Financial Management

Friday 5 December 2014

Time allowed
Reading and planning:
Writing:

15 minutes
3 hours

This paper is divided into two sections:

Section A ALL 20 questions are compulsory and MUST be
attempted
Section B ALL FIVE questions are compulsory and MUST be
attempted
Formulae Sheet, Present Value and Annuity Tables are on
pages 11, 12 and 13.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet until
instructed by the supervisor.
This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Paper F9

Fundamentals Level Skills Module

Section A ALL 20 questions are compulsory and MUST be attempted

Please use the space provided on the inside cover of the Candidate Answer Booklet to indicate your chosen answer to
each multiple choice question.
Each question is worth 2 marks.
1

TKQ Co has just paid a dividend of 21 cents per share and its share price one year ago was $310 per share. The
total shareholder return for the year was 197%.
What is the current share price?
A
B
C
D

$350
$371
$331
$335

Which of the following statements is/are correct?

1
2
3

Securitisation is the conversion of illiquid assets into marketable securities

The reverse yield gap refers to equity yields being higher than debt yields
Disintermediation arises where borrowers deal directly with lending individuals

A
B
C
D

2 only
1 and 3 only
2 and 3 only
1, 2 and 3

Which of the following statements are correct?

1
2
3

Maximising market share is an example of a financial objective

Shareholder wealth maximisation is the primary financial objective for a company listed on a stock exchange
Financial objectives should be quantitative so that their achievement can be measured

A
B
C
D

1 and 2 only
1 and 3 only
2 and 3 only
1, 2 and 3

A company whose home currency is the dollar ($) expects to receive 500,000 pesos in six months time from a
customer in a foreign country. The following interest rates and exchange rates are available to the company:
Spot rate
Six-month forward rate
Borrowing interest rate
Deposit interest rate

1500 peso per $

1530 peso per $
Home country
4% per year
3% per year

Foreign country
8% per year
6% per year

Working to the nearest $100, what is the six-month dollar value of the expected receipt using a money-market
hedge?
A
B
C
D

$32,500
$33,700
$31,800
$31,900

Which of the following statements is correct?

A
B
C
D

Which of the following statements is correct?

A
B
C
D

A bonus issue can be used to raise new equity finance

A share repurchase scheme can increase both earnings per share and gearing
Miller and Modigliani argued that the financing decision is more important than the dividend decision
Shareholders usually have the power to increase dividends at annual general meetings of a company

Tax allowable depreciation is a relevant cash flow when evaluating borrowing to buy compared to leasing as a
financing choice
Asset replacement decisions require relevant cash flows to be discounted by the after-tax cost of debt
If capital is rationed, divisible investment projects can be ranked by the profitability index when determining the
optimum investment schedule
Government restrictions on bank lending are associated with soft capital rationing

An investment project has a cost of $12,000, payable at the start of the first year of operation. The possible future
cash flows arising from the investment project have the following present values and associated probabilities:
PV of
Year 1 cash flow ($)
16,000
12,000
(4,000)

Probability
015
060
025

PV of
Year 2 cash flow ($)
20,000
(2,000)

Probability
075
025

What is the expected value of the net present value of the investment project?
A
B
C
D

Which of the following statements is correct?

A
B
C
D

$11,850
$28,700
$11,100
$76,300

Once purchased, currency futures have a range of close-out dates

Currency swaps can be used to hedge exchange rate risk over longer periods than the forward market
Banks will allow forward exchange contracts to lapse if they are not used by a company
Currency options are paid for when they are exercised

A company has 7% loan notes in issue which are redeemable in seven years time at a 5% premium to their nominal
value of $100 per loan note. The before-tax cost of debt of the company is 9% and the after-tax cost of debt of the
company is 6%.
What is the current market value of each loan note?
A
B
C
D

$9267
$10890
$8993
$10314

[P.T.O.

