FBS 314: Financial Management for BAcc Students – Comprehensive Exam Notes (Stellenbosch University)

FBS 314 is a core third-year Financial Management module in the Stellenbosch University BAcc stream, building directly on FBS 214 and FBS 224. It focuses on applied corporate finance: investment appraisal, financing decisions, working capital management, business valuations, and risk–return analysis. These exam notes are structured around commonly examinable themes and typical question styles that appear in Stellenbosch University past papers and similar BAcc / CTA-level modules at South African universities (e.g. UNISA FNI3701, CUT FMA60AB), but tailored specifically for Stellenbosch University (SU): BAcc – FBS 314.

The notes assume knowledge of basic accounting, financial statement analysis, and introductory financial management. The emphasis is on how to approach exam questions step-by-step, with formulas, worked examples, and common pitfalls to avoid.

1. Core Time Value of Money and Capital Budgeting Techniques

1.1 Time Value of Money Foundations (FBS 314 Context)

The time value of money (TVM) underpins almost every FBS 314 topic. Exam questions rarely test basic TVM directly, but they embed it in capital budgeting, valuation, and cost of capital calculations.

Key principles:

• A rand today is worth more than a rand tomorrow.
• Cash flows at different times are not directly comparable and must be converted to a common point in time (usually present value).
• Discounting uses a required rate of return (or cost of capital) to translate future cash flows to present value.

Core formulas (using annual compounding):

• Future value (FV):
  [
  FV = PV(1 + i)^n
  ]
• Present value (PV):
  [
  PV = \frac{FV}{(1 + i)^n}
  ]
• Present value of an annuity (equal payments, end of each period):
  [
  PV_{\text{annuity}} = C \times \frac{1 – (1 + i)^{-n}}{i}
  ]
• Growing annuity (constant growth g < i):
  [
  PV_{\text{growing annuity}} = \frac{C_1}{i – g}\left[1 – \left(\frac{1 + g}{1 + i}\right)^n\right]
  ]
• Perpetuity (no end date, constant C):
  [
  PV_{\text{perpetuity}} = \frac{C}{i}
  ]
• Growing perpetuity (g < i):
  [
  PV_{\text{growing perpetuity}} = \frac{C_1}{i – g}
  ]

Compounding conventions relevant in SA:

• Nominal vs effective rates:
  • Nominal rate ( i_{nom} ) compounded m times a year → effective annual rate (EAR):
    [
    EAR = \left(1 + \frac{i_{nom}}{m}\right)^m – 1
    ]
• In SU FBS 314 exams, unless otherwise stated, rates are often effective annual rates and cash flows occur annually at year-end.

Exam tips:

• Always draw a simple timeline. Label years 0, 1, 2, … and mark cash flows.
• State your discount rate clearly and indicate if it is nominal or effective.
• Use the same time step for all cash flows in a calculation (e.g. yearly, not mixing monthly and yearly without converting).

1.2 Capital Budgeting Overview

Capital budgeting deals with long-term investment decisions: machinery, plants, IT systems, expansion into new markets, etc. In FBS 314, you must:

• Evaluate projects using NPV, IRR, payback, discounted payback, PI.
• Handle mutually exclusive vs independent projects.
• Incorporate tax, inflation, and working capital.
• Distinguish between accounting profit and cash flow.

The central objective: Maximise shareholder wealth. Therefore, the Net Present Value (NPV) rule is primary.

1.3 Net Present Value (NPV)

Definition:

NPV is the present value of all incremental after-tax cash flows of a project, discounted at the project’s relevant cost of capital.

[
NPV = \sum_{t=0}^{n} \frac{CF_t}{(1 + r)^t}
]

Where:

• ( CF_t ) = incremental cash flow at time t.
• r = discount rate (usually WACC).
• n = project life in years.

Decision rules:

• Independent projects:
  • Accept if NPV > 0
  • Reject if NPV < 0
• Mutually exclusive projects:
  • Choose the project with the highest positive NPV.

