Note: Due to the length of the scenario you have extra reading and writing time.

SCENARIO

Mnandi Chocolates (Pty) Ltd

This scenario continues from the morning session scenario, Mnandi Chocolates (Pty)
Ltd (“Mnandi”). While the context is the same, there is no need to use or remember
specific information from the previous session.

1. Recent operating performance

Refer to Appendix for financial information

Mnandi’s financial performance has been under pressure in recent years. The
company has found itself caught between the lower end of the market that is
increasingly price sensitive, and the upper end of the market that has shifted
towards premium imported and artisanal chocolate brands.

The rising international price of cocoa beans has impacted Mnandi’s profit, as not all
products that Mnandi sells have been able to increase prices accordingly. Further
cost pressures have come from above inflation labour and electricity price increases.

Initially the company responded by stopping all discretionary costs1. Realising that
this was not sustainable, the company has begun discretionary spending again and
is taking proactive steps to reposition itself strategically to capitalise on expected
future growth in South Africa’s chocolate market.

The Cocoa Division (the division that converted cocoa beans into cocoa butter)
posted a good operating performance in 2020. Sales price increases were able to
cover inflationary cost increases without sacrificing volumes. The supply of cocoa
beans was the main limitation in terms of revenue growth.

Total revenue for the Chocolate Division (the division that converted the cocoa
butter into chocolate products) decreased in 2020. The main reason for this was
decreases in sales volumes due to increased foreign suppliers entering the South
African chocolate market, resulting in an oversupply of chocolate products, and
increased sensitivity to pricing.

1
Discretionary costs are expenses such as advertising, maintenance, staff training or research and
development that can be cut without affecting production and sales in the short term.

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 3 of 9
 Divisional overview 2020 2019
Cocoa Division
Revenue (R 000’s) 406 278 361 663
Tons2 of cocoa butter sold 18 760 19 300
Chocolate Division
Revenue (R 000’s) 947 982 992 597
Kg of chocolates sold (000’s) 3 792 4 512

2. Future expectations

Refer to the Appendix for financial information

2.1. Operating activities

2.1.1. Operating profit

An analysis of historical data shows that Mnandi’s revenue is closely linked to the
performance of the South African economy. Mnandi’s financial director uses
probabilities to estimate revenue, and based her 2021 financial year estimates on
the following data:

2021 State of the economy Probability 2021

Revenue
Growth /
(Reduction)
1 Recession (very weak growth) 20% (3%)
2 Weak growth 65% 6%
3 Strong growth 10% 12%
4 Very Strong growth 5% 15%

From the 2022 financial year, it is expected that Mnandi’s revenue will grow at 10%
per annum. This growth is based on market predictions made by researchers in a
recent study that indicated this growth would be sustained for three years and
thereafter would normalise to a 6% per annum sustainable growth rate.

The operating profit margin was low for the 2020 financial year due to the decreased
revenue and associated cost inefficiencies. The 2020 margin is expected to improve
by 0.5% per year for the next 4 years at which point it will stabilise at that level.

2.1.2. Working capital

The financial director expects that all operating current assets and operating current
liabilities will change in direct proportion to rises and falls in the company’s revenue,

2
1 ton = 1 000 kilograms

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 4 of 9
except for the liability for current tax. The liability for current tax is expected be
25% of each year’s tax expense. The current tax rate is 28%. R50 million of cash
and cash equivalents on the statement of financial position represents excess cash
that is not required for operations.

2.1.2. Capital expenditure

To support the planned growth, Mnandi expects to invest in CAPEX3 to ensure that
the 2020 fixed-asset turnover ratio is maintained into the future. Depreciation is
consistently 8% of each year’s opening PPE balance. Wear and tear allowances are
equal to depreciation.

Goodwill and intangible assets arose from business acquisitions.

Mnandi’s will purchase a controlling 60% of the shares of DV Artisan Chocolate in

the 2021 financial year for R50 million in cash. This will increase:

• PPE by R7 million,
• Goodwill by R15 million, and
• Intangible assets by R3 million.

The revenue forecasts in 2.1.1 above have been forecasted on the assumption that
this purchase occurs.

Goodwill is subject to an annual impairment test, but there is no expectation that

goodwill will be impaired. Intangible assets are amortised based on how they are
consumed, which is typically over 3 years. The existing intangible assets will be
amortised evenly over the intangible assets’ remaining useful life of 2 years. SARS
allows deductions are equal to the accounting amortisation.

2.1.3. Investment in Chocomize

Mnandi’s holds a non-influential 10% of the shares of Chocomize (Pty) Ltd

(Chocomize).

Chocomize is one of Mnandi’s customers that buy its bulk chocolate. Chocomize
operates an online website where customers can custom design their own
personalised chocolate gifts, which are then manufactured and delivered.

The original investment in Chocomize occurred when Mnandi agreed to accept

shares of Chocomize as payment for a long outstanding account. Over the years
Mnandi has increased its share as Chocomize has begun to show strong growth
potential.

Dividend income represents dividends received by Mnandi from Chocomize. Mnandi

expects Chocomize’s growth to slow in a straight-line over the next 4 years from

3
Capital expenditure

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 5 of 9
20% per annum in 2021 reaching 5% per annum by 2024 after which it will
normalise at this level.

