Study Guide

Financial Management 830

FBS 830
2017
Prof H P Wolmarans

Content compiled by Prof HP Wolmarans

Instructional Design done by Mrs E Drysdale

Table of Contents
Welcome ............................................................................................................................... 3
Lecturer ................................................................................................................................. 3
Assessment Policy ................................................................................................................ 4
References ............................................................................................................................ 4
Schedule ............................................................................................................................... 5
Study methodology................................................................................................................ 5
Assignments.......................................................................................................................... 5
Module objectives, articulation and learning outcomes .......................................................... 7
Module content ...................................................................................................................... 8
Learning area 1 Introduction to Managerial Finance .......................................................... 8
Learning area 2 Financial Tools ......................................................................................... 8
Learning area 4 Risk and Required Rate of return ............................................................10
Learning area 5 Capital budgeting techniques and cash flows ..........................................11
Learning area 6 Leverage and capital structure decisions ................................................11
APPENDIX A: Assignment 1 ................................................................................................12
APPENDIX B: Assignment 2 ................................................................................................15

Welcome
A hearty welcome to you in FBS 830! The general objective of this course is to expose
students to the theoretical principles and practical applications of the broader aspects of
financial management with regards to the South African firm. To succeed in this goal, it is
necessary to have first of all a clear picture of the study field of financial management and
secondly to master the elementary principles of the subject. The approach and thinking to be
followed are given in the study material and during the group discussions. This study guide
should be used to enhance students learning experience.

Lecturer

Prof H P Wolmarans

Office
Telephone
Fax
E-mail
Communication
policy

EMS Building 3-4

University of Pretoria, Pretoria
+27 12 420 3381
+27 12 420 3916
hendrik.wolmarans@up.ac.za
Please use normal e-mail. Use the module code as the first part of the
subject line. E.g. "FBS830: Subject".
The discussion tool is enabled for the use of the students only. Please do
not try to contact the lecturer via any of the clickUP communication tools.
Discussion will from time to time be monitored by the lecturer.

Assessment Policy
Evaluation criteria
Assignment 1
Assignment 2
Examination
Final mark

Pass requirements

Mark (%)
10
40
50
100

Due date
3 March 2017 before 23:59
14 April 2017 before 23:59
12 May 2017 (see Exam schedule)

You need a sub-minimum of 40% for your semester mark in order to

qualify to write the exam. If you do not obtain the sub-minimum of 40%
for your semester mark but still write the exam, your exam paper will not
be graded. A sub minimum of 40% is required in the exam to pass. A
final mark of at least 50% is required to pass the course.

Please ensure that your assignments comply with the requirements listed under File naming
convention (below) as well as the Harvard referencing convention
Examination: NO laptops or cell phones will be allowed.

References
Prescribed Material

Gitman LJ, Beaumont-Smith M, Hall J, Makina D, Malan M, Marx J, Mestry R,

Ngwenya S & Strydom B. 2014. Principles of Managerial Finance: Global and South
African Perspectives. Cape Town: Pearson, Prentice-Hall.
Suggested Study Material

Brigham, E.F & Ehrhardt, M.C. 2008. Financial Management: Theory and Practice,
12th ed, Harcourt College Publishers.

Firer, C. et.al. 2004. Fundamentals of Corporate Finance. 3rd ed. South African
Edition: McGraw-Hill.

Schedule
Lecture schedule
Date: 6-8 March 2017
Time: 6-7 March 2017: 08:00 - 17:00
8 March 2017: 08:00 13:00
Group work session: 15 March 2017 (with submission of group assignment before
you leave. More about this later.)

Study methodology

Post graduate students must show the ability to study independently and have to study
the prescribed sections of the study material in its whole.
The course is student-centred. Students must consistently attempt to reach a high level
of independent study and must prepare the study units according to the suggested study
programme. Class discussions concentrates on problems and any aspect of the work
that is not entirely clear to students. Although a measure of memorisation is required to
master the material, the main emphasis is placed on finding answers to numerical
problems.
Students must take note of the terminology used in the course. The terminology must be
fully understood and used in assignments and the exam.
In order to achieve the specific outcomes of this course a series of learning areas were
chosen, with specific outcomes set for each learning area.

Assignments

Two individual assignments must be submitted. The first assignment is in Appendix A

while the second assignment is in Appendix B at the end of this study guide. Please
note that any assignment handed in after the due date will not be marked. Your
assignments must be submitted via the ClickUP systems assignment submission tool.
Please note that each Assignment must be ONE DOCUMENT in PDF format (see below)
not exceeding the stipulated number of pages. Students who do not comply with

these requirements may be penalised with 10% for this assignment.