Key FBS 314 exam elements when calculating NPV:

1. Initial outlay (Year 0):
   • Purchase price of asset.
   • Installation, transport, and other capitalised costs.
   • Working capital investment (inventory, receivables minus payables).
   • Less: sale of old asset (after-tax proceeds).
2. Operating cash flows (Years 1 to n):
   • Based on incremental earnings before interest and tax (EBIT).
   • Subtract tax.
   • Add back non-cash charges (depreciation).
3. Terminal cash flows (Year n):
   • Salvage value (after tax).
   • Recovery of working capital.
   • Final operating cash flow.

Incremental cash flow formula:

For each year t = 1 to n:

[
CF_t = (Revenue_t – Costs_t – Depreciation_t)(1 – T) + Depreciation_t
]

Where:

• T = corporate tax rate.

Worked mini-example (simplified):

A company (Stellenbosch-based manufacturer) considers buying a machine for R500 000. Additional installation costs are R50 000. The machine will increase annual revenue by R250 000 and annual cash operating costs by R80 000 for 5 years. The machine will be depreciated straight-line over 5 years to zero. Tax rate is 28%, and the cost of capital is 12%. No salvage value, no working capital effects.

1. Initial outlay (Year 0):

   • Cost = R500 000 + R50 000 = R550 000 (cash outflow).

2. Annual depreciation:

   • R550 000 / 5 = R110 000 per year.

3. Annual pre-tax profit impact:

   • Incremental revenue = R250 000
   • Incremental operating cost = R80 000
   • Depreciation = R110 000
     ⇒ EBIT = 250 000 − 80 000 − 110 000 = R60 000

4. Tax:

   • Tax = 28% × 60 000 = R16 800

5. Net income:

   • R60 000 – R16 800 = R43 200

6. Add back depreciation (non-cash):

   • CF each year = 43 200 + 110 000 = R153 200 for years 1–5.

7. NPV:

   • Use r = 12%.
   • PV annuity factor for 12%, 5 years ≈ 3.6048.
   • PV of cash inflows = 153 200 × 3.6048 ≈ R552 822.
   • NPV = 552 822 − 550 000 = R2 822.

Decision: NPV > 0, accept project.

Common exam pitfalls:

• Forgetting working capital at t=0 and its recovery at t=n.
• Using accounting profits instead of cash flows.
• Ignoring opportunity costs and erosion (cannibalisation) effects.
• Applying pre-tax discount rates to after-tax cash flows (or vice versa).
• Failing to exclude sunk costs (e.g. past feasibility study expenses).

1.4 Internal Rate of Return (IRR) and Modified IRR (MIRR)

IRR definition:

IRR is the discount rate that makes NPV = 0.

[
0 = \sum_{t=0}^{n} \frac{CF_t}{(1 + IRR)^t}
]

Decision rules:

• Independent projects:
  • Accept if IRR > required return (cost of capital).
• Mutually exclusive:
  • Typically choose project with higher NPV, not necessarily higher IRR.

Limitations tested in FBS 314:

• Non-conventional cash flows may give multiple IRRs.
• IRR assumes reinvestment of interim cash flows at IRR (often unrealistic).
• IRR can conflict with NPV when projects have different scales or timing.

Modified Internal Rate of Return (MIRR):

Addresses IRR’s reinvestment assumption.

Steps:

1. Discount all outflows to present value at the finance rate (usually WACC).
2. Compound all inflows to terminal value at the reinvestment rate (often WACC).
3. MIRR is the rate that equates PV of outflows to the FV of inflows over n periods:

[
MIRR = \left(\frac{FV_{\text{inflows}}}{PV_{\text{outflows}}}\right)^{1/n} – 1
]

Merits:

• Unique solution (no multiple roots).
• More realistic reinvestment assumption.

Exam note: If given both IRR and MIRR, you usually mention their theoretical differences and state clearly which you would rely on (NPV remains primary).

1.5 Payback, Discounted Payback, and Profitability Index

These are secondary tools often examined conceptually and computationally.

Payback Period

Time required to recover the initial investment from nominal cash inflows.

• Accept if payback < maximum acceptable period.
• Ignores time value of money.
• Ignores cash flows after payback.

