Page 29 - CIMA MCS Workbook November 2018 - Day 1 Suggested Solutions

SUGGESTED SOLUTIONS

EXERCISE 2 – SOURCES OF FINANCE AND CALCULATION OF WACC

Grapple may need to raise finance in order to:
● acquire one or more subsidiaries
● invest in upgraded PPE – new technology or production equipment etc
● implement any plans to rationalise the business

At 30 June 20X8, Grapple held only Z$2.1m in cash and equivalents, which represents 1.5% of
total assets and 2.2% of net assets. Therefore, it is unlikely that any finance required for capital
projects and/or acquisitions could be funded from existing cash resources. However, in terms of
raising additional finance Grapple could consider potential sources of both debt and equity
finance.

During the year ended 30 June 2018, there was an increase in long‐term loan finance of Z$6.4m to
Z$16.5m. The statement of cash flows identified that there was a relatively small net cash inflow
from operations of only Z$6.3m when profit before tax was Z$10.2m.

Currently, Grapple is an unlisted entity with limited access to additional finance from current
shareholders as it is a family‐owned entity, with four shareholders having no business interest in
the Grapple’s activities.

Debt finance
Grapple could borrow funds from its bank or other organisations that specialise in lending to
entities operating in its business sector. The level of gearing at 14.9% (9.9% in 2017) may be
regarded as not excessive. However, lenders would be concerned with the ability of Grapple to
make finance and capital repayments in line with any agreement. They may be concerned with
the ability of Grapple to generate sufficient cash inflows to ensure available funds to make capital
and interest repayments.

Interest cover improved from 5.0 times in 2017 to 8.3 times in 2018 which would be taken as a
positive sign by lenders, particularly as this was on an increased finance charge for 2018. There is
no indication whether, or to what extent, grapple’s premises or other assets have been used as
security for the current loans. It is likely that any provider of debt finance would seek to ensure
that there was adequate security for any loan finance provided.

Grapple may need to consider whether raising further debt finance might breach any existing loan
covenants. Additionally, it would need to be aware of any covenants that may be imposed by
prospective lenders, for example in the form of a dividend restriction.

Equity finance
Grapple is not currently a listed entity, and so would need to seek an initial listing for an issue of
equity shares if it wanted to make a public issue. This is likely to be an expensive and time‐
consuming process for what is a family‐owned entity to comply with financial regulation and
corporate governance requirements. Any investors (particularly institutional investors) would

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