10 Which of the following statements concerning working capital management are correct?
1
2
3

Working capital should increase as sales increase

An increase in the cash operating cycle will decrease profitability
Overtrading is also known as under-capitalisation

A
B
C
D

1 and 2 only
1 and 3 only
2 and 3 only
1, 2 and 3

11 Which of the following is LEAST likely to fall within financial management?

A
B
C
D

The dividend payment to shareholders is increased

Funds are raised to finance an investment project
Surplus assets are sold off
Non-executive directors are appointed to the remuneration committee

12 Which of the following statements concerning profit are correct?

1
2
3

Accounting profit is not the same as economic profit

Profit takes account of risk
Accounting profit can be manipulated by managers

A
B
C
D

1 and 3 only
1 and 2 only
2 and 3 only
1, 2 and 3

13 A company has annual credit sales of $27 million and related cost of sales of $15 million. The company has the
following targets for the next year:
Trade receivables days
Inventory days
Trade payables

50 days
60 days
45 days

Assume there are 360 days in the year.

What is the net investment in working capital required for the next year?
A
B
C
D

$8,125,000
$4,375,000
$2,875,000
$6,375,000

14 An investor believes that they can make abnormal returns by studying past share price movements.
In terms of capital market efficiency, to which of the following does the investors belief relate?
A
B
C
D

Fundamental analysis
Operational efficiency
Technical analysis
Semi-strong form efficiency

15 Which of the following statements is/are correct?

1
2
3

An increase in the cost of equity leads to a fall in share price

Investors faced with increased risk will expect increased return as compensation
The cost of debt is usually lower than the cost of preference shares

A
B
C
D

2 only
1 and 3 only
2 and 3 only
1, 2 and 3

16 Governments have a number of economic targets as part of their fiscal policy.

Which of the following government actions relate predominantly to fiscal policy?
1
2
3
4

Decreasing interest rates in order to stimulate consumer spending

Reducing taxation while maintaining public spending
Using official foreign currency reserves to buy the domestic currency
Borrowing money from the capital markets and spending it on public works

A
B
C
D

1 only
1 and 3
2 and 4 only
2, 3 and 4

17 The following are extracts from the statement of financial position of a company:
$000
Equity
Ordinary shares
Reserves

$000

8,000
20,000

28,000

Non-current liabilities
Bonds
Bank loans
Preference shares

4,000
6,200
2,000

12,200

Current liabilities
Overdraft
Trade payables

Total equity and liabilities

1,000
1,500

2,500

42,700

The ordinary shares have a nominal value of 50 cents per share and are trading at $500 per share. The preference
shares have a nominal value of $100 per share and are trading at 80 cents per share. The bonds have a nominal
value of $100 and are trading at $105 per bond.
What is the market value based gearing of the company, defined as prior charge capital/equity?
A
B
C
D

150%
130%
118%
73%

[P.T.O.

18 Which of the following statements is correct?

A
B
C
D

Governments can keep interest rates low by buying short-dated government bills in the money market
The normal yield curve slopes upward to reflect increasing compensation to investors for being unable to use
their cash now
The yield on long-term loan notes is lower than the yield on short-term loan notes because long-term debt is less
risky for a company than short-term debt
Expectations theory states that future interest rates reflect expectations of future inflation rate movements

19 A company has just paid an ordinary share dividend of 320 cents and is expected to pay a dividend of 336 cents
in one years time. The company has a cost of equity of 13%.
What is the market price of the companys shares to the nearest cent on an ex dividend basis?
A
B
C
D

$320
$441
$259
$420

20 Which of the following is/are usually seen as forms of market failure where regulation may be a solution?
1
2
3

Imperfect competition
Social costs or externalities
Imperfect information

A
B
C
D

1 only
1 and 2 only
2 and 3 only
1, 2 and 3
(40 marks)

Section B ALL FIVE questions are compulsory and MUST be attempted

1

Flit Co is preparing a cash flow forecast for the three-month period from January to the end of March. The following
sales volumes have been forecast:
Sales (units)

December
1,200

January
1,250

February
1,300

March
1,400

April
1,500

Notes:
1. The selling price per unit is $800 and a selling price increase of 5% will occur in February. Sales are all on one
months credit.
2. Production of goods for sale takes place one month before sales.
3. Each unit produced requires two units of raw materials, costing $200 per unit. No raw materials inventory is
held. Raw material purchases are on one months credit.
4. Variable overheads and wages equal to $100 per unit are incurred during production, and paid in the month of
production.
5. The opening cash balance at 1 January is expected to be $40,000.
6. A long-term loan of $300,000 will be received at the beginning of March.
7. A machine costing $400,000 will be purchased for cash in March.
Required:
(a) Calculate the cash balance at the end of each month in the three-month period.

