ACCA F9 Financial Management Key Point Notes

June 2010

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ACCA
F9
Financial Management

Key Point
Notes
June 2010
These notes are not intended to cover the whole syllabus, but target key examinable areas.

Tutor:

Sunil Bhandari

Tutor Contact Details

Mobile: 07833 096979
E-mail: via
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________________________________________________________________________
 Sunilto
Bhandari
– IAT
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Copyright
Intelligent
Accountancy
Tutors Ltd
1

ACCA F9 Financial Management Key Point Notes

June 2010

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Use of these Key Point Notes
These notes have been written as an aid to assist students
preparing for the ACCA F9 June 2010 Exam. They accrue for
the topics tested in the past exams.
It is of paramount importance that they are used with an up
to date Revision Kit (KAPLAN, BPP or CIMA). A combination
of using the notes and question practice is the best way to
prepare for the forthcoming exams.

________________________________________________________________________
 Sunil Bhandari – IAT Ltd

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ACCA F9 Financial Management Key Point Notes

June 2010

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Index
Chapter Number Chapter Name

Page Numbers

Preliminaries

5-11

Chapter One

Financial Objectives

13-20

Chapter Two

Dividend policy

21-23

Chapter Three

Cost of Capital

25-28

Chapter Four

29-30

Chapter Five

Bonds-Yields & Market
Value
Risk Adjusted WACC

Chapter Six

CAPM

35-43

Chapter Seven

Capital Structure

45-48

Chapter Eight

Project Appraisal

49-62

Chapter Nine

Business Valuations

63-64

Chapter Ten

Sources of Finance

65-71

Chapter Eleven

Ratios

73-75

Chapter Twelve

Working Capital

77-80

Chapter Thirteen

Inventory Control

81-83

Chapter Fourteen

Receivables& Payables

85-87

Chapter Fifteen

Cash Management

89-92

Chapter Sixteen

Foreign Currency Risk

93-99

Chapter Seventeen

Interest Rate Risk

101-108

31-34

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 Sunil Bhandari – IAT Ltd

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ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 4 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 5 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 6 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 7 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 8 .

Rights Issue etc)  Rank the questions according to your ‘strongest’ to ‘weakest’ Next 180 minutes  Attempt the questions in your ranked order.  If the written elements are unrelated to the computations-try front load as they represent ‘easier’ marks.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Exam Technique First 15 minutes  Read the questions carefully  Recognise the topic being tested (eg NPV.  If in doubt about how to compute a value-make a reasonable estimate and move on. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 9 .  Try to attempt all parts to all the questions.  Stay within your time allocation both on each part of the question and on the question itself.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ General Numerical Questions  State formula  Show method  Explain as you go  Make assumptions if in doubt Written Questions  Check format – report / essay/ listed points  Headings / subheadings / columnar  Simple short paragraphs-essays and reports  Use ‘numbered’ points for most questions-simple sentence approach. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 10 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Tips These will be posted on my website sometime in late April/early May 2010. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 11 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 12 .

2 To Measure S/H wealth Value of Equity (Ve) =Number of issued Equity/Ordinary Shares X Current Market Price (Po) 1.4 Check the question very carefully for the size of the company is it: Listed*  Private Company * Market value exist on a stock exchange ________________________________________________________________________  Sunil Bhandari – IAT Ltd 13 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter One Financial Objectives 1 Primary Financial Objective 1.3 To find Po:  Given in the Question if it is a listed company(see below)  Compute Using:    Asset Valuation Models Dividend Valuation Model(DVM) Earnings Based Models Discounted Cash Flow Approach(DCF) 1.1 For profit making business “Maximise Shareholder(S/H) Wealth” 1.

External Factor Affecting Ve & Po 3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2 Indicators 2.1 Financial indicators pointing towards maximising S/H wealth include:      Earning per share(EPS) Dividend per share(DPS) Return on Capital Employed(ROCE) Return on Shareholder Capital(ROSC) Profit after tax Revenue 2.1 The Board cannot control all aspects that effect Ve and/or Po. Two major external factors are: Economic Variables  Regulators ________________________________________________________________________  Sunil Bhandari – IAT Ltd 14 . (Board) 3.2 Non-Financial Indicators include:  Market Share  Customer Satisfaction  Quality Measures The above are all Key Performance Indicators (KPI’s) that need to be measured and reviewed on a regular basis by the board of directors.

If it rises: Costs rise causing a drop in profits  Cause interest rates to rise.2 Economic Variables 3.2.2.2.5 General Taxation –If it rises: Damage company profits  Not encourage investment by companies Important to relate your comments to the effect upon Po & Ve.  Devalues the home currency 3.4 Gross Domestic Product.If it rises: Reduce cash receipts for exporters  Lowers the cost for importers  Discourage exporting 3. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 15 .2.2 Inflation Rates.If they fall: Stimulate demand and revenue  Lower the cost of debt and improve profits  Investors switch to share market for better returns 3.1 Interest Rates.If it falls: Reduce demand and revenue  Cause interest rates to fall to stimulate demand 3.2.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3.3 Foreign Exchange Rate(FOREX).

3.4 ESOPS This provides a way of rewarding Directors by granting them options to buy shares in their company at a fixed price.3. directors are encouraged to take decisions to maximise future share prices. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 16 .3 Solutions to this problem include:  Company Law  Corporate Governance (eg UK Combined Code)  Share Options (ESOPS) 3.3 Agency Problem 3.3.2 Examples of decisions that ‘may’ damage S/H wealth:     Directors pay Taking high risk business decisions Non-payment of dividends Using debt finance (against the wishes of the S/H) 3.3. The agency problem occurs when directors take decisions that DO NOT lead to maximising S/H wealth. This benefits both the directors and the shareholders.1 S/H are the owners of the company and expect their directors (agents) to take decisions to maximise S/H wealth.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3. They can buy the shares in future (normally 1 year) at the fixed price which usually is today’s price.3.Hence.

