Question

Question 2

Mr Radebe has a 70% shareholding in Radebe Holdings (Pty) Limited, which owns several ABC Limited franchise restaurants. Due to Mr Radebe’s extensive experience in the restaurant franchise industry, all of the group restaurants are very successful and most branches have won several ABC Limited franchise awards, all of which are proudly displayed at the entrance to the restaurants.

As Mr Radebe recently turned 55 years old, he is curious as to the value of his equity share in the ABC Limited empire. He is considering selling his share in Radebe Holdings (of which each branch is a subsidiary) and retiring, if the equity value is high enough. If not, he will have to re-evaluate the situation upon turning 60.

An extract of the financial results for the business is presented below:

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2018

Sales	82 496 500
Cost of Sales	(73 413 000)
Gross profit	9 083 500
Finance charges	(150 750)
Net rental income	1 738 000
Dividend income	155 650
Depreciation	(1 102 500)
Other operating expenses	(291 000)
Profit before tax	9 432 900
Tax – 28%	(2 641 212)
Net profit	6 791 688

Additional information:

• Rental income is from commercial properties that are owned by Radebe Holdings. Current, market-related net rental yield is 5%.
• Dividend income is from an investment in shares of a listed company. The current market value of the shares is R 900 000.
• Part of the franchise agreement is that Mr Radebe spends R1 000 000 in cash on refurbishments on all of the restaurants next year (2019). Market research has shown that, due to the refurbishments, Mr Radebe can expect a real growth in gross profit for 2019 of 7% and 5% in 2020, after which gross profit will slow to an inflationary rate.
• All other expenses are expected to be in line with inflation.
• Finance charges consist of interest on a 10% long-term loan. The current interest rate on a similar loan is 13%.
• WACC is 26%, the company tax rate is 28% and inflation is expected to be 4% for the foreseeable future.
• Apart from the R1 000 000 to be spent in 2019, fixed assets are expected to be maintained at annual cash cost of inflation adjusted depreciation.

Required:

Value Mr Radebe’s interest in Radebe Holdings at 1 January 2019, by performing a free cash-flow valuation.                                                                                             (25)

Answer 1

NET PROFIT SHOWING AS PER THE CONSOLIDATED STATEMENT IS 6791688/-

FOR RENTAL INCOME YIELD WILL BE INCREASED BY 5%. NOW RENTAL INCOME IS 1738000/- AFTER INCREASED BY 5% IT WILL BE ARISING 86900/- TOTAL AMOUNT OF 1824900/-

ADDITIONAL EXPENSES INCURED FOR 1000000/- AS OF REFURBISHMENT.

IT ALSO SHOWS THAT GROSS PROFIT IS DRASTICALLY REDUCED IN COMING YEARS FROM 7% TO 5% IN 2019 AND 2020.

IT WAS CLEARLY SHOWS THAT THERE IS NO INFORMATION REGARDING THE SALES DETAILS SO WE ARE ASSUMING THAT THERE IS NO DRASTIC CHANGE IN THE TOTAL SALES TURNOVER.

VALUATION CASH FLOW ASSUMPTION IN DECEMBER 2019

SALES		82496500
COST OF SALES	4% INFLATION	76349520
		6146980
GROSS PROFIT %		7.45120096
FINANCIAL CHARGES		155272
NET RENT INCOME		1824900
DIVIDENT INCOME		155650
DEPRECIATION		1267875
OTHER OPERATING EXPENSES		1302640
PROFIT BEFORE TAX		3576843
TAX 28%		1001516.04
NET PROFIT		5401743
NET PROFIT %		6.54784506

COMPARING THE NET PROFIT CURRENT YEAR AND NEXT YEAR THERE IS A DRASTIC REDUCES IN THE PROFIT PERCENTAGE. ALSO IN EXPENSES PART HEAVY INCREASE WAS SHOWN ACCORDNGLY.

FINDINGS

MR. RADEBE MUST TAKE CORRECTIVE STEP TO INCREASE THE SALES TURN OVER FOR HIS BUSINESS. OTHER INCOME SOURCE LIKE DIVIDENT AND RENT ARE NOT DEPENDABLE IN PROFIT MAKING. MORE OVER AN ADDITION EXPENDURE WAS INCURED IN THE FORM OF REFURBISHMENT. SO TAKEN CARE OF REDUCING THE EXPENSES.