Please note that these assignments have to be independently completed by each

student; they are definitely not group assignments! No extensions will be given.
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Financial calculators

Financial decision-making in a firm is a practical field in which calculations play an

important role.
Therefore each student must have a financial calculator in order to answer the
questions in the assignments and in the examination. The following models are
suggested:
Hewlett Packard 10B
Sharp 733; or 735; or 738
If other models are used, please ensure that the calculator includes time value of money
and statistical functions. You must be able to use your financial calculator!
Please note that laptops are not allowed in the exam.

Feedback

Plagiarism

Referencing

File naming
conventions

Assignment cover
page and template

Feedback will be given within a month after the due date for the specific
assignment/test, and your semester mark will be available on clickUP at
least a week before the examination.
Please read the plagiarism policy of the University of Pretoria, located at
http://www.up.ac.za/media/shared/409/ZP_Files/s4726_09-plagiarismprevention-policy.zp62477.pdf. If students are found to be copying work
done by other students (current and past), websites or any other source
when doing assignments, without providing the necessary references in
the required way, it will be viewed in a serious light and may lead to a
University disciplinary hearing. The punishment, if found guilty, may lead
to expulsion from this university and any other tertiary institution in South
Africa.
It is not necessary to provide a separate plagiarism declaration page
with every assignment. By submitting your assignment, you implicitly
abide with the anti-plagiarism rules.
You need to use the GSTM Harvard Referencing method. You can find
the GSTM Harvard Referencing Method in Appendix 11 of the GSTM
Research Guide available on the Universitys website at the following
link: www.up.ac.za/gstm/student. Students who do not comply with the
Harvard Referencing convention will be penalized with 10% for that
assignment. All students are encouraged to use EndNote or Refworks in
the preparation of the assignments. See Appendix 11 of the GSTM
Research Guide for instructions.
The format, style and presentation should be in accordance with the
standards laid down for the overall program. All assignments are to be
completed in PDF.
File names for electronic submission of all assignments to be
compiled in the following way:
12pt Times New Roman or 11pt Arial; 1.5 line spacing; 2cm
margins
Year [e.g. 2017], module code [e.g. FBS830], assignment number
[e.g. Ass1 or Ass2 or Ass 3], your surname and initials and the
document extension pdf (e.g. 2017FBS830Ass1MandelaN.pdf).
Make sure that the following information is indicated on the first page of
your assignment:
Initials and surname
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Submission process
Examination

Student number
Course name and code
Lecturer
Title of assignment
Date of submission
You may use the assignment template available on the student web.
(www.up.ac.za/gstm/student).
Submit your assignment on clickUP using the Assignment Submission
tool.
No laptops and/or cell phones are allowed in the examination venue.
You will not be allowed to hand any item to another student or to receive
any item from another student. Therefore, please ensure that you bring
along everything that you might need during the exam (including
calculator, pens, erasers, ruler, notes, books, etc.) Exam will be openbook, which means that only your own books and notes are allowed.
There is no supplementary examination. Please ensure that you are
available to write the examination at the date indicated on the schedule.
Please note that, if you arrive late for the examination, you will have to
hand in your examination paper at the scheduled end time of the
examination and will not receive any additional time.
Students are obliged to identify themselves positively by means of a valid
student card when writing a test and/or examination. No access to the
test or examination venue will be allowed without a valid student card.

Module objectives, articulation and learning outcomes

Specific outcomes
After studying the learning content of this course, you should be able to:

Understand the role and key activities of the financial manager.

Evaluate the financial performance of a firm

Understand the interrelationships between Financial Management decisions and other

managerial decisions

Understand the interrelationship between the investment and financing decisions of a

firm

Use appropriate approaches and techniques in the financial management decision

process

Handle the practical application of financial management decisions and the complexities
that accompany such decisions

Formulate research questions with regard to core issues in financial management.

Module content
Learning area 1 Introduction to Managerial Finance
Chapters 1 and 2
Specific outcomes

This learning area provides an overview of the nature and role of

financial management and the financial market environment.
After studying this learning area, you have to demonstrate the
following competencies:

Define the subject financial management;

Describe the academic content of financial management with

specific reference to the interfaces with other disciplines;

Describe the environment of financial management with

reference to South African conditions;

Paraphrase the objectives of financial management; and

Explain the role of the financial manager.

