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ACCA F9 Financial Management Full Course Workbook Solutions!

ACCA F9 Workbook
Lecture 1
Financial Strategy

ACCA F9 Financial Management Full Course Workbook Solutions!

Shareholder Wealth - Illustration 1

Year

Share Price

Dividend Paid

2007

3.30

40c

2008

3.56

42c

2009

3.47

44c

2010

3.75

46c

2011

3.99

48c

There are 2 million shares in issue.
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Calculate the increase in shareholder wealth for each year:
II. Per share
III. As a percentage
IV. For the business as a whole

!

!

Solution
Year

Share
Price

Share Price
Growth

2007

3.30

2008

3.56

(3.56 - 3.30) = 26c

2009

3.47

2010
2011

Div
Paid

Increase
in
S’holder
Wealth

As a
Percentage

Total
Shareholder
Return

42c

(26 + 42) =
68c

(68 / 330) =
20.6%

2m x 68c =
$1.36m

(3.47 - 3.56) = -9c

44c

(-9 + 44) =
35c

(35 / 356) =
9.8%

2m x 35c =
$0.70m

3.75

(3.75 - 3.47) = 28c

46c

(28 + 46) =
74c

(74 / 347) =
21.3%

2m x 74c =
$1.48m

3.99

(3.99 - 3.75) = 24c

48c

(24 + 48) =
72c

(72 / 375) =
19.2%

2m x 72c =
$1.44m

40c

ACCA F9 Financial Management Full Course Workbook Solutions!

EPS - Illustration 2

2010
$‘000

2011
$‘000

PBIT

2000

2100

Interest

200

300

Tax

300

400

Profit After Tax

1500

1400

Preference Dividend

300

400

Dividend

800

900

Retained Earnings

400

100

Share Capital (50c)

5000

5000

Reserves

3000

3100

Share Price

$2.50

$2.80

Calculate the EPS for 2010 and 2011.

Solution

2010

2011

Profit After Tax

1500

1400

Preference Dividend

300

400

Earnings

1200

1000

10,000

10,000

12c

10c

No. Ordinary Shares (5000 / 0.50)

EPS (Earnings / No. Ordinary Shares)

ACCA F9 Financial Management Full Course Workbook Solutions!

Test Your Knowledge
If you can’t answer all of the questions below without
looking at the answer then you need to do some more
work on this area!
Multiple Choice Questions
1. The 3 main areas of the business that Finance Managers plan are:
A. Investments, Financing & Profitability.
B. Dividend Policy, Financing & Investments.
C. Return on Capital, Investments, Profitability.
D. Earnings per share, Profitability, Maximising shareholder wealth.
Answer B
2. Examples of 3 external stakeholders are:
A. Shareholders, Customers & Managers.
B. Banks, Customers & Employees.
C. Suppliers, Government & Customers.
D. Unions, Suppliers & Investors.
Answer C
3. The Agency Relationship exists between:
A. Shareholders and Managers.
B. Auditors and Managers.
C. Shareholders and Stakeholders.
D. Stakeholders and Managers.
Answer A
4. The Agency problem exists because...
A. Managers may be interested in maximising their own earnings.
B. Shareholders have to rely on management to safeguard the assets of the business.
C. Managers may be interested in short term gains over long term stability.
D. All of the above.
Answer D

ACCA F9 Financial Management Full Course Workbook Solutions!

5. In order to maximise the wealth of shareholders, Finance Managers need to increase
shareholder wealth. Shareholder wealth increases are made up of:
A. Profit for the year + Dividends Paid.
B. Earnings per share + Dividends Per Share.
C. Share Price + Dividends Paid.
D. Share Price movement + Dividends Paid.
Answer D
6. ABC Co. Paid out a dividend of 35c last year and 42c this year per share. Their share
price has increased from $4.33 to $5.24 in that time. What is the percentage shareholder
return in the current year.
A. 20.00%
B. 21.10%
C. 30.72%
D. 24.39%
Answer C
Increase in Share Price (4.33 to 5.24) = 91c
Dividend Paid this year
=!42c
Return Per Share! !
!
=!133c
As a % of previous year Share Price (133/433) = 30.72%
7. The following information relates to ABC Co.
Year

Share Price

Dividend Paid

1

$4.50

82c

2

$4.71

84c

3

$3.85

86c

Which of the following statements is correct?
A. Between Year 1 and Year 2 shareholder wealth decreased.
B. Between Year 2 and Year 3 shareholder wealth decreased.
C. There was no increase in shareholder wealth between Year 2 and Year 3.
D. None of the above.
Answer C

Answer C 11. C.. A warning announcement that a firm will make less profit than expected. The company has an ethical policy to look after any injured birds they might find.. A signal sent by Auditors to inform shareholders of the dividend. B.... A signal sent by managers to the auditors to inform them of the dividend. D. Answer Irrelevant 10.. Less profit will be made. More tax will be paid.. B.. Answer A .. C. The government want the company to pay their tax on time.ACCA F9 Financial Management Full Course Workbook Solutions! 8... If a company does not pay dividends then the result will be A... Miller and Modigliani stated in their theory that dividends were .. The signal sent to the market by a company announcing their dividend for the year. Investors prefer a dividend now rather than later as there is a risk that the company could not pay a dividend at all. The ‘signaling effect’ refers to A.. B.. In order for dividends to be paid a company must have made profits in the current year. Managers prefer not to pay a dividend as they can re-invest the cash saved into new investments.. C.. Answer C 12. The ‘Bird in the hand’ argument refers to the fact that A..... More cash is available for investments. D. D. Is this statement TRUE or FALSE? Answer FALSE 9... More debt will be required..

ACCA F9 Financial Management Full Course Workbook Solutions! 13. B. Which of the following best explains the ‘Clientele Effect’? A. Pays no dividend at all. C. The company should choose a dividend policy and stick to it to attract investors who want that type of policy. The company should have a vote every year to ask investors what their dividend policy should be for the year. A company may decide not to pay a dividend for which of the following reasons . Is the above statement TRUE or FALSE Answer TRUE 15. Answer B 18. Is the above statement TRUE or FALSE? Answer TRUE 17. It has large cash reserves and wants to reward shareholders. The company should not pay a dividend. It doesn’t have enough cash to pay a dividend. Answer D 16. C. D. A ‘share buy back scheme’ refers to a situation where a company buys back it’s own shares from shareholders and then cancels those shares. Answer B 14. C. A ‘script dividend’ is where a company: A. B. Pays a larger than average dividend. A company may decide on a ‘Share-buy-back Scheme’ because A. B. The government tells it that it has too many shares. A company can reward investors through script dividends without paying out any cash. D. The clients of the company want as cheap prices as possible. D. It wants to receive cash to pay off some of it’s debt. Pays a dividend in shares rather than cash. Pays a dividend every other year.

Which of the following is an assumption of Miller and Modigliani’s dividend irrelevancy theory? A. C. Answer B . A company pays a steadily rising dividend that grows every year. D. It has low cash reserves. B. Is the above statement TRUE or FALSE? Answer TRUE 20. D. It has several new investments it would like to make. It has retained losses rather than profits. B. All share dealing transactions incur heavy costs.ACCA F9 Financial Management Full Course Workbook Solutions! A. Answer D 19. Dividends and capital gains are taxed at the same rate. Investors would like to see a company pay a steadily rising dividend growing at a rate in excess of inflation. Investors are irrational. All of the above. C.

ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Maximisation of profit. whereas the shareholders are interested in the long term stability and success of their investment. What is Corporate Strategy? Corporate strategy is the overall direction that a firm decides to take and covers such areas as expansion into new markets. What are the 3 main financial objectives of the financial manager? Maximisation of shareholder wealth. the goals of management are not the same as those of the shareholders. 5. 3. penetration of existing markets or diversification into different business areas. How do you calculate the increase in shareholder wealth? Share price growth + dividends paid (Learn this now if you didn’t know!). creating the agency problem. Describe the Agency Problem. The managers are interested in maximising their short term interests through pay and benefits. As such. 4. EPS growth. What are the 3 things that financial managers need to plan? Investments Financing Dividend Policy 2. The managers of a firm act as the agents of the shareholders as they are the owners of the company. .

Outline the Clientele Effect. This is because if a dividend is paid the shareholders get their return in the form of revenue. A firm should choose a consistent dividend policy so that potential investors can choose their investment based on their preference for a return in the form of revenue or share price growth. If the money is reinvested in the business this should lead to more profit and thus an increased share price which increases shareholder wealth by the same amount. 8. How do you calculate EPS? (Profit after tax . What is a script dividend? A dividend paid in the form of more shares rather than cash. Any 2 of: Pay a constant dividend. 10. Why did Miller & Modigliani say that dividends were irrelevant? M & M stated that whether the firm paid a dividend or chose to reinvest the money into the business the shareholders would get the same return.ACCA F9 Financial Management Full Course Workbook Solutions! 6. 7. 9. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: . Pay a constant proportion of earnings. Outline 2 potential dividend payment strategies. Pay whatever is left after making planned investments.Preference dividends) / Number of ordinary shares. Pay an inflation linked dividend.

ACCA F9 Financial Management Full Course Workbook Solutions! December 2010 Q4 Part (d) June 2010 Q4 Part (c) Now do it! ! .

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 2 Performance Measurement .

ACCA F9 Financial Management Full Course Workbook Solutions! Performance Analysis Illustration X1 X2 X3 Non Current Assets 500 700 1000 Current Assets 150 200 300 650 900 1300 Ordinary Shares ($1) 300 300 300 Reserves 100 280 430 Loan Notes 150 200 300 Payables 100 120 270 650 900 1300 Revenue 3000 3500 4200 COS 2000 2400 3200 Gross Profit 1000 1100 1000 Admin Costs 300 350 400 Distribution Costs 200 250 300 PBIT 500 500 300 Interest 100 150 220 Tax 120 90 50 Profit After Tax 280 260 30 Dividends 100 110 30 Retained Earnings 180 150 0 $3.30 $4.00 $2.20 Share Price .

ACCA F9 Financial Management Full Course Workbook Solutions! Using the information on the previous page calculate and comment on the following Ratios: I. Return on Capital Employed II. Revenue Growth VII. Gearing VIII. Dividend Cover X. Interest Cover IX. Net Margin V. Operating Margin VI. Dividend Yield XI. P/E Ratio . Return on Equity III. Gross Margin IV.

270) = 30 Capital Employed 550 780 1030 Total Assets 650 900 1300 Current Liabilities 100 120 270 Capital Employed 550 780 1030 500 500 300 (500 / 550) = 90.120) = 80 (300 .13% PBIT Return on Capital Employed PBIT / Capital Employed .100) = 50 (200 .ACCA F9 Financial Management Full Course Workbook Solutions! Solution ROCE Equity + LT Liabilities Non Current Assets + Net Current Assets Total Assets Current Liabilities X1 X2 X3 Shares 300 300 300 Reserves 100 280 430 LT Loan Notes 150 200 300 Capital Employed 550 780 1030 Non Current Assets 500 700 1000 Net Current Assets (Current Assets Current Liabilities) (150 .10% (300 / 1030) = 29.91% (500 / 780) = 64.

ROE X1 X2 X3 Profit After Tax 280 260 300 Ordinary Shares 300 300 300 Reserves 100 280 430 Total 400 580 730 (280 / 400) = 70% (260 / 580) = 44.13%.13% In the first year the ROCE was 90.8%. . This is a fall of 54.4% indicating that the business may be having difficulty generating the returns it was able to do previously.91% 64.5% from the previous year indicating that the business in not able to make the same return on it’s assets that it has previously been able to do.91%.10% 29.8% (300 / 730) = 41% Return on Equity (PAT / Ord Shares + Reserves) In the first year the ROE was 70%. This is a fall of 29.ACCA F9 Financial Management Full Course Workbook Solutions! Return on Capital Employed (ROCE) X1 X2 X3 90. At first glance this would appear to be a good return. however without industry averages or prior period information we are unable to tell if this is the case. This is a fall of 36% from the previous year indicating that the business in not able to make the same return on the shareholders funds that it has previously been able to do. In the year X3 the ROE is 41%. In the year X3 the ROCE is 29. however without industry averages or prior period information we are unable to tell if this is the case. This is a fall of 8.10%. At first glance this would appear to be a good return.55% indicating that there may be some serious underlying problems which are affecting the ability of the business to generate the return on capital previously generated. In year X2 the ROCE is 64. In year X2 the ROE is 44.

33% (1100 / 3500) = 31. a decrease of over 50%.4% achieved.ACCA F9 Financial Management Full Course Workbook Solutions! Margins X1 X2 X3 Revenue 3000 3500 4200 Gross Profit 1000 1100 1000 PAT 280 260 30 PBIT 500 500 300 Gross Margin (Gross Profit / Revenue) (1000 / 3000) = 33.42% (1000 / 4200) = 23.33% in X1 and holds reasonably steady in X2 at 31.42%.3% (260 / 3500) = 7. . The Operating Margin dropped slightly in X2 to 14. The Net Margin is 9.66% the previous year . before falling dramatically to 0.7% Operating Margin (PBIT / Revenue) (500 / 3000) = 16. or the cost of it’s purchases have gone up.89% Net Margin (PAT / Revenue) (280 / 3000) = 9.28% from 16. The extra interest costs have put pressure on the business.89% indicating that the business has either had to cut prices to sell the greater volume it has.66% (500 / 3500) = 14. However in X3 the Gross Margin falls to 23.4% (30 / 4200) = 0. However another point to note is that interest costs have risen with the increase in long term loans. In X3 the Operating Margin fell away to 7. This is due to the decreasing Gross Margin achieved as well as rises in the other expenses.28% (300 / 4200) = 7.1% The Gross Margin is 33.3% in X1 but begins to fall in X2 with 7.a fall of almost 15%.1%.7% in X3. The main reason for this is the fall in Gross Profit as other costs have risen in line with expectations given the increase in sales.

66%. an increase of over 180%. This is due to debt levels rising to 300 from 200 and the share price dropping to $2.30) = 990 (300 x 4) = 1200 (300 x 2.30 4 2.30 to $4. This is due to debt levels increasing to 200 from 150. an increase of 11% from year X1. .20 Market Value (300 x 3.20) = 660 (150 / 990) = 15% (200 / 1200) = 16. In year X2 gearing increases slightly to 16. although this is offset by the increase in the share price from $3.45% Debt Equity Gearing (Debt / Equity) Gearing levels in year X1 are 15%.20 due to the deteriorating results of the business. In year X3 gearing increases dramatically to 45%. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem excessive.66% (300 / 660) = 45.ACCA F9 Financial Management Full Course Workbook Solutions! Gearing X1 X2 X3 150 200 300 Number of Shares 300 300 300 Share Price 3.

In year X2 dividend coverage falls to 2.33 times. Dividend Cover X1 X2 X3 PAT 280 260 30 Dividends 100 110 30 (280 / 100) = 2. This has occurred due to the interest charge increasing in the period while PBIT has remained constant.8 times.36 times Interest Cover (PBIT / Interest) Interest coverage in year X1 is 5 times.36 times (30 / 30) = 1 time Dividend Cover (PAT / Dividends) Dividend coverage in year X1 is 2. In year X2 interest coverage falls to 3. This is caused by the PBIT achieved decreasing to 300 combined with the increase in the interest charge to 220. The increase in interest is caused by the increase in the long term debt of the company as shown by the gearing ratios calculated above. This will be of concern to investors and their concern is reflected in the fall in the share price from $4 in year X2 to $2.20 in year X3.ACCA F9 Financial Management Full Course Workbook Solutions! Interest Cover X1 X2 X3 PBIT 500 500 300 Interest 100 150 220 (500 / 100) = 5 times (500 / 150) = 3. In year X3 dividend coverage has decreased to 1 time.8 times (260 / 110) = 2. . In year X3 interest coverage has decreased again to 1. This is caused by the decrease in profit achieved by the company restricting the level of dividend payable. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem unreasonable.33 times (300 / 220) = 1.36 times.36 times. the dividend paid this year is greater than last. Without industry averages or prior year data we are unable to assess this level although at first glance it does not seem unreasonable. This would not concern investors as although coverage has gone down slightly.

30 $4 $2.5% which is 50% lower than the previous year.ACCA F9 Financial Management Full Course Workbook Solutions! Dividend Yield X1 X2 X3 Number of Shares (300 / 1) 300 300 300 Dividends 100 110 30 Dividends Per Share (100 / 300) = 33c (110 / 300) = 36c (30 / 300) = 10c Dividend Yield (Dividends Per Share / Share Price) (33 / 330) = 10% (36 / 400) = 9% (10 / 220) = 4. combined with the fall in share price and reduced profitability will be a major concern to investors. . This is unusual as the earnings have decreased to 12% of the previous year. The share price has fallen to reflect this. This indicates that the market expectations for this share have risen since X1 and that investors are now willing to pay 4. In year X4 the P/E ratio has increased dramatically to 22.65 (220 / 10) = 22 Share Price The P/E Ratio in year X1 is 3. This may indicate that the market feels that the results in year X3 were perhaps a one-off and that next years results will improve. In year X2 the P/E Ratio increases to 4. In year X3 the Dividend Yield has fallen to 4.5% The Dividend Yield is 10% in year X1.20 Profit After Tax 280 260 30 No. In year X2 the Dividend Yield falls to 9%. P/E Ratio X1 X2 X3 $3. This will not be overly concerning to investors as the increase in share price over the year will have more than made up for the slightly lower yield.54 (400 / 86) = 4. We don not have industry comparatives or prior year information with which to compare this.65 times what the business earns in a year to own the share. Whilst we do not have comparatives. This. but not by as much as would be expected.54.65. this seems a reasonable return. Ordinary Shares 300 300 300 EPS (280 / 300) = 93c (260 / 300) = 86c (30 / 300) = 10c P/E Ratio (Share Price / EPS) (330 / 93) = 3.

Why do we use PAT . How do you calculate interest cover? Profit before interest and tax / Interest . What does gearing tell us? The amount of financial risk that a firm is exposed to. What is the top line of the ROE calculation? Profit after tax . 4. Total Assets .ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! 1. What should we compare the ratios we calculate with? The same company in prior years.Current Liabilities. Industry average. In the ROCE calculation what are the 3 ways of calculating Capital Employed? PBIT / Capital Employed Equity + Long Term Liabilities. 3.Preference Dividends. 5. Non Current Assets + Net Current Assets. 2.Pref DIvs in the ROE calculation? This is the distributable profits and thus the amount that the investors in the equity of the firm will be interested in. 6.

What does the P/E Ratio tell us? The number if times the current earnings that the market is currently willing to pay for the share.ACCA F9 Financial Management Full Course Workbook Solutions! 7. How do you calculate EPS? (Profit after tax . 9. If the P/E ratio is high it indicates that the market expects strong future earnings. If you’ve successfully answered all of the above questions then you’re ready to do the exam question below: June 2009 Q4 (a) Now do it! .e.Preference dividends) / Number of ordinary shares 8. the amount of dividends that the share has yielded to investors. How do you calculate dividend cover? Profit after tax / dividends paid 10. If the P/E ratio is low it indicates that the market expects weak future earnings. What does dividend yield tell us? The dividend paid as a proportion of the share price i.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 3 Finance Sources .

They are offering a 1 for 4 issue at a price of $6.60 . Solution Number of Shares Share Price Total 4 $8 (4 x $8) = 32 1 $6 (1 x $6) = 6 5 38 We now have 5 shares in issue at total value of $38 so the THERP is (38 / 5) = $7.Illustration 1 XYZ Ltd. intends to raise capital via a rights issue. Calculate the Theoretical Ex-rights Price.ACCA F9 Financial Management Full Course Workbook Solutions! Rights Issue . The current share price is $8.

The share price is currently $5.50) = 27.25m) $4 Number of Shares Share Price Total 5 $5.ACCA F9 Financial Management Full Course Workbook Solutions! Rights Issue .50 and ABC intends to raise $5m.25m Share issue price ($5m / 1.Illustration 2 ABC Ltd. Calculate the Theoretical Ex-Rights Price. has decided to raise capital via a rights issue.25 . There are currently 6.50 (5 x 5.5 We now have 6 shares in issue at total value of $31.5 so the THERP is (31. of shares issued (6.25m shares in issue and ABC is offering a 1 for 5 rights issue. Solution Amount of Capital to raise $5m No.5 / 6) = $5.25m / 5) 1.5 1 $4 (1 x 4) = 4 6 31.

It will lead to a better perception of the firm by potential investors.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. To increase the cost of equity of listed companies. 1 and 3 Answer D . The company may be required to disclose more information about it’s operations. Listing may well lower the cost of equity of the firm as investors will see it as a safer investment and thus accept a lower return. 2 and 3 C. 2. D. To enable companies to raise capital. Which of the following is NOT something a company will consider when choosing a source of finance? A. It will be more difficult for the firm to raise capital. The number of employees in the firm. 1 and 2 B. To facilitate transactions between buyers and sellers. What is NOT a function of the stock market? A. Any security that will need to be used. 3. 2 and 4 D. D. The cost of the finance to the firm. B. C. To enable individuals to sell shares in a company. Which of the following are advantages to a company of being listed on the stock exchange? 1. Answer D 3. Current and future gearing levels. 4. Answer B 2. C. A. B.

