ACCA P4 final mock june2014

ACCA P4 Advanced Financial Management

Final Mock Exam Question+Answer Paper

Q2-4: choose 2 out of 3

ACCA P4 final mock june2014

© Lesco Group Limited, April 2014
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without the prior written permission of Lesco Group Limited.

ACCA P4 final mock june2014

Tramont Co is a listed company based in the USA and manufactures electronic devices. One
of its devices, the X-IT, is produced exclusively for the American market. Tramont Co is
considering ceasing the production of the X-IT gradually over a period of four years because
it needs the manufacturing facilities used to make the X-IT for other products.

The government of Gamala, a country based in south-east Asia, is keen to develop its
manufacturing industry and has offered Tramont Co first rights to produce the X-IT in
Gamala and sell it to the USA market for a period of four years. At the end of the four-year
period, the full production rights will be sold to a government backed company for Gamalan
Rupiahs (GR) 450 million after tax (this amount is not subject to inflationary increases).

Tramont Co has to decide whether to continue production of the X-IT in the USA for the
next four years or to move the production to Gamala immediately.

Currently each X-IT unit sold makes a unit contribution of $20. This unit contribution is not
expected to be subject to any inflationary increase in the next four years. Next year’s
production and sales estimated at 40,000 units will fall by 20% each year for the following
three years. It is anticipated that after four years the production of X-IT will stop. It is
expected that the financial impact of the gradual closure over the four years will be cost
neutral (the revenue from sale of assets will equal the closure costs). If production is
stopped immediately, the excess assets would be sold for $2.3 million and the costs of
closure, including redundancy costs of excess labour, would be $1.7 million.

The following information relates to the production of the X-IT moving to Gamala. The
Gamalan project will require an initial investment of GR 230 million, to pay for the cost of
land and buildings (GR 150 million) and machinery (GR 80 million). The cost of machinery is
tax allowable and will be depreciated on a straight line basis over the next four years, at the
end of which it will have a negligible value.

Tramont Co will also need GR 40 million for working capital immediately. It is expected that
the working capital requirement will increase in line with the annual inflation rate in Gamala.

When the project is sold, the working capital will not form part of the sale price and will be
released back to Tramont Co.

Production and sales of the device are expected to be 12,000 units in the first year, rising to
22,000 units, 47,000 units and 60,000 units in the next three years respectively.

The following revenues and costs apply to the first year of operation:
– Each unit will be sold for $70;
– The variable cost per unit comprising of locally sourced materials and labour will be GR
1,350, and;
– In addition to the variable cost above, each unit will require a component bought from
Tramont Co for $7, on which Tramont Co makes $4 contribution per unit;
– Total fixed costs for the first year will be GR 30 million.

ACCA P4 final mock june2014
The costs are expected to increase by their countries’ respective rates of inflation, but the
selling price will remain fixed at $70 per unit for the four-year period.
The annual corporation tax rate in Gamala is 20% and Tramont Co currently pays
corporation tax at a rate of 30% per year. Both countries’ corporation taxes are payable in
the year that the tax liability arises. A bi-lateral tax treaty exists between the USA and
Gamala, which permits offset of overseas tax against any US tax liability on overseas

The USA and Gamalan tax authorities allow losses to be carried forward and written off
against future profits for taxation purposes.

Tramont Co has decided to finance the project by borrowing the funds required in Gamala.
The commercial borrowing rate is 13% but the Gamalan government has offered Tramont
Co a 6% subsidised loan for the entire amount of the initial funds required. The Gamalan
government has agreed that it will not ask for the loan to be repaid as long as Tramont Co
fulfils its contract to undertake the project for the four years. Tramont Co can borrow dollar
funds at an interest rate of 5%.

Tramont Co’s financing consists of 25 million shares currently trading at $2.40 each and $40
million 7% bonds trading at $1,428 per $1,000. Tramont Co’s quoted beta is 1.17. The
current risk free rate of return is estimated at 3% and the market risk premium is 6%. Due
to the nature of the project, it is estimated that the beta applicable to the project if it is all-
equity financed will be 0.4 more than the current all-equity financed beta of Tramont Co. If
the Gamalan project is undertaken, the cost of capital applicable to the cash flows in the
USA is expected to be 7%.

The spot exchange rate between the dollar and the Gamalan Rupiah is GR 55 per $1. The
annual inflation rates are currently 3% in the USA and 9% in Gamala. It can be assumed
that these inflation rates will not change for the foreseeable future. All net cash flows arising
from the project will be remitted back to Tramont Co at the end of each year.

