1STU401 Corporate Finance Strategy Assignment: Beer Namibia Limited Case Study for Business Diversification & Risk Management

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Task 1 (30 Marks)

Beer Namibia Limited (“BNL”) is a company based in Windhoek that manufactures various alcoholic drinks. In the past two years the company’s revenues were impacted negatively by the advent of the Covid-19 pandemic. Many countries including Namibia were put into various levels of lock down. In Namibia there was even prohibition the sale of alcohol beginning April 2020. Subsequent review of the lock down conditions still saw the ban on selling of alcoholic drinks at certain times during week days and a total ban during the weekend. The introduction of curfews also meant not many parties for which alcoholic drinks would be consumed took place.

Owing to this experience, BNL has learnt that it is very important as part of their business strategy to diversify unsystematic risk. The management of BNL held a meeting at the end of 2021 to review their business strategy. A proposal to build a new plant that will concentrate on producing non-alcoholic drinks was tabled. It was agreed that various sources of finance be considered and an additional meeting should take place to review the proposed sources of finance for the plant.

The finance Manager of BNL has fallen sick and you have been hired on a short-term contract to assist the management of BNL review the sources of finance proposed to BNL. As you prepare for the meeting, you have been presented with the work that had been started and you have been informed that the work was done by a trainee accountant. The finance manager did not get time to review the work.

Financing

1. Bank loan

BNL approached Head Bank for a 5-year loan with the following proposed conditions:

• Loan amount: N$15 000 000
• Date of loan: 1 July 2022
• Interest: 13.83 % effective rate compounded monthly.
• Repayment: The loan will be paid in equal monthly instalments from the day the contract is signed.

The trainee accountant calculated the repayment instalment as follows:

PV = N$15 000 000
N = 5
FV = 0
I/Y = 13.83%
COMP PMT = N$ 4 351 415 divided by 12 = N$362 618

The calculation above is mathematically correct.

On assessment of the conditions of the loan. You have realised that the interest used was based on the Bank of Namibia suppressing the repo rate to boost economic activity. However, you have realised that there is a possibility that interest rates will increase by 1% one year after the loan agreement has been signed.

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2. Preference shares

The facility will also be financed by 9%, 600 000 preference shares of N$150 each. The preference shares will be cumulative and non-redeemable. Since this project is new to BNL, they foresee some cash flow challenges in the first two years of operation. As such, they will only start paying preference dividends after 2 years. To compensate for the deferment of the dividends, the management of BNL will pay the dividends bi annually. Preference shares carrying the same risk in the market have a yield of 10.50%.

The trainee accountant did not value these preference shares. She was unsure of how to do it and wanted the finance manager to guide her.

Choice of products to produce

BNL have identified three products that will require the same quantities of materials, labour and machine capacity. However, they anticipate that the machine capacity is limited and they should choose only one product from the list. The details of the products are as follows:

• Product A is expected to bring N$800 000 per year for the first three years, followed by N$1 000 000 for the next four years, followed by N$2 000 000 at the end of year eight.
• Product B is expected to bring N$3 000 000 at the end of the fourth year followed by N$400 000 indefinitely.
• Product C is expected to bring N$1 000 000 at the end of year 2, N$500 000 at the end of year 3, followed by N$400 000 in year 4 which will grow by 2% indefinitely.

BNL uses a weighted average cost of capital of 10% to assess product choices.

You may assume that the choice is being made on just one of the product lines and there are other product lines to bring cash flows to sustain the new facility.

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Task 2 (50 Marks)

Taximart (Pty) Ltd (“Taximart”) is the leading supplier of taxi’s to taxi operators in South Africa. Taximart was founded in 1996 and now has more than 950 employees. It is based in Midrand in Gauteng, but has a national customer base.

The taxi industry is seen as the heartbeat of South Africa. The taxi industry ensures that South Africans, including the vast majority of the country’s workforce, get to and from their destinations – on time at the lowest cost.

As a taxi supplier, Taximart enables entrepreneurs to start and sustain their own small businesses by catering for all their taxi related needs.

Taximart enables taxi operators to either purchase or lease taxi’s. Rental periods are no longer than 12 months, and rental payments are made monthly in arrears. Taximart classifies these leases as operating leases in accordance with IFRS 16.