Learning area 2 Financial Tools

Chapter 3

Specific outcomes

Chapter 4

Specific outcomes

"Financial Analysis is of vital concern to corporate managers,

security analysis, investors, and lenders, all of whom analyse
financial statements. The focus of any financial analysis depends
on its purpose, which may range from a total analysis of a firm's
strengths and weaknesses to a relatively simple analysis of its
short-term liquidity" (Brigham & Gapenski, 1996: 615). Since the
foundation of most types of financial analysis is the firm's
financial statements, we focus on financial statement analysis
in this study unit.
After completion of this learning area, you should be able to
demonstrate the following competencies:

Explain the nature of the financial statements of listed

companies;

Identify the problems associated with financial statements;

Paraphrase the objectives of an analysis of these

statements;

Calculate and interpret the various ratios; and

Apply the Du Pont approximation when analysing the firm's

financial achievements.
This learning area provides an overview of how to develop the
statement of cash flows and how the pro forma financial
statements are used for planning in the firm.
After studying this learning area, you have to demonstrate the
following competencies:

Understand the effect of depreciation on the firms cash flow;

Understand the firms statement of cash flow;

Understand the financial planning process including longterm financial plans and short-term financial plans;

Prepare and use short-term and long-term cash budgets

8

using the principles of the cash planning process;

Prepare and use pro forma statements of both
comprehensive income and financial position; and

Prepare a cash flow statement.

Chapter 5
To enable students to do time value of money calculations for
the use of financial decision-making.
Specific outcomes
After completion of this learning area you should be able to
demonstrate the following competencies:

Explain the concept time value of money and the importance

thereof;

Explain the principle of interest calculations;

Explain the application and calculation of future values to a

series of equal and unequal amounts;

Explain the application and calculation of present value to a

series of equal and unequal amounts to be received in the
future;

Calculate growth rates, compound and discount rates;

Calculate and compare effective and nominal interest rates;

and

Apply the various time value calculations to practical

situations
Learning area 3 Valuation of Securities

Chapter 6 & 7

This learning area explains the principles applied in the valuation

of assets in general, and specifically shares and bonds.

Specific outcomes

After completion of this learning area, you should be able to

demonstrate the following competencies:

Describe the key inputs- cash flows, timing and required

return- and basic model used in the evaluation process;

Explain yield to maturity, its calculation and the procedure

used to value bonds that pay interest semi-annually;

Understand the concept of market efficiency and basic share

evaluation under each of three cases; zero growth, constant
growth and variable growth;

Discuss three other approaches- book value, liquidation

value and price/earnings multiples- that one could use to
estimate share values; and

Review the relationship between the impact of financial

decisions on both expected return and risk and their
combined effect on the firms value.

Learning area 4 Risk and Required Rate of return

Chapter 8

Specific outcomes

Chapter 9

Specific outcomes

This learning area broadens your knowledge and insight into the
measurement of risk as well as the interaction between risk and
return, as applicable to the financial management of the firm.
After completion of this learning area, you should be able to
demonstrate the following competencies:

Describe the nature of risk;

Understand and explain the principles governing the

probability theory;

Apply the probability approach to determine risk in order to

calculate the variance;

Understand, describe and calculate, with the assistance of

certain data, the various approaches to the calculation of
rates of return;

Understand and explain diversification and its influence on

enterprise risk; and

Apply the capital asset pricing model in solving relevant

problems.
This learning area develops your knowledge of the various
financing instruments available in the South African financial
markets, and to explain the use of cost of capital for financial
and investment decisions.
After completion of this learning area, you should be able to
demonstrate the following competencies:

Explain the relationship between financial policy and the cost

of capital of a firm;

Describe the nature of cost of capital;

Distinguish between various components of the cost of

capital;

Calculate the component cost of capital;

Calculate the contribution of the above components to the

overall cost of capital;

Discuss the meaning and application of the weighted

average cost of capital; and

Calculate the weighted average cost of capital.

10

Learning area 5 Capital budgeting techniques and cash flows

Chapter 10 and 11

Specific outcomes

This learning area develops your knowledge of, insight into and
decision-making skills with regard to capital budgeting
decisions.
After completion of this learning area, you should be able to
demonstrate the following competencies:

Distinguish between various types of investment projects;

Distinguish between various techniques which can be used

to evaluate investment projects;

List the advantages and disadvantages of these techniques;

Apply the techniques, for example for net present value

(NPV), internal rate of return (IRR), and the payback period;

Determine the various components of cash flow;

Demonstrate how depreciation and the tax shield on

depreciation are used in capital budgeting; and

Use all the above techniques to evaluate a project once the

relevant components of cash flow have been identified and
calculated.

