CE AF Week Four Lecture

Corporate
Entrepreneurship:
Entrepreneurial Accounting
and Finance
Lectured by Mr Ncemane
Index
1. Recap of Week Two and Three
2. Individual Assignment
3. Groups
4. Group Assignment and Presentations
5. Part of Week Four Academic Programme - Financial Modelling
6. Week Four Academic Programme – Lecture Content
Recap of Week Two and Three
In week Two and Three we looked at:
• Current Asset Management
• Focus was on Cash Budgeting
• Capital Budgeting
• Focus was on Discounting Capital Budgeting Techniques
Individual Assignment
• Due on 21 February 2022 as provided for in the Study Guide
• Submission to be done via email as other students are experiencing challenges with
accessing myTutor.
• Business Model: Be as comprehensive as possible in populating the canvas
• Financial Analysis: Do not limit yourself to the financial analysis tools, especially ratios
covered in Week One.
• Financial Analysis: use what is in the textbook and collaborate with any industry
specific financial analysis tools that you have access to and/or understanding of.
Groups
Group Assignment
Presentations will start in Week Five.
• Follow the guidelines provided in the Study Guide

• Finalize the concept and/or problem you wish to provide a solution for using the
principles already learnt in class
• Prepare your presentation for Class
• FOR FAIRNESS - All presentations must be ready and submitted by the 25th February
2022
Financial Modelling
How to build a Financial

Model?
Chapter 21
The Basics
Chapter 21
Critical considerations:
1. Setting Financial Modelling Objectives
2. Design and Layout
3. Assumptions
4. Building the Financial Modelling (coding)
5. Testing the Financial Model
6. Using Scenarios in Financial Modelling
7. Use of Financial Model
Capital and Capital
Structure
Part 1:
The Cost of Capital
Chapter 7
Introduction
What is Capital?
Equity : Funds provided by the owners of a business
Debt : Funds borrowed by the business to finance business activities
All Capital has a Cost

Equity : Rate of Return = RoI (Return on Investment)
Debt : Finance Costs = Interest
The proportion in which the company uses a combination of equity and debt to finance
business activities from various sources is known as the CAPITAL STRUCTURE only
applicable to a specific company.
Basics of Capital Structures
Capital Structures are targeted:
• By management
• Approved by the Board
• In line with the requirement of the Companies Act
• As a policy or strategy of a business.
Recall in Week On we discussed Financial Compliance:

In terms of Section 4 of the Companies Act, 2008, there is a solvency and liquidity test.
Solvency relates to the assets of the company, fairly valued, being equal or exceeding the
liabilities of the company.
Liquidity relates to the company being able to pay its debt as they become due in the
ordinary course of business for a period of 12 months.
Basics of Capital Structures
A basic example of a targeted capital structure:
Company A as part of its financing policy has targeted to finance the business using a
maximum of 70% debt with the remainder as equity.
The company requires R100million to finance a project. The after-tax cost of capital is
12% and the rate of return required by shareholders is 18%
Capital Cost Proportion Structure

Equity 18% 30% 5.4%
Debt 12% 70% 8.4%
Weighted Average Cost of Capital (WACC) 13,8%
Weighted-Average Cost of Capital (WACC)
WACC enables an entity to evaluate capital projects.
Recall Capital Budgeting?
Recall the IRR decision making principles: Accept projects with a higher IRR
when compared to the cost of capital.
When is WACC used:

• Evaluation of capital projects (Capital Budgeting)
• Valuation of companies (valuations) using discounting tool
• Determination of the Economic Value Added (EVA) or economic profit
• Pricing decisions
• Determining Fair Value
Principles of WACC
Principles to consider in determining an entity’s cost of capital:
• Use a weighted-average of the costs of the different sources of finance
• Use marginal costs – use new/future cost of debt instead of the old and average
• Include the effects of corporate tax – use after tax discount rate to discount after tax-
cash flows
• Use nominal rates
• Use market values or a targeted capital structure
WACC Formula
Formula to reflet the after-tax cost of each source of finance, weighted by its
contribution to the value of the firm:
Preference shares are a special kind of debt which can also be equity subject to their
structure. If Preference Shares are used as part of the firm’s capital structure, include as
a separate component in the above formula
Component Cost of Capital
Cost of Debt:
Kd = I (1-t)
Where:
Kd = the cost of debt