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There has been a shift in customer demand over the past four years. Customers are increasingly renting as opposed to buying taxis. Taximart has historically adopted a conservative approach to growing its rental business and has used short-term banking facilities to fund the acquisition of taxis for rental.

The abridged financial results of Taximart (Pty) Ltd for the years ended 30 June 2016, 2017 and 2018 are set out below:

TAXIMART (PTY) LTD

STATEMENT OF PROFIT OR LOSS AND OTHER COMPREHENSIVE INCOME

STATEMENT OF FINANCIAL POSITION

The Transaction Capital group is interested in acquiring shares in Taximart. The Transaction Capital group of companies listed on the JSE in June 2012. Transaction Capital’s subsidiaries operate in market segments perceived to be of higher risk, in which they apply specialised credit, risk, analytics and capital management competencies to achieve scale and leading positions.

The Transaction Capital group has put forward the following proposal for acquisition of a shareholding in the business of Taximart:

• The Transaction Capital group is to acquire a 51% shareholding in the business of Taximart.
• The purchase consideration payable by the Transaction Capital group for the business of Taximart will be based on the fair value of the company at 30 June 2018.

The shareholders of Taximart have requested your assistance in valuing the business as at 30 June 2018.

The directors of Taximart have recently finalised the business plan for the company. The business plan was prepared on the basis that Taximart would continue expanding in line with the trend in recent years. The proposed discussions for selling the business were ignored in preparing the forecast financial information. The forecast cash flows per this business plan are summarised below.

STATEMENT OF CASH FLOWS

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Notes

1. Interest on the bank overdraft is charged at 15% per year (compounded annually).
2. SARS allows a wear and tear allowance of 20% per year on taxis subject to rental agreements and 15% per year on furniture and fittings. This is in line with the depreciation policy of the company.
3. Dividends paid in the current year amounted to R8 000 000. Dividends will remain stable for the next three years, after which dividends are expected to grow in line with the expected growth rate after 2021.
4. Information relating to similar listed companies
   • Average price-earnings ratio 8.0
   • Average growth in profit before tax over past two years 12.0%
   • Cost of equity 18.7%
   • Cost of long-term debt (before tax) 11.5%
5. Information specific to Taximart
   • The current debt:equity ratio is seen as optimal.
   • Expected growth rate after 2021 (including dividends) 8.0%
   • You may assume a tax rate of 28%.

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Task 3 (20 Marks)

Africon Investments Ltd (Africon) is an investment company with a diverse portfolio of investments in Africa. You are the financial manager at Africon and your main purpose is to identify new possible acquisitions for the company. You have identified Sellerines (Pty) Ltd (Sellerines) as a possible new acquisition. Sellerines is a company that specialises in the manufacturing and selling of furniture in Southern Africa.

An extract of the financial records of Africon Investments Ltd for the year 2014 is provided to you below:

Additional information:

1. The target capital structure of Africon is 50% equity, 20% preference shares, 15% debentures and 15% long-term loans.
2. The bank overdraft is not used as a source of long-term financing. The bank overdraft currently bears interest at 18%.
3. Africon has authorised share capital of 10 million ordinary shares of which 6 million shares have been issued. The current market price per share is R14.50, cum div. It is expected that the current earnings growth will remain constant for the foreseeable future. Dividend cover was 5 for the current year and this will remain the same for 2015.
4. 14 000 preference shares are currently in issue. New preference shares can be issued at an issuance cost of 4%. The current market price of the preference shares is R160 per preference share. Dividends are paid at the end of each year.
5. Debentures are redeemable in six years’ time at a premium of 5%. Interest on debentures is paid annually in arrears. The interest is market related.
6. The long-term loan is repayable over five years with equal instalments of R1 200 000 payable at the end of each year.
7. The current company tax rate is 28%.
8. The expected return on the purchase of Sellerines is 17.5%.

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REQUIRED:

1. Calculate the weighted average cost of capital that Africon should use when evaluating acquisition of Sellerines. Round all percentages to two decimal places, e.g. 10.25%. (17 Marks)
2. Advise the board of directors on whether the acquisition of Sellerines should be made. (3 Marks)