Calculation:

• If cash flows equal each year:
  Payback = Initial investment ÷ annual cash inflow.
• If not equal:
  Accumulate inflows until they equal the initial cost; interpolate if needed.

Discounted Payback Period

Similar to payback but uses discounted cash flows.

• Accept if discounted payback < maximum.
• Incorporates time value but still ignores later cash flows.
• Always > or = to ordinary payback.

Profitability Index (PI)

[
PI = \frac{PV\ \text{of future cash inflows}}{\text{Initial investment}}
]

Decision:

• Accept if PI > 1.
• Useful when capital rationing is present.

Relationship to NPV:

[
NPV = (PI – 1) \times \text{Initial investment}
]

PI can conflict with NPV under mutually exclusive projects, but is useful for ranking under capital constraints.

2. Cost of Capital and Capital Structure (FBS 314 Focus)

2.1 Concept of Cost of Capital

The cost of capital is the firm’s required return on its investments, reflecting the opportunity cost to providers of capital (equity and debt). It is central in FBS 314 as the discount rate in NPV calculations and valuations.

Weighted Average Cost of Capital (WACC):

[
WACC = \frac{E}{V}k_e + \frac{D}{V}k_d(1 – T)
]

Where:

• ( E ) = market value of equity.
• ( D ) = market value of debt.
• ( V = E + D ).
• ( k_e ) = cost of equity.
• ( k_d ) = cost of debt (pre-tax).
• ( T ) = corporate tax rate.

Important exam conventions:

• Always use market values, not book values, unless clearly told otherwise.
• Use after-tax cost of debt: ( k_d(1 – T) ).
• Check whether preference shares or other sources are included.

2.2 Cost of Equity: CAPM and Dividend Discount Model

Capital Asset Pricing Model (CAPM)

Commonly used to estimate ( k_e ) in FBS 314:

[
k_e = R_f + \beta (R_m – R_f)
]

Where:

• ( R_f ) = risk-free rate (e.g. long-term South African government bond yield).
• ( \beta ) = equity beta (systematic risk measure).
• ( R_m ) = expected market return.
• ( R_m – R_f ) = market risk premium.

Exam approach:

1. Identify ( R_f ), ( R_m ), and β from the question.
2. Compute the market risk premium.
3. Plug into CAPM.

Example:

If ( R_f = 8% ), ( R_m = 15% ), β = 1.2:

• Market risk premium = 15% − 8% = 7%.
• ( k_e = 8% + 1.2(7%) = 8% + 8.4% = 16.4% ).

Dividend Discount Model (DDM)

Used when a share’s value is based on expected dividends and their growth.

1. Zero-growth DDM:
   [
   P_0 = \frac{D}{k_e}
   \Rightarrow k_e = \frac{D}{P_0}
   ]

2. Gordon growth (constant growth):
   [
   P_0 = \frac{D_1}{k_e – g}
   \Rightarrow k_e = \frac{D_1}{P_0} + g
   ]
   Where:

   • ( D_1 ) = dividend next year.
   • g = constant growth rate.

In exam questions, you may be given both CAPM and DDM estimates; you should be able to:

• Calculate both.
• Comment on discrepancies (e.g. share mispricing, different risk assumptions).

2.3 Cost of Debt and Preference Shares

Cost of Debt

The pre-tax cost of debt ( k_d ) is the yield-to-maturity (YTM) on existing debt or the rate at which the firm can borrow now.

If a company issues a bond with:

• Face value = R1 000.
• Coupon rate = 10% (annual interest).
• Current market price = R950.
• Maturity = 5 years.

You must solve for ( k_d ) in:

[
950 = \sum_{t=1}^{5} \frac{100}{(1 + k_d)^t} + \frac{1,000}{(1 + k_d)^5}
]

In the exam, either:

• You will use a financial calculator, or
• You will approximate ( k_d ) using interpolation or be given it.

After-tax cost:
[
k_d(1 – T)
]

If corporate tax rate = 28% and ( k_d = 11.5% ):

• After-tax cost = 11.5% × (1 − 0.28) = 11.5% × 0.72 = 8.28%.

