MAC3702 APPLICATION OF FINANCIAL MANAGEMENT TECHNIQUES EXAM June; July 2021

MAC 3702 JUN/JUL 2021  UNIVERSITY EXAMINATIONS June/July 2021 MAC3702 APPLICATION OF FINANCIAL MANAGEMENT TECHNIQUES

QUESTION 1 (72 marks) Evermec Limited is a pharmaceutical company based in Durban, Kwa-Zulu Natal. The company is currently focussing on pioneering the development of affordable medicine in the fight against Covid-19. During 2020 Evermec Limited identified that the development of medicine such as vitamins at affordable prices, is a major barrier in the market. Evermec has since developed a super-vitamin which is cheap to produce yet also very effective in the prevention of several ailments. The effects of the super-vitamins can be felt within 1-2 days of starting the course. This is a major break-through in this area as vitamins are known to take several weeks before the improvements can be noticed. Evermec Limited’s mission is to become the leading supplier of medicine, particularly vitamins, to every citizen in South Africa as it is their belief that with proper immune systems every citizen in South Africa might have a fighting chance against contracting Covid-19. Evermec Limited’s development has caught the interest of the government of South Africa, so much so that they have been awarded a grant by the Department of Health, for the production and distribution of the super-vitamins as a pilot project. During the pilot phase, Evermec Limited supplied the super-vitamins to several pharmacies and clinics all over the country and received very positive feedback. The pilot phase cost Evermec R500 000. The following information was sourced from the integrated annual report of Evermec Limited. The earnings before tax for the year ending 31 May 2021 was correctly calculated as R132 000 000 (2020: R144 000 000). The industry norm for the return on assets is 7%; 1:1 for the debt : equity ratio and 4 times for total assets : total liabilities. Extract from the statement of financial position at 31 May 2021 Notes R’000 Ordinary shares 1, 2 500 000 Retained income 2 720 000 Shareholders’ capital and reserves 1 220 000 14% Preference shares 3 120 000 Long term loan – FNB Bank (12.67%) 680 000 Total equity and liabilities 2 020 000 MAC 3702 JUN/JUL 2021 Additional information 1. The ordinary shares were issued at R8 per share. The current market price for ordinary shares is R150 per share. New issues will have no effect on this price, although ordinary share issue costs will be 3% of the current market share price. 2. An ordinary share dividend of 105,46 cents was paid for the 2021 financial year end. (2020: 95,87 cents and 2019: 87,15 cents). The Evermec Limited Board intends to maintain the average historical growth in dividends. 3. The preference shares were issued at R80 per share. Preference shares in the similar risk class are currently yielding 11,67%. Preference shares carry a dividend pay-out rate of 14% and will be redeemed at a premium of 5% after 4 years. The premium is, however, only paid a year after the redemption date. 4. Evermec Limited aims to maintain a debt: equity ratio of 1: 1 going forward (based on book values). 5. To service the demand for the vitamins Evermec Limited is planning to buy new high-tech machinery at a cost of R600 million (assumed project start date is 1 June 2021). The company will use this infrastructure for 6 years in full production, and then scrap it for R50 million. The depreciation on the high-tech machinery is R100 million per year. The required working capital is R100 million of which only 60% will be recovered at the end of the project. 6. The expected annual production quantities (bottles) of this new machine for which demand exists are given below: Quantity Probability 10 000 000 30% 14 000 000 40% 19 000 000 20% 22 000 000 10% 7. The budgeted fixed costs for the production are R30 000 000 per month and the selling price, for the first year, is set at R155 per bottle of vitamins. The selling price is expected to grow with the current inflation rate of 4% per annum. It is expected that the inflation rate will stay unchanged for the duration of the project. The contribution is fixed for the duration of the project at 30% on sales. 8. The following options are available to finance the new machinery:  New ordinary shares can be issued (retained earnings cannot be utilised).  A loan from Crypto Bank of R400 000 000 at prime + 800 basis points.  A top-up loan from FNB Bank of R110 million at the same rate as the existing loan, which is considered to approximate the fair market interest rate. The loans can only be taken at the total amounts as made available by the banks.