(5 marks)

(b) Calculate the forecast current ratio at the end of the three-month period.

(2 marks)

(c) Assuming that Flit Co expects to have a short-term cash surplus during the three-month period, discuss
whether this should be invested in shares listed on a large stock market.
(3 marks)
(10 marks)

[P.T.O.

Recent information on the earnings per share and share price of Par Co is as follows:
Year
Earnings per share (cents)
Year-end share price ($)

2011
64
915

2012
68
988

2013
70
1049

2014
62
1090

Par Co currently has the following long-term capital structure:

$m
Equity finance
Ordinary shares
Reserves
Non-current liabilities
Bank loans
8% convertible loan notes
Total equity and liabilities

$m

300
384

150
400

684

550

1234

The 8% loan notes are convertible into eight ordinary shares per loan note in seven years time. If not converted, the
loan notes can be redeemed on the same future date at their nominal value of $100. Par Co has a cost of debt of 9%
per year.
The ordinary shares of Par Co have a nominal value of $1 per share and have been traded on a large stock exchange
for many years. Listed companies similar to Par Co have been recently reported to have an average price/earnings
ratio of 12 times.
Required:
(a) Calculate the market price of the convertible loan notes of Par Co, commenting on whether conversion is
likely.
(5 marks)
(b) Calculate the share price of Par Co using the price/earnings ratio method and discuss the problems in using
this method of valuing the shares of a company.
(5 marks)
(10 marks)

PZK Co, whose home currency is the dollar, trades regularly with customers in a number of different countries. The
company expects to receive 1,200,000 in six months time from a foreign customer. Current exchange rates in the
home country of PZK Co are as follows:
Spot exchange rate:
Six-month forward exchange rate:
Twelve-month forward exchange rate:

4178042080 euros per $

4230242606 euros per $
4282543132 euros per $

Required:
(a) Calculate the loss or gain compared to its current dollar value which PZK Co will incur by taking out a forward
exchange contract on the future euro receipt, and explain why taking out a forward exchange contract may
be preferred by PZK Co to not hedging the future euro receipt.
(4 marks)
(b) If the interest rate in the home country of PZK Co is 4% per year, calculate the annual interest rate in the
foreign customers country implied by the spot exchange rate and the twelve-month forward exchange rate.
(2 marks)
(c) Discuss whether PZK Co should avoid exchange rate risk by invoicing foreign customers in dollars.
(4 marks)
(10 marks)

Uftin Co is a large company which is listed on a major stock market. The company has been evaluating an investment
proposal to manufacture Product K3J. The initial investment of $1,800,000 will be payable at the start of the first
year of operation. The following draft evaluation has been prepared by a junior employee.
Year
Sales (units/year)
Selling price ($/unit)
Variable costs ($/unit)

1
95,000
25
11

2
100,000
25
12

3
150,000
26
12

4
150,000
27
13

(Note: The above selling prices and variable costs per unit have not been inflated.)
Sales revenue
Variable costs
Fixed costs
Interest payments
Cash flow before tax
Tax allowable depreciation
Taxable profit
Taxation
Net cash flow
Discount at 12%
Present values

Present value of cash inflows

Cost of machine
NPV

$000
2,605
(1,260)
(155)
(150)

1,040
(450)

590
(137)

453
0797

361

$000
2,475
(1,097)
(155)
(150)

1,073
(450)

623

623
0893

556

$000
4,064
(1,890)
(155)
(150)

1,869
(450)

1,419
(130)

1,289
0712

918

$000
4,220
(2,048)
(155)
(150)

1,867
(450)

1,417
(312)

1,105
0636

703

$000
2,538
(1,800)

738

The junior employee also provided the following information:

1.
2.
3.
4.
5.
6.
7.
8.
9.

Relevant fixed costs are forecast to be $150,000 per year.