Cost of Preference Shares

1. Perpetual preference shares (no maturity):
   [
   k_{pref} = \frac{D_{pref}}{P_0}
   ]
   Where:

   • ( D_{pref} ) = annual preference dividend.
   • ( P_0 ) = current market price per preference share.

2. Redeemable (finite life) preference shares:

   • Treat similar to a bond; compute yield to maturity based on:
     • Annual preference dividend.
     • Redemption value at maturity.
     • Issue price.

2.4 Calculating WACC: Worked Example

Assume a Stellenbosch-based listed company, StellenFin Ltd, has the following capital structure (market values):

• Equity: 2 000 000 ordinary shares trading at R25 each → E = R50 000 000.
• Debt: Bonds with a total market value of R20 000 000 → D = R20 000 000.
• Total value V = 50 000 000 + 20 000 000 = R70 000 000.

Given:

• ( k_e ) from CAPM = 16%.
• Pre-tax ( k_d = 10% ), corporate tax rate T = 28%.

Weights:

• ( \frac{E}{V} = \frac{50,000,000}{70,000,000} = 0.7143 ).
• ( \frac{D}{V} = \frac{20,000,000}{70,000,000} = 0.2857 ).

After-tax debt cost:

• ( k_d(1 – T) = 10% \times 0.72 = 7.2% ).

WACC:

[
WACC = 0.7143(16%) + 0.2857(7.2%) = 11.4288% + 2.0571% = 13.4859% \approx 13.49%
]

This WACC would then be used as the discount rate in NPV computations for average-risk projects.

2.5 Capital Structure Theory and FBS 314 Application

Although FBS 314 is numerically heavy, theory regarding capital structure (mix of debt and equity) is also examined.

Key theories:

1. Modigliani and Miller (MM) without tax:

   • In a perfect market, firm value is independent of capital structure.
   • No taxes, no bankruptcy costs, symmetric information.

2. MM with tax:

   • Interest is tax-deductible.
   • Levered firm value > unlevered due to tax shield.
   • Value of tax shield:
     [
     V_L = V_U + T \times D
     ]

3. Trade-off theory:

   • Firm trades off tax benefits of debt against expected costs of financial distress/bankruptcy.
   • Optimal capital structure where marginal benefit of tax shield = marginal cost of financial distress.

4. Pecking order theory:

   • Firms prefer:
     1. Internal funds (retained earnings).
     2. Debt.
     3. New equity (last resort).
   • Due to asymmetric information and issue costs.

5. Signalling theory:

   • Debt/equity issuance can signal management’s view of firm value to the market.
   • Equity issue may signal overvaluation.

Exam-style conceptual tasks:

• Explaining why WACC initially declines as debt increases (due to tax shield) but then rises beyond a point (due to financial distress costs).
• Discussing capital structure implications in the South African context: e.g., high interest rates, thin bond markets, bank-dominated funding.

3. Working Capital Management and Short-Term Finance

3.1 Nature and Importance of Working Capital

Working capital comprises current assets and current liabilities.

Key definitions:

• Gross working capital: total current assets.
• Net working capital (NWC): current assets − current liabilities.

In FBS 314, focus is on managing NWC to ensure liquidity and profitability.

• Too high NWC → idle funds, lower return.
• Too low NWC → liquidity shortages, risk of financial distress.

3.2 Cash Management

Objectives:

• Maintain sufficient cash for transactions, precaution, and possibly speculation.
• Minimise idle cash while avoiding liquidity problems.

Cash budget:

A forward-looking statement showing expected cash inflows and outflows over time (monthly, weekly).

Structure of a simple cash budget:

Month	Jan (R)	Feb (R)
Opening balance	50 000	30 000
Cash receipts	100 000	120 000
Cash payments	120 000	110 000
Net cash flow	-20 000	10 000
Closing balance	30 000	40 000

Exam questions often require:

• Preparing a monthly cash budget.
• Identifying periods of surplus and deficit.
• Suggesting short-term financing or investment strategies.