ACCA F9 Financial Management Full Course Workbook Solutions! 4. 2 and 4 C. What is the Theoretical ex-rights price? A. $6. Which of the following are disadvantages to a company of being listed on the stock exchange? 1. $6. 3. A company has 10m shares in issue at a share price of $7 and undertakes a rights issue of 1 for 5 to raise $12m.83 . of shares issued (10m / 5) 2m Share issue price ($12m / 2m) $6 Number of Shares Share Price Total 10m $7 $70m 2m $6 $12m 12m $82m We now have 12m shares in issue at total value of $82m so the THERP is ($82m / 12) = $6. 3 and 4 D. $6. $6.44 Answer B Amount of Capital to raise $12m No. 1 and 2 B. Control by the current owners will be increased. There are ongoing costs of listing compliance.17 B. 4. A.00 D. It is expensive to become listed. Listing may well lower the cost of equity of the firm as investors will see it as a safer investment and thus accept a lower return.83 C. 2. 1 and 4 Answer A 5.

B. Answer A 9. All of the new Shares being issued to one large institutional investor. All of the new Shares being issued to one large institutional investor. The government Answer B . An issue to current shareholders of shares instead of dividends. An offering of new shares to all investors in the market to enable them to purchase them if they wish. Answer B 7. iv)The share price achieved for the issue may not be as high as expected. The market D. Which of the following best describes a placing as a means of issuing shares? A. D. Shareholders B. Offering shares to current shareholders in the same proportion as they currently own them. ii) It may need to be underwritten to ensure the shares are taken up. C. i) ii) and iii) only Answer B 8. Which of the following are disadvantages of an IPO? i) It can be very expensive. An issue to current shareholders of shares instead of dividends. An offering of new shares to all investors in the market to enable them to purchase them if they wish. i) ii) and iv) only C. Offering shares to current shareholders in the same proportion as they currently own them. D. i) iii) and iv) only B. B. Banks C. All of the above D. iii)The company will need to to deal with one large institutional investor only. C.ACCA F9 Financial Management Full Course Workbook Solutions! 6. Which of the following best describes an IPO? A. Who demands covenants to be placed on debt? A. A.

Answer C . B. D.ACCA F9 Financial Management Full Course Workbook Solutions! 10. To prepare the financial statements of the firm. To manage any currency risk that the firm may be exposed to. To manage the liquidity of the firm. Which of the following is NOT a function of the treasury department in a company? A. C. To set and achieve the financial objectives of the firm.

The availability of the finance to the firm. 4. It may well lower the cost of equity of the firm as investors will see it as a safer investment and thus accept a lower return.not all of it fair and balanced. There are ongoing costs of listing compliance. Current and future gearing levels. 3. Are there any disadvantages of being listed? It is expensive to become listed. What is the primary function of the stock market? To enable firms to raise capital and investors to buy equity.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Any security that will need to be used. . What are the advantages to the company of being listed? It will lead to a better perception of the firm by potential investors. It will be easier for the firm to raise capital. 2. What 5 things will a company consider when choosing a source of finance? The cost of the finance to the firm. The length of time the firm needs the finance for. It opens the firm up to a lot of public scrutiny . Control by the current owners will be diluted.

7. corporate governance requirements. It may need to be underwritten to ensure the shares are taken up. Who demands covenants to be placed on debt? The bank who offers the finance. 9. listing fees. 8. What is an IPO? An Initial Public Offering of shares to investors as a method of raising capital. What is a placing? A placing of a new issue of shares with institutional investors such as insurance companies or pension funds. A company has 10m shares in issue at a share price of $7 and undertakes a rights issue of 1 for 5 to raise $12m. The share price achieved for the issue may not be as high as expected. What is the Theoretical ex-rights price? Amount of Capital to raise $12m No. advertising costs.ACCA F9 Financial Management Full Course Workbook Solutions! 5.83 6. . compliance costs. underwriting costs). What are the disadvantages of an IPO? It can be very expensive (Legal fees. of shares issued (10m / 5) 2m Share issue price ($12m / 2m) $6 Number of Shares Share Price Total 10m $7 $70m 2m $6 $12m 12m $82m We now have 12m shares in issue at total value of $82m so the THERP is ($82m / 12) = $6.

To determine the funding requirements of the firm. What is the function of the treasury department in a company? To set and achieve the financial objectives of the firm. To manage any currency risk that the firm may be exposed to. If you’ve successfully answered all of the above questions then you’re ready to do the exam question below: June 2009 Q4 (b) & (c) Now do it! . To manage the liquidity of the firm.ACCA F9 Financial Management Full Course Workbook Solutions! 10.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 4 Economic Environment .

D. Answer D 2. Sales tax decreases. B. FALSE . 3 and 4 D. stable growth. Is this statement A. 1. Price stability. High. TRUE B. C. Low consumer prices. Full employment. 2 and 4 C. Rising cost of commodities. Fiscal policy can be described as tax revenues raised by the government and spent on services and subsidies for the public. 3. 1 and 4 Answer A 3. High demand in the economy A. 4. 2.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. 1 and 2 B. Which of the following are examples of cost-push inflation. Wage increases. Which of the following is not a target of government economic policy? A.

By selling foreign currency on the currencies exchange. Money markets could be best described as: A. More consumer demand in the economy. An increase in interest rates is likely to lead to which of the following: 1. 4. 2. Higher cost of borrowing for companies. More sales for many companies. B. 3 and 4 D. 1 and 2 B. Excessive consumer demand in the economy. By providing insurance on transactions for buyers and sellers. Reduced consumer demand in the economy. Concerns that growth in the economy may be low. 4. Answer D 7. Answer C . Which of the following might cause policy makers to decide to decrease interest rates? 1. How can financial intermediaries help to make the market more efficient? A. D. Expectations that the economy will grow strongly. 3 and 4 D. B. D. 3. A. C. 2 and 3 C. A market for the trade of foreign currency. A market for the trade of commodities such as oil and wheat. 2. A market for newly printed notes and coins. 3. 1 and 4 Answer B 6. By buying commodities from sellers and trading them on the commodities exchange. 1 and 2 B. Less consumer demand in the economy A. By providing finance to enable transactions to take place. A market to enable banks to borrow and lend to each other. 1 and 4 Answer D 5. C.ACCA F9 Financial Management Full Course Workbook Solutions! 4. 2 and 4 C.

High. credit cards etc. 2. What is fiscal policy? Tax revenues raised by government and spent on services and subsidies. What are the 4 targets of economic policy? Full employment. What are the money markets? Banks borrow and lend to each other in the money markets. 4. Wage increases. This will decrease demand for goods as consumers will have less money to spend on goods because they are spending more money on the increased cost of financing (mortgages. 5.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Sales tax increases. How is an increase in interest rates likely to effect the economy? An increase in interest rates will increase the cost of financing to individuals and companies in the economy. Balance of payments. When might policy makers decide to decrease interest rates? When excessive consumer demand is causing inflation interest rates may be raised to decrease demand. 6. Name 2 examples of cost-push inflation.). stable growth. Rising cost of commodities. Price stability. 3. .

Name 5 types of securities? Treasury bills. Preference shares.ACCA F9 Financial Management Full Course Workbook Solutions! 7. If you’ve successfully answered all of the above questions then you’re ready to do the exam question below: Now do it! . Banks & finance houses. How can financial intermediaries help to make the market more efficient? Financial intermediaries enable the transaction between buyers and sellers by providing finance to the buyers e. 8.g. Corporate bonds. Long term government bonds. Ordinary shares.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 5 Working Capital .

ACCA F9 Financial Management Full Course Workbook Solutions!

Working Capital Illustration
Balance Sheet
$‘000
ASSETS
Non Current Assets

1000

Inventory

300

Receivables

200

Cash

300
1800

LIABILITIES
Ordinary Shares

800

Reserves

200

Long term Liabilities

700

Payables

100

Overdraft

1800

Income Statement
$‘000
Revenue

1000

COS

800

Gross Profit

200

Other Costs

100

Net Profit

100

Other Information:
All sales are made on credit.
Required:
Calculate the Cash Operating Cycle for Inter Ltd.

ACCA F9 Financial Management Full Course Workbook Solutions!

Solution

Item

Working

Days

Inventory Period

300/800 x 365

137

Collection Period

200/1000 x 365

73

100/800 x 365

46

Less:
Payables Period

164

Working Capital Illustration Part II
Show the journal entries and calculate the Revised Balance sheet if the operating cycle
changes to:

Item

Days

Inventory Period

200

Collection Period

100

Less:
Payables Period

30
270

ACCA F9 Financial Management Full Course Workbook Solutions!

Solution

Item

New Days

Old Days

Old
Balance

Working

New
Balance

Movem’t

Inventory

200

137

300

300 x
200/137

438

138

Receivabl
es

100

73

200

200 x
100/73

274

74

30

46

100

100 x
30/46

65

-35

270

164

Less:
Payables

Entries
Dr Inventory

Dr
138

Cr Cash
Dr Receivables

138
74

Cr Cash
Dr Payables
Cr Cash

Cr

74
35
35

ACCA F9 Financial Management Full Course Workbook Solutions!

Revised Balance Sheet
$‘000

Movement

$‘000

ASSETS
Non Current Assets

1000

1000

Inventory

300

138

438

Receivables

200

74

274

Cash

300

-247

53

1800

1765

Ordinary Shares

800

800

Reserves

200

200

Long term Liabilities

700

700

Payables

100

Overdraft

0

0

1800

1765

LIABILITIES

-35

65

ACCA F9 Financial Management Full Course Workbook Solutions!

Working Capital Illustration Part III
Show the journal entries and calculate the Revised Balance sheet if the operating cycle
changes to:

Item

Days

Inventory Period

90

Collection Period

30

Less:
Payables Period

60
60

Solution

Item

New Days

Old Days

Old
Balance

Working

New
Balance

Movem’t

Inventory

90

200

438

438 x
90/200

197

-241

Receivabl
es

30

100

274

274 x
30/100

82

-192

60

30

65

65 x 60/30

130

65

60

270

Less:
Payables

ACCA F9 Financial Management Full Course Workbook Solutions! Entries Dr Dr Cash Cr 241 Cr Inventory 241 Dr Cash 192 Cr Receivables 192 Dr Cash 65 Cr Payables 65 498 498 Revised Balance Sheet $‘000 Movement $‘000 ASSETS Non Current Assets 1000 1000 Inventory 438 -241 197 Receivables 274 -192 82 Cash 53 498 551 1765 1830 Ordinary Shares 800 800 Reserves 200 200 Long term Liabilities 700 700 Payables 65 Overdraft 0 0 1765 1830 LIABILITIES 65 130 .

ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. 2 and 4 Answer B 2. Intangible Assets. Payables. i) iii) and iv) only B. i) ii) and iii) only Answer B . 4. A. i) Reliance on long term finance. Inventory. 1 and 2 B. All of the above D. 2. v) Deteriorating Current ratio. 3 and 4 D. Non Current Assets. ii) iii) and v) only C. 3. iv) Rapidly decreasing sales. iii) Build up of inventory. Which of the following are components of working capital within the financial statements: 1. ii) Offering lax credit terms. Which of the following are indicators of overtrading. A. 2 and 3 C.

The following information has been calculated for A Co: Trade receivables collection period Raw material inventory turnover period Work in progress inventory turnover period Trade payables payment period Finished goods inventory turnover period 52 days 42 days 30 days 66 days 45 days What is the length of the working capital cycle? A B C D 103 days 131 days 235 days 31 days Answer A 4.ACCA F9 Financial Management Full Course Workbook Solutions! 3. TRUE B. If inventory days go up from 100 to 150 the company will need to invest more cash in the business. Is this statement: A. FALSE Answer A 5. 2 and 3 Answer B . Which of the following statements concerning working capital management are correct? 1 The twin objectives of working capital management are profitability and liquidity 2 A conservative approach to working capital investment will increase profitability 3 Working capital management is a key factor in a company’s long-term success A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1.

A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. 2 and 3 Answer A . Which of the following statements concerning working capital management are correct? 1 The twin objectives of working capital management are profitability and liquidity 2 A moderate approach to working capital investment will increase profitability 3 An aggressive approach to working capital investment uses more long term finance than short term. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. 2 An aggressive approach to working capital investment will increase profitability 3 Working capital management has no effect on profitability of the company. Which of the following statements concerning working capital management are correct? 1 The twin objectives of working capital management are profitability and liquidity 2 A aggressive approach to working capital investment will increase profitability 3 Working capital management is not a key factor in a company’s long-term success A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. 2 and 3 Answer A 7.ACCA F9 Financial Management Full Course Workbook Solutions! 6. 2 and 3 Answer B 8. Which of the following statements concerning working capital management are correct? 1 A conservative approach to working capital investment employs uses long term finance to finance some fluctuating current assets.

receivables and cash that are required to support seasonal fluctuations in business operations. How do we calculate the cash operating cycle? Inventory Period + Receivables Period . What is the Quick Ratio and what does it tell us? (Current Assets . Deteriorating Quick Ratio. .Payables Period 5. 3. Receivables.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Rapidly expanding sales. Deteriorating Current ratio. State 6 indicators of overtrading. Offering lax credit terms. What are the components of working capital? Current Assets (Inventory. Reliance on short term finance. receivables and cash that are required to support the day to day running of the business. Cash) Current Liabilities (Payables) 2. What are permanent current assets? The level of inventory. 7. If my inventory days go up from 100 to 150 will I need to invest more or less cash in the business? More cash as cash is being tied up in inventory.Inventory) / Current Liabilities 4. What are fluctuating current assets? The levels of inventory. 6. Build up of inventory.

It is more efficient. 9.e. 10. What are the advantages of a conservative working capital financing policy? There is less chance of the firm running out of cash i. What are the advantages of an aggressive working capital financing policy? It will lead to more profit as financing short term finance is cheaper. What is the matching principle? Matching short term assets with short term finance and long term assets with long term finance. less liquidity risk.ACCA F9 Financial Management Full Course Workbook Solutions! 8. The firm is able to meet sales demand changes. If you’ve successfully answered all of the above questions then you’re ready to do the exam question below: June 2009 Q3 (a) & (b) Now do it! . By offering more credit the firm may well increase sales.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 6 Managing Receivables .

Illustration 1 Credit sales: 1200 3 month credit terms Overdraft rate = 10% New Policy 2% discount if paid in less than 10 days 2 month terms for everyone else. 20% will take the discount Solution Method = Compare the savings through reducing receivables by offering the discount to the profit lost by doing so.ACCA F9 Financial Management Full Course Workbook Solutions! Receivables . Working Receivables Before Receivables After 20% who take discount 1200 x 3/12 300 (1200 x 10/365) x 20% 7 Everyone else (1200 x 2/12) x 80% 160 167 Saving = (Reduction in receivables x Overdraft rate) (300 .167) x 10% 13 Lost Profit = Amount of Discount (1200 x 20%) x 2% 4.8 The saving made is greater than the profit lost so the discount should be offered .

400.000 Total Benefits 526.000 per year in administration costs and $350. A condition of the factoring agreement is that the factor would advance 80% of the face value of receivables at an annual interest rate of 7%.184 1.000.526. The factor will maintain a trade receivables collection period of 30 days and Gorwa Co will save $100.184 -644.122.301 Admin Cost Savings 100.000 Bad Debt Savings 350.05 76.973 Difference 1.973 x 80% x (7% .ACCA F9 Financial Management Full Course Workbook Solutions! Receivables .000 A factor has offered to take over the administration of trade receivables on a non-recourse basis for an annual fee of 3% of credit sales.03 1.526.000 37.000 x 0.600.301 Costs Of Using Factor Annual Fee 37. The current overdraft rate is 5% Difference on Receivables Current Receivables Receivables Under Factor 4.400.Illustration 2 Receivables are currently $4.073.883 .027 Benefits & Costs of Factor Benefits of Using Factor Reduced Overdraft Interest 1.000 Extra Interest Cost 3.600. Sales are $37.000 per year in bad debts.027 x 0.400.171.5%) Total Costs Total Benefits Less Total Costs 49.000 x (30 / 365) 3.073.

Ask for a written promise to pay. How can a company assess the credit worthiness of their customers? 1.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. 2. 3. Offer initial high levels of credit. Risk of more bad debt as customers take longer to pay. Use a credit rating agency. 2. Better liquidity for the firm. 4. 2 and 3 Answer A . A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. 4. Loss of customers who don’t take advantage of the discount. 3. Less interest as less or no overdraft will be required. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. Which of the following are benefits of a company offering a discount to customers for early payment of invoices? 1. Get trade references from other suppliers or from banks. 2 and 3 Answer A 2.

3.479 B $394. The company retains the risk of bad debt.521 C $78. The factor advances a percentage of the invoice value to the company. 4. Invoice discounting can be used by any company. It can lose the goodwill of customers.384 Answer A 4. Assume 365 days in a year. What is the annual finance cost saving if the management reduces the collection period to 60 days? A $85. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. 2.ACCA F9 Financial Management Full Course Workbook Solutions! 3. 3. The management of XYZ Co has annual credit sales of $20 million and accounts receivable of $4 million. It creates a bad impression with customers because the debt is collected by the factor. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. The factor collects the debt. Working capital is financed by an overdraft at 12% interest per year. 2. It can increase the liquidity of the company. It can be expensive. 4. 2 and 3 Answer D 5. Which of the following are disadvantages of debt factoring for a company? 1. Which of the following statements relate to invoice discounting through a factor? 1.904 D $68. 2 and 3 Answer B .

The factor will charge a fee for the service and will charge interest on any amounts outstanding until the money is collected. What is debt factoring? A factor (usually a bank) buys the debt of the company for a percentage of the invoice amount. 6. 5. What are the benefits of offering a discount to customers? Better liquidity for the firm. Less bad debt as customers pay early. 2. It can lose the goodwill of customers. Send regular statements to customers. Maintain and review a file on the customer. It creates a bad impression with customers because the debt is collected by the factor. Use a credit rating agency. What are the disadvantages of factoring for a company? It can be expensive. How can a company assess the credit worthiness of their customers? Get trade references from other suppliers or from banks.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Less interest as less or no overdraft will be required. 3. Outline a clear policy to customers. Maintain an internal credit rating system. New customers as they take advantage of the discount. 4. Offer initial low levels of credit. Identify overdue accounts on a timely basis. How do you decide whether to offer a discount or not? Assess the saving through early payment (Change in receivables x Overdraft interest) Compared to the cost of the discount. . Any 3 of: Maintain an aged debtors listing. Outline 3 ways of maintaining good credit control.

How can a company seek to ensure that foreign receivables are collected? Agree early payment. References & credit checks. If you’ve successfully answered all of the above questions then you’re ready to do the exam question below: Now do it! . Export factor. What is invoice discounting? A factor forwards the company money secured against the debt ledger of the business but it is still collected by the business. Bills of exchange. Insurance. 8.ACCA F9 Financial Management Full Course Workbook Solutions! 7. Letters of credit.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 7 Inventory Management .

Holding cost per year of 10% of the purchase price of the goods.Illustration 1 Demand of 1200 units per month.400 Holding Cost $10 x 10% 1 Ordering Cost 12 EOQ √(2 x 12 x 14.ACCA F9 Financial Management Full Course Workbook Solutions! EOQ . Cost of making an order of $12. Solution Working Annual Demand 1200 x 12 14.400) / 1 588 12 x (14. Calculate the EOQ & check that it is correct. Cost of one unit $10.400 / 588) 294 1 x (588 / 2) 294 Test Ordering Costs (Cost Per order x (Demand / EOQ)) Holding Costs (Cost Per Unit x (EOQ / 2)) .

(4 x 7.000 4 weeks 7. Calculate the buffer stock.500 20.500) 50.ACCA F9 Financial Management Full Course Workbook Solutions! Buffer Stock .000 It takes 4 weeks to receive new stock from the time of ordering. The company uses 7.500 units on average per week. Solution Buffer Stock = Re-order level less usage in lead time Re-order level Lead Time Usage per week 50.Illustration 2 Company orders when the level of stock reaches 50.000 .000 .

000/25.5 x (25.000 / 0.000 / 2) 6.000/50) 10. Calculate EOQ with buffer stock Solution Working Buffer Stock (Re-order level .000 units when the inventory level falls to 35.000 Order Costs (Cost per order x No.ACCA F9 Financial Management Full Course Workbook Solutions! EOQ With Buffer Stock . Both costs are expected to be constant during the next year.000 EOQ ignoring buffer stock Total cost Calculations Total Costs 17.000 units.500 . Forecast demand to meet production requirements during the next year is 625.000) 6. Orders are received two weeks after being placed with the supplier. Orders) 250 x (625. You should assume a 50-week year and that demand is constant throughout the year. The cost of placing and processing an order is €250.(Lead time x amount used per week)) 35.000 units.(2 weeks x 625.250 Holding Costs (Holding cost p/unit x Average Stock) 0.250 Holding Cost for Buffer (Holding cost p/unit x Buffer Stock) 0.5) 25.Illustration 3 Dec 07 Exam Question The current policy is to order 100.000 5.000 . while the cost of holding a unit in stores is €0·50 per unit per year.5 x 10.000 √ (2 x 250 x 625.

of stock value.000 / 1500) 240 (1. Order cost £30 Holding cost 10% p.000 x 11 132. Orders) Holding Costs (Holding cost p/unit x Average Stock) Cost of Purchases 30 x (12. Purchase cost per unit £11.1) 809 30 x (12. Orders) Total Costs 132.1 x (809/2) 445 Cost of Purchases 12.Illustration 4 Demand is 1000 units per month.000 / 1.a.1 x 99%) x (1500/2) 817 12.ACCA F9 Financial Management Full Course Workbook Solutions! EOQ with discounts .890 If 1500 are ordered to take the discount: Total cost Calculations Order Costs (Cost per order x No.665 .000 x (11 x 99%) 130. Required Calculate the minimum total cost with a discount of 1% given on orders of 1500 and over Solution EOQ with Discounts 1) Calculate EOQ in normal way (and the costs) 2) Calculate costs at the lower level of each discount above the EOQ Working EOQ √ (2 x 30 x 12.608 Total Costs 131.000 Total cost Calculations Order Costs (Cost per order x No.000 / 809) 445 Holding Costs (Holding cost p/unit x Average Stock) 1.