Chocomize’s cost of finance is estimated as below:

• Cost of equity – 20% per annum

• Cost of debt – 14% per annum
• Cost of capital – 18% per annum

2.2. Financing activities

Refer to Appendix for financial information

2.2.1. Ordinary shares

As at 30 September 2020, Mnandi had authorised and issued 250 000 ordinary
shares. The average historic market risk premium for the South African equity
market is 7% per annum. The following information relates to the listed food
manufacturing sector:

Listed manufacturing sector averages

Levered beta 1.53
Unlevered beta 1.30
Debt-equity ratio 25%
PE Multiple 16

𝐵𝑙
𝐵𝑢 =
𝐷
1 + (1 − t) 𝐸

• 𝐵𝑢 = 𝑈𝑛𝑙𝑒𝑣𝑒𝑟𝑒𝑑 𝐵𝑒𝑡𝑎

• 𝐵𝑙 = 𝐿𝑒𝑣𝑒𝑟𝑒𝑑 𝐵𝑒𝑡𝑎

• 𝑡 = 𝑡𝑎𝑥 𝑟𝑎𝑡𝑒

• 𝐷 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡

• 𝐸 = 𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦

2.2.2. Debt

Mnandi uses of a combination of short term and long-term debt in its capital
structure. Mnandi aims to have a debt ratio of 50% as a way to enhance returns to
shareholders. Current market values of the debt (give below) represent the target
proportions of short- and long-term debt in the total debt of the capital structure.

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 6 of 9
Short term debt is made up of money market instruments with maturities of less
than a year. The current carrying amount of short-term debt closely approximates
its fair value. Current fair interest rates on equivalent short-term debt would be
10.5% per annum.

Long-term debt is a 10-year bond that was issued 5 years ago. The bond has a face
value of R375 million and a coupon rate of 9% per annum. The bond will be
redeemed at face value in 5 years’ time. The current market value of the bond is
R322 million.

The current government bond yields are as follows:

Instrument Yield per annum

Treasury bill – 91 days 7.41%
R208 bond – maturing 2021 3.50%
R186 bond – maturing 2026 7.14%

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 7 of 9
Appendix

Mnandi Chocolates (Pty) Ltd - Statement of Financial Position

at 30 September 2020 2019
R'000 R'000
Equity and liabilities
Equity 215 562 153 983
Ordinary share capital and premium 21 472 21 862
Retained earnings and other reserves 194 090 132 121

Non-current liabilities 436 388 427 120

Long-term debt 313 531 309 521
Post-retirement benefit obligations 39 221 35 019
Provisions 43 815 41 095
Deferred taxation 39 821 41 485

Current liabilities 457 429 399 246

Trade and other payables 245 505 226 692
Accrued expenses 13 799 13 944
Taxation payable 14 613 16 433
Derivative liabilities 9 274 7 842
Short-term debt 140 488 100 585
Current portion of Long-term debt 33 750 33 750

Total equity and liabilities 1 109 379 980 349

Assets
Non-current assets 614 413 569 580
Property, plant and equipment 529 541 488 998
Goodwill 42 018 43 754
Intangible assets 20 074 19 406
Investments at cost 22 780 17 422

Current assets 494 966 410 769

Inventories 212 994 159 363
Trade and other receivables 205 283 189 241
Prepaid expenses and other 16 944 25 337
Cash and cash equivalents 59 745 36 828

Total assets 1 109 379 980 349

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 8 of 9
Mnandi Chocolates (Pty) Ltd - Statement of Profit or Loss
for the year ended 30 September 2020 2019
R'000 R'000

Revenue 1 354 260 1 391 013

Cost of sales (690 673) (723 327)
Gross profit 663 587 667 686
Distribution costs (194 858) (196 826)
Marketing and administration costs (280 125) (259 375)
Research and development costs (19 683) (21 165)
Other (4 220) (7 951)
Operating profit 164 701 182 369
Dividend income 5 005 4 171
Net finance costs (54 145) (42 331)
Profit before taxation 115 561 144 209
Taxation (32 935) (43 263)
Profit for the year and total comprehensive income 82 626 100 946

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 9 of 9
REQUIRED ONLY

Marks
Afternoon Paper Sub- Total
total

(a) Critically analyse and comment on Mnandi’s financial

performance and financial position for its 2020 financial year.
• Calculate relevant ratios to assist you in your analysis. 20

(b) Using the dividend growth model, estimate the value of

Mnandi’s investment in Chocomize at 30 September 2020. 5

(c) Calculate Mnandi’s estimated weighted average cost of capital

(WACC). 10

(d) Using a discounted cash flow to the firm approach, estimate the
value of 100% of the ordinary shares of Mnandi Chocolates at
30 September 2020. 37

(e) Discuss the positive and negative implications for Mnandi of

using short term debt versus long term debt, in their capital
structure. 4

(f) Critically analyse Mnandi’s financing of its working capital using

short term relative to long term debt. Identify and explain the
risks and benefits.
• Support your answer with relevant calculations. 7

(g) i. Briefly explain the transactional foreign exchange risk to

which Mnandi is exposed when importing cocoa beans
from foreign suppliers.
ii. Explain some of the different methods Mnandi can
7
manage these risks.

Total 90

© Milpark Education. Management Accounting & Finance. Final Exam 2020 Page 2 of 2