Learning area 6 Leverage and capital structure decisions

Chapter 13

Specific outcomes

This learning area develops your knowledge of different financing

methods, the impact of leverage on capital structure and how
to determine the optimal financing mix.
After completion of this study unit, you should be able to
demonstrate the following competencies:

To understand operating leverage;

Understand the principles involved in the financial and

operating leverage concepts;

Explain the influence of the utilisation of debt capital on the

rate of return on equity capital (ROE);

Quantify the influence of various financing alternatives on the

return on equity and the earnings per share;

Explain financial risk and quantify financial risk through the

application of ratio analysis; and

Explain the concept optimal capital structure and discuss the

factors influencing the optimum capital structure.

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APPENDIX A: Assignment 1
Please ensure that your Assignment 1 is ONE DOCUMENT in pdf format not
exceeding 10 pages. Students who do not comply with these requirements will be
penalised with 10%.
QUESTION 1 - FINANCIAL STATEMENTS
(35 marks)
The financial statements of Imagineering Ltd, a company listed on the Johannesburg
Stock Exchange (JSE) follow. Statements are for the financial year ending February
of each year.
STATEMENT OF COMPREHENSIVE INCOME
Financial year ending
2015
February
R million
Sales
5 240
Cost of goods sold
2 650
Gross profit
2 590
Operating expenses
1 820
Operating income
770
Interest paid
220
Profit before taxation
550
Tax
201
Profit after taxation
349
Dividends
144
Retained income for the year
205
Share price (R) at year end
R17

2016
R million
6 430
3 450
2 980
2 433
547
250
297
90
207
0
207
R7

Notes
1. Assume all sales are on credit and assume a 365 day year.
2. Assume 70% of cost of goods sold are purchases.
Industry average
2016
1.5
0.9
7 times
25 days
35 days
2.5 times
40%
4 times
55%
16%
9%
17%
30%
16 times
5 times

Current ratio
Quick ratio
Inventory turnover
Average collection period
Average payment period
Total asset turnover
Total debt ratio
Times interest earned
Gross profit margin
Operating profit margin
Net profit margin (after tax)
Return on total assets
Return on equity
Price/Earnings (P/E) ratio
Market/Book (M/B) ratio
12

STATEMENT OF FINANCIAL POSITION

Financial year ending February
ASSETS
Interest in subsidiaries
Non-current assets
Long term receivables
Current assets
Inventory
Trades receivable
Cash and cash equivalents
Total assets
EQUITY AND LIABILITIES
Share capital (shares @ R1 each)
Retained earnings
Long-term liabilities
Current liabilities
Short term loans
Trade payables
Accruals
Total equity and liabilities

2015
R million

2016
R million

202
1 005
80

202
1 050
90

498
414
206
2 405

820
805
0
2 967

300
910

300
1 117

430

430

305
205
255
2 405

485
350
285
2 967

Shareholders of this company have contacted you and expressed a concern that no
dividend was declared for the past year and that the company has no cash on hand.
REQUIRED
(a)

Do a complete analysis of the companys financial statements.

(A Du Pont analysis is not needed)

(b)

Comment on the companys financial position based on the relevant ratios. Try
to answer shareholders concerns about the dividend and cash position, and
express your views on what the company could do to improve the situation.
(10)

13

(25)

QUESTION 2 : CASH BUDGET

(15 marks)

Euro Tech Plc., a South African based company listed on the London Stock
Exchange supplies technical components for the European defence industry. The
following sales and cash disbursement estimates for the period May September of
2016 has been prepared, while the beginning cash balance for 1 July 2016 is 115
000 (British pound sterling):
Month
May
June
July
August
September

Sales
400 000
500 000
600 000
300 000
500 000

Cash disbursement
550 000
400 000
300 000
500 000
350 000

In the past, on average, 30% of sales have been for cash, while 70% of the credit
sales are collected 1 month after the sale. The remaining 30% are collected 2
months after the sale. The firm wishes to maintain a minimum monthly end balance
of 25 000 in its cash account. Excess cash balances will be invested in short-term
securities (cash equivalents), while any deficits will be financed through short-term
bank borrowing (notes payable).
REQUIRED
(a) Prepare a cash budget for July, August and September.
(9)
(b) What is the maximum amount of financing that Euro Tech requires to meet its
obligations during this 3-month period?
(2)
(c) Calculate the size of each of the following accounts at the end of September
2016: cash; notes payable; cash equivalents; and trade receivables.
(4)

14

APPENDIX B: Assignment 2
Please ensure that your Assignment 2 is ONE DOCUMENT not exceeding 20 pages
(including the financial statements). Students who do not comply with these

requirements will be penalised with 10% for this assignment.