Which of the following types of cost we are seeking to minimise by using the Economic Order Quantity? A. The cost of making an order is $49.687.500.34 B. Holding costs and security costs Answer B 2. $6. (EOQ / Cost per order) x Holding costs D. Ordering costs and holding costs C. Annual demand x EOQ Answer A 3. If a company uses the Economic Order Quantity as the level at which to order.413.71 and the cost of holding one unit for one year is $0. $6. sells widgets and expects annual demand of 3. Cost per order x (Annual Demand / EOQ) B. how will they calculate total ordering costs for the year? A. What is the total ordering costs per year: A. $6. Ordering costs and insurance costs D. $5. Holding costs and inventory movement costs B.50.81 C.430. Annual Demand x (Cost per order /EOQ) C. ABC Co.54 D.32 Answer C .4m units.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.

2. 1. ABC Co. 9.850 B.750 C.450 D. Which of the following are drawbacks of a company using the Economic Order Quantity method of stock management? 1.ACCA F9 Financial Management Full Course Workbook Solutions! 3. What is the buffer stock level for Layla Co.780. The cost of making an order is $25. Assumes no buffer stock or lead time. sells 200m wigs in a year with each order taking 15 days to be delivered once made. $2. 2 and 4 only 1 and 3 only All of the above 1. Assumes constant demand. $2.2m units. They make an order every time their stock levels reach 10m wigs.666 C. What is the total holding costs per year: A.666. Layla Co.822 B. sells widgets and expects annual demand of 1.333. 2.21 and the cost of holding one unit for one year is $0.750 Answer D 4. 6. 3. $2. Assumes known annual demand. A.333 D. 2 and 3 Answer C . 4. $3.345.632 Answer A 5. Assumes constant ordering costs.50. A B C D 1.

000 . while the cost of holding a unit in stores is $1 per unit per year.000 Answer D Solution Working Buffer Stock (Re-order level .000 / 2) 6.000 units when the inventory level falls to 55.000 units. Forecast demand to meet production requirements during the next year is 800.000 Holding Costs (Holding cost p/unit x Average Stock) 1 x (12. Orders are received three weeks after being placed with the supplier. The cost of placing and processing an order is $90. $6. Stavros Co’s current inventory policy is to order 60. $19.000/50) 7. $12.000/12.000 / 1) 12. $7.000 D.000 .000 units.000 EOQ ignoring buffer stock √ (2 x 90 x 800.ACCA F9 Financial Management Full Course Workbook Solutions! 6. What is the total cost of ordering at the EOQ level? A.000 7.000 B.000 Total cost Calculations Order Costs (Cost per order x No. Both costs are expected to be constant during the next year.(3 weeks x 800.000 90 x (800.000) 6.000 C.(Lead time x amount used per week)) 15. Orders) Total Costs 19. You should assume a 50-week year and that demand is constant throughout the year.000 Holding Cost for Buffer (Holding cost p/unit x Buffer Stock) 1 x 7.

How do we calculate the buffer stock? Re-order level . What are the problems with the EOQ method? Assumes constant ordering costs. What are the two types of cost we are seeking to minimise? Ordering costs. How do we calculate total holding costs for the year? Holding cost per unit x Average stock held (EOQ / 2) 4. How do we calculate total ordering costs for the year? Cost per order x Number of orders (Annual Demand / EOQ) 3. 2. What are the steps in calculating the total costs when there is a buffer stock? Calculate the EOQ ignoring the buffer stock.usage in lead time 5. Assumes constant demand.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Assumes no buffer stock or lead time. Holding costs. 6. Assumes no bulk discounts. 8. Why might we not use the EOQ when there are bulk discounts available? The saving on the discount may mean that it is cost beneficial to order at that level. Assumes known annual demand. Calculate the buffer stock. . Add the holding cost for the buffer.

ACCA F9 Financial Management Full Course Workbook Solutions! If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: June 2009 Q3 (d) December 2010 Q3 (a) Now do it! .

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 8 Cash Management .

Illustration 1 A business expects to move 500.000 Interest Rate 7% Cost of making a transfer Amount to transfer $250 √(2 x 250 x 500.07 $59. How much should the business transfer into cash each time it makes a transfer? Solution Working Annual Disbursements $500.ACCA F9 Financial Management Full Course Workbook Solutions! Baumol Cash Model .000 from it’s interest bearing account into cash over the course of one year.761 . The interest rate is 7% and the cost of making a transfer is $250.000) / 0.

Illustration 2 Using the information in illustration 1 calculate the total cost to the business each year of their cash management policy. Solution Working Holding Cost (Ave Cash Balance x Interest Rate) ($59761 / 2) x 0.000 / 59. Transfers) $250 x (500.ACCA F9 Financial Management Full Course Workbook Solutions! Baumol Cash Model .761) 2091 Total Cost 4182 .07 2091 Trading Cost (Cost of Transfer x No.

000.700 .000 / 230.09) 230.Illustration 3 Subsonic Speaker Systems (SSS) has annual transactions of $9 million.000 Interest Rate 9% Cost of making a transfer Amount to transfer $264.000.ACCA F9 Financial Management Full Course Workbook Solutions! Baumol Cash Model . Transfers) $264.09 10.50 x (9. What is the optimal deposit size? Solution Working Annual Disbursements $9.50 √(2 x 264.000.350 Trading Cost (Cost of Transfer x No.350 Total Cost 20.000) / 0.000 / 2) x 0.000 Working Holding Cost (Ave Cash Balance x Interest Rate) (230.50 per conversion.000) 10. The annual opportunity cost of funds is 9%. The fixed cost of converting securities into cash is $264.5 x 9.

000 + (1/3 x 25. and the variance of its daily cash flows is £4m (ie std deviation £2.434 . Solution Working Lower Limit Given in Question 8.ACCA F9 Financial Management Full Course Workbook Solutions! Miller-Orr Model .303) 16. The cost of buying/ selling securities is £50 & the daily interest rate is 0.Illustration 4 If a company must maintain a minimum cash balance of £8.00025))1/3 25.000 + 25.303 Return Point (Lower Limit + (1/3 x Spread) 8.000.303 33.000).000 Spread (3 x ((3/4 x 50 x 4.000) / 0.303 Upper Limit (Lower Limit + Spread) 8. the upper limit & the return point. Calculate the spread.000.025 %.

000.107 D.426 C.43 Answer B Working Annual Disbursements $30. What is the optimal deposit size? A. $42. The annual opportunity cost of funds is 6%.107 .09) 707.000) / 0. $707. The fixed cost of converting securities into cash is $500 per conversion. Speculation 2. Reaction A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1. Persuasion 3. $21. Which of the following are the reasons for a company to hold cash? 1. $42.5 x 9. Transaction 4.000 Interest Rate 6% Cost of making a transfer Amount to transfer $500 √(2 x 264. has annual transactions of $30 million.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. Revaile Co.000.213 B. 2 and 3 Answer B 2.

ACCA F9 Financial Management Full Course Workbook Solutions! Working Holding Cost (Ave Cash Balance x Interest Rate) (707. and the variance of its daily cash flows is £6.06 21.303 33. What is the upper-limit using the Miller-Orr model of cash management? Working Lower Limit Given in Question 20.303) 16. Transfers) $500 x (30. Assumes a risk free interest rate 4.035 %. Assumes that there are no cash receipts.213 Trading Cost (Cost of Transfer x No.00035))1/3 25.434 . 2 and 3 Answer D 4.000.107 / 2) x 0. If a company must maintain a minimum cash balance of £20. Which of the following are problems with the Baumol Model? 1.000 + 25.303 Upper Limit (Lower Limit + Spread) 8.000 + (1/3 x 25. just movements 3.500). Assumes constant cash disbursements 2.250.426 3.213 Total Cost 42.000) / 0.25m (ie std deviation £2. Assumes no safety buffer for cash A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1.000 Spread (3 x ((3/4 x 80 x 6.107) 21.000 / 707.303 Return Point (Lower Limit + (1/3 x Spread) 8. The cost of buying/ selling securities is £80 & the daily interest rate is 0.000.

What does the Baumol Model tell us? The optimum cash amount to transfer from interest bearing investments into cash each time cash is transferred.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. How do we calculate the total holding costs in the year? Average cash balance (C / 2) x Interest rate. Why does the Miller-Orr model tell us to buy securities with extra cash? To earn interest on excess cash. Why is there a cost of holding cash? By holding cash you are not earning interest so the cost is the opportunity cost of the interest you could have earned. 3. . 4. 6. How do we calculate the total trading costs in the year? The cost of moving cash x number of movements (Total cash moved per year / amount moved each time) 5. What are the three reasons to hold cash? Speculation Precaution Transaction 2.just movements from interest bearing account to cash Assumes no safety buffer for cash 7. What are the problems with the Baumol Model? Assumes constant cash disbursements Assumes that there are no cash receipts .

08 / 365) 10. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Pilot Paper Q3 (You now know enough to do this all) Now do it! . If the interest rate is 8% what figure should be included in the Miller-Orr model for i? 0.00022 (0. 9. How do we calculate the upper limit? Lower limit + spread.ACCA F9 Financial Management Full Course Workbook Solutions! 8. How do we calculate the variance of cash flows? Standard Deviation of cash flows squared.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 9 Investment Appraisal I .

000 Total Depreciation Equipment of $175.000 360.000 ROCE (Ave.Illustration 1 ABC Ltd are considering expanding their internet cafe business by buying a business which will cost $275. They expect the following cash to come in: Year Net Cash Profits (£) 1                 45.000 Average Profits $185.000 + 80.000 + 200.833 Average Investment (Capital Investment + Residual Value) / 2 (450. after the sixth year.000 9.000 6                 60.000 3                 80.000 5                 50. Profit / Ave Investment) 30.000 + 50.000 Calculate the ARR or ROCE of this investment Solution Total Profit over 6 years 45.833 / 325.ACCA F9 Financial Management Full Course Workbook Solutions! ARR . they can sell the business for $200.000 + 60.000 2                 75.000) / 2 325.000 / 6 years 30.000 The equipment will be depreciated to a zero resale value over the same period and.000 to buy and a further $175.000 Total Profits 185.000 4                 50.5% .000 + 50.000 + 75.000 fully depreciated 175.000 to refurbish.

I. Item Relevant Cash Flow? Explain Feasibility Study No This is a sunk cost as it has already been paid. New Equipment Yes This is a relevant cash flow. Managers Salary No The managers salary must be paid whether the project goes ahead or not so is not relevant. . IV.ACCA F9 Financial Management Full Course Workbook Solutions! Relevant Cash Flow Criteria . The Managers salary. Rent No The rent is not relevant as it must be paid whether the project goes ahead or not.5m will have to be bought and will be depreciated on a straight line basis over 10 years.000 per year and currently runs a similar project will also manage the new project taking up 25% of his time. The rent charged to the project. II. New equipment costing $2. The new equipment. State whether each of the following items are relevant cash flows and explain your answer. A manager who earns $30. III. The cost of the feasibility study. The depreciation on the new equipment. Depreciation No Depreciation is not a cash-flow but an accounting entry.000 on a feasibility study which suggests that the project will be profitable. They have already spent $20.000 of the current monthly rent allocated to the project. The headquarters of the company has spare floor space which will be allocated to the project with $7.Illustration 2 A business is considering investing in a new project. V. It is not incremental.

ACCA F9 Financial Management Full Course Workbook Solutions! Payback Period .8m. Calculate the Payback Period.8m / $400. Annual Cash Flows of $400.Illustration 3 Initial Investment of $5.000 14.5 years .000. Solution Payback Period (Initial Investment / Annual Cash Flows) $5.

000 Year 3:! $2.Illustration 4 Initial Investment of $6.600.000 Year 4:! $1.000 so it will take (300.400.000 5.200.000 2 2.000 7.700.200.200.900. Solution Year Cash Flows Cumulative Cash Flows 1 1.000 / 1.000) x 12 = 2.2m.000 Payback period is between 3 and 4 years Additional amount required to return capital (6.700.500.000 3.000 .000 1.11 months .000 Calculate the Payback Period.700.000 Year 2:! $2.200.000 Total cash flows in year 4 of 1.ACCA F9 Financial Management Full Course Workbook Solutions! Payback Period .900.200.700.500.5. Cash Flows of: Year 1: ! $1.000 4 1.000) = 300.000 3 2.200.

155 = 15.ACCA F9 Financial Management Full Course Workbook Solutions! Discounted Cash-flows . therefore: 1+m = (1+0.10) x (1+0.05) 1+m = 1. Inflation is 5% What is the MONEY/NOMINAL rate required? Solution Use Formula: 1+m = (1+r) x (1+inf) We are looking for m.Illustration 5 An investor wants a real return of 10%.155 m = 0.5% .

000 3 8.000 0.000 0. Calculate the present value of the cash flows for each of the six years and in total.000 The company has a cost of capital of 10%.621 6.Illustration 6 A company undertakes a project with the following cash-flows: Year Cash-Flows 1 5.830 5 11.782 3 8.683 6.826 5.000 2 7.008 4 10.000 5 11.000 0.545 2 7.751 6.000 4 10.909 4. Solution Year Cash-Flows Discount Rate (From Tables) Present Value 1 5.076 Total 35.000 6 9.000 0.072 .831 6 9.564 5.ACCA F9 Financial Management Full Course Workbook Solutions! Discounted Cash-flows .000 0.000 0.

545 2 5.775 .751 3.000 2 5.820 Total 21.909 4.564 2.770 Years Cash-flow Discount Rate (Annuity Tables) Present Value 1-6 5.826 4.000 0.ACCA F9 Financial Management Full Course Workbook Solutions! Discounted Cash-flows .000 0.000 0.105 6 5.000 0.000 3 5.000 0.000 4 5.130 3 5.755 4 5.000 5 5.000 6 5. Calculate the present value of the total cash flows for the six years Solution Year Cash-Flows Discount Rate (From Tables) Present Value 1 5.000 4.621 3.Illustration 7 A company undertakes a project with the following cash-flows: Year Cash-Flows 1 5.355 21.683 3.000 The company has a cost of capital of 10%.415 5 5.000 0.

000 0.10 = $1m .000 per year forever.10 100. Their cost of capital is 10%.ACCA F9 Financial Management Full Course Workbook Solutions! Discounted Cash-flows . Solution Annual Cash Flow Cost of Capital (10%) Perpetuity (Cash-Flow / Cost of Capital) $100.000 / 0.Illustration 8 A company expects to receive $100. Calculate the present value of the perpetuity.

000 Total Profits Average Profits Average Investment (Capital Investment + Residual Value) / 2 ROCE (Ave.000 + 175.000 and they expect the following cash to come in: Year 1 2 3 4 5 6 Net Cash Profits (£) 25. What is the Accounting Rate of Return (Return on Capital Employed) of the project? A.175.000 + 80. 12% Answer B Total Profit over 6 years Total Depreciation 25.000 $100.000 (375.000 + 30.000) / 2 550.000 + 70.000 The investment will be depreciated to a scrap value of $175.000 30. 3% C.000 300.668 / 550.000 55.668 (375. JoJo Ltd are considering investing in a new project which will cost an initial $375.000 .000) 200.000 3% .000 + 55.000 70.000 / 6 years 16. 18% D.000 + 40.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.000 40. Profit / Ave Investment) 100.000 over the period of the project.000 16. 6% B.000 80.

intends to make an investment of $4. 3. What is the Payback period of the investment? A. No discount rate is used to allow for inflation and risk. It does not consider the whole life of the project.000 The investment will be depreciated to a scrap value of $1.000 550.000 400. The calculation uses accounting profit rather than cash.700. 2. 2 and 4 1 and 3 only 2 and 3 only 1. 4 Years 2 months D. 2 Years 6 months C. A B C D 1.000 2. Aldios Co.5m in a project lasting 5 years. The project cashflows are forecast to be as follows: Year 1 2 3 4 5 Net Cash Profits (£) 250. It disregards the timing of the inflows.800. 4.5m over the period of the project.000 2. 3 Years 4 months B. 2 and 3 Answer A 3. Which of the following are weaknesses of the Accounting Rate of Return (Return on Capital Employed)? 1.ACCA F9 Financial Management Full Course Workbook Solutions! 2. 2 Years 4 months Answer A .

13% D. uses a real discount rate of 8%. They are carrying out an investment appraisal using an inflation rate of 5%.000 so it will take (1.000.000) = 1.000 6.ACCA F9 Financial Management Full Course Workbook Solutions! Year Cash Flows Cumulative Cash Flows 1 250.000. Jpeg Co. 11% Answer C .000 3.000 250.500. What discount rate should be used to discount the cash flows for the project: A.000 .000 3 2.000 Total cash flows in year 4 of 2. 8% B.000 800.500.700.000 Payback period is between 3 and 4 years Additional amount required to return capital (4. 5% C.800.000 / 3.000 4 3.000.000.000) x 12 = 4 months 4.500.500.000 2 550.3.

6. Implementation and monitoring. To evaluate management performance on the project. Uses accounting profit rather than cash so can be manipulated. What are the 6 steps in investment appraisal? Identify investment opportunities. How do you calculate the average investment? (Cost + Residual Value) / 2 5. Why carry out a post-completion audit? To ensure that managers are more careful in future. Approval by the board. No discount rate to allow for inflation and risk. 3. 2. Disregards the timing of cashflows. To evaluate future projects. What are the weaknesses of the ARR? The gain is expressed as a percentage so does not take into account the size of the investment. Post completion review or audit. What are the 3 relevant criteria for cash-flows in investment appraisal? Cash Incremental (Caused by the project) Future . What is the calculation for the ARR or ROCE? Average accounting profit / Average investment 4. Screen the proposals to see that they fit with the organisation. Analyse and evaluate the proposals.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1.

10 Money Discount Rate = 10% 10. again as it focuses on getting the capital invested back.10 m = 0. If the real discount rate is 7% and inflation is running at 3% what is the nominal/money discount rate? 1+m = (1+r) x (1+inf) 1+m = (1.ACCA F9 Financial Management Full Course Workbook Solutions! 7.07) x (1. Uses cash rather than accounting profit.03) 1+m = 1.623 (from annuity tables) = $36. Maximises liquidity. 9.000 x 4. Minimises risk as it focuses on getting the capital invested back.984 If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: June 2009 Q2 (a) Now do it! .000 per year for 6 years and my cost of capital (discount rate) is 8% what is the present value of the total of these cash-flows? $8. What are the advantages of using the payback period method? Simple. Why do we need to discount cash-flows? To allow for risk and inflation. If I am going to receive $8. Good for conservative managers. 8.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 10 Investment Appraisal II .

00 7.63 3 3 56.Illustration 1 A business buys a piece of equipment for $100.22 4 4 42.22 5. Capital allowances are available at 25% reducing balance.16 5 Sale of Item -25.50 2 2 75.5 5.16 .19 17.75 5.00 25.63 4.06 4.00 18.25 14. The tax rate is 30% After the 4 year project the equipment can be sold for $25.ACCA F9 Financial Management Full Course Workbook Solutions! WDA .00 Period 0 1 2 3 4 5 Tax Saving - - 7. Solution Period Balance 25% WDA 30% Tax Saving Period 1 100.19 5.

000 4 32.Illustration 2 A business requires the following working capital investment into a four year project: Initial Investment:! ! 30. Solution Period 0 1 2 3 Total Invested 30.000 45.000 Year 1!! ! ! 35.000 Year 2!! ! ! 45.000 -10.000 .000 Movement to NPV Calculation -30.000 Year 3!! ! ! 32.ACCA F9 Financial Management Full Course Workbook Solutions! Working Capital .000 35.000 Show the working capital line in the NPV calculation.000 -5.000 32.000 13.

II.000 in the first year and are expected to increase by 5% per year. Capital investment will be $200.000 (200. Solution Working 1 . III. Costs will be $50. V.Illustration 3 A business is evaluating a project for which the following information is relevant: I.WDAs Initial Investment WDAs Tax Saving Periods 200. IV. Working Capital invested will be 20% of projected sales for the following year.ACCA F9 Financial Management Full Course Workbook Solutions! NPV . General inflation is expected to be 3% over the course of the project and the business uses a real discount rate of 9%. Calculate the NPV for the project.000 / 5) = 40. Sales will be $100.000 and are expected to increase by 7% per year.000 2-6 .000 (40.000 and attracts tax allowable depreciation of the full value of the investment over the 5 year length of the project. VI.000 x 30%) = 12. The tax rate is 30% and tax is payable in the following year.

000 100.551 Costs 50.12 12% .07 1.000 Inflation - 1.000 105.03) 1 + m = 1.07 to power of 3 1.Discount Rate Working Real Discount Rate In Question 9% Inflation In Question 3% Nominal Discount Rate 1 + m = (1 + 0.05 to power of 4 Inflated Sales 100.000 53.Inflation Period 1 2 3 4 5 100.000 50.12 m = 0.000 50.000 Inflation - 1.000 100.09) x (1 + 0.000 50.07 to power of 2 1.000 100.05 to power of 3 1.250 115.252 65.000 110.ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .000 50.763 121.000 100.245 61.05 to power of 2 1.07 to power of 4 Inflated Costs 50.05 1.540 Sales Working 3 .500 57.

ACCA F9 Financial Management Full Course Workbook Solutions!