There are two main political parties in Gamala: the Gamala Liberal (GL) Party and the
Gamala Republican (GR) Party.

Gamala is currently governed by the GL Party but general elections are due to be held soon.
If the GR Party wins the election, it promises to increase taxes of international companies
operating in Gamala and review any commercial benefits given to these businesses by the
previous government.

(a) Prepare a report for the Board of Directors (BoD) of Tramont Co that

(i) Evaluates whether or not Tramont Co should undertake the project to produce
the X-IT in Gamala and cease its production in the USA immediately. In the
evaluation, include all relevant calculations in the form of a financial assessment
and explain any assumptions made.

It is suggested that the financial assessment should be based on present value of
the operating cash flows from the Gamalan project, discounted by an appropriate
all-equity rate, and adjusted by the present value of all other relevant cash flows.
(27 marks)
ACCA P4 final mock june2014
(ii) Discusses the potential change in government and other business factors that
Tramont Co should consider before making a final decision. (8 marks)
Professional marks for format, structure and presentation of the report for part (a)
(4 marks)
(b) Although not mandatory for external reporting purposes, one of the members
of the BoD suggested that adopting a triple bottom line approach when monitoring
the X-IT investment after its implementation, would provide a better
assessment of how successful it has been.

Discuss how adopting aspects of triple bottom line reporting may provide a better
assessment of the success of the X-IT. (6 marks)

(c) Another member of the BoD felt that, despite Tramont Co having a wide range
of shareholders holding welldiversified portfolios of investments, moving the
production of the X-IT to Gamala would result in further risk diversification

Discuss whether moving the production of the X-IT to Gamala may result in
further risk diversification for the shareholders already holding well diversified
portfolios. (5 marks)
(50 marks)

ACCA P4 final mock june2014
Alecto Co, a large listed company based in Europe, is expecting to borrow
€22,000,000 in four months’ time on 1 May 2012 and today is 1 DEC2011. It
expects to make a full repayment of the borrowed amount nine months from now.
Currently there is some uncertainty in the markets, with higher than normal rates
of inflation, but an expectation that the inflation level may soon come down. This
has led some economists to predict a rise in interest rates and others suggesting an
unchanged outlook or maybe even a small fall in interest rates over the next six
Although Alecto Co is of the opinion that interest rates could increase by 0·5% in
four months, it wishes to protect itself from interest rate fluctuations by using
derivatives. The company can borrow at LIBOR plus 80 basis points and LIBOR is
currently 3·3%. The company is considering using interest rate futures as possible
hedging choices.
The following information and quotes from an appropriate exchange are provided
on Euro futures and options. Margin requirements may be ignored.
Three month Euro futures, €1,000,000 contract, tick size 0·01% and tick value €25
March 96·27
June 96·16
September 95·90

(a)Show the outcome of hedge by using interest rate futures. (15marks)
(b)Calculate the effective interest costs as a result of interest rate future
(c)Alecto Co is considering to selling the hotel properties, the board of directors is
considering a demerger of the hotel services and a separate property company which would
own the hotel properties. The property company would take over 70% of Alecto Co ‘s long-
term debt and pay Alecto Co cash for the balance of the property value.

Explain what a demerger is, and the possible benefits and drawbacks of pursuing
the demerger option as opposed to selling the hotel properties. (8 marks)
ACCA P4 final mock june2014

Doric Co has two manufacturing divisions: parts and fridges. Although the parts
division is profitable, the fridges division is not, and as a result its share price has
declined to $0.50 per share from a high of $2.83 per share around three years ago.
Assume it is now 1 January 2013 .
The board of directors are considering two proposals:
(i) To cease trading and close down the company entirely, or;
(ii) To close the fridges division and continue the parts division through a leveraged
management buyout.. The new company will continue with manufacturing parts
only, but will make an additional investment of $50 million in order to grow the
parts division after-tax cash flows by 3.5% in perpetuity. The proceeds from the
sale of the fridges division will be used to pay the outstanding liabilities. The
finance raised from the management buy-out will pay for any remaining
liabilities, the funds required for the additional investment, and to purchase the
current equity shares at a premium of 20%. The fridges division is twice the
size of the parts division in terms of its assets attributable to it.

