Cloth Group Ltd ('Cloth Group') is a clothing retailer with 55 stores throughout South Africa. These stores, which focus on fashion clothing, are situated in suburban shopping malls and their target market is 25 to 45 year-old females and males. Approximately 75% of sales are on credit and customers are granted 30 days' interest-free credit from the date of the statement. If payments are not made within this period, customers have to pay interest on the outstanding balance, calculated from the date of purchase, at the prime overdraft lending rate (currently 15,5% per annum) plus 4%. Customers are required to settle the full amount owing on a purchase within six months.
Cloth Group is listed on the JSE Securities Exchange. The company has performed well over the past two years, reporting revenue of R412 million for the year ended 31 January 2009 (2008: R357 million) and achieving a gross profit margin of 42% for the 2009 financial year (2008: 41%).
Cloth Group purchases clothing from foreign and local suppliers. Suppliers are selected based on the quality of merchandise supplied, pricing and reliability. The majority of foreign suppliers are based in Europe and invoice Cloth Group in euro ().
The audited statement of financial position of Cloth Group at 31 January 2009, together with comparative figures, is set out below:
CLOTH GROUP LTD
STATEMENT OF FINANCIAL POSITION AT 31 JANUARY
2009 2008
R'000 R'000
ASSETS
Non-current assets
Property, plant and equipment 102 280 89 180
Current assets 198 050 169 800
Inventories 49 800 43 340
Trade receivables 129 600 110 180
Cash and cash equivalents 18 650 16 280
TOTAL ASSETS 300 330 258 980
EQUITY AND LIABILITIES
Share capital 15 000 15 000
Retained earnings 192 875 153 000
Total equity 207 875 168 000
Current liabilities 92 455 90 980
Current borrowings (bank overdraft) 29 050 42 090
Trade and other payables 34 080 27 100
Shareholders for dividends 11 250 9 750
Taxation payable 18 075 12 040
TOTAL EQUITY AND LIABILITIES 300 330 258 980
8
Raising of medium-term finance
The Treasury Division of Cloth Group has been tasked with raising finance of between R100 million and R125 million. Cloth Group requires the funding to grow its trade receivables and consequently revenue. The Treasury Division has received various formal proposals and has short-listed the following two proposals:
1 Euro denominated bond
Total nominal value 9 600 000
Coupon (fixed) 6,9%
Issue date 31 March 2009
Maturity date 31 March 2012
Interest coupon on the bond is payable annually in arrears. The total nominal value is repayable in full on the maturity date.
2 Syndicated loan
Principal amount R120 000 000
Nominal interest rate 3 month JIBAR plus 2,5%
Loan advance date 31 March 2009
Term 3 years
Upfront issuance cost 2% of the principal amount
Interest on the loan is to be calculated and paid quarterly in arrears. The current Johannesburg Interbank Agreed Rate (JIBAR) is 12,5%. The principal amount is to be repaid in three equal annual instalments, with the first repayment due on 31 March 2010. The upfront issuance cost is to be paid by Cloth Group on the loan advance date, or the company can elect to receive 98% of the principal amount on the advance date.
Cloth Group's policy is to hedge all foreign currency exposure. Their commercial bankers have quoted the following spot and forward exchange contract rates:
Current spot rate €1 : R12,50
12 months forward to 31 March 2010 €1 : R13,75
24 months forward to 31 March 2011 €1 : R15,10
36 months forward to 31 March 2012 €1 : R16,60
Capital structure
Cloth Group has historically funded its growth out of its own cash flows and through shortterm borrowings, mainly in the form of bank overdrafts. The Chief Executive Officer of Cloth Group has asked the Financial Director to determine what impact the raising of medium-term finance will have on the weighted average cost of capital (WACC) of Cloth Group.
Information that may be relevant in determining Cloth Group's WACC is set out in the table
below:
Cloth Group
Number of shares in issue 15 000 000
Current share price R24,60
Beta co-efficient 0.90
Effective normal income tax rate 28%
Dividend per share declared on 31 January 2009 75c
Other information
Current yield of the R204 RSA government bond,
maturity date 21 December 2018
9,0%
Current yield of the R153 RSA government bond,
maturity date 31 August 2010
9,4%
Premium for market risk 8,0%
REQUIRED
(a) Calculate and determine which debt instrument will be the most cost effective way for Cloth Group Ltd to raise medium-term finance.
(b) Identify and describe the key factors that Cloth Group Ltd should consider in evaluating which debt instrument to issue.
(c) Calculate, with reasons, the weighted average cost of capital (WACC) of Cloth Group Ltd at 31 March 2009, assuming that the company
elects to issue the euro denominated bond.
(d) Assuming that Cloth Group Ltd elected to enter into the syndicated loan agreement, discuss the key factors and issues that Cloth Group Ltd should consider in evaluating whether to change from a floating interest rate to a fixed interest rate.
(e) Briefly describe the concept of asset-backed securitisation and indicate what benefits, if any, could accrue to Cloth Group Ltd from securitising its trade receivables.
(f) Identify the key procedures that Cloth Group Ltd should follow in assessing the creditworthiness of new customers.
Presentation marks: Arrangement and layout, clarity of explanation, logical argument and language usage.
A table of present value factors for various interest and/or discount rates for varying periods and a table of various nominal interest rates paid quarterly in arrears together with the equivalent effective annual interest rates are provided on the next page.
FUTURE VALUE AND PRESENT VALUE TABLES: CLOTH GROUP
Present value tables
Present value interest factors for R1,00 discounted at various rates for varying periods
Interest ratPeriod e
10,00% 11,00% 12,00% 13,00% 14,00% 15,00% 16,00% 17,00% 18,00%
1 0,909 0,901 0,893 0,885 0,877 0,870 0,862 0,855 0,847
2 0,826 0,812 0,797 0,783 0,769 0,756 0,743 0,731 0,718
3 0,751 0,731 0,712 0,693 0,675 0,658 0,641 0,624 0,609
4 0,683 0,659 0,636 0,613 0,592 0,572 0,552 0,534 0,516
5 0,621 0,593 0,567 0,543 0,519 0,497 0,476 0,456 0,437
6 0,564 0,535 0,507 0,480 0,456 0,432 0,410 0,390 0,370
7 0,513 0,482 0,452 0,425 0,400 0,376 0,354 0,333 0,314
8 0,467 0,434 0,404 0,376 0,351 0,327 0,305 0,285 0,266
9 0,424 0,391 0,361 0,333 0,308 0,284 0,263 0,243 0,225
10 0,386 0,352 0,322 0,295 0,270 0,247 0,227 0,208 0,191
I
nterest rates
Nominal interest rate
paid quarterly in arrears
Equivalent effective
annual interest rate
10,00% 10,38%
11,00% 11,46%
12,00% 12,55%
13,00% 13,65%
14,00% 14,75%
15,00% 15,87%
16,00% 16,99%
17,00% 18,11%
18,00% 19,25%
19,00% 20,40%
20,00% 21,55%