Financial Management

Friday 5 June 2015

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 10, 11
and 12.
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.
Do NOT record any of your answers on the exam paper.
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 grid provided on page two of the Candidate Answer Booklet to record your answers to each multiple
choice question. Do not write out the answers to the MCQs on the lined pages of the answer booklet.
Each question is worth 2 marks.
1

Which of the following statements is/are correct?

(1) Monetary policy seeks to influence aggregate demand by increasing or decreasing the money raised through
taxation
(2) When governments adopt a floating exchange rate system, the exchange rate is an equilibrium between demand
and supply in the foreign exchange market
(3) Fiscal policy seeks to influence the economy and economic growth by increasing or decreasing interest rates
A
B
C
D

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

Which of the following statements are correct?

(1) The general level of interest rates is affected by investors desire for a real return
(2) Market segmentation theory can explain kinks (discontinuities) in the yield curve
(3) When interest rates are expected to fall, the yield curve could be sloping downwards
A
B
C
D

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

The following information relates to a company:

Year
Earnings per share (cents)
Dividends per share (cents)
Share price at start of year ($)

0
300
130
195

1
318
132
198

2
339
133
201

3
357
150
225

Which of the following statements is correct?

A
B
C
D

The dividend payout ratio is greater than 40% in every year in the period
Mean growth in dividends per share over the period is 4%
Total shareholder return for the third year is 26%
Mean growth in earnings per share over the period is 6% per year

Which of the following statements is correct?

A
B
C
D

One of the problems with maximising accounting profit as a financial objective is that accounting profit can be
manipulated
A target for a minimum level of dividend cover is a target for a minimum dividend payout ratio
The welfare of employees is a financial objective
One reason shareholders are interested in earnings per share is that accounting profit takes account of risk

Which of the following statements is NOT correct?

A
B
C
D

Return on capital employed can be defined as profit before interest and tax divided by the sum of shareholders
funds and prior charge capital
Return on capital employed is the product of net profit margin and net asset turnover
Dividend yield can be defined as dividend per share divided by the ex dividend share price
Return on equity can be defined as profit before interest and tax divided by shareholders funds

Which of the following statements are correct?

(1) The sensitivity of a project variable can be calculated by dividing the project net present value by the present
value of the cash flows relating to that project variable
(2) The expected net present value is the value expected to occur if an investment project with several possible
outcomes is undertaken once
(3) The discounted payback period is the time taken for the cumulative net present value to change from negative
to positive
A
B
C
D

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

Which of the following statements is/are correct?

(1) The asset beta reflects both business risk and financial risk
(2) Total risk is the sum of systematic risk and unsystematic risk
(3) Assuming that the beta of debt is zero will understate financial risk when ungearing an equity beta
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) Share option schemes always reward good performance by managers
(2) Performance-related pay can encourage dysfunctional behaviour
(3) Value for money as an objective in not-for-profit organisations requires the pursuit of economy, efficiency and
effectiveness
A
B
C
D

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

Which of the following are financial intermediaries?

(1) Venture capital organisation
(2) Pension fund
(3) Merchant bank
A
B
C
D

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

[P.T.O.

10 A company has in issue loan notes with a nominal value of $100 each. Interest on the loan notes is 6% per year,
payable annually. The loan notes will be redeemed in eight years time at a 5% premium to nominal value. The
before-tax cost of debt of the company is 7% per year.
What is the ex interest market value of each loan note?
A
B
C
D

$9403
$9694
$10291
$10310

11 Which of the following statements are correct?

(1) Capital market securities are assets for the seller but liabilities for the buyer
(2) Financial markets can be classified into exchange and over-the-counter markets
(3) A secondary market is where securities are bought and sold by investors
A
B
C
D

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

12 Which of the following statements are correct?

(1) A certificate of deposit is an example of a money market instrument
(2) Money market deposits are short-term loans between organisations such as banks
(3) Treasury bills are bought and sold on a discount basis
A
B
C
D

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

13 A company is evaluating an investment project with the following forecast cash flows:
Year
Cash flow ($m)

0
(65)

1
24

2
31

3
21

4
18

Using discount rates of 15% and 20%, what is the internal rate of return of the investment project?
A
B
C
D