Cash management models (short conceptual coverage):

• Baumol model: optimal cash holding similar to EOQ model:
  [
  C^* = \sqrt{\frac{2bT}{i}}
  ]
  Where b = fixed cost per transaction, T = total cash needed, i = opportunity cost (interest rate).
• Miller–Orr model: uses upper and lower control limits for cash balances.

FBS 314 may touch these models conceptually with simple numerical illustration.

3.3 Inventory Management

Inventory types:

• Raw materials.
• Work in progress.
• Finished goods.

Inventory trade-off:

• High inventory → lower stock-out risk but higher holding costs.
• Low inventory → higher stock-out risk and potential lost sales, but lower carrying costs.

Economic Order Quantity (EOQ) model:

[
EOQ = \sqrt{\frac{2DS}{H}}
]

Where:

• D = annual demand (units).
• S = ordering cost per order.
• H = carrying cost per unit per year.

Total inventory cost:

[
TC = \frac{D}{Q}S + \frac{Q}{2}H
]

Exam tasks:

• Solve for EOQ.
• Compute total cost and compare at different Q values.
• Interpret managerial implications.

Reorder point:

[
\text{Reorder point} = \text{average usage per period} \times \text{lead time}
]

Adding safety stock if demand/lead time uncertain.

3.4 Receivables Management and Credit Policy

Objective:

• Maximise sales and profits by offering credit, while controlling bad debts and collection costs.

Key variables in credit policy:

• Credit standards (which customers qualify).
• Credit terms (e.g., 2/10, n/30).
• Collection policy.

Evaluating a change in credit policy:

FBS 314 often tests:

1. Impact on sales (and contribution margin).
2. Change in average collection period (ACP) and investment in debtors.
3. Change in bad debt losses.
4. Change in collection costs.
5. Opportunity cost of funds tied up in receivables.

Formula for average investment in receivables:

[
\text{Average receivables} = \text{Annual credit sales} \times \frac{\text{ACP}}{365}
]

Incremental NPV analysis:

• Incremental contribution margin – incremental bad debts – incremental collection costs – opportunity cost of additional receivables.

If the NPV of the policy change is positive, the new credit policy is acceptable.

3.5 Short-Term Financing: Sources and Costs

Common short-term financing sources relevant for South African firms:

• Bank overdrafts.
• Short-term bank loans.
• Trade credit (accounts payable).
• Commercial paper (for larger firms).
• Factoring of receivables.

Key exam aspects:

• Calculate the effective annual cost of various facilities (including fees).
• Compare spontaneous financing (e.g. trade credit) vs negotiated financing (bank loans).
• Evaluate the cost of not taking discounts on creditors.

Cost of trade credit:

If terms are 2/10, net 30:

• Discount = 2%.
• Credit period if discount not taken: 30 − 10 = 20 days.
• Effective annual cost:

[
\text{Cost of not taking discount} = \frac{\text{Discount %}}{1 – \text{Discount %}} \times \frac{365}{\text{Days beyond discount period}}
]

[
= \frac{2%}{1 – 2%} \times \frac{365}{20} = \frac{0.02}{0.98} \times 18.25 \approx 0.0204 \times 18.25 \approx 0.3723 \text{ or } 37.23%
]

Very high effective cost → usually optimal to take the discount and finance elsewhere at lower cost.

4. Investment Appraisal under Risk, Capital Rationing, and Inflation

4.1 Risk and Return Basics

FBS 314 expects strong understanding of risk–return trade-off:

• Expected return:
  [
  E(R) = \sum_{i} p_i R_i
  ]
• Variance and standard deviation (measure of total risk):
  [
  \sigma^2 = \sum_{i} p_i (R_i – E(R))^2
  ]

In an exam, you might be given a discrete distribution of possible project returns and asked to calculate expected return and standard deviation.

Portfolio risk reduction:

• Combining assets with less than perfectly positive correlation reduces overall risk.
• CAPM separates:
  • Systematic risk (non-diversifiable, measured by beta).
  • Unsystematic risk (diversifiable).

Only systematic risk is priced; hence CAPM for cost of equity.