I = the interest rate payable
t = the marginal tax rate
Always calculate the after-tax interest rate being I (1-t)

Cost of Preference Shares:
Kp = Dp / Vp (1-F)
Where:
Kp = the cost of preference share

Dp = the dividend rate (rate always provided)
Vp = the value of preference share ((expected dividend rate/required rate per market)*
issue price)
F = the flotation rate (flotation cost/ Vp)
Cost of Shareholders’ Equity:
Cost of Retained Earning(Kr), Cost of New Shares (Ks)and Cost of Equity (Ke)are impacted by
the company’s dividend policy
Kr = (D1 / P0 ) + g
Where:
D1 = the expected dividend (expected earnings per share * dividend payout ratio)
P0 = the current share market price
g = the growth rate (assumed at constant)
Ks = (D1 / P(1-F)) + g
Where:
P = the current share market price
F = the flotation costs
Cost of Shareholders’ Equity:
Using the Capital Asset Pricing Model (CAPM)
Ke = Rf + β(Rm – Rf)
Where:
Ke = the cost of shareholders' equity

Rf = the risk-free rate (government bonds)
β = the beta of the shares which measures the volatility of a share (standard deviation)
Rm = the return on the market portfolio
WACC in Summary
Capital and Capital
Structures.
Working Capital.
Working Capital: Definition and Realities
Working Capital (WC) refers to current assets and is different to net working capital
which refers to (liquidity) current assets less current labilities or net current assets.
• Crital to all businesses as it affects inventory, debtors and cash.
• Influenced by company current asset management policy.
Recall from week one we looked at working capital, inventory, debtors' days and current
ratios as part of financial analysis. We also looked Companies Act requirements.
We followed this up in week two by doing capital budget which were impacted by the
components of working capital and net working capital.
Today we look at how policies affecting working capital and net working capital are
formulated.
Working Capital: Policy Objectives
WC cycle is concerned with financing a level of investment in WC where the return
generated and the exposure to risk are finely balanced.
A challenging task it the economic environment and nature of the business impact WC
and the WC policy.
Policy objectives are focused on
• Balancing WC returns and risk
• Reducing the WC cycle (see 11-4)
Working Capital Policy
WC Policy involves two decisions:
1. The appropriate level of investment in current assets
2. How to finance current assets
Optimisation involves scenario planning.
Types of WC Policies:
• Credit Management Policy affecting sales and debtors
• Inventory Management policy affecting how and when inventory is purchased and
financed
• Cash Management Policy affecting retention, investment and utilisation of cash
Critical to WC financing is the impact it has on the firms CAPITAL STRUCTURE

Tools for Working Capital Policy Design
Tools may involve
1. Monthly (even shorter) Reporting
2. Financial Analysis
3. Forecasting as impacted by
• Demand for firm products
• Availability of supplier goods which you need as materials
• Material lifespan
• Production cycles
• Company exposure to financing
• Market opportunities
Capital Structure
Read Chapter 14 per

the study guide as it
puts the past lectures
into perspective.
Capital Budgeting Techniques
Important
Things to remember:
Individual Assignment is due on the Monday the 21st
February 2022 until 23H59:59.
The assumption is that you all have a text book and follow the
contents of the lectures. Asking private question after class
doesn’t help the broader development of others.
Kindly ask all your questions in class.
Next class there will involve presentation from the various
group for the Group Assignment to introduce the problem to
be solved.
Thank You

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Corporate

• Follow the guidelines provided in the Study Guide

How to build a Financial

All Capital has a Cost

Recall in Week On we discussed Financial Compliance:

Capital Cost Proportion Structure

When is WACC used:

Kd = the cost of debt

Always calculate the after-tax interest rate being I (1-t)

Kp = the cost of preference share

Ke = the cost of shareholders' equity

Critical to WC financing is the impact it has on the firms CAPITAL STRUCTURE

Read Chapter 14 per

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