158%
172%
178%
194%

14 Which of the following statements are correct?

(1) Interest rate options allow the buyer to take advantage of favourable interest rate movements
(2) A forward rate agreement does not allow a borrower to benefit from a decrease in interest rates
(3) Borrowers hedging against an interest rate increase will buy interest rate futures now and sell them at a future
date
A
B
C
D

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

15 A company needs $150,000 each year for regular payments. Converting the companys short-term investments into
cash to meet these regular payments incurs a fixed cost of $400 per transaction. These short-term investments pay
interest of 5% per year, while the company earns interest of only 1% per year on cash deposits.
According to the Baumol Model, what is the optimum amount of short-term investments to convert into cash in
each transaction?
A
B
C
D

$38,730
$48,990
$54,772
$63,246

16 Which of the following statements is/are correct?

(1) Factoring with recourse provides insurance against bad debts
(2) The expertise of a factor can increase the efficiency of trade receivables management for a company
A
B
C
D

2 only
1 only
Neither 1 nor 2
1 and 2

17 An investor plans to exchange $1,000 into euros now, invest the resulting euros for 12 months, and then exchange
the euros back into dollars at the end of the 12-month period. The spot exchange rate is 1415 per $1 and the euro
interest rate is 2% per year. The dollar interest rate is 18% per year.
Compared to making a dollar investment for 12 months, at what 12-month forward exchange rate will the investor
make neither a loss nor a gain?
A
B
C
D

1223
1412
1418
1439

per
per
per
per

$1
$1
$1
$1

18 Which of the following statements are correct?

(1) If a capital market is weak form efficient, an investor cannot make abnormal returns by using technical analysis
(2) Operational efficiency means that efficient capital markets direct funds to their most productive use
(3) Tests for semi-strong form efficiency focus on the speed and accuracy of share price responses to the arrival of
new information
A
B
C
D

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

19 On a market value basis, GFV Co is financed 70% by equity and 30% by debt. The company has an after-tax cost
of debt of 6% and an equity beta of 12. The risk-free rate of return is 4% and the equity risk premium is 5%.
What is the after-tax weighted average cost of capital of GFV Co?
A
B
C
D

54%
72%
83%
88%

[P.T.O.

20 The following financial information relates to QK Co, whose ordinary shares have a nominal value of $050 per share:
$m
Non-current assets
Current assets
Inventory
Trade receivables

$m
120

8
12

20

140

Total assets
Equity
Ordinary shares
Reserves

25
80

105

Non-current liabilities
Current liabilities

20
15

140

Total equity and liabilities

On an historic basis, what is the net asset value per share of QK Co?
A
B
C
D

$210
$250
$280
$420

per
per
per
per

share
share
share
share
(40 marks)

Section B ALL FIVE questions are compulsory and MUST be attempted.

Please write your answers to all parts of these questions on the lined pages within the Candidate Answer Booklet.
1

Rose Co expects to receive 750,000 from a credit customer in the European Union in six months time. The spot
exchange rate is 2349 per $1 and the six-month forward rate is 2412 per $1. The following commercial interest
rates are available to Rose Co:
Euros
Dollars

Deposit rate
40% per year
20% per year

Borrow rate
80% per year
35% per year

Rose Co does not have any surplus cash to use in hedging the future euro receipt.
Required:
(a) Evaluate whether a money market hedge or a forward market hedge would be preferred on financial grounds
by Rose Co.
(5 marks)
(b) Briefly explain the nature of a forward rate agreement and discuss how a company can use a forward rate
agreement to manage interest rate risk.
(5 marks)
(10 marks)

Chad Co is a stock-market-listed company which has managed to increase earnings over the last year. As a result,
the board of directors has increased the dividend payout ratio from 400% for the year to March 2014 to 414% for
the year to March 2015. Chad Co has a cost of equity of 125%. The following information is also available:
Year to March
Earnings
Ordinary shares

2014
$000
13,200
8,000

2015
$000
13,840
8,000

The nominal value of the ordinary shares of Chad Co is $050 per share. Listed companies similar to Chad Co have
an earnings yield of 82%.
Required:
(a) Calculate the equity market value of Chad Co using the dividend growth model.

(3 marks)

(b) Calculate the equity market value of Chad Co using the earnings yield method.