Working 4 - Working Capital

Period

0

Inflated Sales

1

2

3

4

5

100,000

105,000

110,250

115,763

121,551

Working Capital
Required (20%)

20,000

21,000

22,050

23,153

24,310

Movement

-20,000

-1,000

-1,050

-1,103

-1,158

24,310

NPV

Period

0

1

2

3

4

5

6

Inflated Sales
(W2)

100,000 105,000

110,250

115,763

121,551

Inflated Costs
(W2)

-50,000 -53,500

-57,245

-61,252

-65,540

Profit

50,000

51,500

53,005

54,510

56,011

Tax at 30%

-15,000

-15,450

-15,902

-16,353

-16,803

Tax Saving
(W1)

12,000

12,000

12,000

12,000

12,000

Capital
Investment

-200,000

Working Capital
(W4)

-20,000

-1,000

-1,050

-1,103

-1,158

24,310

Total Cash
Flows

-220,000

49,000

47,450

48,452

49,451

75,968

-4,803

1

0.893

0.797

0.712

0.636

0.567

0.507

-220,000

43,757

37,818

34,498

31,451

43,074

-2,435

Discount Rate
12% (W3)
Discounted
Cash Flows

NPV

-31,838

ACCA F9 Financial Management Full Course Workbook Solutions!

Test Your Knowledge
If you can’t answer all of the questions below without
looking at the answer then you need to do some more
work on this area!
Multiple Choice Questions
1. Asfor Co. plans to undertake a project with an initial investment of $5m. The inflation
adjusted cash flows expected from the project are as follows:
Year

$

1

$1.2m

2

$1.8m

3

$2.1m

4

$2.2m

5

$2.5m

Asfor Co. uses a real discount rate of 6% and general inflation is expected to be 5% per
year for the duration of the project.
What is the NPV of the project ignoring tax:
A. $8,178
B. $8,108
C. $2,010
D. $7,010
Answer C
Discount Rate (1.06 x 1.05) = 11%
1

2

3

4

5

Cash

1,200

1,800

2,100

2,200

2,500

DR 11%

0.901

0.812

0.731

0.659

0.593

PV Cash

1,081

1,462

1,535

1,450

1,483

Total PV

7,010

Capital

5,000

NPV

2,010

ACCA F9 Financial Management Full Course Workbook Solutions!

2. Asfor Co. plans to undertake a project with an initial investment of $16m. The cash flows
(profit) before inflation expected from the project are as follows:

Year

$

1

$4.2m

2

$4.9m

3

$5.5m

4

$5.8m

5

$6.1m

Asfor Co. uses a real discount rate of 10% and general inflation is expected to be 3% per
year for the duration of the project.
The tax rate on profits is 30% payable the following year.
What is the NPV of the project:
A. $417
B. $2,048
C. -$298
D. $2,233
Answer B
Discount Rate (1.10 x 1.03) = 13%
1

2

3

4

5

Cash

4,200

4,900

5,500

5,800

6,100

Inflated

4,326

5,198

6,010

6,528

7,072

-1,298

-1,560

-1,803

-1,958

-2,121

Tax

6

Total

4,326

3,901

4,450

4,725

5,113

-2,121

DR 13%

0.885

0.885

0.885

0.885

0.885

0.885

PV Cash

3,829

3,452

3,939

4,182

4,525

-1,878

Total PV
Cash

18,048

Capital

16,000

NPV

2,048

ACCA F9 Financial Management Full Course Workbook Solutions!

3. Asfor Co. plans to undertake a project with an initial investment of $16m and a scrap
value of $3m at the end of the project. The cash flows after inflation expected from the
project are as follows:

Year

$

1

$4.2m

2

$4.9m

3

$5.5m

4

$5.8m

5

$6.1m

Asfor Co. uses a nominal discount rate of 10%. Inflation is expected to be 3% per year.
The tax rate on profits is 30% payable the following year. Tax allowable depreciation is
available at 25% reducing balance.
What is the NPV of the project:
A. $1,477
B. $6,945
C. $17,477
D. $3,340
Answer D

Period

Balance

25% WDA

30% Tax
Saving

Period

1

16,000

4,000

1,200

2

2

12,000

3,000

900

3

3

9,000

2,250

675

4

4

6,750

1,688

506

5

5

5,063

2,063

619

6

Sale of Item

3,000

ACCA F9 Financial Management Full Course Workbook Solutions!

0

1

2

3

4

5

4,200

4,900

5,500

5,800

6,100

Tax

-1,260

-1,470

-1,650

-1,740

-1,830

Tax
Saving on
WDAs

1,200

900

675

506

619

Cash

6

Capital

-16,000

Total

-16,000

4,200

4,840

4,930

4,825

7,866

-1,211

DR 10%

1.000

0.909

0.893

0.751

0.683

0.621

0.564

PV Cash

-16,000

3,818

4,322

3,702

3,295

4,885

-683

NPV

3,340

3,000

The working capital requirement will initially be $1m rising by 5% each year before being returned at the end of the project.900 5.000 NPV 4.590 3. The tax rate on profits is 30% payable the following year.909 3.095 5.978 4. plans to undertake a project with an initial investment of $10m. The cash flows (profit) after inflation expected from the project are as follows: Year $ 1 $4.518 -1.000 -50 -53 -55 1.470 -1.987 2.200 3.1m Asfor Co.740 Tax 6 -1.621 0. $9.893 0.293 Capital 10. $4. uses a nominal discount rate of 10%.830 W.650 -1.9m 3 $5.8m 5 $6.909 0.797 3.683 0.2m 2 $4.032 Total PV Cash 14.158 Total 3. $4.293 Answer D Cash 1 2 3 4 5 4.830 DR 10% 0.260 -1. What is the NPV of the project: A. $4.500 5.097 D.564 PV Cash 2.427 -1.566 C.ACCA F9 Financial Management Full Course Workbook Solutions! 4. Asfor Co.800 6.5m 4 $5.751 0.293 .100 -1.200 4.Capital -1.605 B.206 2.

148 6.034 1. The tax rate on profits is 30% payable the following year.000 5 320.033 1.032 1. $11.000 3 350. $5.052 1.055 Inflated 32 33 35 36 38 Cost Price 15 15 15 15 15 Inflation 1. uses a nominal discount rate of 10%. plans to undertake a project with an initial investment of $6m and scrap value of $1m. $8.833 6.ACCA F9 Financial Management Full Course Workbook Solutions! 5.053 1.418 7.111 Answer A 1 2 3 4 5 30 30 30 30 30 Inflation 1. The sales are expected to be subject to inflation of 5% with the costs subject to inflation of 3%.000 Asfor Co.035 Inflated 15 16 16 17 17 Profit Per Unit 16 17 18 20 21 Units (‘000) 200 300 350 400 320 Total Cash 3.079 B.210 5. Year Units 1 200.000 2 300. The sales price per unit in real terms is $30 with cost per unit of $15. What is the NPV of the project: A.054 1.097 D. Asfor Co. $4.688 Sales Price .912 C.03 1.000 4 400.05 1.

315 -1.908 5.079 .148 6.006 DR 10% 0.006 Capital -6.660 4.185 4.132 NPV 11.544 -1.909 0.000 Total -2.564 PV Cash -2.790 4.688 -963 -1.833 6.874 5.000 1.338 -2.893 0.683 0.536 3.751 0.035 3.350 Tax 6 -2.210 5.ACCA F9 Financial Management Full Course Workbook Solutions! Cash 1 2 3 4 5 3.925 -2.621 0.418 7.737 3.

000 3 350.034 1.000 5 320.035 Inflated 103 133 169 180 168 .052 1.000.054 1. -$2.000 D. uses a nominal discount rate of 10%. -$33.03 1. Asfor Co. $107.053 1.033 1.000 160.000 C. What is the NPV of the project to the nearest ‘000? A.032 1.000 Answer D 1 2 3 4 5 Sales 200 300 350 400 320 Inflation 1.ACCA F9 Financial Management Full Course Workbook Solutions! 6. The sales and costs in real terms are forecast to be Year Sales $ Costs $ 1 200. plans to undertake a project with an initial investment of $600.000 2 300.000 4 400.000 Asfor Co. The tax rate on profits is 30% payable the following year. The sales are expected to be subject to inflation of 5% with the costs subject to inflation of 3%. $72.000 and scrap value of $100.000 155.000 145.000 B.000 100.000 125.05 1.055 Inflated 210 331 405 486 408 Costs 100 125 155 160 145 Inflation 1.

ACCA F9 Financial Management Full Course Workbook Solutions! 1 2 3 4 5 Sales 210 331 405 486 408 Costs -103 -133 -169 -180 -168 Profit 107 198 236 306 240 -32 -59 -71 -92 Tax 6 -72 Capital -600 100 Total -493 166 177 235 248 -72 DR 10% 0.909 0.893 0.621 0.564 PV Cash -448 148 133 161 154 -41 NPV 107 .751 0.683 0.

4.one year later. the discount rate for period one applies to cash flows that occur 1 year after the start of the project. 3. 2. This would be time consuming and difficult.3 = $1.e.000 and a tax rate of 30% how much tax will I pay and when? Tax to pay: 4. . If I have profits in period 2 of $4. Why do we need a period 0? The initial investment is made now .ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1.in the current time period and as such is not discounted as no inflation will have occurred. What are we comparing in NPV analysis? The initial investment in the project is being compared to the forecast cash-flows which are discounted to reflect the risk of the project and inflation. If we did not assume that the cash we earn during year one occurred at the end of that period then we would have to adjust the discount rate for the month in which they occur (by using a fraction of the discount rate). Why do we assume that cash-flows occur at the end of each period? The discount rates given to us in the discount table applys to a whole year i.000 x 0.200 This will be paid in period 3 .

How do we account for working capital in NPV analysis? The initial working capital required is invested in period 0.500? Period Balance 25% WDA 30% Tax Saving Period 1 7500 1875 375 2 2 5625 1406 281 3 3 4219 1055 211 4 4 3164 791 158 5 5 2373 873 175 6 Sale of Item -1500 6.500 with a residual value of $1. The closing balance of working capital is returned at the end of the project so that the working capital line in the NPV calculation should add across to zero. 7. Payables. Receivables. 8. If my cash flows in my NPV analysis are inflated should I use the real or the nominal discount rate? The real rate.ACCA F9 Financial Management Full Course Workbook Solutions! 5. What makes up working capital? Inventory. We then adjust the working capital for the increase or decrease required in each period. If the cash flows are inflated then the discount rate needs to be adjusted for inflation also. If I receive 25% capital allowances and have a tax rate of 20% what will my tax saving be in each year over a 5 year project if the capital investment is $7. .

ACCA F9 Financial Management Full Course Workbook Solutions! If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: June 2010 Q3 (a) & (b) Now do it! .

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 11 Investment Appraisal III .

At a discount rate of 10% the NPV will be $100.000) (15 .ACCA F9 Financial Management Full Course Workbook Solutions! IRR .Illustration 1 ABC has evaluated a project and come to the following conclusions.000 At a discount rate of 15% the NPV will be -$75.10) .(75.000 ! 10 +! 100.000 .000 What is the IRR? Solution ! ! ! ! IRR = !! 100.

Which of the following best describes the result of calculating the Internal Rate of Return of a prospective project? A. 11.760 .645 Initial investment = 17.000 per year for 5 years and had an initial investment of $17.000 x 3. The amount of shareholder wealth expected to be created by the project. The discount rate at which the NPV of the project is expected to be zero.000) .0% Answer A NPV at discount rate of 5%: Present value of cash flows (5.000 NPV = -240 (16.000 what is the IRR? A.000 NPV = 4. If a project has cash inflows of $5. The forecast return on the project as a percentage of the capital invested.5% B. B.352) = 16.760 Initial investment = 17.000) NPV at discount rate of 15%: Present value of cash flows (5.17. 15. D. The amount of time expected to be taken for the capital invested in the project to be returned.0% D. 10. Answer D 2. 14.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.000 x 4.17.329) = 21. C.645 .645 (21.5% C.

5% 3.05% B.23. 9.5)] IRR = 14.000 x 3.000 what is the IRR? A.ACCA F9 Financial Management Full Course Workbook Solutions! Fill into IRR 5 + [(4.07% D. 10.23% Answer B NPV at discount rate of 5%: Present value of cash flows (6.888)) (15 .000 NPV = -2.112 Initial investment = 23.07% C.974 / (2.974 Initial investment = 23.974 .000 per year for 5 years and had an initial investment of $23. 11.5% .000) NPV at discount rate of 15%: Present value of cash flows (6.000) Fill into IRR 5 + [(2.888 (20.112 .-2. If a project has cash inflows of $6.645 .000 NPV = 2.23.974 . 12.000 x 4.5)] IRR = 14.329) = 25.-240)) (15 .352) = 20.645 / (4.974 (25.

A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer D 5. Which of the following are disadvantages of using the Internal Rate of Return (IRR) as an investment appraisal technique? 1. 3 and 4 2 and 3 only 1 and 3 only Answer B . 2 and 4 2. 4.ACCA F9 Financial Management Full Course Workbook Solutions! 4. 3. 3. IRR focuses on the maximisation of shareholder wealth. 2. IRR gives an answer in the form of an understandable percentage. IRR covers the payback period of the project. All of the figures are based on forecasts. It is possible to get multiple IRRs depending on the timing of the cashflows. A B C D 1. 4. It gives an absolute figure rather than a percentage as the result. IRR assumes that all returns are re-invested in the project which is not necessarily the case. Which of the following are advantages of using the Internal Rate of Return (IRR) as an investment appraisal technique? 1. IRR uses accounting profit to assess the project. 2.

ACCA F9 Financial Management Full Course Workbook Solutions!

Short Form Questions
1. What are we trying to find with the Internal Rate of Return?
We are trying to find the discount rate at which the NPV of the project would equal
zero i.e. if we discounted the cash flows at that discount rate the project would have
neither a positive or negative NPV but an NPV of 0.

2. What is the formula for the IRR?
L + [(NPV L / (NPV L - NPV H)) (H - L)]

3. If a project has cash inflows of $5,000 per year for 5 years and had an initial investment
of $17,000 what is the IRR?
NPV at discount rate of 5%:
Present value of cash flows (5,000 x 4.329) = 21,645
Initial investment = 17,000
NPV = 4,645 (21,645 - 17,000)
NPV at discount rate of 15%:
Present value of cash flows (5,000 x 3.352) = 16,760
Initial investment = 17,000
NPV = -240 (16,760 - 17,000)
Fill into IRR
5 + [(4,645 / (4,645 - -240)) (15 - 5)]
IRR = 14.5%

4. What are the advantages of the IRR?
IRR gives an answer in the form of an understandable percentage.
IRR uses cash flows and not accounting profit.
IRR covers the whole life of the project.
IRR (like NPV) focuses on the maximisation of shareholder wealth.

ACCA F9 Financial Management Full Course Workbook Solutions!

5. What are the disadvantages of the IRR?
The calculation is assumed to be complicated.
It gives a percentage rather than an absolute figure as the result.
All of the figures are based on forecasts.
It is possible to get multiple IRRs depending on the timing of the cashflows.
IRR assumes that all returns are re-invested in the project which is not necessarily
the case.

If you’ve successfully answered all of the above
questions then you’re ready to do the exam questions
below:
June 2009 Q2 (b) & (c)
December 2010 Q1 (a) & (b)
December 2007 Q2 (a) & (b)
Pilot Paper Q4

Now do it!

ACCA F9 Financial Management Full Course Workbook Solutions!

Lecture 12
Further Appraisal

ACCA F9 Financial Management Full Course Workbook Solutions!

Expected Values - Illustration 1

A business is considering 2 different projects. The likely profit made from each project is
outlined below:
Project A

Project B

Projected Profit

Percentage
Likely-hood

Projected Profit

Percentage
Likely-hood

$10,000

10%

$10,000

15%

$15,000

30%

$15,000

25%

$20,000

40%

$20,000

30%

$23,000

20%

$23,000

30%

Calculate the expected value for each of the projects.

Solution

Project A

Project B

Project
ed
Profit

Percent
age
Likelyhood

Working

EV

Project
ed
Profit

Percent
age
Likelyhood

Working

EV

$10,000

0.1

(10,000 x
0.1)

$1,000

$10,000

0.15

(10,000 x
0.15)

$1,500

$15,000

0.3

(15,000 x
0.3)

$4,500

$15,000

0.25

(15,000 x
0.25

$3,750

$20,000

0.4

(20,000 x
0.4)

$8,000

$20,000

0.3

(20,000 x
0.3)

$6,000

$23,000

0.2

(23,000 x
0.2)

$4,600

$23,000

0.3

(23,000 x
0.3)

$6,900

EV

$18,100

1

1

EV $18,150

ACCA F9 Financial Management Full Course Workbook Solutions!

Sensitivity Margin - Illustration 2

A business is considering a project which will cost them an initial 20,000
The sales expected for the 2 year duration are 20,000pa.
The variable costs are 2,000pa
Cost of capital 10%
Calculate the sensitivity margin of:
I.

The initial investment.

II.

The variable costs of the projects.

III. The sales of the project.

Solution

Working 1 - NPV of Project
Period

1

2

Cash-Flows

20,000

20,000

Variable Cost

-2,000

-2,000

-20,000

18,000

18,000

1

0.909

0.826

PV Cash Flows

-20,000

16,362

14,868

NPV

11,230

Capital Investment

Total Cash Flows
Discount Rate 10%

0
-20,000

000 Discount Rate 10% 0.000 -2.180 16.000 Sensitivity Margins Item Working Sensitivity Margin Explanation Initial Investmen t NPV / PV Initial Investment (11.000 Discount Rate 10% 0.230 / 34.000) 56% The NPV is 56% of the initial investment.652 Present Value of Variable Costs (1.PV of each item Period 0 1 2 Variable Costs -2. . Variable Costs NPV / PV Variable Costs (11.230 / 20.700 Present Value of Initial Investment = $20.818 -1.909 0.230 / 3470) 323% The Variable costs would need to rise by 323% to create a negative NPV Sales NPV / PV Sales (11.000 20.470 Sales 20.826 Total 18.909 0.826 Total -1.818 + 1.700) 32% Sales would need to drop by 32% before the NPV would be negative.520 Present Value of Sales (18.652) = $3.180 + 16.ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .520) = $34.

22 6 .41 5 5 3164.00 1406.Capital Allowances Period Balance 25% WDA 30% Tax Saving Period 1 10000.164.00 2500.06 949. The tax rate is 30%.00 562.28% pre tax cost 2) 5 year Finance Lease @ $2.75 1054.Illustration 3 Machine cost        $10.88 4 4 4218.69 316.200 pa in advance If the machine is purchased then maintenance costs of $100 per year will be incurred. Should the company lease or buy the machine.00 750.00 2 2 7500.ACCA F9 Financial Management Full Course Workbook Solutions! Lease V Buy .50 3 3 5625.000 The Machine has a useful economic life of 5 years with no scrap value Capital allowances available at 25% reducing balance Finance choices 1)  5 year loan 14.00 1875.06 3.25 421. Solution Buy Working 1 . The leasing company will maintain the machine if it is leased.

ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .28 x (1 .683 0.751 0.564 PV Cash Flows -10.Maintenance Amount Tax Saving $100 per Year (100 x 30%) = $30 Working 3 .000 -91 562 369 240 153 552 NPV -8.621 0.28% Tax Rate 30% Post Tax Borrowing Rate 14.000 -100 680 492 352 246 979 1 0.909 0.NPV Period Capital 0 1 3 4 5 6 750 562 422 316 949 -100 -100 -100 -100 30 30 30 30 30 -10.0.826 0.214 Discount Rate 10% (W3) .Discount Rate Pre-tax Borrowing Rate 14.3) = 10% Working 4 .000 WDA Tax Saving (W1) Maintenance -100 Maintenance Tax Saving (W2) Total Cash Flows 2 -10.

909 0.898 Discount Rate 10% (W3) Based on the above. .564 PV Cash Flows -2.200 -2000 -1272 -1157 -1052 410 372 NPV -6.751 0.683 0.826 0. the company should lease the machine.ACCA F9 Financial Management Full Course Workbook Solutions! Lease Period Capital 0 1 2 3 4 -2200 -2200 -2200 -2200 -2200 660 660 Tax Saving on Lease Payment Total Cash Flows 5 6 660 660 660 -2200 -2200 -1540 -1540 -1540 660 660 1 0.621 0.

000 Running costs Year 1                  10..000 Year 2                  11.000   Cost of capital = 10% Is it better to replace the machine every year or to replace it every 2 years? .500 Residual Value (if sold after.Illustration 4 Machine Cost   30.) Year 1                  19.ACCA F9 Financial Management Full Course Workbook Solutions! Equivalent Annual Cost .000 Year 2                  16.

000 -10.909) = -$24.000 1 0.909 0.000 -30.500 1 0.000 Running Costs -10.003 NPV for replacement after two years Period 1 2 Running Costs -10.181 NPV -21.500 Residual Value - 16.090 3.736) = -$20.000 Cash Flows -30.000 4.000 1.000 8.373 / 1.000 Residual Value 19.909 PV Cash Flows -30.373 Capital Investment Cash Flows Discount Rate 10% Annuity Factor from tables (2yrs at 10%) 0 -30.000 -11.819 / 0.736 Equivalent Annual Cost (NPV / Annuity Factor) = (-35.909 Equivalent Annual Cost (NPV / Annuity Factor) = (-21.000 -9.819 Discount Rate 10% Annuity Factor from tables (1yr at 10%) 0.ACCA F9 Financial Management Full Course Workbook Solutions! Solution NPV for replacement after one year Period 0 Capital Investment 1 -30.000 9.376 .826 PV Cash Flows -30.717 NPV -35.

