IRR)	Probability	Internal rate of return (IRR)	Probability
12%	30%	7%	40%
16%	40%	15%	20%
20%	30%	25%	40%

 

Required:

• For each of these drones, calculate its expected internal rate of return, standard deviation and coefficient of variation. (24)
• Which drone do you recommend the survey team consider purchasing? Provide reasons for your recommendation. (14)

Question 5 [31]

Agrico Ltd is a manufacturer of agricultural products. The company intends to invest in the development and production of a new type of multipurpose fertilizer. The initial research and development costs are R7 800 000. The company’s cost of capital is 11% and it estimates the after-tax operating cash flows as set out in the table below.

Year	Cash flows
1	2 500 000
2	3 500 000
3	3 200 000
4	2 400 000

 

Required:

• Use the information provided to calculate the net present value of this investment project. Use 20% as an alternative cost of capital. (20)
• Calculate the internal rate of return for the project.  (7)
• Would you recommend to Agrico to invest in this new product? Give reasons for your recommendation. (4)

TOTAL: [155]

 LIST OF REFERENCES

Els, G., Van Gaalen, R., Strydom, N.T. & Beekman, R. 2015. Fundamentals of finance – a practical guide to the world of finance. 6^th ed. Cape Town: LexisNexis.

Gitman, L.J., Beaumont Smith, M., Hall, J., Lowies, B., Marx, J., Strydom B. & Van der Merwe, A. 2015. Principles of managerial finance: global and southern African perspectives. 2^nd ed. Boston: Pearson Prentice Hall.

Marx. J., De Swardt, C.J., Beaumont-Smith, M. & Erasmus, P. 2009. Financial management in South Africa. 5^th ed (revised). Cape Town: Pearson.

Ross, S.A., Westerfeld, R.W. & Jordan, B.D. 2019. Fundamentals of corporate finance. 12^th ed. New York: McGraw-Hill.

Ross, S.A., Westerfeld, R.W. & Jordan, B.D. 2020. Essentials of corporate finance. 10^th ed. New York: McGraw-Hill/Irwin.

Zimmerman, F. 1997. Cash flow planning. The Entrepreneur Network.

ANNEXURES

SELECTED FINANCIAL RATIOS