Extracts from the most recent financial statements:
Financial Position as at 31 December 2012
Non-Current Assets 110
Current Assets 220
Share capital ($0.40 per share par
Reserves 10
Liabilities (Non-current and current) 280

ACCA P4 final mock june2014

Income Statement for the year ended 31 December 2012
Sales revenue: Parts division
Fridges division
Costs prior to depreciation, interest payments and tax:
Parts division
Fridges division

Depreciation, tax and interest (34)
Loss (14)

If the entire company’s assets are sold, the estimated realisable values of
assets are as follows:
Non-current assets 100
Current assets 110

The following additional information has been provided

Redundancy and other costs will be approximately $54 million if the whole company
is closed, and pro rata for individual divisions that are closed. These costs have
priority for payment before any other liabilities in case of closure.

The taxation effects relating to this may be ignored.

Corporation tax on profits is 20% and it can be assumed that tax is payable in the
year incurred. Annual depreciation on non-current assets is 10% and this is the
ACCA P4 final mock june2014
amount of investment needed to maintain the current level of activity. The new
company’s cost of capital is expected to be 11%.
(a) Briefly discuss the possible benefits of Doric Co’s parts division being
divested through a management buy-out.
(4 marks)
(b) Estimate the return the liability holders and the shareholders would
receive in the event that Doric Co is closed and all its assets sold.
(3 marks)
(c) Estimate the additional amount of finance needed and the value of the
new company, if only the assets of fridges division are sold and the parts
division is divested through a management buy-out. Briefly discuss
whether or not the management buy-out would be beneficial.
(10 marks)
(d) Doric Co’s directors are of the opinion that they could receive a better
price if the fridges division is sold as a going concern instead of its assets
sold separately. They have been told that they need to consider two
aspects when
selling a company or part of a company:
(i) Seeking potential buyers and negotiating the sale price; and,
(ii) Due diligence.

Discuss the issues that should be taken into consideration with each
(8 marks)
(25 marks)

ACCA P4 final mock june2014

Hav Co is a publicly listed company involved in the production of highly technical and
sophisticated electronic components for complex machinery. It has a number of diverse and
popular products, an active research and development department, significant cash reserves
and a highly talented management who are very good in getting products to market quickly.

A new industry that Hav Co is looking to venture into is biotechnology, which has been
expanding rapidly and there are strong indications that this recent growth is set to continue.
However, Hav Co has limited experience in this industry. Therefore it believes that the best
and quickest way to expand would be through acquiring a company already operating in this
industry sector.

Strand Co is a private company operating in the biotechnology industry and is owned by a
consortium of business angels and company managers. The owner-managers are highly
skilled scientists who have developed a number of technically complex products, but have
found it difficult to commercialise them.

They have also been increasingly constrained by the lack of funds to develop their
innovative products further.

Discussions have taken place about the possibility of Strand Co being acquired by Hav Co.
Strand Co’s managers have indicated that the consortium of owners is happy for the
negotiations to proceed. If Strand Co is acquired, it is expected that its managers would
continue to run the Strand Co part of the larger combined company.

Strand Co is of the opinion that most of its value is in its intangible assets, comprising
intellectual capital. Therefore, the premium payable on acquisition should be based on the
present value to infinity of the after tax excess earnings the company has generated in the
past three years, over the average return on capital employed of the biotechnological
industry. However, Hav Co is of the opinion that the premium should be assessed on
synergy benefits created by the acquisition and the changes in value, due to the changes in
the price-to-earnings (PE) ratio before and after the acquisition.

Given below are extracts of financial information for Hav Co for 2013 and Strand Co for
2011, 2012 and 2013:

ACCA P4 final mock june2014
The current average PE ratio of the biotechnology industry is 16·4 times and it has been
estimated that Strand Co’s PE ratio is 10% higher than this. However, it is thought that the
PE ratio of the combined company would fall to 14·5 times after the acquisition. The annual
after tax earnings will increase by $140 million due to synergy benefits resulting from
combining the two companies.
Both companies pay tax at 20% per annum and Strand Co’s annual cost of capital is
estimated at 7%. Hav Co’s current share price is $9·24 per share. The biotechnology
industry’s pre-tax return on capital employed is currently estimated to be 20% per annum.

Hav Co has proposed to pay for the acquisition using one of the following three methods:

(i) A cash offer of $5·72 for each Strand Co share; or

(ii) A cash offer of $1·33 for each Strand Co share plus one Hav Co share for every two
Strand Co shares; or

(iii) A cash offer of $1·25 for each Strand Co share plus one $100 3% convertible bond for
every $5 nominal value of Strand Co shares. In six years, the bond can be converted into
12 Hav Co shares or redeemed at par.