1 To maximize S/H wealth the board must take  Investment  Finance  Dividend 4.3.e.2 Must always consider how investments impact upon: Company Liquidity  Future Profits and Asset values  Business Risk Profile i.2 They will consider: Cash available within the company  Access to new sources of finance  Impact on KPI’s like gearing ratio(Debt:Equity)  Cost of Finance (WACC or Ko) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 17 .2.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4 The Three Key Decisions 4.3. 4.2 Investment 4. 4. effect upon variability of the cash flows and profits.1 To finance investments the board have to decide the best balance of equity and debt.1 Allocate cash for: Organic Growth (Projects)  Acquisitions 4.2.3 Finance 4.

Example: New projects need new finance but must generate cash to service the finance providers including paying dividends to the shareholders.4 Dividends 4.4.1 The Board needs to establish a dividend policy – see Chapter 2 4. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 18 .5 The three decisions are interlinked.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 5 Objectives of Not-For-Profit.Organisations (NFP’S) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 19 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 20 .

Either a) Pay the same dividend per share (DPS) each year. 2 Theories Several theories have been put forward to assist:2. b) Maintain the payout ratio (DPS/EPS) c) Maintain the same year-on-year growth rate in dividends. 2.2 Pattern – Be consistent with dividend payments. The latter links into the Po via the dividend valuation model (DVM) Po= Do (1+g) (re-g) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 21 .1 Residual – If spare cash exists at the end of the year pay dividend.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Two Dividend Policy 1 Introduction To maximise S/H wealth the Board should establish a dividend policy-the payment pattern to the equity investors.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2. The Ve will rise and the S/H can sell shares to create the cash the need(Manufacture Dividends).2 This will allow the S/H to sell extra shares for cash and the gain will be subject to CGT. 4.1 The S/H will receive extra shares instead of cash on a pro rata basis.1.1.1 Scrip Dividends 4.  Dividend growth should be greater than inflation  Tax impact upon S/H  Effect the dividend will have on dividend cover(EPS/DPS)  Number of investment opportunities will restrict dividend payments. 3 Practical Considerations There are many to consider:  Availability of Cash  What dividends to S/H want (clientele effect)?  Signalling effect –payment of dividends indicates a healthy company  Retaining cash is a key source of Finance.  Risk-paying now is safer than promising to pay next year  Is the dividend within the company law regulations? 4 Alternatives to Cash Dividends 4.3 Irrelevancy In a perfect capital market providing the directors can invest in projects with a positive NPV no dividends are required. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 22 .

f) Criticism-is this the best use of company cash.2.1 If the board has “one off” period of excess cash. c) Tax implications for the S/H(CGT) d) Reduced number of shares will cut supply for trading purposes. they could consider a share buy back.2 Share Buy Back 4. 4.3 The effect will:a) Increase the issued equity capital b) Dilute EPS and Po values c) Create pressure for the board to pay more total dividends in the future as more shares are in issue 4. e) Less dividend pressure on the board in future.e. Buy back shares at Po and cancel them.2.2 Considerations:a) Allowable under company law. b) Increase gearing as Ve may fall. i.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4.1. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 23 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 24 .

g.2 Vd=Total Book value of the Debt X Po $100 2.1 Ve=Total Number of Issued Shares X Po 2. 1:4 b) Gearing Percentage e. 35% Hence Vd=35.3 Alternative Presentations a) Ratio (Vd:Ve) e.g.Ve=65 For WACC equation ________________________________________________________________________  Sunil Bhandari – IAT Ltd 25 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Three Cost of Capital 1 Weighted Average Cost of Capital (WACC) Ke=Cost of Equity Kd=Should be “Kd(1-t)”=Cost of Debt Ve=Market Value of Equity Vd=Market Value of Debt 2 Market Values 2.

3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3 Cost of Equity (Ke) 3.2 CAPM Ke=Rf+ (Rm-Rf)βe where Rf=Risk free return Rm=Return on the market portfolio (Rm-Rf)=Equity Risk Premium βe=Risk measure for the risks being faced by the S/H 3.3 DVM Where Po=Ex Dividend Share Price d1=The DPS at Time 1 do=The DPS at Time 0 g =Constant annual future growth rate in the DPS 4 Cost of Debt (Kd (1-t)) Depends upon the type of Debt Also note:a) Kd=Called Yield(the minimum return of the lender) b) “Kd (1-t)”=Cost of Debt* * This is part of the cost of capital computation.1 The minimum return required by the S/H to compensate for the risks they face from the equity investment. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 26 .

ACCA F9 Financial Management Key Point Notes

June 2010

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4.1 Non traded debt (Bank Loans)
 Kd is the Interest rate on the loan(i.e. the yield)
 “Kd (1-t)”=Interest Rate X (1-t)
4.2 Traded Bonds
4.2.1 These are issued and traded in blocks of $100
or £100.Do all computations per block of “100”.
4.2.2 Undated Bonds-the process is:a) Establish the Kd(Yield)
 Given in the question
 Kd(Yield)= Ints
Po
b) “Kd (1-t)”= Yield X (1-t)
4.3.3 Redeemable Bonds-the process is via IRR computation
Time
To
Po
T1-Tn Ints x (1-t)
Tn Capital Repayment

$
(X)

Take two guesses at
the Kd(1-t) like
10% & 1% and
Perform IRR computation

X
X

5 Uses of the WACC
5.1 The Ko is the money or nominal cost of capital to use in
project DCF approaches. It can be used:a. To compute the NPV as the discount rate.
b. Compare with the project IRR.
IRR>WACC-Accept
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 Sunil Bhandari – IAT Ltd

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ACCA F9 Financial Management Key Point Notes

June 2010

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5.2 The WACC is useable if the new project under
consideration:a) Is a core activity –same as the company’s
normal activities
b) Does not alter the capital structure of the
company (Vd:Ve)
5.3 In all the past F9 exam questions, it has been very clear
within the question details that the conditions exist to
use the WACC. If the WACC can’t be used then the Risk
Adjusted Cost of Equity per Chapter 5 may be used.
6 What if’s?
6.1 Extend the WACC formula for all extra methods of
company finance. So you could have a WACC with:


Equity
Preference Capital
Bank loans
Traded Bonds

6.2 For Preference Capital
> Kp=D.P.S
Po
> Vp= No of issued
Preference shares

X Market price per
share (PO)

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 Sunil Bhandari – IAT Ltd

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ACCA F9 Financial Management Key Point Notes

June 2010

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Chapter Four
Bonds –Yields and Market Values
1 Bonds
Debt which is issued in blocks of “100” and trades on the
stock exchange.
2 Market Value
2.1 The market value is Po/$100 and can be established via
the DVM
“The present value of future cash flows received by the
investor and discounted at the yield(Kd)”
2.2 Undated Debt
Po=

Ints
Yield

2.3 Redeemable Bonds
Time

$

Yield%

Ti-Tn Ints

X

X

X

Tn Capital
Repayment*

X

X

X
Po

PV

=

XX

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 Sunil Bhandari – IAT Ltd

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2.2 Undated Bonds Yield = Ints Po 3.5 Bank loans market value is the book value.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2.1 Yield is the minimum return of a lender.4 Bank Loans  Yield=Interest Rate on the loan ________________________________________________________________________  Sunil Bhandari – IAT Ltd 30 .4 Convertible Bonds Replace the * Capital repayment with the share value if higher than the cash repayment.3 Redeemable Bonds Time To Po $ (X) T1-Tn Ints X Tn Capital Repayment X Take two guesses at the yield say 10% & 1% and perform IRR computation 3. 3 Yield (the minimum return required by the lender) 3. Practically we would expect:RF<Inter-Bank rate(LIBOR)<Yield required by the lender 3.

Then average all the βa c. Re-gear βa to find the project βe d.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Five Risk Adjusted Cost of Equity 1 Uses When the company wants to assess a project that is noncore. Put the Project βe into CAPM Project Ke =Rf + (Rm-Rf) Project βe Note:(Rm-Rf) is the Equity Risk Premium. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 31 . Take the Proxy Company Beta equity and degear via b. 2 Process a. Repeat the above for other Proxy Company Betas.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3 Concerns  Will the project finance truly have no effect upon the company’s gearing?  Proxy company βe:a) Does it exist? b) Does the proxy company specialise in the noncore field or does it have many different business activities c) If we are not listed-how do we gear up the βa ________________________________________________________________________  Sunil Bhandari – IAT Ltd 32 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4 Examiners Article ________________________________________________________________________  Sunil Bhandari – IAT Ltd 33 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 34 .

1 Single Equity  Take/Find βe  Put into CAPM Minimum Return = Rf+(Rm-Rf)βe  Forecast a return for the investment (could use past returns)  Forecast exceeds/equals minimum return-Buy or Keep the share ________________________________________________________________________  Sunil Bhandari – IAT Ltd 35 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Six CAPM 1 CAPM Equation Minimum return = Rf+ (Rm-Rf) β There are several uses of the CAPM equation: To find the company’s Ke(Chapter 3)  Risk Adjusted Ke (Chapter 5)  Assist a stock market investor to buy or sell equities 2 CAPM & Buy/Sell Equities 2.

3 Combining Equities (portfolio) a) Created a weighted average portfolio Beta i. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 36 .3 Systematic risk is how market factors effect that investment.1 A βe is the measure of risk being faced by equity shareholders 3. Market factors are: Macroeconomic variables  Political factors The measure is relative to the benchmark of the market portfolio.e (Cash in Share (1)/Total Cash in Equities X β1) + (Cash In Share (2)/Total Cash in Equities X β2 ) b) Put into CAPM Minimum Return = Rf+(Rm-Rf)Weighted Average β c) Forecast exceeds/equals minimum return-Buy or keep the portfolio. 3 Meaning of a βe 3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2.2 βe can be split into: Systematic Business Risk-measured by βasset  Financial Risk 3.

4 CAPM assumes that the investor eliminated the unsystematic risk. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 37 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4 Criticisms of CAPM ________________________________________________________________________  Sunil Bhandari – IAT Ltd 38 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 5 Examiners Articles ________________________________________________________________________  Sunil Bhandari – IAT Ltd 39 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 40 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 41 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 42 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 43 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 44 .

Interest will lead to tax savings i. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 45 . Level of Tangible Assets on which secure the loans.  Effect upon the company gearing ratio Debt/Equity+Debt OR Debt/Equity  Will the debt providers exercise influence over the company?  The chance of bankruptcy.access to Debt capital Forecast Cash Flows-to service and repay the debt.e Tax Shield Constraints on the level of debt from a) Articles Of Association b) Loan Agreements.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Seven Capital Structure 1 Introduction How should the company decide the mix of equity and debt capital? 2 Practical Issues If the company uses Debt capital funding it should consider:       Credit Rating of the company Rate of interest it will pay Market conditions.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3 Theories of Optimal Capital Structure 3. 2) Kd is initially uneffected by gearing but rises at “high” gearing levels due to the perception of the possibility of bankruptcy. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 46 .2 Traditional View Key Points:1) Ke rises due to financial risk caused by gearing.1 Common Ground-both major views accept two facts:a) Yield<Ke b) Gearing causes Ke to rise 3.

3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3) Ko (WACC) -trade off of Ke and Kd. 4) Once point X is reached via trial and error it must be maintained.3 MM and Tax Key points:1) Assumption behind the model:All debt is risk free Only corporation tax exists Debt is issued to replace Equity All types of debt carry one yield. the risk free rate  Full distribution of profits  Perfect Capital Market     ________________________________________________________________________  Sunil Bhandari – IAT Ltd 47 . Point X is the optimum gearing level where WACC is lowest.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2) MM concluded companies should gear up to the maximum levels. 4 Pecking Order Theory ________________________________________________________________________  Sunil Bhandari – IAT Ltd 48 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Eight Project Appraisal 1 Accounting Rate of Return (ARR) 1.3 Decision rule is:ARR> Target return-accept the project OR Take the project with the highest ARR 1.2 Investment is:a) Initial Investment b) (Initial Investment +Scrap Value) 2 1.4 Limitations and Strengths ________________________________________________________________________  Sunil Bhandari – IAT Ltd 49 .1 Average Annual Post Depreciation Profit Investment X 100 1.