Sales and production volumes are the same and no finished goods inventory is held.
The corporation tax rate is 22% per year and tax liabilities are payable one year in arrears.
Uftin Co can claim tax allowable depreciation of 25% per year on a reducing balance basis on the initial
investment.
A balancing charge or allowance can be claimed at the end of the fourth year.
It is expected that selling price inflation will be 42% per year, variable cost inflation will be 5% per year and
fixed cost inflation will be 3% per year.
The investment has no scrap value.
The investment will be partly financed by a $1,500,000 loan at 10% per year.
Uftin Co has a weighted average cost of capital of 12% per year.

Required:
(a) Prepare a revised draft evaluation of the investment proposal and comment on its financial acceptability.
(11 marks)
(b) Explain any TWO revisions you have made to the draft evaluation in part (a) above.

(4 marks)
(15 marks)

[P.T.O.

Tinep Co is planning to raise funds for an expansion of existing business activities and in preparation for this the
company has decided to calculate its weighted average cost of capital. Tinep Co has the following capital structure:
$m
Equity
Ordinary shares
Reserves

$m

200
650

850

Non-current liabilities
Loan notes

200

1,050

The ordinary shares of Tinep Co have a nominal value of 50 cents per share and are currently trading on the stock
market on an ex dividend basis at $585 per share. Tinep Co has an equity beta of 115.
The loan notes have a nominal value of $100 and are currently trading on the stock market on an ex interest basis
at $10350 per loan note. The interest on the loan notes is 6% per year before tax and they will be redeemed in
six years time at a 6% premium to their nominal value.
The risk-free rate of return is 4% per year and the equity risk premium is 6% per year. Tinep Co pays corporation tax
at an annual rate of 25% per year.
Required:
(a) Calculate the market value weighted average cost of capital and the book value weighted average cost of
capital of Tinep Co, and comment briefly on any difference between the two values.
(9 marks)
(b) Discuss the factors to be considered by Tinep Co in choosing to raise funds via a rights issue.

(6 marks)
(15 marks)

10

Formulae Sheet
Economic order quantity
2C0D

Ch
MillerOrr Model
Return point = Lower limit + (

1
spread)
3
1

3 transaction cost variance of cash flows 3

Spread = 3 4

interest rate

The Capital Asset Pricing Model

(( ) )

()

E ri = R f + i E rm Rf

The asset beta formula

Vd 1 T
Ve

a =
e +
d

V
+
V
1

T
V
+
V
1

T
d
d
e
e

))

))

The Growth Model

Po =

D0 1 + g

(r

Gordons growth approximation

g = bre
The weighted average cost of capital
V

e
d
k +
k 1 T
WACC =
e
Ve + Vd
Ve + Vd d

The Fisher formula

(1 + i) = (1 + r ) (1 + h)
Purchasing power parity and interest rate parity

S1 = S0

(1 + h )
(1 + h )
c

F0 = S0

(1 + i )
(1 + i )
c

11

[P.T.O.

Present Value Table

Present value of 1 i.e. (1 + r)n
Where

r = discount rate
n = number of periods until payment
Discount rate (r)

Periods
(n)