(2 marks)

(c) Discuss the relative merits of the dividend growth model and the earnings yield method as a way of valuing
Chad Co.
(5 marks)
(10 marks)

[P.T.O.

The finance director of Widnor Co has been looking to improve the companys working capital management.
Widnor Co has revenue from credit sales of $26,750,000 per year and although its terms of trade require all credit
customers to settle outstanding invoices within 40 days, on average customers have been taking longer. Approximately
1% of credit sales turn into bad debts which are not recovered.
Trade receivables currently stand at $4,458,000 and Widnor Co has a cost of short-term finance of 5% per year.
The finance director is considering a proposal from a factoring company, Nokfe Co, which was invited to tender to
manage the sales ledger of Widnor Co on a with-recourse basis. Nokfe Co believes that it can use its expertise to
reduce average trade receivables days to 35 days, while cutting bad debts by 70% and reducing administration costs
by $50,000 per year. A condition of the factoring agreement is that the company would also advance Widnor Co 80%
of the value of invoices raised at an interest rate of 7% per year. Nokfe Co would charge an annual fee of 075% of
credit sales.
Assume that there are 360 days in each year.
Required:
(a) Advise whether the factors offer is financially acceptable to Widnor Co.

(7 marks)

(b) Briefly discuss how the creditworthiness of potential customers can be assessed.

(3 marks)
(10 marks)

Grenarp Co is planning to raise $11,200,000 through a rights issue. The new shares will be offered at a 20%
discount to the current share price of Grenarp Co, which is $350 per share. The rights issue will be on a 1 for 5
basis and issue costs of $280,000 will be paid out of the cash raised. The capital structure of Grenarp Co is as
follows:
$m
Equity
Ordinary shares ($050 nominal)
Reserves

$m

10
75

85

Non-current liabilities
8% Loan notes

30

115

The net cash raised by the rights issue will be used to redeem part of the loan note issue. Each loan note has a
nominal value of $100 and an ex interest market value of $104. A clause in the bond issue contract allows
Grenarp Co to redeem the loan notes at a 5% premium to market price at any time prior to their redemption date.
The price/earnings ratio of Grenarp Co is not expected to be affected by the redemption of the loan notes.
The earnings per share of Grenarp Co is currently $042 per share and total earnings are $8,400,000 per year. The
company pays corporation tax of 30% per year.
Required:
(a) Evaluate the effect on the wealth of the shareholders of Grenarp Co of using the net rights issue funds to
redeem the loan notes.
(8 marks)
(b) Discuss whether Grenarp Co might achieve its optimal capital structure following the rights issue.
(7 marks)
(15 marks)

Hraxin Co is appraising an investment project which has an expected life of four years and which will not be repeated.
The initial investment, payable at the start of the first year of operation, is $5 million. Scrap value of $500,000 is
expected to arise at the end of four years.
There is some uncertainty about what price can be charged for the units produced by the investment project, as this
is expected to depend on the future state of the economy. The following forecast of selling prices and their probabilities
has been prepared:
Future economic state
Probability of future economic state
Selling price in current price terms

Weak
35%
$25 per unit

Medium
50%
$30 per unit

Strong
15%
$35 per unit

These selling prices are expected to be subject to annual inflation of 4% per year, regardless of which economic state
prevails in the future.
Forecast sales and production volumes, and total nominal variable costs, have already been forecast, as follows:
Year
Sales and production (units)
Nominal variable cost ($000)

1
150,000
2,385

2
250,000
4,200

3
400,000
7,080

4
300,000
5,730

Incremental overheads of $400,000 per year in current price terms will arise as a result of undertaking the investment
project. A large proportion of these overheads relate to energy costs which are expected to increase sharply in the
future because of energy supply shortages, so overhead inflation of 10% per year is expected.
The initial investment will attract tax-allowable depreciation on a straight-line basis over the four-year project life. The
rate of corporation tax is 30% and tax liabilities are paid in the year in which they arise. Hraxin Co has traditionally
used a nominal after-tax discount rate of 11% per year for investment appraisal.
Required:
(a) Calculate the expected net present value of the investment project and comment on its financial
acceptability.
(9 marks)
(b) Critically discuss if sensitivity analysis will assist Hraxin Co in assessing the risk of the investment project.
(6 marks)
(15 marks)

[P.T.O.

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

10

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

11

[P.T.O.

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

12