QUESTION 1: FINANCIAL STATEMENTS

(40 marks)

Obtain recent annual financial statements of any South African company (preferably
your own company). Do a complete analysis of the financial statements by applying
financial ratios and the Du Pont Analysis. Comment on the companys financial
position based on the relevant ratios and identify critical areas in need of
improvement. Attach the financial statements as concisely as possible. NOTE:
Please do NOT send an electronic copy of the whole annual report! (Refer to a
short discussion in class on this important matter.)

QUESTION 2: WACC and CAPITAL BUDGETING

(30 marks)

GSTM Corporation wants to replace a three year old machine with a brand new one
costing R6m. The new machine costs R500 000 to install and will be used for 4
years. The initial change in working capital will be as follows: Inventory is expected to
decrease by R500 000, trade receivables to increase by R350 000 and trade
payables to increase by R250 000. Working capital will not be recouped at the end of
the project. The old machine was originally purchased for R2m and can be sold
today for R300 000. Both machines qualify for a straight line wear & tear write-off
period of 4 years. It is estimated that the new machine will have a market value of
R1m at the end of 4 years. A technical analysis that was undertaken last year by a
consulting firm cost R300 000 and showed that the new machine is not expected to
increase revenues, but it will decrease operating costs from R4m to R1,8m per year.
GSTM is financed by R80 million long-term debt, R20 million preferred shares and 2
million issued ordinary shares. The firm also has R10 million in short-term debt at a
cost of 15% per year. The firm can raise long-term debt by selling R1000 par value,
12% annual coupon rate (coupons paid semi-annually), 4 year bonds at a discount of
3% on par value and has to pay R30 per bond flotation cost. The firm can also sell
10% preferred shares with a par value of R100 for R80, and has to pay R5 per share
in flotation cost. TGSLs ordinary shares are selling at R50 each (a beta factor of 1.3
applies) and a dividend of R5 per share has just been paid. The risk free rate is 6%
and the market return is 14%. The firms tax rate is 30%.

15

REQUIRED
Do a complete capital budgeting analysis of the incremental cash flows resulting from
the replacement and calculate the NPV as well as the IRR. What is your
recommendation?
QUESTION 3 : CAPITAL STRUCTURE

(15 marks)

Limpopo Electronics Corporation (LEC) manufactures and sells car radios. The
following is an extract from their financial records for the year which ended 31
December 2011.
Revenue (1000 units at R600 each)

R600 000

Variable operating costs (R200 per unit)

(200 000)

Fixed costs

(100 000)

EBIT

R300 000

LEC is financed by R500 000 in long term debt, 100 000 ordinary shares are
issued and preference shares of R200 000 with a 15% preference dividend. The
tax rate is 30%, the cost of debt is 12% and the required return for shareholders is
15%. The financial manager of LEC is considering changing the capital structure
to R600 000 long term debt, R50 000 short-term debt, 150 000 issued ordinary
shares and R50 000 preference shares. Under the proposed structure the
required return for shareholders will change to 18%.
REQUIRED
(a) Calculate the EPS and shareholder wealth under each structure. Which
structure would you recommend and why?
(b) Calculate the financial breakeven point for each structure.
(c) Calculate the firms degree of financial leverage for each structure.
(d) Which structure has the greatest financial risk? Motivate your answer.

16

QUESTION 5: RISK AND RETURN

(15 marks)

A year ago Lerato Ramahlodi invested R100 000 to set up the following portfolio:
Asset

Cost

Beta at
purchase

Annual
income

Value
today

R20 000

0.80

R1 600

R20 000

R35 000

0.95

R1 400

R36 000

R30 000

1.50

R34 500

R15 000

1.25

R375

R16 500

(a) What is the portfolio beta based on the original cost figures?
(b) At the time that Lerato made the investments, investors were estimating that
the market return for the coming year would be 10% and that the risk-free rate
of return would average 4% for the year. What was the expected rate of return
on the portfolio based on the CAPM?
(c) On the basis of the actual results, concisely explain how assets C; D and the
portfolio as a whole performed relative to what was expected under CAPM
assumptions. What factors could explain these differences?

17