2 General Approach:Time To T1 T2 T3 T4 T5 Cash Flows (X) X X X X X Cumulative Cash flows (X) (X) (X) X - 2.3 Annuity and Perpetuity cash flows Payback period=Initial Outflow Annual Inflows ________________________________________________________________________  Sunil Bhandari – IAT Ltd 50 .1 Time it takes the project to payback it’s initial investment. 2.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2 Payback 2.

1 NPV is the increase in S/H wealth arising from the project.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3 Net Present Value (NPV) 3.2 Two formats to consider Format (A) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 51 . 3.

057= $352 2) Discounting (tables) Eg: Cash flow at T5 is $390. r=10%pa PV=$390 x 0.108 = $2843 ________________________________________________________________________  Sunil Bhandari – IAT Ltd 52 .3 Incremental Cash Flows  Result from/caused by the project  Include opportunity cash flows  Ignore: Non-Cash Flows  Sunk Costs  Interest /Dividend payments 3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Format B Time To T1-Tn T2-Tn CF R% PV$’000 (X) X X NPV 1.4 Financial Maths Required:1) Compounding Eg: Inflation is 5% pa Real cash flow at time 7 is $250 Money cash flow =$250 x 1.0 X X (X) X X $XXX 3.621 =$242 3) Annuity (tables) Eg: Cash flow from T1-T9 is $400 pa r=5% PV =$400 x 7.

791-1. r= 4% PV= $500 x 1 r =$500 x 1 = $12.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4) Delayed Annuity Eg: Cash flow T3-T5 =$300 pa r=10% PV=$300 x (AF1-5 –AF1-2) =$300 x (3.333 (0.736) =$617 5) Perpetuity Eg:Cash flow is $500 pa from T1 each year forever.366 7) Perpetuity with Growth Eg: Cash Flow at time 1 will be $120 and then it will grow at 3% pa.723)= $10. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 53 .12-0.04 6) Delayed Perpetuity Eg: Cash flow is $600 from T4-Tperp r= 5% PV=$600 x (1/r –AF1-3) =$600 x (1/0. r=12% PV= $120 x 1 (r-g) PV=$120 x 1 = $1.05-2.03) 8) Delayed Perpetuity with Growth Eg: As for (7) above but $120 is cash flow at T5.500 0.

Effective Discount Rate= 1 x DF4 at 12% (r-g) 1 x 0.636 (0.067 PV =$120 x 7.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ PV= $120 x Effective Discount Rate.03) = 7.12-0.6 Include Inflation Money cash flows can be: Given in the question  Computed via Real CF x (1+h)n Money cost of Capital can be  Given in the question  WACC (see earlier chapter)  Computed via Money rate=Real Rate x (1+general ‘h’) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 54 .067 = $848 3.5 Inflation.Factors to consider: a) ‘h’ is symbol for inflation b) ‘r’ is symbol for real –excludes inflation c) ‘i’ is symbol for money/nominal –includes inflation d) Two approaches are possible 3.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Exclude Inflation  Not yet tested by the examiner at F9  Cash flows are REAL  Discounted at REAL Cost of Capital 3.7 Working capital-think of as a project bank account:i.(RTQ re timings of tax flows!!!) 1) Operating Flows x Tax rate 2) Tax saved on Capital allowances or Tax Allowable Depreciation(TAD):a) TAD-straight line. eg: CAPEX is $1m.8 Taxation-relevant cash flows to be included in the NPV computation.Scrap value at T4=$200K.TAD is 4 years and tax rate is 30% (No delay) Tax saved= [($1000-$200)] x 30% =$60 pa T1-T4 4 b) TAD-Reducing Balance eg: Asset is bought at T0 (1/1/09)cost $1m. ii.TAD is 25% reducing ________________________________________________________________________  Sunil Bhandari – IAT Ltd 55 .Sold at T4 for $200k. iii. Eg: Project needs WC at end of each year as follows: Relevant CF’s T0 (300) T1 300 (50) T2 350 (25) T3 375 375 3. Invest at To Adjust each year Close at end of the project.

30% 4. Time Tax saved $’000 75 56 42 67 240 T2 $1000 x 25% x 30% T3 75 x (100% -25%) T4 56 x75% T5 Bal Figure 30% x (1000-200) 4 Internal Rate of Return (IRR) 4. +.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ balance. +.3 Decision Rule IRR>Project Cost of Capital-Accept 4.-) IRR computed above is incorrect ________________________________________________________________________  Sunil Bhandari – IAT Ltd 56 .1 The cost of capital that gives an NPV=Nil 4. Tax is 30% (1 year delay). +.2 Approach-Take the following example: NPV@ 10% =$200K NPV@ 20% = ($15K) IRR= 10+ (200/200-(-15)) x (20-10) =19.4 PROS CONS *Easier to explain *Simple decision rule *Will mislead if comparing projects * If cash flows are nonregular (-.

3 Period –only single period is examinable i.Capex Budget 5. Approach:1)Compute Project NPV’S 2)Take best combination of projects that maximise The total NPV but spend less than or equal to cash available in the critical period.4 Divisible projects –can invest in proportions of a project from 0% to 100% maximum.e.5 Non-Divisible –take all or none of any project.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 5 Capital Rationing 5. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 57 .Eg:.2 Causes: Hard Soft External constraint on Raising cash. Approach:1)Compute Project NPV’s 2)Compute Profitability Index(PI) = NPV Cash Invested at critical period 3) Rank-High to Low PI 5.Credit Crunch Crisis Internal within the Company Eg:. cash may Be restricted at T0 or T1. 5.1 A restriction of cash preventing the company from accepting all projects with a positive NPV 5.

