Welcome to your SL2 Mock Paper 03 (based on the unseen)

Unseen

New Building Construction

CBE intents to expedite the building construction work which got delayed due to payment issues and covid 19 restrictions in order to double the intake after the completion. However they have realized that modern education trends are changing and due to Covid restrictions like in many other places they have also started teaching and testing using digital platforms. Although there were some resistance at the beginning from both students and lecturers, the company has realized that the trends are fast changing and professional, undergraduate and postgraduate students now prefer digital environments where they can learn from their home at convenient times and schedules. Online learning trend is on the rise and students are now getting used to the methodology due to they being tech savy and are familiar with digital environments. They prefer the flexibility of digital courses and the fact that they can watch the recorded videos any number of times at their convenience

Taking into consideration the current trends, the management of CBE is now worrying whether they have invested in an investment which will significantly behave differently than expected. They were expecting after the completion of the project / investment CBE will be able to increase the intake and double the profits. With the final disbursement of the loan at the beginning of 2021/22, the company has received the full value of the loan of Rs. 6Bn from the bank and the project completion is expected to take 2 more years. The company would be able to recruit new students for physical classes commencing from F/Y 2023/24. Due to the changes in the trends, the actual intake would be lower than expected and the company will need 5 years from now to double the existing student base. It will be having 50% more students than the current base in 2023/24 which will increase to 75% in 2024/25 and will reach 100% commencing from 2025/26. The loan obtained for the building construction will start to be paid from the beginning of year 2021/22.

Due to the shifts in the education trends, the company does not wish to maintain the same administrative structure when it starts physical classes in the new building beginning 2023/24. CBE expects that most of the lectures and other administrative works can be provided to the students through digital platforms with the experience of working from home as a result of Covid 19 and therefore, expects it would be able to reduce its operating expenses by 50% compared to the present level of operations. Operating expenses is a fixed cost. You may assume the current price levels. The current taxation rate can be assumed to be applicable in the future.

After 2025/26, EBIT can be assumed to increase at a rate of 5% continuously for the new project.

Integrated Digital Platform

In addition to the building investment, the company is also thinking of improving its IT infrastructure and creating a digital learning platform to conduct online courses and online testing. A proposal has been received from an IT solutions provider to create a Learning Management System to provide course materials and lectures through a digital learning platform. The company would be able to not only conduct lectures but also conduct assessments and tests using the digital platform. It’s expected that the digital platform will be used by the existing students as they are now used to online lectures and also by a greater majority of the new students once it’s enabled. The offer by the IT Solutions provider will include;

01. Offer
a. Provides platform/portal to log in and practice exams to practice from Home and get a self-assessment for
    1. Undergraduate and Postgraduate programs
    2. Professional education
    3. Short Courses
    4. Job related technical knowledge assessments as a candidate qualifying criteria
b. Provides scores and a peer comparison evaluation with ratings and Z score
c. Value additions
    1. Analysis of score with probabilities
    2. Answer papers - voice clip explains the answer
d. Learning platform – Online delivery of lectures

02. Type of Product
    1. Only MCQ
    2. 1-2 hr simulated exam
    3. Lectures English and Mandarin languages

It’s expected that the company could use this platform when it’s completed to provide distance learning opportunities for foreign students specially from Maldives and Middle eastern countries who are willing to invest for quality and flexible education. The Digital learning platform will generate revenue of approximately Rs. 500Mn each year with an approximate student base of 5000 each year and will have a higher GP than the traditional GP margin of the business. CBE’s direct costs of operations would be lower and EBIT would be 40% of the annual real revenue. 

 Sale of Shares by Kiriella

Kiriella family is unlikely to hold onto its shares in the future and Lalith has indicated his intention to sell the shares immediately. Since, Jagath is interested to continue the business operation, Jagath has indicated that he would purchase the shares at a mutually agreeable price with Lalith. Lalith is also thinking of selling his shares in the market in the event the company is listed in the “Diri savi” Board of the stock exchange.

Lalith is non - committal of his willingness to sell his shares to Jagath and is considering all available options to maximize his exit returns.

You are required to;

1a. Based on the given information in the pre seen and unseen, calculate the approximate WACC of this company with suitable assumptions.   (5 Marks)

1b.

  1. Calculate the net profit of the project for the 1st 3 years and thereafter
  2. Calculate the net cash flows for the investment appraisal purposes and the terminal value (10 Marks)

1c. Calculate the NPV of the new project and advise the board of directors whether the investment in the new building makes financial sense  (5 Marks)

2a. Jagath is eager to know the maximum amount of investment that should be made to introduce the digital learning platform as outlined above. Make suitable assumptions regarding the cash flows and cost of capital.   (5 Marks)

2b. The company has estimated that its working capital from the existing business will increase each year by 3% for the next 5 years while routine investment in capital expenditure would be Rs. 100mn for the next 5 years. If FCFE is going to increase by 5% after 5th year, calculate the value of the company and value per share based on the FCFE model.  (10 Marks)

2c. What other valuation methods can be used by the company to calculate the share price given that it’s a private company. What would be the reaction of Lalith and what would be the minimum price that he will expect to transfer his shares  (5 Marks)

2d. Assuming the company is going to be listed in the “Diri Savi” Board, what factors the company and the existing shareholders should consider (5 Marks)
3. Discuss the impact of excess gearing to the capital structure and WACC of an organization. Is it advisable to have high gearings and what could be the long term impacts (5 Marks)