000 30% $25.000 30% $16. A business is considering 2 different projects.000 30% $30.000 12% $12.000 30% Project 3 Project 4 Projected Profit Percentage Likely-hood Projected Profit Percentage Likely-hood $12.000 20% $30.000 40% $25.000 15% $16.000 9% $30.000 22% Which of the projects should be chosen on the basis of the Expected Values? A B C D Project 1 Project 2 Project 3 Project 4 Answer C .000 35% $16.000 44% $25.000 18% $16.000 25% $25.000 10% $12.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.000 30% $30. The likely profit made from each project is outlined below: Project 1 Project 2 Projected Profit Percentage Likely-hood Projected Profit Percentage Likely-hood $12.

000 30% $9.000 9% $2.000 $22.000 18% $2.440 $12.000 30% $7.000 12% $1.500 $30.000 $25.300 Project 4 Projected Profit Percentage Likely-hood Projected Profit Percentage Likely-hood $12.000 10% $1.000 Project 3 $22.000 30% $4.000 $30.500 $30.000 30% $4.000 40% $10.000 15% $1.000 35% $5.700 $30.000 $25.800 $16.000 $25.600 $20.000 20% $6.200 $12.000 25% $4.740 $21.800 $25.ACCA F9 Financial Management Full Course Workbook Solutions! Project 1 Project 2 Projected Profit Percentage Likely-hood Projected Profit Percentage Likely-hood $12.060 .160 $16.600 $16.000 30% $7.000 22% $6.800 $16.000 44% $11.

4% .4% D  18.000/$971.840 Sensitivity = $280.000 Present value of the annual cash inflow = $320.840 = 28. A company is considering investing in a project with an expected life of four years.000 x 3.037 = $971.000 which occur at the end of each of the five years. No tax is payable on projects of this type.9% C  3. The project’s estimated cash flows include net cash inflows of $320.5% B  21.5% D  28.000 when discounted at the cost of capital of 10% per annum.25% B  118. The project includes annual net cash inflows of $100.8% Answer D Net Present Value of the project = $280. The project has a positive net present value of $280. A five year investment project has a positive net present value of $320.8% 3.ACCA F9 Financial Management Full Course Workbook Solutions! 2.1k = 84.5% C  84.791 = $379. What is the sensitivity margin of the cash inflows of the project? A  87.1k Sensitivity = $320k / $379. What is the sensitivity margin of the cash inflows of the project? A  31.5% Answer C Discounted value of cash inflow = $100k x 3.000 when cash flows are discounted at 12% per annum.000 for each of the four years.

The pre-tax cost of borrowing is 17.14%.450 1.659 0.500 -3.050 1. Maintenance costs of $65.050 1.050 1 0. Davos Co. The tax rate is 30%. -$1.864 D. The pre-tax cost of borrowing is 15.864 Discount Rate 11% 15.731 0.71%.050 Tax Saving on Lease Payment Total Cash Flows 5 6 1.974 Answer C Period Capital 0 1 2 3 4 -3.615 C. What is the present value cost to the business of buying the machine? A.500 -3. The tax rate is 30%.440 B. $10.71 x (1 .050 1.786 B. -$1. $10. -$2. $10.050 -3.480 C.450 -2. intends to buy a machine a payment of $2m.172 Answer A .901 0. What is the present value cost to the business of leasing the machine? A.500 -3. intends to lease a machine on a 5 year operating lease for a payment of $3.593 0.500 -3.849 D.500 -3.812 0. $9. -$1.3) 5.535 PV Cash Flows -3.0.500 -2. Tax allowable depreciation is allowable over 5 years at 25% reducing balance.ACCA F9 Financial Management Full Course Workbook Solutions! 4.000 are payable each year. Davos Co.050 1.450 -2.500 1.500 payable in advance.500 -3154 -1989 -1791 -1615 623 562 NPV -10.

5 209.567 0.5 1 0.ACCA F9 Financial Management Full Course Workbook Solutions! Period Balance 25% WDA 30% Tax Saving Period 1 2000 500 150 2 2 1500 375 113 3 3 1125 281 84 4 4 844 211 63 5 5 633 633 190 6 Period Capital 0 1 3 4 5 6 150 113 84 63 190 -65 -65 -65 -65 19.893 0.5 19.3)) .000 -65 104.5 67.786 Discount Rate 12% (17.14% x (1 .5 19.5 19.797 0.5 -2.5 17.712 0.5 19.000 -58 83 48 24 10 106 NPV -1.000 WDA Tax Saving Maintenance -65 Maintenance Tax Saving Total Cash Flows 2 -2.5 38.507 PV Cash Flows -2.0.636 0.

000 12. Machine Cost   40.976 33.000 x 1.690 28.712 9.000 x 0.000 x 0.000 Running costs $12.000 .ACCA F9 Financial Management Full Course Workbook Solutions! 6.820 16. At the end of year 1 B.690 3 40.000 Year 4!! 14.000 Year 2                  16.996 70.102 37.. has a piece of machinery which cost $40.000 Year 3!! 14. Kevlar Co.000 4 40.000 x 0.893 10.893 37.000 12.000 x 0.402 24.224 14.968 58.000 x 2.000 x 0.228 3.000 per year Residual Value (if sold after.000 x 3. The following information relates to the machine.640 Year Cost Costs 1 40.636 6.716 2 40.102 22.) Year 1                  19.893 16.797 12.068 1. At the end of year 2 C.000 Cost of capital = 12% When is best to replace the machine based on the EAQ? A. At the end of year 3 D.752 48.402 28.503 12.740 0.443 12. At the end of year 4 Answer D Residual Value NPV Cost Annuity Factor EAC 19.783 20.000 and is trying to decide how often to replace it based on the Equivalent Annual Cost (EAQ).824 14.856 2.

What are the relevant costs of leasing the item? The lease payments. There is no requirement to take out a loan to finance the item. What is an operating lease? An operating lease is a leasing arrangement where a company does not take ownership of the item being leased but pays a periodic amount to use it. The residual value at the end of the useful life. Maintenance costs which will be incurred when the item is owned. .ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Tax allowance on the maintenance costs (or any other tax allowable cost in a question). 2. 4. 5. Tax allowance on the lease payments. How can we deal with each of risk and uncertainty in investment appraisal? Risk can be quantified using probabilities. What are the relevant costs of buying the item? The cost of the item. Why might a company want to lease an item rather than buy it? There may be tax benefits to leasing the item. What is the difference between risk and uncertainty? Risk can be quantified whereas uncertainty cannot. This enables us to calculate an expected value and use this in our investment appraisal. The lessor retains the risk of obsolescence and maintenance. It will remain on the lessor’s balance sheet and they will be responsible for maintaining it. Written down allowances against tax. 6. 3. It can be used as a form of off-balance-sheet finance.

487 Equivalent Annual Cost (NPV / Annuity Factor) = (-37.953 .975 Answer = 9.000 7.000 to maintain each year.751 PV Cash Flows -30.487 0.000 Residual Value Cash Flows 3 7.ACCA F9 Financial Management Full Course Workbook Solutions! 7. If I have a pre-tax borrowing rate of 13% and the tax rate is 25% what is the post-tax borrowing rate? 0.13 x (1 . What is the equation for the EAC? NPV / Annuity factor.178 Discount Rate 10% Annuity Factor from tables (3yrs at 10%) 2.000 -30. I have an item of plant costing $30.000 Running Costs -5.435 5. The residual value after 3 years is $7.000 1 2. If I have a cost of capital of 10% after how long should I replace the asset? EAC for replacing after 3 years Period Capital Investment 0 1-3 -30.25) = 0.0.000 new and $5.187 / 2.75% 8.257 NPV -37.487) = -$14. What does the equivalent annual cost method tell us? EAC tells us when best to replace assets as it shows us the cost per year to own and operate them.000 and after 4 years is $5. 10.000 -5.000 -12.13 x (1-T) 0. 9.000.

000 Running Costs -5.000 -30.000 -5. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: December 2009 Q1 (a) & (b) December 2007 Q2 (c) Now do it! .850 4.683 PV Cash Flows -30.170 Equivalent Annual Cost (NPV / Annuity Factor) = (-41.000 7.170) = -$12.000 Residual Value Cash Flows 4 5.069 / 3.000 1 3.ACCA F9 Financial Management Full Course Workbook Solutions! EAC for replacing after 4 years Period Capital Investment 0 1-4 -30.170 0.956 It is better to replace the plant every 4 years as the EAC is lower.069 Discount Rate 10% Annuity Factor from tables (3yrs at 10%) 3.781 NPV -41.000 -15.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 13 Further Appraisal II .

000 Which projects should the business undertake? Solution Project Investment NPV PI (NPV / Investment) Rank A 90.000 D 75.000 29% 1% E 70.3) 15.000 E 70.ACCA F9 Financial Management Full Course Workbook Solutions! Profitability Index .000 -8.000 15.000 22.000 All of B 110.000 -8.000 20% 3% D 75.000 B 110.000 to invest and the projects are divisible. They have $200. Project Investment NPV A 90.000 10.000 x 0.Illustration 1 A business has identified the following projects.000 30% of C (50.000 17% 4% B 110.000 22.000 25.000 23% 2% C 50.000 15.000 Total Investment 200.000 - Investment Project Investment All of D 75.000 .000 25.000 10.000 C 50.

000 = 37. .000 + 50.000 2 A+C 90.000 = 165. Project Investment NPV A 90.000 = 185.000 3 B+C 110.000 = 160.000 25.000 = 125.000 + 75.000 = 40.000 = 200.000 C 50.000 = 140.000 + 22.000 + 75.000 to invest and the projects are non-divisible.000 B 110.000 1 C+D 50.000 + 10.000 = 47.000 = 32.000 + 75. They have $200.000 + 110.000 = 35.000 15.000 + 22.000 22.000 15.000 10.000 4 B+D 110.000 + 25.000 + 50.000 25.000 5 The business should undertake projects B and D as these will yield the highest NPV.000 + 10.000 25.000 15.000 + 22.Illustration 2 A business has identified the following projects.ACCA F9 Financial Management Full Course Workbook Solutions! Investment Choices .000 = 25.000 Which projects should the business undertake? Solution Project Investment NPV Rank A+B 90.000 10.000 6 A+D 90.000 15.000 D 75.

355 80.13 2 200 2.42 3 350 4.37 Project 3 has the highest EAA.Illustration 3 ! ! ! ! NPV                        Duration Project 1                             300                              5 yrs  Project 2                             200                              3 yrs Project 3                             350                              6 yrs Calculate the EEA of each project given a cost of capital of 10% Solution Project NPV Annuity Factor Working (NPV / Annuity Factor) EAA 1 300 3. .791 300 / 3.487 200 / 2.487 80.791 79.355 350 / 4.ACCA F9 Financial Management Full Course Workbook Solutions! Equivalent Annual Annuity .

500 after discounting at the company’s cost of capital of 12% per annum.000 and has a residual value of $130.28 0.54 0. The net present value of the project is $140.500 / $500.26 Answer C The profitability index = net present value of the investment / initial investment = $140.38 0. The profitability index of the project is: A B C D 0. An investment project requires an initial investment of $500.000 = 0.281 .000 at the end of five years.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.

85 B.7 D 40 13.70 0.08 7 - - .33 0.25 4 80 28. What is the maximum NPV that could be achieved from investing the $80m using the Profitability Index? A.15 6 - - E 50 3.70 E 50 3.3m C.43 1 20 8.50 D 40 13.80 F 20 4.10 C 20 8. Each project is divisible therefore investment in part of a project can be undertaken.20 B 40 6.10 0.80 0. Cumulative NPV C 20 8.50 0.53m D.90 G 20 4. $26. $31.33 None of the projects can be carried out more than once.42 2 30 12.34 3 70 26.20 0.ACCA F9 Financial Management Full Course Workbook Solutions! 2.5 A 10 4.90 0. $28.4 F 20 4.22 5 - - B 40 6. $45.4m Answer A Project Investme nt NPV PI Rank Cumulative Inv. A company has a maximum of $80 million available for investment and seven independent projects in which it could invest as follows: Project Investment NPV A 10 4.85 G 20 4.

ACCA F9 Financial Management Full Course Workbook Solutions! 3. Extra capital is available to the company due to internal factors such as excess cash from operations. A limited amount of capital is available to the company due to external factors such as banks unwillingness to lend. C. Which of the following best describes ‘hard’ capital rationing? A. B. A limited amount of capital is available to the company due to external factors such as banks unwillingness to lend. A limited amount of capital is available to the company due to internal factors such as management unwillingness to take more risk. A limited amount of capital is available to the company due to internal factors such as management unwillingness to take more risk. Answer A 4. Which of the following best describes ‘soft’ capital rationing? A. Extra capital is available to the company due to internal factors such as excess cash from operations. C. D. Extra capital is available to the company due to external factors such as banks who are keen to lend. B. Answer B . D. Extra capital is available to the company due to external factors such as banks who are keen to lend.

the company can do a proportion of one project if they do not have the capital to do it all. 3. 4. If projects are non divisible how do we make a decision? Trial and error. What is the difference between divisible and non-divisible projects? For divisible projects.e. What is hard capital rationing? Hard capital rationing is externally imposed by factors outside of the organisation. How do we calculate the Profitability Index? NPV of project / Cost of investment. 7. 2. If the projects are divisible.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. 5.which method should be used to decide which projects to undertake? Profitability index. What is capital rationing? Capital rationing refers to the fact that companies do not have an unlimited amount of capital available to invest. What is the equivalent annual benefit? The EAB tells us what the NPV of the project would be the equivalent to as an annual amount. Non divisible projects cannot be split i. 6. . they are all or nothing.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: December 2009 Q1 (c) & (d) Now do it! .ACCA F9 Financial Management Full Course Workbook Solutions! 8. What is soft capital rationing? Soft capital rationing is imposed by factors internal to the organisation.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 14 Business Valuations .

000 Current Assets 170.000 10% Loan Notes 150.000 The Market Value of property in the Non Current Assets is $50.000 Current Liabilities -80.000 Current Liabilities -80.000 Share Capital 300.500 532.000 Reserves 200.000 (Property value) 600.500 Value of 70% 532. The Loan Notes are redeemable at a 5% premium.500 x 70% 372.000 10% Loan Notes 150.000 + 50.ACCA F9 Financial Management Full Course Workbook Solutions! Net Assets Valuation Method Illustration 1 Non Current Assets 550.000 x 105% -157.000 Current Assets 170.750 .   What is the value of a 70% holding using the net assets valuation basis? Solution Non Current Assets Working $ 550.000 more than the book value.

What is the Value of the business? Solution Working Constant Dividend In Question 45c Required Return (Cost of Equity or Ke) In Question 15% Share Price (Dividend / Ke) 45 / 0.Illustration 2 ABC pays a constant dividend of 45c. The shareholders require a return of 15%.15 300c No.ACCA F9 Financial Management Full Course Workbook Solutions! DVM . Ordinary Shares In Question 3m Value of the business 300c x 3m $9m . It has 3m ordinary shares.

ACCA F9 Financial Management Full Course Workbook Solutions! DVM .5) = 6m (6m x 810c) = $48.Business Valuation Dividend Paid 30c Required Return (Ke) 12% Dividend Growth 8% Share Price (Dividend (1+g)) / (Ke .Dividend Growth Dividend Paid Now 30c Dividend Paid 4 Years Ago 22c (4√(30 / 22)) =1.08) / (0.08) = 810c ($3m / 0.08 =8% Dividend Growth Working 2 .6m .0. Solution Working 1 .g) No Ordinary Shares Value of business (30 x 1.Illustration 3 A business has Share Capital made up of 50c shares of $3 million Dividend per share (just paid) 30c Dividend paid four years ago 22c Required Return = 12% Calculate the Value of the business using the dividend valuation method.12 .

000) = $3.64m 2 12 260.ACCA F9 Financial Management Full Course Workbook Solutions! P/E Ratio Method .000 (14 x 30.Illustration 4 X1 X2 X3 $‘000 $‘000 $‘000 Revenue 3000 3500 4200 COS 2000 2400 3200 Gross Profit 1000 1100 1000 Admin Costs 300 350 400 Distribution Costs 200 250 300 PBIT 500 500 300 Interest 100 150 220 Tax 120 90 50 Profit After Tax 280 260 30 Dividends 100 110 30 Retained Earnings 180 150 0 Industry P/E Average 13 12 14 Calculate the Value of the Company for each of the 3 years using the P/E Ratio method.000) = $420.000 .12m 3 14 30.000 (13 x 280.000 (12 x 260. Solution Year Industry P/E Ratio Total Earnings Value of Company 1 13 280.000) = $3.

ACCA F9 Financial Management Full Course Workbook Solutions! P/E Ratio Method . .Illustration 5 X1 X2 X3 $‘000 $‘000 $‘000 Revenue 3200 3800 4800 COS 2000 2400 3200 Gross Profit 1200 1400 1600 Admin Costs 300 350 400 Distribution Costs 200 250 300 PBIT 700 800 900 Interest 100 150 220 Tax 120 90 50 Profit After Tax 480 560 630 Dividends 100 110 150 Retained Earnings 380 450 480 Industry P/E Average 17 15 18 Number of Shares 3m 3m 3m Calculate the Earnings Per Share for each of the 3 years Calculate the Value of the Company for each of the 3 years using the EPS you calculate.

4m 3 18 21c $3.66c $2.80 (2. Shares EPS (Earnings / No.ACCA F9 Financial Management Full Course Workbook Solutions! Solution Year Earnings No.72 x 3m) = $8.34m .000 3m 21c Year Industry P/E Ratio EPS Share Price (EPS x P/E Ratio) Value of Company 1 17 16c $2.78 x 3m) = $11.80 x 3m) = $8.78 (3.66c 3 630.16m 2 15 18.000 3m 16c 2 560.72 (2. Ordinary Shares) 1 480.000 3m 18.

5 0.Illustration 6 X1 X2 X3 $‘000 $‘000 $‘000 Revenue 3100 3700 4600 COS 2000 2400 3200 Gross Profit 1100 1300 1400 Admin Costs 300 350 400 Distribution Costs 200 250 300 PBIT 600 700 700 Interest 100 150 220 Tax 120 90 50 Profit After Tax 380 460 430 Dividends 100 110 150 Retained Earnings 280 350 280 Earnings Yield 0.88c 3 430.75 0. Ordinary Shares) Earnings Yield Share Price (EPS / Earnings Yield) 1 380.ACCA F9 Financial Management Full Course Workbook Solutions! Earnings Yield .18 63. Solution Year Earnings No.15 0.17 Number of Shares 4m 4m 4m Calculate the Earnings Per Share for each of the 3 years and the share price using the earnings yield. Shares EPS (Earnings / No.18 0.23c .33c 2 460.5c 0.17 63.000 4m 10.000 4m 11.000 4m 9.15 63.

909 0.252 .257 1.10 .763 121.02) = 1.683 0. Calculate the value of the company using the present value of future cash flows method.250 3 4 5 6 (127.938 83. Solution Period Cash Inflows 1 2 105.019 79.628 (0.000 in cash inflows this year.010.067 86.527 Total 1. They expect this to increase in each of the next 5 years by 5% and after that to increase by 2% forever. The company uses a cost of capital of 10%.621 0.751 0.ACCA F9 Financial Management Full Course Workbook Solutions! Present Value of Future Cash Flows .000 110.826 0.628 x 1.621 PV Cash Flows 95.0.445 91.627.446.02) / 115.551 127.Illustration 7 ABC Company earned $100.257 Discount Rate 10% 0.

  What is the value of a 80% holding using the net assets valuation basis? A.000 C.000 The Market Value of property in the Non Current Assets is $100.000 more than the book value.000 10% Loan Notes 200.000 Share Capital 500. Non Current Assets 700.000 D.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.000 Current Liabilities -100.000 B. $584.000 Current Assets 250. $730.000 Reserves 300. $444.000 Answer C . The Loan Notes are redeemable at a 10% premium. $664.

ACCA F9 Financial Management Full Course Workbook Solutions! Solution Non Current Assets Working $ 700.Business Valuation Dividend Paid 50c . Calculate the Value of the business using the dividend valuation method. has Share Capital made up of 50c shares of $5 million.000 Current Liabilities -100. $54.000 730.000 + 100.000 x 80% 584.000 800. They have just paid a dividend per share of 50c and paid a dividend per share four years ago of 35c. ABC Co. $389.000 Value of 70% 730.000 Current Assets 250.3m C. $343.000 2.6m B.000 10% Loan Notes 200.65m Answer C Solution Working 1 . The cost of capital is 14%.000 x 1.3m D.1 -220. $109.Dividend Growth Dividend Paid Now 50c Dividend Paid 4 Years Ago 35c Dividend Growth (4√(50 / 35)) =1.09 =9% Working 2 . A.

SKV Co has paid the following dividends per share in recent years: Year 2013 2012 2011 2010 Dividends 36.09) / (0. Using the geometric average historical dividend growth rate and the dividend growth model.1 The dividend for 2013 has just been paid and SKV Co has a cost of equity of 12%.3m 3.14 .0.5) = 10m Value of business (10m x 1093c) = $109.09) = 1093c No Ordinary Shares ($5m / 0. what is the market price of SKV Co shares to the nearest cent on an ex dividend basis? A $4·67 B $5·14 C $5·40 D $6·97 Answer C The geometric average dividend growth rate is (36·0/31·1)1/3 – 1 = 5% The ex div share price = (36·0 x 1·05)/(0·12 – 0·05) = $5·40 .ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .g) (50 x 1.0 33.Business Valuation Required Return (Ke) 14% Dividend Growth 9% Share Price (Dividend (1+g)) / (Ke .8 32.8 31.