E factor prior to discounting .A. Equivalent Annual NPV is the method to use. the best are:7.E Factor 1.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 6 Asset Replacement 6. 6. 7 Accruing for Risk or Uncertainty within NPV Several methods.85 Adj CF (1000) 630 765 RF% 1.2 Probabilities –One project cash flow may be uncertain. b) E.Example:Time T0 T1 T2 $’000 (1000) 700 900 C.0 ________________________________________________________________________  Sunil Bhandari – IAT Ltd 58 .NPV = NPV Annuity Factor for life of the project @cost of capital c) As (b) will give negative values.1 Certainty Equivalents-Reduce cash flows by C.70 0. take the least expensive.30 1.2 Process a) Compute the NPV for each replacement cycle.90 0.0 X X 7.0 0. Example Sales in year 1 $’000 2000 1000 P 0.1 If assets have to be replaced on a periodic basis.

4 Sensitivity Analysis-What if?  NPV X 100% For Cash flows PV of the cash flow that is uncertain  IRR-Cost of Capital X 100% For the Cost of capital Cost of Capital  Lower the sensitivity % the higher the risk 7.F (X) (X) (X) X - ________________________________________________________________________  Sunil Bhandari – IAT Ltd 59 .F (X) X X X X X Cumulative D.70)+ (1000 X 0.3 Risk adjusted Cost of Equity –See Chapter 5 7.5 Discounted Payback  Payback using discounted cash flows  Format Time T0 T1 T2 T3 T4 T5 D.C.30) =$1700K 7.C.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Sales in T1 for NPV= (2000 X 0.

________________________________________________________________________  Sunil Bhandari – IAT Ltd 60 . It relies upon markets being efficient (see chapter 9) to reflect the project data within the new market price. NPV represents the change in S/H wealth arising from the project.1 As stated earlier. 9.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 8 Post Completion Audit (PCA) 9 NPV and S/H wealth 9. It is the only method that can be directly related to the primary objective of financial management.2 The NPV is effectively the change in the market capitalisation of the company and the movement in its share price.

3) HIJ pays corporate tax at 30% 4) Assume cash flows. but at much higher rate of interest. The initial capital investment required.4 19. It is considering three investment opportunities.24 Duration years 6 7 Indefinite Notes: 1) The projects are not divisible and cannot be postponed.60 3.but could borrow a maximum of $30 million at the present time at a gross interest rate of 10%. 2) The discount rate considered appropriate for all three investments is 12% net of tax.8 NPV $million(after tax) 2.75 3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Appendix – Capital Rationing Question HIJ is a private transport and distribution entity. other than the initial investment. which are not mutually exclusive.explain the usefulness of these methods of evaluation in the circumstances ________________________________________________________________________  Sunil Bhandari – IAT Ltd 61 . the NPV and the duration o each project is as follows: Project A Project B Project c Initial Investment $million 15. Required: (a) (i) Calculate the profitably index and equivalent annual annuities for all three projects . occur evenly throughout the duration of the investments.0 12.Borrowing above this amount might be possible. HIJ is no cash reserves .

briefly. briefly. how the calculation for NPV should be adjusted and what effect the changes might have and on your recommendation. (5 marks) (iii) You later discover that the discount rate used was nominal but the cash flows have been calculated in real terms. (4 marks) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 62 . and recommend which project(s) should be undertaken. You are not required to do any calculations for this section of the question. the advisability of the directors of HIJ limiting their capital expenditure in this way. Explain. (10marks) (ii) Explain the differences between ‘hard’ and ‘soft’ capital rationing and which type is evident in the scenario here. Discuss.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ here.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Nine Business Valuations 1 Equity 1.2 DGM/DVM Po is the present value of future dividends discounted at the cost of equity(re or Ke) Po= Do (1+g) (re-g) 1. 1.1 Preference shares PO = D rp ________________________________________________________________________  Sunil Bhandari – IAT Ltd 63 . 2 Others 2.1 To value equity /ordinary shares on a per share basis two primary methods exists.3 P/E Model PO =EPS X P/E Ratio P/E Ratio may have to come from a proxy company.

3 Semi-Strong-prices include past data +public announcements.4 Strong-prices reflect past. The market can be efficient at 3 levels: Weak  Semi-Strong  Strong 3.3 Traded debt –Redeemable PO per $100:Time T1-Tn Ints Tn Capital Repayment $ rd PV X X X X X X PO X 3 Efficient Market Hypothesis (EMH) 3. public and insider (secret) data. 3. 3.5 Most of the world’s stock markets are closer to semi strong.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2.2 Traded Debt-Undated PO per $100 = Ints rd 2.1 EMH explains how stock market prices change to reflect data /information. 3.2 Weak –the prices reflect only historic/past data. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 64 .

1 Ordinary shares of the company with voting rights. 2.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Ten Sources of Finance 1 Introduction Where and how do companies raise long term capital. 2. 2.4 “A Stock Exchange Listing” ________________________________________________________________________  Sunil Bhandari – IAT Ltd 65 . 2 Equity –General Factors 2.3 Could be traded on the stock exchange if company is listed.2 Carry the greatest risk but also the best possible returns.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3 Equity.Raising New Capital 3.1 Retained Earnings-First source of cash. Hold back the payment of dividends. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 66 . Will effect the dividend policy and can raise a small amount of cash.

Sell a large batch of new shares to institutions.50/4 =£5.Sell shares to investors at a fixed price after issuing a prospectus.00 5.50 TERP =£ 23. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 67 .3 From the exam questions will need to obtain or compute:a) Po just before the rights issue (Cum Rights price) b) Issue Price c) Ex Rights Price-price directly after the share issue (TERP) For Example: 1 for 3 rights issue at 550p and cum rights is 600p No 3 at 600p 1 at 550p 4 £ 18.50 =38p 3.2.4 Prospectus. 3.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3.4 Shareholder can sell the rights to another shareholder at the value of the rights. 3. 3.2 Rights Issue-Pro Rata issue to existing S/H.£5.50 £ 23.3 Placing.88 d) Value of the right £ 5.88.2.