4.2 Risk in Capital Budgeting: Approaches

FBS 314 covers several ways to incorporate risk into NPV analysis:

1. Risk-adjusted discount rate (RADR):

   • Use a higher discount rate for riskier projects, and lower for safer ones.
   • E.g., base WACC 13%; high-risk project discount at 17%, low-risk at 10%.

2. Certainty equivalent (CE) approach:

   • Adjust each expected cash flow for risk, using certainty equivalent factors (α):
     [
     \text{Risk-free NPV} = \sum_{t=1}^{n} \frac{\alpha_t \times E(CF_t)}{(1 + R_f)^t} – CF_0
     ]
   • α_t < 1 for risky flows.
   • Less commonly used in SA exams; know conceptually.

3. Sensitivity analysis:

   • Change one key input at a time (e.g., sales volume, selling price, variable cost) and observe impact on NPV/IRR.
   • Identify critical variables that NPV is most sensitive to.

4. Scenario analysis:

   • Construct discrete scenarios: best-case, most likely, worst-case.
   • Compute NPV for each scenario and, optionally, expected NPV.

5. Simulation (conceptual only in most FBS 314 exams):

   • Use probability distributions for inputs, run many iterations, obtain distribution of NPV.

Sensitivity analysis example (conceptual):

If base NPV = R500 000, and a ±10% change in selling price causes NPV to change from R200 000 to R800 000 (±60%), while a ±10% change in variable cost changes NPV from R450 000 to R550 000 (±10%), the project is far more sensitive to changes in selling price.

4.3 Capital Rationing

Capital rationing occurs when a firm cannot fund all positive NPV projects due to limited capital or other constraints. FBS 314 looks at:

• Single-period capital rationing (most common in exams).
• Hard vs soft capital rationing:
  • Hard: external market-imposed limits.
  • Soft: internally imposed budget constraints.

Decision tools:

1. Profitability index (PI) for ranking projects under a single-year budget.
2. Linear programming approach (conceptual; rarely mathematically detailed).
3. Mutually exclusive vs divisible projects:
   • If projects are divisible (can be partially invested), choose combination that maximises NPV using a knapsack approach.
   • If indivisible, must consider integer combinations; often trial-and-error in exams.

Example (simplified):

Assume three projects with:

Project	Initial Cost (R)	NPV (R)	PI
A	1 000 000	300 000	1.30
B	800 000	240 000	1.30
C	500 000	175 000	1.35

Budget limit = R1 300 000.

• If projects are divisible, invest first in C (highest PI), then A or B (same PI).
• If indivisible, evaluate combinations:
  • A + B = R1 800 000 → not feasible.
  • A + C = R1 500 000 → not feasible.
  • B + C = R1 300 000 → feasible, NPV = 240 000 + 175 000 = 415 000.
  • A only = NPV 300 000.
  • B only = 240 000.
  • C only = 175 000.
    Best combination: B + C.

4.4 Inflation and Capital Budgeting

South African context: inflation is a persistent reality. FBS 314 exams often test whether candidates:

• Distinguish between nominal (money) and real (inflation-adjusted) cash flows.
• Match nominal cash flows with nominal discount rates, and real cash flows with real discount rates.

Relationship between nominal (i) and real (r) rates:

[
1 + i = (1 + r)(1 + \pi)
\Rightarrow r = \frac{1 + i}{1 + \pi} – 1
]

Where:

• i = nominal interest rate.
• r = real interest rate.
• π = expected inflation rate.

Rules:

• If cash flows incorporate expected inflation (e.g., prices and costs escalate), use nominal WACC.
• If cash flows are in constant rands (ignoring inflation), discount at real WACC.

Example:

Assume nominal WACC = 15%, expected inflation = 6%. Then:

[
r = \frac{1.15}{1.06} – 1 \approx 1.0849 – 1 = 0.0849 = 8.49%
]

Real WACC ≈ 8.49%. Use this rate if cash flows are real.

Examiners often penalise mismatches: e.g., using nominal WACC to discount real cash flows.