$‘000 Revenue 3000 COS 2000 Gross Profit 1000 Op. Costs 500 Net Profit 500 Number of Shares 1m Share Price $5 Industry P/E Average 15 What is the the Value of the Company Using the P/E ratio calculation? A.ACCA F9 Financial Management Full Course Workbook Solutions! 4. $7. $5m B.000 $7. The following information relates to Stovie Co.5m .5m C. $8m D.5m Answer B Solution Year Industry P/E Ratio Total Earnings Value of Company 1 15 500. $5.

0.621 0. $1.795.000 D.1 .04) / (0. A.902.751 0.ACCA F9 Financial Management Full Course Workbook Solutions! 5.000 Answer A Solution Period 1 2 3 4 5 Post Yr 5 Cash Inflows 100 108 117 126 136 136(1.000 in cash inflows this year. They expect this to increase in each of the following 4 years by 8% and after that to increase by 4% forever. Calculate the value of the company to the nearest $‘000 using the present value of future cash flows method.000 B.675.464 Total 1.000 C.683 0.357 Discount Rate 10% 0. $1. $3.621 PV Cash Flows 91 89 88 86 84 1. Archie Company expects to earn $100.340. $2.826 0.909 0. The company uses a cost of capital of 10%.04) = 2.902 .

$8. $11.909 0.000 Answer C Solution Period 1 2 3 4 5 Post Yr 5 Cash Inflows 500 535 572 613 655 655(1.000 B.751 0.0. A.569.000 in cash inflows this year.683 0.03) = 9. They expect this to increase in each of the following 4 years by 7% and after that to increase by 3% forever.826 0.985 Total 8.1 .ACCA F9 Financial Management Full Course Workbook Solutions! 6.137. Archie Company expects to earn $500. Calculate the value of the company to the nearest $‘000 using the present value of future cash flows method.000 D. $7.000 C.621 0.638.621 PV Cash Flows 455 442 430 418 407 5.137 . $9.790. The company uses a cost of capital of 10%.03) / (0.638 Discount Rate 10% 0.

7%) Share Price = 50 (1+0. What are the downsides of using the Net Assets Valuation method? It ignores intangibles that are not shown on the balance sheet.057) / (0. Calculate the share price using DVM. A company pays a constant dividend of 50c and has a cost of capital of 13%. It will often lead to an under-valuation. When and how can we adjust the P/E Ratio used? .13 = $3. The company has a cost of capital of 13%.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. rather that what it is achieving. 2. 6. The future growth is estimated from historic data. 3.24 5. 50 / 0. 7. If asset stripping a company.057 (5.85 4.057) = $7.13 . Growth = [4√(50 / 40)] -1 = 0. If we buy the business we will intend to improve it’s performance at least to the industry average. Calculate the share price using DVM. What are the downsides of using DVM? It assumes constant growth in the dividends. It is not based on earnings which is usually the reason for buying a business. Why do we use a proxy P/E Ratio when valuing a business with this method? To base our valuation on what the business should be achieving based on the industry it is in.0. When is it appropriate to use the Net Assets Valuation method? To value a property investment company. As the minimum price in a takeover. The model is very sensitive to changes in any of the variables. A company pays a dividend of 50c and paid a dividend of 40c 4 years ago.

8. The industry average P/E ratio for the fashion industry is 13. The P/E ratio will be dependent on the view of the market which is not always correct.ACCA F9 Financial Management Full Course Workbook Solutions! When we are valuing a risky company or an unlisted company we may adjust the P/ E ratio down by say 10% to reflect this.000 this year that is expected to grow at 4% forever.000 (1 + 0. A business is expected to earn $250. We are valuing an unlisted fashion business who have an EPS of 22c and 12m shares in issue.68 9.04) = $2.64 x 12 = $31.64m $2. 10.14 . What are the downsides of using the P/E ratio method? Using a proxy company may be inaccurate.000 If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: December 2007 Q1 (a) June 2008 Q2 (a) & (b) December 2008 Q1 Now do it! .0.600. it is based on earnings which may be manipulated or include one-off items which distort the resulting valuation. What is the value of the business using the present value of future cash flows if their cost of capital is 14%? We can use the growth formula in the DVM model to calculate this: 250. What is the value of the firm? A fashion business is risky as fashion changes and it is also unlisted so let’s adjust the P/E ratio down to 12 and say: 22c x 12m = Total earnings of $2.04) / (0.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 15 WACC I .

25. Solution Dividend 35 Share Price 325 Cost of Equity (Dividend / Share Price) (35 / 325) = 10. Calculate the Cost of Equity (Ke) using DVM. The current share price is $3.Illustration 1 ABC Company has just paid a dividend of 35c.76% .ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Equity using DVM .

152 = 15.04) / 325) + 0.25.Illustration 2 ABC Company has just paid a dividend of 35c.04 = 0. Calculate the Cost of Equity (Ke) using DVM.2% . The dividend paid has grown by 4% per year for the past 5 years. Solution Dividend 35 Share Price 325 Dividend Growth 4% Cost of Equity (Dividend (1+g) / Share Price) +g ((35 x 1. The current share price is $3.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Equity using DVM .

2% . The average return than investors in the market can expect is 15%.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Equity using CAPM .4)) = 17. Solution Rf (Risk Free Rate) 4 Rm (Ave Return on the Market) 15 Beta 1.Illustration 3 Company A has a Beta of 1.2(15 . Government bonds are currently trading at 4%. Calculate the Cost of Equity using CAPM.2.2 Ke = Rf + β(Rm .Rf) (4 + 1.

2. The average return than investors in the market can expect is 12%. .5)) = 12% Ke = Rf + β(Rm .2 1 (5 + 1.5)) = 13.Illustration 4 Company A has a Beta of 1.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Equity using CAPM . Also notice that a higher Beta of 1.4% (5 + 1(12 .4% showing that a higher Beta means higher risk.2 gives a higher Ke of 13. Calculate the Cost of Equity using CAPM for each company. Government bonds are currently trading at 5%.2(12 .Rf) Notice that when Beta is 1 (Company B) Ke is 12% which is the same as the average return on the market. Solution Company A Company B Rf (Risk Free Rate) 5 5 Rm (Ave Return on the Market) 12 12 Beta 1. Company B has a Beta of 1.

more risk.Rf) Remember to look out for the market risk PREMIUM as this is always (Rm .8% (5 + 1.3 1.e.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Equity using CAPM Illustration 5 Company A has a Beta of 1.2. Company B has a Beta of 1.3(6) = 12.3. The average market risk premium is 6%.Rf) rather than Rm (Average return on the market) Again notice that a higher Beta leads to a higher Ke i.Rf (Ave Market Risk Premium) 6 6 1.2% Beta Ke = Rf + β(Rm . Calculate the Cost of Equity using CAPM for each company.2 (5 + 1. Solution Company A Company B Rf (Risk Free Rate) 5 5 Rm . . Government bonds are currently trading at 5%.2(6)) = 12.

15% C.54 What is the cost of equity using the dividend growth model? A. The current share price is $6. 12% B. 11% Answer B Dividend 75 Share Price 654 Dividend Growth 3% Cost of Equity (Dividend (1+g) / Share Price) +g ((75 x 1.Government bonds are currently trading at 4%.03) / 654) + 0.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. 12.03 = 0. 11. 11.2% B. Company Alpha has a Beta of 1. What is the cost of equity using the capital assets pricing model? A.1. 7. 7% D.7% C. The average market risk premium is 7%. The dividend paid has grown by 3% per year for the past 4 years. Entrie Company has just paid a dividend of 75c.3% D.4% Answer B .15 = 15% 2.

2. not just a particular stock or industry. is risk that can be diversified away by investors. Systematic D. Systematic risk risk risk risk affects the overall market. Answer A 4. It assumes that the risk free rate is 5% A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer B . It assumes that all investors are diversified. 4. is company or industry specific risk. Systematic risk risk risk risk affects the overall market.ACCA F9 Financial Management Full Course Workbook Solutions! 3. is risk that can be diversified away by investors. is company or industry specific risk. Which of the following statements about ‘systematic risk’ are correct when referring to the capital assets pricing model? A. is determined by the gearing of the company. Which of the following statements about ‘unsystematic risk’ are correct when referring to the capital assets pricing model? A. Systematic C. It assumes a capital market with high transaction costs. not just a particular stock or industry. Systematic B. Systematic D. is determined by the gearing of the company. Answer B 5. Which of the following are assumptions made by the capital asset pricing model (CAPM) are correct? 1. Systematic C. Systematic B. It assumes that investors can borrow at the risk free rate. 3.

Which of the following are downsides of the capital assets pricing model (CAPM) are correct? 1. The A B C D Beta used is calculated using historic data. share price fluctuates on a daily basis. 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer B .ACCA F9 Financial Management Full Course Workbook Solutions! 6. assumptions it makes are not necessarily reflected in reality. The 4. dividend growth is based on historic data. The 3. The 2.

Dividend 5 Ordinary Shareholders Ord. There may be more equity than debt so to get the average cost of these capital sources we need to weight the average based on the market value of each.45 what is the cost of equity? 40 / 345 = 11. Dividend 3. 4.59% 5. Set out the creditors hierarchy. Why is debt cheaper to service than equity (2 reasons!)? Debt holders take less risk as they are higher on the creditors hierarchy. Interest payments on debt are tax deductible. What is the weighted average cost of capital? Each item of capital that a company has e. If the dividend in question 4 is growing at a rate of 5% what is the cost of equity? [40 (1+0. Type Cost 1 Fixed Charge Creditors Interest Paid 2 Floating Charge Creditors Interest Paid 3 Unsecured Creditors Interest Paid 4 Preference Shareholders Pref.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. 2.05 = 17.17% . debt and equity has a cost. If a company has a dividend of 40c and a share price of $3.05) / 345] + 0.g. The cost for debt will be the interest that the company has to pay and the cost for equity will be the dividends paid.

The market risk premium is 6% and government bonds are trading at 4%. A company has a Beta of 1. 8. 11. 10. What type of risk is CAPM a measure of? The systematic risk of a particular company. CAPM assumes a perfect capital market with no transaction costs.3(6) Ke = 11. What does Beta tell us? How the shares of a company have historically fluctuated with the average of all the shares in the market.Rf) Ke = 4 + 1.8 12. What are the two types of risk mentioned in the CAPM lecture? Systematic Risk & Unsystematic Risk.2 a more risky or less risky investment than a company with a Beta of 1. CAPM assumes that all investors are diversified (so we can ignore unsystematic risk). Ke = Rf + β(Rm . .6 is more risky than the one with 1.2.3. 7. Why can we ignore unsystematic risk? Unsystematic risk can be diversified away by the diversification of investors portfolios. What are the assumptions of CAPM? CAPM assumes that you can borrow at the risk free rate. Is a company with a Beta of 1.ACCA F9 Financial Management Full Course Workbook Solutions! 6. Calculate the cost of equity using CAPM. 9.6? The company with a Beta of 1.

14. The past fluctuations are projected into the future. What are the downsides of CAPM? Beta is based on historic data.ACCA F9 Financial Management Full Course Workbook Solutions! 13. How is Beta calculated? Beta is calculated by plotting the historic data as to how that share price has fluctuated in the past on a graph against the average share price in the market. The assumptions it makes are not necessarily reflected in reality (see Q10) If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: You’re not Ready Yet . CAPM is really supposed to be used for one period only and we may use it to evaluate a 5 year project.Do the next lecture! Now do it! .

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 16 WACC II .

Illustration 1 A company has issued 10% irredeemable debt. Solution Interest paid (Per $100 nominal) $10 Tax Rate 30% After tax interest (Amount Paid (1 .t)) Market Value of Debt (Per $100 nominal) Cost of Debt (After tax interest / Market Value of Debt) $10 x (1 .7% .30) = $7 $90 (7 / 90) = 7.ACCA F9 Financial Management Full Course Workbook Solutions! Irredeemable Debt .0. The tax rate is 30% Calculate the cost of debt (Kd). The market value of the debt is $90.

40 0.497 49.03 -25. Calculate the Cost of Debt (Kd).Illustration 2 A Company has issued debt which is redeemable in 5 years time.03 / (11.63 3.5) = 8.352 26. The current market value of the debt is $102. Solution Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest 8 4.(25. Interest is payable at 8%.48)) (15 .03 .48 IRR Calculation: 5 + (11.ACCA F9 Financial Management Full Course Workbook Solutions! Redeemable Debt .329 34.02% .82 5 Capital 100 0. Ignore taxation.70 Market Value -102 -102 11.784 78.

Interest is payable at 10%.Illustration 3 A Company has issued debt which is redeemable in 5 years time. Tax is payable at 30%.784 78.40 0.70 -30.70 Market Value -104 -104 4.329 30.(30.46 5 Capital 100 0.ACCA F9 Financial Management Full Course Workbook Solutions! Redeemable Debt .497 49. Calculate the Cost of Debt (Kd).3) 7 4.352 23.0.30 3. The current market value of the debt is $104. Solution Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest (10 x (1 .7 .7 / (4.84 IRR Calculation: 5 + (4.32% .5) = 6.84)) (15 .

Calculate the Cost of Debt (Kd). Tax is payable at 30%. or II. Solution Working 1 .04 to the power of 5) Number of shares per $100 Conversion Value $7. The current market value of the debt is $120. The current share price is $6 and it is expected to grow in value by 4% per year.40 into the capital repaid .ACCA F9 Financial Management Full Course Workbook Solutions! Convertible Debt . investors will have a choice of either: I.Cash or Convert? Working Cash (15% Premium) 100 x 1. Interest is payable at 10%.Illustration 4 A Company has issued debt which is convertible in 5 years time. Do an IRR the same as for redeemable but filling $131.30 x 18 $131.30 18 7. On conversion.40 The conversion value is higher than the cash so the investors will choose to convert. Cash at a 15% premium.15 $115 Shares Current Value Value in 5 years with 4% growth $6 6 x (1. 18 shares per loan note.

4 0.5) = 8% Preference Shares .31 Market Value -120 -120 13. The tax rate is 30%.23 IRR Calculation: 5 + (13.46 5 Conversion Value 131.0.Illustration 5 A company has issued 8% preference shares with a nominal value of $1.(31.3) 7 4. The market value of the shares is 80c. Calculate the cost of the preference shares (Kd).352 23.32 . Solution Interest Paid 8 Market Value of share 80 Cost (Kd) (Interest Paid / Market Value) (8 / 80) = 10% .32 / (13.784 103.329 30.23)) (15 .30 3.497 65.02 0.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Debt Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest (10 x (1 .32 -31.

Illustration 6 A company has a bank loan of $2m at an interest rate of 10%.0.3)) 7% . Calculate the cost of debt (Kd).ACCA F9 Financial Management Full Course Workbook Solutions! Bank Debt . The tax rate is 30%. Solution Interest Rate before Tax 10 Tax Rate 30% After Tax Cost of Debt (10 x (1 .

Illustration 7 Company A is funded as follows: Item Capital Structure Cost Equity 85% 15% Debt 15% 7% Calculate the Weighted Average Cost of Capital.75 Debt 15% 7 1. Solution Item Capital Structure Cost Ave Equity 85% 15 12.8 .05 WACC 13.ACCA F9 Financial Management Full Course Workbook Solutions! WACC .

Given in the Question Ordinary Shares 13% Loan Notes 8% Bank Loan 5% . Solution Working 1 .ACCA F9 Financial Management Full Course Workbook Solutions! WACC .Illustration 8 Company A is funded as follows: Balance Sheet Extract Ordinary Shares (50c) 3000 Loan Notes 2000 Bank Loan 1000 The cost to the company of each of the above items has been calculated as: Ordinary Shares 13% Loan Notes 8% Bank Loan 5% The Loan notes are currently trading at $94. The current share price is $1.Calculate Cost of Capital for each item.50 Calculate the Weighted Average Cost of Capital.

880) 8 (1880 / 11.Calculate the weighting of each item. Item Market Value Weighting Equity 9000 (9000 / 11.880) x 8 = 1.50) = 6000 Share Price = $1.880) x 5 = 0.880) 5 (1000 / 11.880) = 15.880) = 75. SFP Market Value Ordinary Shares (50c) 3000 No.27 Bank Loan 1000 (1000 / 11.ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .42 WACC 11.75% Loan Notes 1880 (1880 / 11.880) 13 (9000 / 11.880) = 8.85 Loan Notes 1880 (1880 / 11.880) x 13 = 9.50) = 9000 Loan Notes 2000 Loan Notes nominal value (on SFP) = 100 Market Value = 94 (2000 x (94 / 100) = 1880 Bank Loan 1000 No market for this so use SFP value 1000 Working 3 .54% 11880 .Weighted Average Cost of Capital Item Market Value Weighting Cost (W1) Ave Equity 9000 (9000 / 11.Calculate the Market Value of Debt and Equity. of shares (3000 / 0.41% 11880 Working 4 .50 (6000 x $1.82% Bank Loan 1000 (1000 / 11.

. The tax rate is 30%.Illustration 9 Company A is funded as follows: Balance Sheet Extract Ordinary Shares (50c) 2000 12% Loan Notes 1500 8% Preference Shares ($1) 500 Bank Loan 750 Details on these are as follows.25. Government bonds are currently trading at 6% and the average market risk premium is 7%. The bank loan has an interest rate of 10%. The preference shares are trading at 92c. The Loan notes are currently trading at $106 and are redeemable at par in 5 years time.ACCA F9 Financial Management Full Course Workbook Solutions! WACC .2. The current share price is $1. Calculate the Weighted Average Cost of Capital. The company has an equity beta of 1.

2(7)) = 14.4% Cost of 12% Loan Notes Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest (12 x (1 .0.76 / (8. Cost of Equity using CAPM Rf (Risk Free Rate) 6 (Rm .37% Cost of Preference Shares Interest Paid 8 Market Value of share 92 Cost (Kd) (Interest Paid / Market Value) (8 / 92) = 8.14 IRR Calculation: 5 + (8.70 Market Value -106 -106 8.Calculate Cost of Capital for each item.2 Ke = Rf + β(Rm .36 3.497 49.784 78.40 0.352 28.14)) (15 .76 -28.Rf)(Ave market risk premium) 7 Beta 1.76 .3) 8.(28.7% .Rf) (6 + 1.ACCA F9 Financial Management Full Course Workbook Solutions! Solution Working 1 .4 4.16 5 Capital 100 0.5) = 7.329 36.

Calculate the weighting of each item. Item Market Value Weighting Equity 5000 (5000 / 7800) Loan Notes 1590 (1590 / 7800) Preference Shares 460 (460 / 7800) Bank Loan 750 (750 / 7800) 7800 .0.25) = 5000 (1500 x (106 / 100) = 1590 (500 x (92 / 1)) = 460 750 Working 3 . SFP Market Value Ordinary Shares (50c) 2000 No.ACCA F9 Financial Management Full Course Workbook Solutions! Cost of Bank Debt Interest Rate before Tax 10 Tax Rate 30% After Tax Cost of Debt (10 x (1 .25 12% Loan Notes 1500 Loan Notes nominal value (on SFP) = 100 Market Value = 106 8% Preference Shares ($1) 500 Preference shares nominal value (on SFP) = $1 Market Value = 92c Bank Loan 750 No market for this so use SFP figure (4000 x $1.Calculate the Market Value of Debt and Equity. of shares (2000 / 0.3)) 7% Working 2 .50) = 4000 Share Price = $1.

23 Loan Notes 1590 (1590 / 7800) 7.67 WACC 11.7 = 0.Weighting & Weighted Average Cost of Capital Item Market Value Weighting Cost (W1) Ave Equity 5000 (5000 / 7800) 14.4 (5000 / 7800) x 14.50 Preference Shares 460 (460 / 7800) 8.ACCA F9 Financial Management Full Course Workbook Solutions! Working 4 .91% 7800 .7 (460 / 7800) x 8.51 Bank Loan 750 (750 / 7800) 7 (750 / 7800) x 7 = 0.37 = 1.37 (1590 / 7800) x 7.4 = 9.

has irredeemable debt in issue that interest at a rate of 12%.7% C. A company has 10% irredeemable debt in issue at a market value of $97.30) = $8.0.2% B. 10% D. If the tax rate is 30% what is the cost of the debt? A.40 $84 (8. Avecas Co. 6. 7.5% D. 12% C. 8.2% Answer A 10 (1-0.t)) Market Value of Debt (Per $100 nominal) Cost of Debt (After tax interest / Market Value of Debt) $12 x (1 . What is the cost of debt? A.2% . The market value of the debt is $84 and the tax rate is 30%.3) / 97 = 7. 14% B.4 / 84) = 10% 2. 11% Answer C Interest paid (Per $100 nominal) $12 Tax Rate 30% After tax interest (Amount Paid (1 . 9.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.

Interest is payable at 12%.70 Market Value -102 -102 12.ACCA F9 Financial Management Full Course Workbook Solutions! 3.14)) (15 .36 3.6 .24% Answer B Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest (12 x (1 .14 IRR Calculation: 5 + (12. What is the cost of debt (kd) using linear extrapolation and discount rates of 5% and 15% in the calculation? A.(24.4 4. A Company has issued debt which is redeemable in 5 years time.00% B.3) 8. 9.16 5 Capital 100 0.329 36. The current market value of the debt is $102.497 49.40 0. Tax is payable at 30%.47% .00% D. 12. 8.0.352 28. 7.784 78.76 / (12.76 -24.47% C.5) = 8.