2 Terms & Conditions depend upon market conditions and credit rating. 4 DEBT 4.2 Bank Loans 4.3.1 Loan is split into blocks of $100 and issue on the market.2.Request investors to tender for the shares at a price they would want to pay.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3.3 Bond has a yield and market value (Chapter 4) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 68 . The board then establishes final price.1 Funds come from one bank or group of banks. Debt holders will:a)Interest paid from pre-tax profits b) Security via  Fixed charged  Floating charge  Securitisation of future income. 4.5 Tender.2.3. 4.3.2 Can be undated or redeemable. c) Covenants-restrict company activity in areas such as:  Dividend payments  Issues of further debt 4. 4.3 Traded Bonds 4. 4.1 Loans provided to the company on a long term basis.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4. c) Mezzanine Loan-Loan used in MBO’s. normally at redemption. 5 Leases ________________________________________________________________________  Sunil Bhandari – IAT Ltd 69 . b) Eurobonds-Rare large foreign currency loan in the home country. Used by MNC’s and minimum values normally $1m.4 Other Types of Debt a) Convertible Bonds-Debt that can be converted to shares. Loan that carries high interest but normally only paid if profits are made. d) Grants-Free government finance providing conditions are met.

e Pretax % X (1-t) 2. 3. Ascertain the post tax cost of debt i. NPV of the lease cash flows using (1) Lease cash flows are:  Payments/Rental  Tax savings caused by rentals. NPV of buy cash flows using (1) Relevant flows are: Capital Cost  Scrap value  Tax saved on Capital allowances or Tax allowable depreciation.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 5.2 Lease Vs Buy Evaluation 3 Step approach 1. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 70 .

2 Roles include:Managing the groups cash resources Liaise with the banks. 6.1 Treasury functions mainly exist in Large MNC.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 6 The role of Treasury Function 6.  Deciding upon investment policy. Advising on Heading strategies for: Forex Risk  Interest Rate Risk Establishing source of Finance and cost of capital for the group. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 71 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 72 .

2 Gearing Capital Gearing= Debt or Debt X 100 Equity Debt+Equity NB Preference shares are generally treated as debt.1 Investor EPS = PAT less Preference Dividends No of ordinary shares in issue P/E = Po EPS Dividend Cover= EPS DPS Payout Ratio = DPS EPS Dividend Yield = DPS Po 1. Interest Cover = Operating Profit Interest ________________________________________________________________________  Sunil Bhandari – IAT Ltd 73 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Eleven Ratios 1. Ratios-You must Learn!!!! 1.

________________________________________________________________________  Sunil Bhandari – IAT Ltd 74 .Assets C. substitute the relevant figures from the question and compute the ratio.Liabilities Inventory Days= Inventory x 365 COS or purchases Receivables Days= Trade Receivables x 365 Sales Payables Days = Trade Payables x 365 COS or Purchases 2 Important    Learn the ratios State on answer book.Liabilities Quick/Acid Test = (C.Assets-Inventory) Ratio C.4 Liquidity Current Ratio= C.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 1. Comment on each ration in a sensible manner.3 Profitability ROCE = Operating Profit X 100 Equity +Debt ROE = PAT X 100 Equity Margin = Operating Profit X 100 Turnover 1.

C.00(?) CL=$260K=$208K $1.25($260K) CL=1. Payables are $108K.25 Bank O/D=$208K-$108K =$100K ________________________________________________________________________  Sunil Bhandari – IAT Ltd 75 .Assets are $260K and C.What is the value of the bank overdraft? Solution CA=1.Liabilities are made up of bank overdraft and payables.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------  Be ready to change the ratios around Eg: C.Ratio is 1.25:1.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 76 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Twelve Working Capital ________________________________________________________________________  Sunil Bhandari – IAT Ltd 77 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 78 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 79 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 80 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Thirteen Inventory Control 1 INVENTORY MANAGEMENT Economic Order Qty(EOQ) -Optimise stock order quantity and Re-order level -Minimises stock associated costs No discounts Just In Time(JIT) -Nil/minimum stock With discounts ________________________________________________________________________  Sunil Bhandari – IAT Ltd 81 .

recalculate the EOQ using the formula taking into account the relevant discount. This is the starting point. Q/2 ROL 0 TIME Co=Fixed cost per order D=Annual Demand £ Total relevant costs Variable holding costs CH=Variable holding cost per unit.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ EOQ Assumptions  Demand is known  Purchase price is constant (No discounts)    Lead time is constant (No Stock outs) Re-order level = demand in lead time Graphs EOQ + DISCOUNTS Q Method 1) Calculate the EOQ using the formula. 2) If. 3) Finally. and only if. ignoring any potential discounts. the EOQ calculated in 1) would result in a discounted purchase price. calculate the total annual cost using the EOQ calculated in 2) AND the total annual cost ordering in quantities higher than the EOQ but where greater discounts are available. All costs are known and constant Fixed order costs EOQ Q ________________________________________________________________________  Sunil Bhandari – IAT Ltd 82 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Forecast Sales qtys (2) Demand Driven (1) No Finished (3) Goods inventory Close Link with suppliers (7) No or Ltd Raw material Inventory(6) JIT (Factors) NO WIP(5) JIT Production (4) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 83 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 84 .

1 Receivables management is the balance between: liquidity (hold a lower balance)  profitability(offer more credit) 1.  Advances of cash  Insurance cover for “bad” debts.  Receivables administration/collection of cash. All the above have costs & fees attached.2 Factors to consider when offering credit.3 To collect cash from receivables efficiently:     Invoice promptly State terms on the invoice Send out monthly statements Call customers to chase payment Consider legal proceedings as a last resort.  Do competitors offer credit?  Industry norms  Check the credit rating of both new and existing customers  Set realistic credit limits 1. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 85 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Fourteen Receivables and Payables 1 Receivables 1. 1.4 Factoring companies offer “contracted out” receivables management.