(a) Distinguish between the different types of synergy and discuss possible
sources of synergy based on the above scenario. (9 marks)

(b) Based on the two different opinions expressed by Hav Co and Strand Co,
calculate the maximum acquisition premium payable in each case. (6 marks)

(c) Calculate the percentage premium per share that Strand Co’s shareholders will
receive under each acquisition payment method and justify, with explanations,
which payment method would be most acceptable to them. (10 marks)
(25 marks)

ACCA P4 final mock june2014

ACCA P4 Advanced Financial Management

Final Mock Exam Answer Paper

ACCA P4 final mock june2014

© Lesco Group Limited, April 2014
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without the prior written permission of Lesco Group Limited.

ACCA P4 final mock june2014

To:board of directors
From: financial analyst
Subject: project appraisal.
Introduction: This report addresses the above subjects in turn.

Evaluation: [all calculations are in the appendix]

We firstly calculate base case NPV for projects started in GAMALA and then
adjusted for any other financing effect and other relevant cash flows.

Based on the calculation in the appendix, the APV is $2.4m and this suggests that
company should move its production to GAMALA.


We have used cost of capital to discount the subsidy instead of risk free rate but
risk free rate can be used as well.
ACCA P4 final mock june2014

We borrow money for the full amount of $270 but in the real world this would be
based on the debt capacity rather than full amount.

The exchange rate is predicted using purchasing power parity and this may not be

Other factors:

There would be a government change soon and this would increase company taxes
and hence reduce company’s profit.

Company should consider whether it has international trade experience as well, ie,
fit into GAMALA’s culture?

Company should also consider other real options as well, eg, option to delay
projects given a large amount of opportunity costs incurred in year 1.

Company would need to consider whether or not the investment fits into the overall
company’s strategy.

Co needs to consider the impact on its reputation due to possible redundancies.
Following a detailed analysis by using NPV, APV, government changes and other
factors and it would be advisable to move company to GAMALA.

Appendix: (copy from tutor)
ACCA P4 final mock june2014


Triple bottom line measures profit, planet and people.

Management should make sure that when making a decision that they have
considered all these three factors and produce a report as long as the benefit or it
exceeds the costs of it.

Eg, moving company to GAMALA then company can highlight its impact on planet
and people and this would make company become a good citizen and hence
improve its reputation as well.

Also, company can claim more potential government grant from being a good
citizen as well.

And hence this would further improve company’s reputation and allow company to
make more profit.

And this in turn would create more jobs opportunities to the society as well.


ACCA P4 final mock june2014
Shareholders would suffer systematic risk and this cannot be diversified away.

Eg, inflation; economic recession.

Shareholders would diversify unsystematic risk if they hold well diversified

Eg, company’s specific risk.

In the Q, it is not clear whether diversification benefits will result in the investment
in Gamala because it depends on the size of the investment and the nature of the
business operations as well and also whether the investment is the diversification
away from the market as well.

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ACCA P4 final mock june2014
Q2 answer

Consider (borrow) (3.3%+0.5%)+(80/100 %) X€22,000,000X5/12 (421,667)
Profit or loss from future market(W1) €12,950
Actual borrow €408,717

W1: Profit or loss from future market:
P/L per future contract(W2) X number of contracts(W3) XContract size = total P/L
Ticks (P/L per future contract(W2)(already in %)/ (0.01%): 0.14 %/0.01% =14ticks )
X number of contracts(W3) :37
X tick value(€25 given. Or 0.01%X €1,000,000X3/12)
= total P/L=14X37X€25=€12,950

W2: P/L per future contract (Table)
Now(DEC2011) Settlement(1may2012) P/L
Spot 96.7 (3.3%) 96.2 (3.3%+0.5%) 0.5
Future 96.16(sell June) 96.02(buy) 0.14
Basis 0.54

96.16-96.02=0.14 or for interest rate future we can use a trick:
9616-9602=14ticks(when calculate ticks)

ACCA P4 final mock june2014

W3: number of contracts

No of contracts= Amount X duration
Contract Size 3
=€22,000,000 X 5(begin in 4months and pay back in 9 months: so duration=5months)
€1,000,000 3

(b) Effective(net) cost= effective rate x amount X 5/12
So effective rate=effective cost/amount /5 X12
=€408,717/€22,000,000/5 X12=4.46%

De-merger means to split one company into two parts.
Each company then would remain independent.
By separating companies into hotel and property then it would make the individual
value of each company more apparent.
Separate management teams would focus on individual company and to create
more value to each company.
This would not lower down the value of company comparing to selling lots of
properties to the outside.