19 IRR Calculation: 5 + (1.97 3.4% .352 20.37 -33.40 0.4% Answer D Period Item $ DR 5% PV DR 15% PV 1 -5 Interest (8 x (1 .25)) 6 4.(33.37 .19% D. 5. A company has 5 year 8% redeemable debt in issue at a market value of $103.11 5 Capital 100 0. 5. 7.497 49.ACCA F9 Financial Management Full Course Workbook Solutions! 4.70 Market Value -103 -103 1.5) = 5. The tax rate is 25%.329 25.37 / (1.95% C.19) (15 .784 78. What is the cost of debt (kd) using linear extrapolation and discount rates of 5% and 15% in the calculation? A.26% B.0. 6.

39.0% C.9% . investors would be indifferent between the cash and conversion option.0% D. Based on the information available. What is the cost of the preference shares? A. 3. The tax rate is 30%. 2. Based on the information available. 6.0.2% Answer C 6 (1-T) = 6 (1 . 4.ACCA F9 Financial Management Full Course Workbook Solutions! 5. Which of the following statements is correct? A. What is the cost of the bank debt? A.6% Answer A 8 / 94 = 8. Answer B 6. investors will have a choice of either: Cash at a 10% premium.39. Based on the information available.5% B. 5. A company has 8% preference share in issue at a current value of 94c. investors would be better off choosing to take the conversion option by $6. The tax rate is 35%. 8.9% D. Interest is payable at 12% and the current market value of the debt is $108. D.35) or 3.5% 7. B. 8. On conversion. or 14 shares per loan note. A company has a bank loan of $7m at a rate of 6%. Jeeves Company has issued debt which is convertible in 5 years time. C. Based on the information available.0% B.94. The current share price is $7 and it is expected to grow in value by 3. investors would be better of choosing to take the cash option by $8.5% per year. investors would be better off choosing to take the cash option by $6.1% C. 6.

Company A is funded as follows: Balance Sheet Extract Ordinary Shares (50c) 2500 Loan Notes 1000 Bank Loan 500 The cost to the company of each of the above items has been calculated as: Ordinary Shares 17% Loan Notes 7% Bank Loan 6% The Loan notes are currently trading at $98.19% C.24% Answer B . 16. The current share price is $3. 11.ACCA F9 Financial Management Full Course Workbook Solutions! 8.50 What is the Weighted Average Cost of Capital? A. 17. 13.34% D.56% B.

19% Equity 18980 .50) = 17.980) 6 (500 / 18.980) x 6 = 0.980) 17 (17.980) 7 (980 / 18. of shares (2500 / 0.500 Loan Notes 1000 Loan Notes nominal value (on SFP) = 100 Market Value = 98 (1000 x (98 / 100) = 980 Bank Loan 500 No market for this so use SFP value 500 Working 2 .Calculate the Market Value of Debt and Equity.50 (5000 x $3.980) x 17 =15.50) = 5000 Share Price = $3.67 Loan Notes 980 (980 / 18. SFP Market Value Ordinary Shares (50c) 2500 No.980) x 7 = 0.ACCA F9 Financial Management Full Course Workbook Solutions! Working 1 .Weighted Average Cost of Capital Item Market Value Weighting Cost (W1) Ave 17.36 Bank Loan 500 (500 / 18.500 / 18.16 WACC 16.500 (17.500 / 18.

The current share price is $18 and is expected to grow at 2%.40 0.2% 5.5) = 5. If the tax rate is 30% what is the cost of the debt? 10 (1-0. What is the cost of the debt? Period Item $ DR 5% PV DR 15% PV 1 -5 Interest (8 x (1 . A company has 10% irredeemable debt in issue at a market value of $97. The tax rate is 25%.329 25.19) (15 .4% 6.497 49.25)) 6 4.784 78. What is the nominal value of issued debt? $100 2.352 20. What is convertible debt convertible into? Shares. A company has 5 year 8% redeemable debt in issue at a market value of $103. A company has 10% convertible debt in issue at a market value of $111 that is redeemable in 5 years at either cash or 5 shares per nominal.37 .0.37 -33.70 Market Value -103 -103 1. The tax rate is 30%.3) / 97 = 7. What is the calculation for irredeemable debt? Annual Interest (1-T) / Market Value of debt 4.19 IRR Calculation: 5 + (1. What is the cost of debt? .97 3. 3.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1.11 5 Capital 100 0.37 / (1.(33.

Cost of Debt Perio d Item $ DR 5% PV DR 15% PV 1 -5 Interest (10 x (1 .30 -37.352 23.35 The conversion value is lower than the cash so the investors will choose not to convert.Cash or Convert? Working Cash $100 Shares Current Value $18 Value in 5 years with 4% growth 18 x (1.784 78.0.57% .329 30.84 IRR Calculation: 5 + (2.3 / (2.30 3.(37.02 to the power of 5) $19.5) = 5.497 49.3 .40 0.ACCA F9 Financial Management Full Course Workbook Solutions! Working 1 .3) 7 4.46 5 Conversion Value 100 0.70 Market Value -111 -111 -2.87 Number of shares per $100 Conversion Value 5 19.84)) (15 .87 x 5 $99.

The company has each of the types of debt in questions 4 to 6 on their balance sheet at a book value of $10m for each of them except for the bank debt which is on the balance sheet at $7m. What is the cost of the preference shares. A company has a bank loan of $7m at a rate of 6%. 8 / 94 = 8.3m Convertible Debt 10m 10m x 111/100 11. What is the cost of the bank debt? 6 (1-T) = 6 (1 . The tax rate is 35%.0.5% 8.1m 8% Preference Shares ($1) 10m 10m x 94/100 9.Calculate the Market Value of Debt and Equity. If the company has a market value of $110m with a cost of equity of 14% then what is the company’s weighted average cost of capital? Working 1 . SFP Market Value Ordinary Shares 10m Market Value given will be the value of the shares 110m Irredeemable Debt 10m 10m x 97/100 9.35) or 3.ACCA F9 Financial Management Full Course Workbook Solutions! 7.7m Redeemable Debt 10m 10m x 103/100 10.9% 9.4m Bank Loan 7m No market for this so use SFP figure 7m . A company has 8% preference share in issue at a current value of 94c.

4 (9.78 Irredeemable Debt 9.5) 7.5) 14 9. SFP Market Value Ordinary Shares 8m Market Value given will be the value of the shares 99m Irredeemable Debt 8m 8m x 97/100 7.44 Redeemable Debt 10.5) 5.5 0.57 0.7 / 157.76m Redeemable Debt 8m 8m x 103/100 8.17 WACC 11.24m Convertible Debt 8m 8m x 111/100 8.5 10.52m Bank Loan 7m No market for this so use SFP figure 7m .3 (10.4 0.Calculate the Market Value of Debt and Equity.5) 8.5) 3.9 0.88m 8% Preference Shares ($1) 8m 8m x 94/100 7. If the company has a market value of $99m with a cost of equity of 12% then what is the company’s weighted average cost of capital? Working 1 .51 7 (7 / 157. What if the company has each of the types of debt in questions 4 to 6 on their balance sheet at a book value of $8m for each of them except for the bank debt which is on the balance sheet at $7m.1 / 157.1 (11.7 (9.ACCA F9 Financial Management Full Course Workbook Solutions! Item Market Value Weighting Cost Ave Ordinary Shares 110 (110 / 157.39 8% Preference Shares ($1) 9.4 / 157.35 Convertible Debt 11.5) 5.65 Bank Loan 157.2 0.3 / 157.

20 WACC 11.88 / 138.4) 7.4 0.4) 5.24 (8.88 (8.2 0.01 Irredeemable Debt 7.36 8% Preference Shares ($1) 7.52 (7.76 (7.5 0.4) 5.4) 14 10.46 7 (7 / 138.4 If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: December 2008 Q3 (a) June 2010 Q2 June 2008 Q1 Now do it! .57 0.76 / 138.40 Redeemable Debt 8.4) 3.ACCA F9 Financial Management Full Course Workbook Solutions! Item Market Value Weighting Cost Ave 99 (99 / 138.32 Convertible Debt 8.24 / 138.4) 8.76 Ordinary Shares Bank Loan 138.52 / 138.9 0.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 17 Capital Structure .

ACCA F9 Financial Management Full Course Workbook Solutions!

Capital Structure - Illustration 1
A company has total capital of $1,000 with debt making up $300 and equity making up
$700 of the total. The company’s cost of debt is 5% and cost of equity is 14%.
I.
II.

Calculate the company’s current WACC.
Calculate the WACC if the company substitutes $200 of equity for $200 of debt
causing their cost of equity to rise to 16%.
III. Calculate the WACC if the company substitutes $300 of equity for $300 of debt
causing their cost of equity to rise to 25%.

Solution
I.
Item

Market Value

Weighting

Cost

WACC

Debt

300

300 / 1000

5%

1.5

Equity

700

700 / 1000

14%

9.8

1000

11.3

II.
Item

Market Value

Weighting

Cost

WACC

Debt

500

500 / 1000

5%

2.5

Equity

500

500 / 1000

16%

8

1000

10.5

III.
Item

Market Value

Weighting

Cost

WACC

Debt

600

600 / 1000

5%

3

Equity

400

400 / 1000

25%

10

1000

13

ACCA F9 Financial Management Full Course Workbook Solutions!

Test Your Knowledge
If you can’t answer all of the questions below without
looking at the answer then you need to do some more
work on this area!
Multiple Choice Questions
Which of the following statements concerning capital structure theory is correct?
A. In the traditional view, there is a linear relationship between the cost of equity and
financial risk
B. Modigliani and Miller said that, in the absence of tax, the cost of equity would remain
constant
C. Pecking order theory indicates that preference shares are preferred to convertible debt
as a source of finance
D. Business risk is assumed to be constant
Answer D
2. Which of the following statements concerning capital structure theory is correct?
A. The traditional view of capital structure suggests that the company can minimise their
weighted average cost of capital
B. Modigliani and Miller said that, incorporating tax, the weighted average cost of capital
would remain constant
C. Pecking order theory indicates that preference shares are preferred to convertible debt
as a source of finance
D. Modigliani and Miller said that, incorporating tax, as gearing levels increase so the value
of the company will decrease
Answer A
3. Which of the following are assumptions that Modigliani and Miller made in their ‘no tax’
model?
1. No risk of bankruptcy no matter how much debt the company has.
2. High transaction charges.
3. The company is able to borrow at the risk free rate.
4. The company has no debt in it’s capital structure.
A
B
C
D

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

Answer B

ACCA F9 Financial Management Full Course Workbook Solutions!

4. What does the M&M model with tax suggest a company should do with their capital
structure?
A. As there is greater financial risk at high levels of gearing the company should have as
little debt as possible.
B. As the transaction costs will be high the company should retain their current capital
structure for as long as possible.
C. As taking on more debt reduces the weighted average cost of capital the company
should increase their gearing levels.
D. The company should find the optimum capital structure at which it can minimise its
weighted average cost of capital.
Answer C

ACCA F9 Financial Management Full Course Workbook Solutions!

Short Form Questions
1. What is capital structure?
How much debt and equity a company has.

2. What does the traditional view suggest you can do with the WACC?
Minimise it.

3. Why would you want to do this?
The WACC is a cost to the business - as with any cost the company will wish to
minimise it.
4. What other assumptions did M & M make in their ‘no tax’ model?
No risk of bankruptcy no matter how much debt the company has.
No transaction charges.
The company is able to borrow at the risk free rate.

5. What does the M&M model with tax suggest we should do with our capital structure?
As the interest on debt is tax deductible and thus debt is cheaper, M&M suggested
that a company should substitute Equity for Debt in order to take advantage of this
fact.
This will also have the effect of increasing the value of the business using the PV of
future cash-flows method as the WACC and thus the discount rate will be lower
leading to a higher valuation.

If you’ve successfully answered all of the above
questions then you’re ready to do the exam questions
below:
Pilot Paper Q1 (b)
June 2009 Q1 (c)

Now do it!

ACCA F9 Financial Management Full Course Workbook Solutions!

Lecture 18
Financing &
Investment

4 (800 / (800 + 500)) = 0. Ignore Tax Solution Working 1 .4 Value of Equity 1000 800 Value of Debt 400 500 The risk free rate is 4%.Un-gear the proxy βe to get βa.2 1.4 Value of Equity of Proxy 800 Value of Debt of Proxy 500 βa = βe(Ve / (Ve + Vd)) 1. Proxy Equity Beta 1.Illustration 1 Company A intends to undertake a project in an unrelated industry.86 . The following details are relevant: Item Company A Proxy Company Equity Beta (βe) 1. Calculate a project specific discount rate.ACCA F9 Financial Management Full Course Workbook Solutions! Project Specific Discount Rate . The average return on the market is 12%.

Fill into CAPM Rf (Risk Free Rate) 4 Rm (Ave return on the market) 12 Beta 1.2(12 .20 Working 3 .Rf) (4 + 1.86 ((1000 + 400) / 1000) = 1.ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .86 Value of Equity of Company A 1000 Value of Debt of Company A 400 βe = βa (Ve + Vd ) / Ve) 0.4)) = 13.2 Ke = Rf + β(Rm .6% .Re-gear βa with our capital structure βa 0.

Calculate a project specific discount rate.96 . Proxy Equity Beta 1.Un-gear the proxy βe to get βa.3 (900 / (900 + (450 x 0. The average return on the market is 12%. The tax rate is 30%.1 1.7)) = 0.3 Value of Equity of Proxy 900 Value of Debt of Proxy 450 βa = βe(Ve / (Ve + (Vd x 1-t)) 1. Solution Working 1 . The following details are relevant: Item Company A Proxy Company Equity Beta (βe) 1.Illustration 2 Company A intends to undertake a project in an unrelated industry.3 Value of Equity 1200 900 Value of Debt 500 450 The risk free rate is 4%.ACCA F9 Financial Management Full Course Workbook Solutions! Project Specific Discount Rate .

4)) = 13.24 Working 3 .Rf) 1.92% .7)) / 1200) = 1.24 (4 + 1.24(12 .Re-gear βa with our capital structure βa 0.ACCA F9 Financial Management Full Course Workbook Solutions! Working 2 .96 Value of Equity of Company A 1200 Value of Debt of Company A 500 βe = βa (Ve + (Vd x 1-t) / Ve) 0.Fill into CAPM Rf (Risk Free Rate) 4 Rm (Ave return on the market) 12 Beta Ke = Rf + β(Rm .96 ((1200 + (500 x 0.

Which of the following would be the project specific discount rate for Alpha Co.3 whereas Horizon Co. 12. The risk free rate is 4% and the average return on the market is 12%. The tax rate is 30%. 13.34% B.12% D. has a Beta of 1. 10.92 ((1000 + (400 x 0. 11.7)) = 0.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions Company Alpha is financed with $1.000 of equity and $400 of debt and intends to undertake a project in an unrelated industry.92 Value of Equity of Company A 1000 Value of Debt of Company A 400 βe = βa (Ve + (Vd x 1-t) / Ve) 0. has a Beta of 1.2 Value of Equity of Proxy 700 Value of Debt of Proxy 300 βa = βe(Ve / (Ve + (Vd x 1-t)) 1. They have identified Horizon Co.92 Working 2 . Alpha Co.25% C.2. when entering the new industry? A.18 . as a company in the new industry with $700 of equity and $300 of debt.Re-gear βa with our capital structure βa 0.7)) / 1000) = 1. Proxy Equity Beta 1.2 (700 / (700 + (300 x 0.42% Answer D Working 1 .Un-gear the proxy βe to get βa.

Rf) 1.18(12 .18 (4 + 1.ACCA F9 Financial Management Full Course Workbook Solutions! Working 3 .42% .Fill into CAPM Rf (Risk Free Rate) 4 Rm (Ave return on the market) 12 Beta Ke = Rf + β(Rm .4)) = 13.

00% C. Alpha Co. The tax rate is 30%. Which of the following would be the project specific discount rate for Alpha Co.14 Value of Equity of Company A 60 Value of Debt of Company A 40 βe = βa (Ve + (Vd x 1-t) / Ve) 1.4.4 Value of Equity of Proxy 75 Value of Debt of Proxy 25 βa = βe(Ve / (Ve + (Vd x 1-t)) 1. They have identified Horizon Co.1 whereas Horizon Co. 16. 19. The risk free rate is 6% and the average return on the market is 14%.4 (75 / (75 + (25 x 0.7)) / 60) = 1.67 .Un-gear the proxy βe to get βa.Re-gear βa with our capital structure βa 1.14 ((60 + (40 x 0.20% D.32% Answer A Working 1 .14 Working 2 . has a Beta of 1.38% B.ACCA F9 Financial Management Full Course Workbook Solutions! 2. as a company in the new industry with 75% equity and 25% debt. 17. Company Alpha is financed with 60% equity and 40% debt and intends to undertake a project in an unrelated industry. 18.7)) = 1. Proxy Equity Beta 1. when entering the new industry? A. has a Beta of 1.

67(14 .6)) = 19.ACCA F9 Financial Management Full Course Workbook Solutions! Working 3 .Rf) 1.67 (6 + 1.Fill into CAPM Rf (Risk Free Rate) 6 Rm (Ave return on the market) 14 Beta Ke = Rf + β(Rm .38% .

The tax rate is 30%.01 ((4 + (1 x 0.26% D. has a Beta of 1. has a Beta of 1.49% C.ACCA F9 Financial Management Full Course Workbook Solutions! 3. as a company in the new industry with debt/equity 1/3.01 Working 2 .Un-gear the proxy βe to get βa.28% Answer B Working 1 .01 Value of Equity of Company A 4 Value of Debt of Company A 1 βe = βa (Ve + (Vd x 1-t) / Ve) 1. Proxy Equity Beta 1. Which of the following would be the project specific discount rate for Alpha Co. Alpha Co. The risk free rate is 6% and the average return on the market is 14%. 17.Re-gear βa with our capital structure βa 1. 18. 16. They have identified Horizon Co.23% B.05 whereas Horizon Co. Company Alpha is financed with debt/equity of 1/4 and intends to undertake a project in an unrelated industry.24.19 .7)) / 4) = 1.24 (3 / (3 + (1 x 0. when entering the new industry? A.24 Value of Equity of Proxy 3 Value of Debt of Proxy 1 βa = βe(Ve / (Ve + (Vd x 1-t)) 1.7)) = 1. 15.

6)) = 19.38% .19(14 .ACCA F9 Financial Management Full Course Workbook Solutions! Working 3 .Fill into CAPM Rf (Risk Free Rate) 6 Rm (Ave return on the market) 14 Beta Ke = Rf + β(Rm .Rf) 1.19 (6 + 1.

e. no issue of debt or equity to finance the project. No change in capital structure i.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. 3. Re-gear the asset beta with our company’s financial risk to get a new ‘equity beta’ for that project. 2. . The project is small in relation to the size of the company. What are the steps to calculate a project specific discount rate? Select a ‘proxy’ company with the same business risk as the new project area. What are the two types of risk included in a company’s equity Beta? Business risk & financial risk. The project has the same risk profile as the company. What is capital structure? How much debt & equity a firm has. 4. Fill the new equity beta into CAPM. Un-gear the equity beta of the proxy to remove it’s financial risk and get the ‘asset beta’ which just includes the business risk of the new project area. When do we use the WACC as a discount rate? For a project in the same business area as the current business.

ACCA F9 Financial Management Full Course Workbook Solutions! 5. debt with a market value of 100 and equity with a market value of 200 calculate a project specific discount rate. The risk free rate is 4% and the average market risk premium is 7%.93 ((400 + 100 / 400) = 1.Re-gear βa with our capital structure βa 0. Proxy Equity Beta 1.2.4 Value of Equity of Proxy 200 Value of Debt of Proxy 100 βa = βe(Ve / (Ve + (Vd x 1-t)) 1.Fill into CAPM Rf (Risk Free Rate) 4 Rm (Ave return on the market) 12 Beta Ke = Rf + β(Rm .Rf) 1.92% . If the proxy has a Beta of 1. Ignore tax.93 Working 2 . Working 1 .163 Working 3 .Un-gear the proxy βe to get βa.4. Our business has a Beta of 1.24 (4 + 1.24(12 .93 Value of Equity of Company A 400 Value of Debt of Company A 100 βe = βa (Ve + (Vd x 1-t) / Ve) 0. debt with a market value of 100 and equity with a market value of 400.4)) = 13.4 (200 / (200 + 100)) = 0.

If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: December 2008 Q3 (c) June 2010 Q3 (c) (iii) December 2010 Q1 (c) Now do it! . 7. What are the 3 types of market efficiency? Weak form. The share price reflects public data as well as historic data. semi-strong form and strong form.ACCA F9 Financial Management Full Course Workbook Solutions! 6. Investors cannot therefore ‘beat the market’ as the price responds only to new information that investors do not have. Describe weak form market efficiency.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 19 More Debt .

Market Value Working 1 . The current ordinary share price of Phobis Co is $4·45 and this is expected to grow at a rate of 6·5% per year for the foreseeable future. (iii) conversion premium.10 Number of shares per $100 Conversion Value 20 6.Cash or Convert? Working Cash $100 Shares Current Value $4. (ii) floor value.065 to the power of 5) $6. each bond may be converted on that date into 20 ordinary shares of the company.89 II. Phobis Co has a cost of debt of 7% per year. Floor Value .5% growth 4.713 86.ACCA F9 Financial Management Full Course Workbook Solutions! December 07 Exam Question (6 marks) Phobis Co has in issue 9% bonds which are redeemable at their par value of $100 in five years’ time.90 5 Conversion Value 122 0.45 x (1.99 123.1 36.45 Value in 5 years with 6. Solution i. Alternatively.10 x 20 $122 Answer Period Item $ DR 7% PV 1-5 Interest 9 4. Required: Calculate the following current values for each $100 convertible bond: (i) market value.