5. Business Valuation, Dividend Policy, and Exam Technique for FBS 314 (SU BAcc)

5.1 Business Valuation Methods

In FBS 314, valuation questions often appear in the context of:

• Company acquisitions or mergers.
• Estimating share price for a JSE-listed company.
• Project or division valuation for strategic decisions.

Main valuation approaches:

1. Discounted cash flow (DCF) valuation.
2. Dividend discount valuation.
3. Relative (multiple-based) valuation.
4. Asset-based valuation (less common for going concerns).

Discounted Free Cash Flow (FCF) Valuation

Two perspectives:

1. Free Cash Flow to the Firm (FCFF):

   • Cash flow before interest, available to all capital providers (debt + equity).
   • Discounted at WACC → gives enterprise value.

2. Free Cash Flow to Equity (FCFE):

   • Cash flow after interest and net debt repayments, available only to equity holders.
   • Discounted at ( k_e ) → gives equity value.

Typical FCFF formula:

[
FCFF = EBIT(1 – T) + \text{Depreciation} – \text{Capital expenditure} – \Delta NWC
]

Valuation:

[
V_{\text{firm}} = \sum_{t=1}^{n} \frac{FCFF_t}{(1 + WACC)^t} + \frac{TV}{(1 + WACC)^n}
]

Where terminal value (TV) based on Gordon growth:

[
TV = \frac{FCFF_{n+1}}{WACC – g}
]

Equity value then:

[
V_{\text{equity}} = V_{\text{firm}} – \text{Market value of debt}
]

Share price:

[
P_0 = \frac{V_{\text{equity}}}{\text{Number of shares}}
]

Dividend Discount Model (DDM) Valuation

Particularly relevant when:

• Firm has stable dividend policy.
• Dividends are a good proxy for cash flows to equity.

Constant growth DDM:

[
P_0 = \frac{D_1}{k_e – g}
]

Multi-stage DDM:

• Forecast dividends explicitly for high-growth period.
• Then apply constant growth formula to get a terminal value.
• Discount all dividends and terminal value at ( k_e ).

Relative Valuation (Multiples)

Common multiples:

• Price–earnings (P/E).
• EV/EBITDA.
• Price-to-book (P/B).

Example: If a comparable company group trades at an average P/E of 12, and your company’s expected EPS is R2.50:

[
\text{Estimated share price} = 12 \times 2.50 = R30.00
]

Exams may ask to:

• Compute a value using multiples.
• Compare to DCF or DDM valuation.
• Discuss reasons for differences (e.g. growth prospects, risk, accounting differences).

5.2 Dividend Policy: Relevance, Irrelevance, and South African Practice

Dividend policy involves decisions on:

• How much of earnings to distribute vs retain.
• Timing and form of distribution (cash dividends, share buybacks, special dividends).

FBS 314 conceptual coverage includes:

1. Dividend irrelevance (MM):

   • In a perfect market, dividend policy does not affect firm value.
   • Investors can create “homemade dividends” by selling shares.

2. Bird-in-the-hand theory:

   • Investors may prefer certain dividends over uncertain capital gains.
   • Higher dividends may lower perceived risk, raising share price.

3. Tax preference theory:

   • If taxes on dividends higher than on capital gains, investors may prefer lower payouts.

4. Signal and information content:

   • Dividend changes signal management’s view on future earnings.
   • Dividend increases often interpreted positively; cuts negatively.

5. Residual dividend policy:

   • Firm first funds all positive NPV projects, then distributes residual earnings as dividends.

South African context:

• Many JSE-listed firms pay interim and final dividends annually.
• Share buybacks have become more common as alternative form of payout.
• Dividend withholding tax (DWT) affects investors’ after-tax returns.

Exam tasks may involve:

• Calculating sustainable growth rate given a target payout ratio.
• Evaluating the impact of a change in payout on company financing needs.
• Discussing reasons for a stable dividend policy (e.g., investor expectations, signalling, access to capital markets).

5.3 Integrated Exam Technique for FBS 314 (SU BAcc)

Beyond technical content, success in FBS 314 exams depends on exam technique, particularly given time pressure and multi-part questions.