00  Effectively. Eg Receivables normally pay in 45 days a settlement discount of 1.33 (1+0.0% is offered for payment within 30 days.Services can be offered with or without recourse. Annual value is:365 (45-30) = 24.33-1 x 100 =27. The debt is paid off when the receivables settle their debt. 1.4%  Discounts costs the company 27.7 Offering early settlement discounts to customers.01 $99.4 % but save 20%.Hence.00 = 0. Bank overdraft rate is 20%pa Solution  Assume sale of $100  Discount is $ 1.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 1. If without recourse.5 Recourse.01)24.6 Invoice discounting-this is where cash can be raised using certain receivables balances as security. the factoring company will suffer any bad debts should they arise. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 86 . don’t offer these terms. Customers are not aware of the transaction. 1.

8 Changes of Policy  Prepare all computations on an annual basis  Show incremental relevant cash costs and savings when changing from old to new policy. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 87 . 2 Payables 2.7.2 Taking early settlement discount offered by suppliers – same approach as receivables as per 1.1 Again balancing act: Maximise use of free credit  Not to over extend and lead to:a) Costs/Charges b) Supplier withdrawing supply c) Supplier going out of business. 2.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 1.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 88 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Fifteen Cash Management 1 GENERAL Motives to hold cash  Transactions-Day to Day payments  Precautionary-To cover “rainy day”  Speculative-Possible investment opportunities Business may have  Surpluses  Deficits Surpluses Consider:  Amount  Time  Access  Return  Risk Deficits Uses: 1. Bank facils. 2. Factoring co’s. Investments  Deposits  Building society a/c’s  Inter bank market  Gilts  Aim  London SE  Futures 3. Extend trade payables finance. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 89 .

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2 CASH BUDGETS-LAYOUT January February March Receipts Cash sales Receipts from debtors Sale of assets Payments Cash purchases Payments to creditors Expenses Purchase of assets Tax Dividends Interest Net cash inflow/(outflow) Balance b/f Balance c/f ________________________________________________________________________  Sunil Bhandari – IAT Ltd 90 .

 Workings for others e. 3. £ Max Bal Spread Min Bal Time ________________________________________________________________________  Sunil Bhandari – IAT Ltd 91 .g.1 Baumol Model The “inventory control” model of cash.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Exam Technique  Proforma (as above)  Copy in easy figures. payables payments. receivables receipts.  Total & tidy!! 3 CASH MODELS Aim is to optimise the amount of cash held in the longterm.

2 Spread comes from EOQ formula: 3. £ Max Bal SPREAD Return Point One third of spread Min Bal Time Sell Investments and Replenish cash Formulae are: ________________________________________________________________________  Sunil Bhandari – IAT Ltd 92 .3 Miller Orr A model to cope with the daily variances in the use of cash.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3.

75 £5. 2008 - at $1.96m) Funded by a $10m loan. Translation Exposure This is a Financial Reporting risk.67m 2005 - at $1.50 £6. The change in the value of an asset /liability caused by a change in the spot exchange rate. Transaction Exposure Change in the value of the spot rate over the short term (less than a year) causing a cash gain or loss.1 Example-ABC plc has a US subsidiary worth $10m. 2004 - at $1.75 £5.50 £6. 2.67m 2009 - at $1.71m Gain to equity £0.2 Must hedge!! ________________________________________________________________________  Sunil Bhandari – IAT Ltd 93 . 1. only due to financial reporting!!!! 2.96m 1.71m Loss to equity (£0.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Sixteen Foreign Currency Risk 1.2 Not a cash risk.

£0.1 Typical presentation of SPOT and Forward Rates. Economic Exposure Longterm change in the spot rates effecting project cash flows .6667 / $ (Bid) (Offer) 4. (Bid) (Offer) $1.6429 .5000 .Risk can be reduced by Global Diversification. Internal Hedges for Transaction Risk 5. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 94 .1 Invoice in home currency  All transactions in home currency  Transfer risk to the other party  Only useable rarely-if “we” have monopoly power. SPOT and Forward Rates 4.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 3. 4.$1.2 Picking the correct rate –Good Method  Spot and Forward rates presented as FX/Home currency  If “we” are Receiving Forex  Use the right hand rate 5.5555 / £ Reciprocal and cross over!!!!! £0.

2 Foreign currency bank account  Held in the main currencies ($.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 5. Euro)  Pool all transactions in same FX  Liking have 3 bank accounts with 3 cheque books!! 5.4 Netting  Match all FX transactions in the same FX occurring on the same day  Eg: 30 June we expect Receive $200K Pay ($50k) Net Rec $150k ________________________________________________________________________  Sunil Bhandari – IAT Ltd 95 .3 Leading and Lagging  Watcher / predictor of spot rate changes  Leading – accelerate exchange  Lagging – delay the exchange  Used a lot by Importers who have to sell their home currency 5.

Exchange FX at the forward rate(Remember if receiving FX use the right hand rate) 6. Net the future transactions in same FX and same date.2 Money Market Hedge “The exchange will take place today at the known spot rate”. 2. X months. Technique Home Today £Answer Abroad Today’s Spot FX X 1+ints home ÷ 1+ ints foreign Future Date £ Answer FX FX ________________________________________________________________________  Sunil Bhandari – IAT Ltd 96 . External Hedges for Transaction Risk 6.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 6. at Given as a ‘spread’ 3.1 Forward Market “Fix the rate today that will apply on a set future date” Technique: 1. Forward contract. Ascertain if “buying” or “selling” the £.

Predicting Future Exchange Rates  Best long term prediction model is PPPT S0=Spot Today S1=Spot 1 years time hc=annual inflation rate foreign hb=annual inflation rate base/home country  In the short term use IRPT F0=Forward/future spot rate i=interest rate ________________________________________________________________________  Sunil Bhandari – IAT Ltd 97 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 7. certainty  Inflexible/contract Easy  Lose out on the Cheap upside potential or Tailored(Any size of gain transaction)  Must ensure FX receipts arrive Convert today Cheap Tailored Flexible MMH  Complicated  May not apply for FX receipt as borrowing may not be possible abroad 8. Pros & Cons Pros         Cons Forward Market Fixed Rate.

