Page 177 - Adopt-a-School Foundation 2016-2017 Annual Report

ADOPT-A-SCHOOL FOUNDATION NPC
NOTES TO THE ANNUAL FINANCIAL STATEMENTS
for the year ended 30 June 2017

3 financial instruments (continued)

d) Valuation Process

Choice of valuation model
The valuation of the BEE deal requires consideration of both the cash flows arising from and the evolution of the purchased equity and the B Preference
Shares. The outstanding balance on the B Preference Shares is dependent on the ordinary shareholders’ dividends generated by Sandvik Mining with
these dividends depending on the underlying share price at the time they are declared. The structure therefore represents a path dependent option. Path
dependent options can generally not be valued using traditional option pricing models such as the Black-Scholes formula since they are unable to model
the evolution of all potential path dependent variables. A typical risk-neutral option valuation approach using Monte Carlo Simulation was applied as it
provides the necessary flexibility to model the features of the deal with fewer approximations.

e) The main level 3 inputs used by the Foundation are derived and evaluated as follows:

1. Volatility
Since Sandvik Mining is unlisted, we sourced daily, weekly and monthly historical price data for Sandvik Sweden from Bloomberg. We calculated annualised
equity volatilities over terms to maturity of 1 year, 3 year and 5 year periods and identified a range of 30% to 35% as reasonable for the theoretical share
price volatility of Sandvik Mining. Implied volatilities inferred from market prices of traded options with longer terms to maturity and low/high moneyness
tend to be higher than at-the-money implied volatilities. We have taken historical volatility of 32.5% per annum as a crude indication of the theoretical at-
the-money volatility of Sandvik Mining and consequently used a volatility assumption of 40.0% per annum to approximate a theoretical Fair Value of the BEE
deal.

2. Interest rates
Risk-free interest rates were determined from a bootstrapped zero coupon perfect fit swap curve as at 30 June 2017 that we obtained from the Bond
Exchange of South Africa. The forward prime curve was constructed by applying a fixed spread of 3.15% (NACC) to the swap curve.

3. Dividend yield
A fixed dividend yield of 5.0% per annum was applied. We note that the valuation result is not particularly sensitive to this assumption.

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