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4
5

0990
0980
0971
0961
0951

0980
0961
0942
0924
0906

0971
0943
0915
0888
0863

0962
0925
0889
0855
0822

0952
0907
0864
0823
0784

0943
0890
0840
0792
0747

0935
0873
0816
0763
0713

0926
0857
0794
0735
0681

0917
0842
0772
0708
0650

0909
0826
0751
0683
0621

1
2
3
4
5

6
7
8
9
10

0942
0933
0923
0914
0905

0888
0871
0853
0837
0820

0837
0813
0789
0766
0744

0790
0760
0731
0703
0676

0746
0711
0677
0645
0614

0705
0665
0627
0592
0558

0666
0623
0582
0544
0508

0630
0583
0540
0500
0463

0596
0547
0502
0460
0422

0564
0513
0467
0424
0386

6
7
8
9
10

11
12
13
14
15

0896
0887
0879
0870
0861

0804
0788
0773
0758
0743

0722
0701
0681
0661
0642

0650
0625
0601
0577
0555

0585
0557
0530
0505
0481

0527
0497
0469
0442
0417

0475
0444
0415
0388
0362

0429
0397
0368
0340
0315

0388
0356
0326
0299
0275

0350
0319
0290
0263
0239

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

0901
0812
0731
0659
0593

0893
0797
0712
0636
0567

0885
0783
0693
0613
0543

0877
0769
0675
0592
0519

0870
0756
0658
0572
0497

0862
0743
0641
0552
0476

0855
0731
0624
0534
0456

0847
0718
0609
0516
0437

0840
0706
0593
0499
0419

0833
0694
0579
0482
0402

1
2
3
4
5

6
7
8
9
10

0535
0482
0434
0391
0352

0507
0452
0404
0361
0322

0480
0425
0376
0333
0295

0456
0400
0351
0308
0270

0432
0376
0327
0284
0247

0410
0354
0305
0263
0227

0390
0333
0285
0243
0208

0370
0314
0266
0225
0191

0352
0296
0249
0209
0176

0335
0279
0233
0194
0162

6
7
8
9
10

11
12
13
14
15

0317
0286
0258
0232
0209

0287
0257
0229
0205
0183

0261
0231
0204
0181
0160

0237
0208
0182
0160
0140

0215
0187
0163
0141
0123

0195
0168
0145
0125
0108

0178
0152
0130
0111
0095

0162
0137
0116
0099
0084

0148
0124
0104
0088
0074

0135
0112
0093
0078
0065

11
12
13
14
15

12

Annuity Table

(1 + r)n
Present value of an annuity of 1 i.e. 1
r
Where

r = discount rate
n = number of periods
Discount rate (r)

Periods
(n)

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4
5

0990
1970
2941
3902
4853

0980
1942
2884
3808
4713

0971
1913
2829
3717
4580

0962
1886
2775
3630
4452

0952
1859
2723
3546
4329

0943
1833
2673
3465
4212

0935
1808
2624
3387
4100

0926
1783
2577
3312
3993

0917
1759
2531
3240
3890

0909
1736
2487
3170
3791

1
2
3
4
5

6
7
8
9
10

5795
6728
7652
8566
9471

5601
6472
7325
8162
8983

5417
6230
7020
7786
8530

5242
6002
6733
7435
8111

5076
5786
6463
7108
7722

4917
5582
6210
6802
7360

4767
5389
5971
6515
7024

4623
5206
5747
6247
6710

4486
5033
5535
5995
6418

4355
4868
5335
5759
6145

6
7
8
9
10

11
12
13
14
15

10368
11255
12134
13004
13865

9787
10575
11348
12106
12849

9253
9954
10635
11296
11938

8760
9385
9986
10563
11118

8306
8863
9394
9899
10380

7887
8384
8853
9295
9712

7499
7943
8358
8745
9108

7139
7536
7904
8244
8559

6805
7161
7487
7786
8061

6495
6814
7103
7367
7606

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

0901
1713
2444
3102
3696

0893
1690
2402
3037
3605

0885
1668
2361
2974
3517

0877
1647
2322
2914
3433

0870
1626
2283
2855
3352

0862
1605
2246
2798
3274

0855
1585
2210
2743
3199

0847
1566
2174
2690
3127

0840
1547
2140
2639
3058

0833
1528
2106
2589
2991

1
2
3
4
5

6
7
8
9
10

4231
4712
5146
5537
5889

4111
4564
4968
5328
5650

3998
4423
4799
5132
5426

3889
4288
4639
4946
5216

3784
4160
4487
4772
5019

3685
4039
4344
4607
4833

3589
3922
4207
4451
4659

3498
3812
4078
4303
4494

3410
3706
3954
4163
4339

3326
3605
3837
4031
4192

6
7
8
9
10

11
12
13
14
15

6207
6492
6750
6982
7191

5938
6194
6424
6628
6811

5687
5918
6122
6302
6462

5453
5660
5842
6002
6142

5234
5421
5583
5724
5847

5029
5197
5342
5468
5575

4836
4988
5118
5229
5324

4656
4793
4910
5008
5092

4486
4611
4715
4802
4876

4327
4439
4533
4611
4675

11
12
13
14
15

End of Question Paper

13