5.3.1 Reading and Planning

• Spend 5–10 minutes reading through the entire paper.
• Start with sections where you are strongest and that carry high marks.
• Underline key instructions:
  • “Ignore inflation.”
  • “Assume straight-line depreciation.”
  • “Use WACC of 13% unless otherwise indicated.”
  • “Tax rate = 28%.”

5.3.2 Structuring Calculations

1. Set out timelines for capital budgeting/valuation questions.

2. Use tables to structure cash flow calculations, e.g.:

   Year	Revenue	Costs	Depreciation	EBIT	Tax (28%)	Net income	+Depreciation	CF

3. Clearly label where you:

   • Calculate operating cash flows.
   • Deduct initial outlay.
   • Add terminal values and working capital recovery.
   • Compute NPV or IRR.

4. Show all formulas and substitution steps; partial marks are often awarded even if the final answer is wrong.

5.3.3 Using Financial Calculators/Spreadsheets Logic

While you won’t have spreadsheets in the exam, think in spreadsheet logic:

• Break problems into smaller components.
• Use consistent cell-like references in your workings.
• For IRR and NPV, clearly show the sequence of cash flows you’d feed into a calculator.

If using a financial calculator:

• For NPV: input discount rate, then cash flows.
• For IRR: input cash flows and compute IRR.
• Double-check signs: initial outlay negative, inflows positive.

5.3.4 Handling Theory Questions

FBS 314 exam papers usually contain discursive questions on:

• Capital structure theory.
• Dividend policy.
• Risk and return.
• Working capital trade-offs.

To maximise marks:

• Define key terms briefly and accurately.
• Use structured paragraphs with headings: Introduction, Main Argument 1, Argument 2, Conclusion.
• Provide examples (especially SA / JSE examples).
• Where appropriate, refer back to numeric outcomes (e.g., “As shown by the earlier NPV calculation…”).

5.3.5 Common FBS 314 Mistakes to Avoid

1. Mixing nominal and real values without proper adjustment.
2. Ignoring tax in cost of capital and project cash flows.
3. Treating sunk costs as relevant.
4. Omitting opportunity costs and side effects.
5. Confusing accounting depreciation and economic depreciation; remember, depreciation’s role is only via tax.
6. Using book values instead of market values in WACC.
7. Not reconciling the initial outlay with subsequent tax and salvage implications in replacement decisions.
8. Failing to adjust WACC for different project risk levels when instructed.
9. Poor time management: spending too long on one calculation and leaving theory questions blank.

5.4 Linking FBS 314 to Other South African Modules and Future Studies

For Stellenbosch University BAcc students, FBS 314:

• Bridges earlier modules (e.g., FBS 214 & FBS 224) and advanced courses such as:
  • FBS 424 (Advanced Financial Management).
  • Postgraduate modules in the Postgraduate Diploma in Accounting (PGDA) and CTA-equivalent programmes.
• Overlaps conceptually with modules at other universities, like:
  • UNISA FNI3701 – Corporate Finance (risk, cost of capital).
  • CUT FMA60AB – Financial Management (working capital, investment appraisal).

Understanding these connections helps contextualise FBS 314 within broader SAICA/IRBA competence frameworks.

Future professional exams (SAICA ITC and APC) draw significantly on:

• NPV and IRR analysis with tax, inflation, and risk.
• Cost of capital and capital structure insights.
• Business valuations and shareholder value analysis.
• Financing recommendations and dividend policy implications.

Strong mastery of FBS 314 content thus provides a robust foundation for both further academic study and professional practice in auditing, corporate finance, and management consulting.

Summary:
This study guide has covered the major examinable domains in FBS 314: Financial Management for BAcc Students at Stellenbosch University: time value of money, capital budgeting techniques, cost of capital and capital structure, working capital management, investment appraisal under risk and capital rationing, and business valuation with dividend policy. Applying these concepts with rigorous exam technique, careful attention to tax and inflation, and structured workings will position BAcc students strongly for high performance in FBS 314 and related modules within the Stellenbosch University (SU): BAcc curriculum.