Economic growth-strengthens home currency value 3. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 98 . b) Spot rate moves in the direction to cause a transaction profit. Trader activity-buying & selling of currencies 5. hence two will cancel out. hence two will cancel out.  “Futures exchange rates” are always similar to spot rates and this is a key factor. a profit will be made on the futures market.  Hedge is based upon:1) Find the direction of the change in the spot rate that would cause a transaction loss. Political stability-strengthens home currency value 2. Central bank action acting as a trader in FX 6. Commodity pricing-oil is priced in dollars 4. 2) Use the Futures market and effectively “spread bet” on the futures rate moving in directions that cause a loss.1 Futures  This is a method of hedging which is trying to fix the future spot rate at a value approximately equal to the current spot rate. a loss will be made on the futures market.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------  Practical Factors influencing the Spot Rate 1. 3) If:a) Spot rate moves in the direction to cause a transaction loss. Changing interest rates-protect the value of the home currency. 9 Derivatives (written questions only at F9) 9.

 With an option:1) Take a contract to give us the option (right)to exchange in the future at approx current spot rate. 9.  Think of an insurance policy-very similar ________________________________________________________________________  Sunil Bhandari – IAT Ltd 99 . there would be no transaction risk.2 Options  If “we” could take the current spot rate and use it in the future.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------  It’s not a perfect hedge due to basis risk and “odd” contract sizes. 2) Pay a non-refundable premium 3) Future-use the option rate if spot rate has move unfavourably. Otherwise the option lapses.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 100 .

________________________________________________________________________  Sunil Bhandari – IAT Ltd 101 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Chapter Seventeen Interest Rate Risk 1 What are the issues? We have loan finance and interest rates are set at a variable rate on a regular basis (more likely exam questions) We have deposits earning a variable interest rate Cover an interest Rate rise Cover an interest rate fall Note 1) Interest rate relationship:Yield on Govt Stock<Interbank Rates<Rates set by (see yield curves) lender(as above) 2) F9 syllabus requires students to discuss: a) How to fix rates. b) How to create a ceiling on interest rates.

ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 2 How to fix the Interest Rate Forward rate agreements (FRA) Purchased from a merchant bank Pros .flexible .contract size (≥ $1m) Contract that fixes future interest rates for a set period eg FRA 3-9 Fix start 3 Months from now @ 4% pa Fixed Rate Fix stops 9 months from now ________________________________________________________________________  Sunil Bhandari – IAT Ltd 102 .cheap Cons .easy .

ACCA F9 Financial Management Key Point Notes

June 2010

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Interest rate future

Fixing the interest rate can be achieved by using futures.
One of the main markets that is used is the UK LIFFE
(London International Financial Futures Exchange).

The hedge is achieved by effectively ‘betting’ on the futures
market that its interest rate will change. The bet is always
on the downside (ie those with loans are betting that rates
will increase). Also, the futures interest rate is derived from
the market interest rates.

If the downside occurs, the company will have to pay more
on its loans as the market rate has risen, but would have
made a profit on the futures market. If rates go down, loan
interest will fall but a loss will be made on the futures
market. In both cases, the effective interest rate is fixed.

Futures are complicated by a number of factors.
 Contract sizes
 Margins / deposits payable at the start of the
hedge(Refundable)
 Speculators – who dominate the market and can
effect the future rates.

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 Sunil Bhandari – IAT Ltd

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ACCA F9 Financial Management Key Point Notes

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Overview Illustration-to enhance understanding.
Concerned ints rate will go up
T Now

T 6 months

LOAN = £10m

Ints = 6% p.a.

Ints = 4% p.a.

LIFFE
Ints = 6.2% p.a.

LIFFE Ints = 4.1%
Bet that this
will rise.

Win on the bet

Pay more ints.

Match up!!!!!

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ACCA F9 Financial Management Key Point Notes

June 2010

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3 How to set Ceiling Rates
Interest rate guarantee
(IRG)

Purchased from
a merchant bank for
a fee

Covers the adverse
side of interest rate
changes, but at a cost!!!

Contract that caps
the future interest
rate for a set
period
eg IRG 3-9

@ 4% pa at cost of 0.1% of loan

Cap starts in
3 months time

Cap stops 9
months from now

Capped Rate

Non –refundable
Fe

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 Sunil Bhandari – IAT Ltd

105

Contract sizes and a standard length of three months complicate interest rate options.75 94. As an example.29 0.77 1. If the market interest rates started to rise.75%.25 Call options premium % Put options premium %\\ 1.25 94. the business will exercise its put option.75 5. The cash received from this should cover most of the extra interest paid on the loan. it would purchase a put option.33 If a company wished to protect itself against an interest rate increase above. the company would have to pay more interest on its loans. Strike price (SP) % 93. However.77% would be payable now.75 Interest rate cap (100 – SP) % 6. suppose that today is 30 June and the following data is available on September LIFFE options. interest rates on the futures market will also rise and should this exceed 5. say.25 5. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 106 .69 0. The hedge is to effectively have the ‘right to bet’ on an interest rate increase as shown on the futures market.23 0.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ Interest Rate Option The future and options market provides a product that can cap interest rates for borrowers like an IRG.75%. A premium of 0. 5.16 0.

________________________________________________________________________  Sunil Bhandari – IAT Ltd 107 . Yield Curves The shape of the yield curve is influenced by:  Liquidity Preference Theory – the longer cash is loaned /invested with any entity the greater the returns are needed for not having access to the cash.ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------ 4.

________________________________________________________________________  Sunil Bhandari – IAT Ltd 108 .ACCA F9 Financial Management Key Point Notes June 2010 ------------------------------------------------------------------------------------------------------------  Expectations Theory.the yield curve reflects money interest rates which incorporates predicted inflation rates.

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