ACCA P4 final mock june2014

The process would be expensive to the company and hence decrease market value
of company.
The new property company would need to raise the extra finance to pay the cash
for the remaining property values
Coeden Co may not have the expertise among its existing management team to
manage a property company.

ACCA P4 final mock june2014
(a) Benefits:

 This would have fewer costs compared to other ways to dispose because for
example, company doesn’t need to incur advertising expense relating to
management buy-outs.

 It’s quick by raising money from management buy-outs.

 There would be less resistance from the managers and employees making the
process smoother.

 The offer price would be more given management has knowledge in this field
and they are able to make it successful.

If total assets are sole then we should use “net realizable value” for the assets to
reflect the “salable assets value”.
Noncurrent assets 100
+ Current assets 110
Total assets 210
- Redundancy & other costs (54)
Net proceeds 156
Liabilities(SOFP) 280

The debt holders would get 156/280= $0.56 per $1 liability (owing to them).

ACCA P4 final mock june2014
And because there would be no residual value after using the net proceeds to pay
off the liabilities and hence there would be nothing to pay back to shareholders any

Sell off the PARTS Division to existing management:
Funds needed:
 Debt {total liability-2/3xnet proceeds of 156(b)=(280-
 Equity (OSC+reserves:40+10)X(1+20%) 60
 Others
New investment

Funds required: $286m
New value of company= CF in perpetuity (W1)
Cost of capital – growth rate

W1: CF in perpetuity:
Sales 170
-Costs (120)
PBT 41.7
-tax (41.7X20%) (8.3)
ACCA P4 final mock june2014
PAT(assume CF) 33.4

 Because the total value of new company is $461m which is 1.6times greater
than funds required for MBO so it would be beneficial to proceed with the MBO.

 But the estimation of value of new company may be wrong and subject to future
changes and hence it would be more appropriate to use other methods to value
the company like using free cash flow method as well.

Seeking buyers
 The potential buyers may be sought through a long process from market or

 To seek who is going to buy should be careful because some of them would be
competitors and company may subject to hostile bid and hence making the
overall price of the company being forced to drag down.

Negotiate the price
 The negotiation of the price would be a long process as well with the buyer.

 Buyer would use lots of techniques estimating the value of the company and this
would be based on the due diligence result below.

Due diligence
 This would mean the buyer would assess the financial information and non-
financial information of the target company.

 Doric should present the most up to date account to the buyer as well as all
ACCA P4 final mock june2014
legal documents relating to the assets being transferred as well to the potential

 Doric would need to assess how the buyer would finance the acquisition and
time it takes as well to complete the sale.

 Also Doric should have a legal team to assess any contractual issues as well.

ACCA P4 final mock june2014
Q4 answer
The reason why business combined together is because they want to have
synergies, ie, 1+1>2.

There are three types of synergies:
Revenue synergy
Cost synergy
Financial synergy

Revenue synergy:
This means after combination, business can further increase their sales revenue.

In the scenario:
1. Hav Co can use its funds to help advertise Strand Co products and hence get
more sales revenue.

2. Hav and Strand co can share the active research and development department to
create profitable products.

3. Some of the Strand products would need components in Hav Co and hence cross
selling chances would arise and hence increase sales revenue.

Cost synergy:
This means after combination, business can further save their costs.

ACCA P4 final mock june2014
In the scenario:
1. The combined entity would have more power as a buyer and hence this would
decrease the price paid to suppliers.

2. Functions within company can be combined like accounting department and
company would benefit from economic of scale and hence reduce its costs.

Financing synergy:
This means after combination, business can further use up the funds and increase
debt borrowing.

In the scenario:
Hav Co surplus funds can be used to develop Strand Co products.

Finance would be cheaper given the equity issued by company.

ACCA P4 final mock june2014


ACCA P4 final mock june2014

(c) Comment:
The cash and bond offer gives the highest return of 31.3%.

The convertible bond would be converted into equity in 6 years in 12 shares, ie,
including current share price, it would be 12sharesX$9.24/share-$110 which is
better than redeem $100 as cash.

The cash and share for share offer would allow shareholders to become the owner
of Hav company and they would have an option to sell their shares immediately and
if this is the case then it would cause the share price to decrease and hence the
overall return would be lower.

For cash consideration only, it’s the quickest way to get cash although the return is

For Strand Co shareholders and managers who would like to continue to work in
Hav co and they may choose the cash+bond offer.

But for some of them who may prefer cash offer and this would depend on different
attitude of risks and other factors.

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