ACCA F9 Financial Management Full Course Workbook Solutions! Period Item $ DR 7% PV 1-5 Interest 9 4.20 III.45 x 20 89 Expected Value in 5 years (W1) 123.89 / 20 1.1 36.89 Premium 34.89 Premium Per share 34.30 108.713 71.90 5 Minimum Redemption 100 0. Conversion Premium Current Conversion Value Working Amount 4.74 .

621 66. Luke Co has 8% convertible loan notes in issue which are redeemable in five years’ time at their nominal value of $100 per loan note.07 96. each loan note could be converted after five years into 70 equity shares with a nominal value of $1 each.33 5 Conversion Value 106. The equity shares of Luke Co are currently trading at $1·25 per share and this share price is expected to grow by 4% per year.52 70 Conversion Value $106. What is the current market value of each loan note to the nearest dollar? A.40 Period Item $ DR 10% PV 1-5 Interest 8 3.25 x (1. $92 B. $109 Answer B Working Cash $100 Shares Current Value $1. The before-tax cost of debt of Luke Co is 10% and the after-tax cost of debt of Luke Co is 7%.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1.4 0. $104 D. Alternatively.40 .5% growth 1.25 Value in 5 years with 6. $96 C.791 30.04 to the power of 5) Number of shares per $100 $1.

28 4 Minimum Redemption 100 0. The annual interest has just been paid for the current year. $92 C. The bond will repay the par value of $100 when it matures in seven years’ time. What is the the expected current market price of the bond to the nearest dollar? A. What is the the expected current market price of the bond to the nearest dollar? A.78 .5 5.5% per annum.855 85.81 7 Redemption 100 0.30 108.389 45. $106 Answer C Period Item $ DR 7% PV 1-7 Interest 8. The next interest payment will be made in one year’s time.50 106. $108 D. $93 C. $96 B.546 21.ACCA F9 Financial Management Full Course Workbook Solutions! 2. A bond has a coupon rate of 6% per annum and will repay its face value of $100 on its maturity in four years’ time.623 62. $98 B. A bond has a coupon rate of 8.11 3. The before-tax cost of debt is 7% and the after-tax cost of debt is 5%. The yield to maturity on similar bonds is 4% per annum. $107 Answer D Period Item $ DR 4% PV 1-4 Interest 6 3. $110 D.

ACCA F9 Financial Management Full Course Workbook Solutions! 4.713 75.06 to the power of 5) $3.5% growth 2.25 Value in 5 years with 6.01 Number of shares per $100 35 Conversion Value $105. The tax rate is 30% The equity shares of Angus Co are currently trading at $2·25 per share and this share price is expected to grow by 6% per year. Angus Co has 8% convertible loan notes in issue which are redeemable in five years’ time at their nominal value of $100 per loan note. $98 D.6 4.1 22. The before-tax cost of debt of Luke Co is 10% and the after-tax cost of debt of Luke Co is 7%. $96 C. What is the current market value of each loan note to the nearest dollar? A. each loan note could be converted after five years into 35 equity shares with a nominal value of $1 each. Alternatively.25 x (1.35 0.07 . $87 B.35 Answer Period Item $ DR 7% PV 1-5 Interest (8 x 0.7) 5.96 5 Conversion Value 105. $108 Answer C Working 1 .11 98.Cash or Convert? Working Cash $100 Shares Current Value $2.

Similar bonds have a yield to maturity of 10%.30 93.683 68. $94 C.66 . $96 B. The next interest payment is due in one year’s time. $100 Answer B Period Item $ DR 10% PV 1-4 Interest 8 3.36 4 Minimum Redemption 100 0.ACCA F9 Financial Management Full Course Workbook Solutions! 5. A $100 bond has a coupon rate of 8% per annum and is due to mature in four years time. What is the the expected current market price of the bond to the nearest dollar? A. $110 D.170 25.

4.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. What is the conversion premium? The difference between the expected conversion value and the current conversion value. What will the capital repaid figure in the IRR calculation be the higher of? Cash or conversion value. How is the floor value calculated? Discount the interest and the nominal capital to be repaid at the cost of the debt. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Now do it! . 3. What is the floor value of convertible debt? The minimum value that the debt should ever be. 2. How is the market value of convertible debt calculated? The present value of the interest and capital paid to debt holders. discounted at the cost of debt. 5.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 20 Currency Risk I .

25) = £1.Illustration 1 You have an invoice to pay to a US business of $1250 and you are a UK business. The rate offered by the bank is $:£ 1.ACCA F9 Financial Management Full Course Workbook Solutions! Buy or Sell Currency .1. 1.2500 .2500 For a receipt use the rate on the right We are making a payment so we use the rate on the left i.2500 Cost of $ (Amount of $ / FX Rate) ($1250 / 1.3500 How many £ will it take to pay the $125? Solution Bank sells low We want to buy $ with our £ and the bank will sell them to us at the low rate of 1.e.000 .

5500 How many £ will you receive for the $2000? Solution Bank sells low We want to sell the $ we will receive.1.Illustration 2 You have issued an invoice to a US customer of $2000 and you are a UK business.ACCA F9 Financial Management Full Course Workbook Solutions! Buy or Sell Currency .5500 Value of $ (Amount of $ / FX Rate) ($2000 / 1.5500 For a receipt use the rate on the right This is a receipt so use the rate on the right of 1.290 . The rate offered by the bank is $:£ 1. The bank will buy them from us at the high rate of 1.55) = £1.4500 .

08)) = 1. What will the FX rate be in 1 years time? Solution Current Spot Rate 2 Inflation in Counter (US) 6% Inflation in Base (UK) 8% Forecast (Spot Rate Counter x (1 + Inf in Counter / 1 + Inf in Base) 2 x ((1 + 0.06) / (1 + 0.Illustration 3 The current exchange rate is 2$ per £.ACCA F9 Financial Management Full Course Workbook Solutions! Purchasing Power Parity Theory . Inflation in the US is 6%. Inflation in the UK is 8%.96 .

ACCA F9 Financial Management Full Course Workbook Solutions! Interest Rate Parity Theory .02)) = 2.Illustration 4 The current exchange rate is 2$ per £. The interest rate in the US is 3%.02 . What will the FX rate be in 1 years time? Solution Current Spot Rate 2 Interest rate in Counter (US) 3% Interest rate in Base (UK) 2% Forecast (Spot Rate Counter x (1 + Int in Counter / 1 + Int in Base) 2 x ((1 + 0.03) / (1 + 0. The interest rate in the UK is 2%.

0500 is the same as saying $:£ 1.6000 +/.6000 +/.6500) = £303.Illustration 5 ABC Company has entered into a contract whereby they will receive $500. A 3 month forward rate is available at $:£ 1.0500. Calculate the amount of £ ABC would receive under the forward contract.ACCA F9 Financial Management Full Course Workbook Solutions! Forward Rate .0.1.030 .0.6500 (500. Solution A rate quoted at $:£ 1.000 / 1.6500 Rate to use (For a receipt use the one on the right) Convert ($ amount / Forward rate) 1.000 from a US customer in 3 months.5500 . ABC is a UK company.

.How much Foreign Currency? Amount of $ to pay 350. The transfer is made at the spot rate.000.000 x (100 / 101.5% Amount to deposit (Total $ discounted at 1. Exchange rate now: $:£ 1.Illustration 6 A UK business needs to pay $350.6500 . Deposit Rate in US per year 6% Deposit Rate for 3 months (Annual rate x 3/12) 6 x (3/12) = 1.827 We will deposit $344.5% annual How much £ will the transaction cost using a money market hedge? Solution Step 1 .5%) 350.7000 Deposit rates UK 4% annual US 6% annual Borrowing rates UK 5% annual US 6.1.827 in the US where it will earn interest of 1.000 to a US supplier in 3 months time.ACCA F9 Financial Management Full Course Workbook Solutions! Money Market Hedge .5) = $344.5% over the 3 months making it worth $350. We transfer the money now so that there is no more FX risk.000 when the payment becomes due.000 We will deposit the money in the US where it will earn interest so that in 3 months we have $350.

827 / 1. Spot rate (We are making a payment) Convert ($ Amount / Spot Rate) 1.986 Step 3 .986 (208.986 x 1.827 We transfer the money now so that there is no more FX risk.612) = £211.589 .6500) = £208.Borrow the Home Currency Amount to Borrow (Step 2) £208. The transfer is made at the spot rate.986 We will have to pay interest on the amount we have borrowed for 3 months.25%) = £2.986 + 2.Convert using the Spot Rate Amount to Transfer (Step 1) $344.25% Total Cost of transaction Amount transferred to US Interest on borrowings in UK (£ amount x 3 month UK borrowing rate) Total Cost (Amount transferred + interest incurred) £208.612 (208.ACCA F9 Financial Management Full Course Workbook Solutions! Step 2 . Borrowing Rate per year in UK 5% Borrowing Rate for 3 months (Annual Rate x 3/12) (5 x 3/12) = 1.6500 (344.

5% 6.ACCA F9 Financial Management Full Course Workbook Solutions! Money Market Hedge Illustration 7 A UK business will receive $350.625) = $344.000 in 3 months.000 We will borrow the money in the US now and transfer it home.625% over the 3 months making it worth $350. The transfer is made at the spot rate. We transfer the money now so that there is no more FX risk.403 We will borrow $344.7000 Deposit rates UK 4% annual US 6% annual Borrowing rates UK 5% annual US 6.403 in the US where it will earn interest of 1.625%) 6.6500 .5 x (3/12) = 1.000 when the receipt becomes due.000 x (100 / 101. Borrowing Rate in US per year Borrowing Rate for 3 months (Annual rate x 3/12) Amount to borrow (Total $ discounted at 1.How much foreign currency? Amount of $ to receive 350. Exchange rate now: $:£ 1.1.000 from a US supplier in 3 months time. .5% annual How much £ will the business receive using a money market hedge? Solution Step 1 .625% 350. We will pay off the loan in the US when we receive the $350.

ACCA F9 Financial Management Full Course Workbook Solutions! Step 2 .7000) = £202.026 (202. Deposit Rate per year in UK 4 Deposit Rate for 3 months (Annual Rate x 3/12) (4 x 3/12) = 1% Total Receipt Amount transferred to UK Interest on deposit in UK (£ Amount x 3 month UK borrowing rate) Total Receipt (Amount transferred + interest received) £202. The transfer is made at the spot rate.616 .Convert into home currency using spot rate. Amount to Transfer (Step 1) $344.590 Step 3 .403 / 1.403 We transfer the money now so that there is no more FX risk.590 (202.590 x 1%) = £2.590 We will receive interest on the money we deposit. Spot rate (We are receiving the foreign currency) Convert ($ Amount / Spot Rate) 1.590 + 2.Place the money on deposit in the UK Amount to Deposit (Step 2) £202.026) = £204.7000 (344.

six-month forward rate = 20·00 x (1·07/1·03)0·5 = 20·39 Dinar per $ 2. The home currency of ACB Co is the dollar ($) and it trades with a company in a foreign country whose home currency is the Dinar.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. What is the impact of a fall in a country’s exchange rate? 1 Exports will be given a stimulus 2 The rate of domestic inflation will rise A B C D 1 only 2 only Both1 and 2 Neither 1 nor 2 Answer C .00 Dinar per $ Interest Rate 3% per year 7% per year Inflation Rate 2% per year 5% per year What is the six-month forward exchange rate? A B C D 20·39 Dinar per $ 20·30 Dinar per $ 20·59 Dinar per $ 20·78 Dinar per $ Answer A Using interest rate parity. The following information is available: Home Country Spot Rate Foreign Country 20.

0.000 x (100 / 101.0. is a UK business that needs to pay $250.818 B. 6 Month Rate $:£ 1. £245.897 D. £181.000 Answer A 4. Borrowing rates in the UK are 3% annual and in the US are 4. £181.0.7000.75%) Convert at Spot Rate ($245. £206. £495. 3 Month Rate $:£ 1.000 to a US supplier in 3 months time. What will the transaction cost Hilasys Co. £148.5% annual. Deposit rates in the UK are 5% annual and in the US are 7% annual.75% £150.026 . Hilasys Co.0075) 250.5000 +/. Avecas Co.000 from a US customer on 01 April 2014. is a UK company.0500.700 / 1.818 B.6500 .909 D. The spot rate now is: $:£ 1.700 C.6000 +/.75) = $245. £193.ACCA F9 Financial Management Full Course Workbook Solutions! 3. has entered into a contract whereby they will receive $300.909 x 1. The date is 31 January 2014 and Avecas Co.909 3 x (3/12) = 0. £150.026 Answer D Amount of $ to pay Deposit Rate in US per year Deposit Rate for 3 months (Annual rate x 3/12) Amount to deposit (Total $ discounted at 1.548 C.1. receive under the appropriate forward contract to the nearest £.65) Borrow at home (Annual rate x 3/12) Total Cost (£148.? A. What amount in £ will Avecas Co. The following forward rates are available: 2 Month Rate $:£ 1.0500.75% 250.0500.4000 +/.700 £148.000 7% 7 x (3/12) = 1. to the nearest £ using a money market hedge? A.

£291.206 x 1. Varys Co is a UK business that will receive $500.5% annual.0125) £294. The spot rate now is: $:£ 1.000 4% 4 x (3/12) = 1% 500.7000. £495.1.846 .000 from a US supplier in 3 months time. £256.6500 .732 B.206 Deposit at home (Annual rate x 3/12) 5 x (3/12) = 1. £294. Deposit rates in the UK are 5% annual and in the US are 6.050 / 1.ACCA F9 Financial Management Full Course Workbook Solutions! 5.7) £291.25% Total Cost (£291. Borrowing rates in the UK are 3% annual and in the US are 4% annual How much to the nearest £ will the Varys receive using a money market hedge? A.000 x (100 / 101) = $495.846 C.050 Convert at Spot Rate ($495.206 D.050 Answer B Amount of $ to receive Borrowing Rate in US per year Borrowing Rate for 3 months (Annual rate x 3/12) Amount to Borrow (Total $ discounted at 1%) 500.

Offsetting receipts & payments in a foreign bank account.45.000 .45 = £344 For a receipt of foreign currency use the rate on the right.0.000? Rate to use: 1.1.paying up front. $/£ 1. 3. What will the FX rate be in one year’s time? Future rate = spot rate x (1 + inf in the counter) / (1 + inf in the base) Future rate = 1. Remember this as the base is always on the right or that this is dollars (plural) to the pound (singular).6 $400.45 which currency is the counter currency? The dollar. 5.35 .55 +/. Leading . UK company receiving $500.1.35. 6.000 / 1. How many £ will the company receive? 500 / 1.31 4. US inflation is 2%.05 for an amount of $400.35 .ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. How many £ will a company receive if they take a forward contract at a rate of $/£ 1. What are the disadvantages of a forward contract? Contractual commitment that you cannot renege upon. The spot rate is $/£ 1.paying when the rate is favourable. UK inflation is 5%. What are the internal methods of hedging currency risk? Invoicing in the home currency.55 + 0. 2.05) = 1. Spot rate is $/£ 1.02 / 1.6 = £250.35 x (1. Lagging .05 = 1. Can’t take advantage of favourable movements in the currency.

575 We transfer the money now so that there is no more FX risk.375% Amount to deposit (Total $ discounted at 1.ACCA F9 Financial Management Full Course Workbook Solutions! 7.5% and the borrowing rate is 6. The UK deposit rate is 4.508 . Deposit Rate in US per year 5. The transfer is made at the spot rate. The spot rate is $/£ 1.575 in the US where it will earn interest of 1. A UK company is going to pay $400.575 / 1. 8.000 x (100 / 101.575 We will deposit $394.000 We will deposit the money in the US where it will earn interest so that in 3 months we have $350.Convert using the Spot Rate Amount to Transfer (Step 1) $394. Spot rate (We are making a payment) Convert ($ Amount / Spot Rate) 1. The US deposit rate is 5.025. The transfer is made at the spot rate.000.How much Foreign Currency? Amount of $ to pay 400.5%.0.5 x (3/12) = 1. Calculate the cost of the payment if the company uses a money market hedge? Step 1 . How does a money market hedge eliminate the foreign currency risk? The transfer is made today at the spot rate so no more exposure to the risk.375% over the 3 months making it worth $400.375) = $394.000 when the payment becomes due.375%) 400.475) = £267.475 (394.5% Deposit Rate for 3 months (Annual rate x 3/12) 5.5% and the borrowing rate is 5. Step 2 . We transfer the money now so that there is no more FX risk.5%.000 to a US supplier in 3 months time.5 +/.

508 Interest on borrowings in UK (£ amount x 3 month UK borrowing rate) (267.ACCA F9 Financial Management Full Course Workbook Solutions! Step 3 .678 Total Cost (Amount transferred + interest incurred) (267.508 + 3.678) = £271.375% Total Cost of transaction Amount transferred to US £267.508 We will have to pay interest on the amount we have borrowed for 3 months.508 x 1. Borrowing Rate per year in UK 5.Borrow the Home Currency Amount to Borrow (Step 2) £267.5% Borrowing Rate for 3 months (Annual Rate x 3/12) (5.186 If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Pilot Paper Q2 (All except part (a)) December 2008 Q4 (a).5 x 3/12) = 1. (b) & (c) Now do it! .375%) = £3.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 21 Currency Risk II .

ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. It is an effective hedge. ‘There is a risk that the value of our foreign currency-denominated assets and liabilities will change when we prepare our accounts. It can be traded and thus closed out at any time.’ To which risk does the above statement refer? A B C D Translation risk Economic risk Transaction risk Interest rate risk Answer A 2. 4. 2. 3. The company can take advantage of “upside risk”. High transaction costs. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer C . Which of the following are advantages of a using a futures contract to hedge foreign exchange risk? 1.

A B C D 1 and 2 only 1 and 3 only 3 and 4 only 1 and 4 only Answer C 5. They can be arranged for standard contract sizes only 2. Which of the following are disadvantages of a using a futures contract to hedge foreign exchange risk? 1. There is a large premium to pay on the contract. Which of the following are disadvantages of a using an option on a currency to hedge foreign exchange risk? 1. There is a large premium to pay on the contract. High transaction costs. 3. There is no upside risk if the currency movement is in your favour 4. There is no upside risk if the currency movement is in your favour 4. They can be arranged for standard contract sizes only 2.ACCA F9 Financial Management Full Course Workbook Solutions! 3. It can be traded and thus closed out at any time. 4. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer B 4. It is an effective hedge. 2. They are available for a a wide range of currencies 3. Which of the following are advantages of a using an option on a currency to hedge foreign exchange risk? 1. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer D . The company can take advantage of “upside risk”. They are available for a a wide range of currencies 3.

What are the 3 types of FX risk? Translation. 5. It is exchange traded and can be closed out at any time for a profit or a loss.e. Buy or sell the future depending on the risk you wish to hedge. 2. They operate on 3 monthly cycles and are for specific contract sizes of currency. Can be traded and thus closed out at any time. 6. Economic. What is a futures contract? A futures contract is a contract to buy or sell currency in the future. Top up the margin daily if required. What are the disadvantages of a future? They can be arranged for standard contract sizes only. 4. 3. Translation risk is the risk that losses will be incurred in translating foreign assets or liabilities in the balance sheet at the year end. They are available for a limited range of currencies. There is no upside risk if the currency movement is in your favour. Pay the initial margin required.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. Economic risk is long term transaction risk i. Transaction. Explain each of the 3. Transaction risk is the risk that in the period between agreeing a transaction and settling it fluctuations in currency rates lead to a loss. It is an effective hedge. . What are the advantages of a future? Low transaction costs. How do you undertake a future contract? Call up the exchange. the risk that your operations in a foreign currency make FX losses over the long term.

10. Receive your profit or pay the loss accrued. What is an option? An option is the right but not the obligation to buy or sell a currency at a certain price in the future. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Pilot Paper Q2 (a) December 2008 Q4 (d) Now do it! . Options are available for relatively few currencies. 7.ACCA F9 Financial Management Full Course Workbook Solutions! Close out the transaction by trading in the opposite direction. 9. What is the main advantage of an option? The user of an option can take advantage of upside risk if the currency movement is favourable to them by choosing not to exercise the option. Are there any downsides to an option? The premium is expensive and has to be paid whether the option is exercised or not.What type of risk will an option hedge? Transaction risk. 8.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 22 Interest Rate Risk .

Which of the following are disadvantages of using an interest rate swap to hedge interest rate risk? 1. The decision to move into the swap may be the wrong decision as interest rates may change unexpectedly. Interest rate options carry an obligation to the holder to complete the contract at maturity C. Which of the following statements are correct in reference to using an ‘over the counter’ interest rate option to manage interest rate risk? A. It is an agreement with a bank that ensures that the company can take advantage of low rates. 4. Forward rate agreements are the interest rate equivalent of forward exchange contracts D. The transactions costs can be very high.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice Questions 1. It is a reversible agreement. which of the following statements is correct? A. There is a risk that one of the parties fails to pay their side of the swap. A B C D 1 and 2 only 1 and 3 only 2 and 3 only 1 and 4 only Answer B 3. but secure against high rates. 3. It enables the company to swap from a fixed interest rate to a floating rate or vice-versa. Answer B . B. C. It constitutes an contract with a bank to secure a specific interest rate no matter what happens. The flexible nature of interest rate futures means that they can always be matched with a specific interest rate exposure B. It is an exchange traded contract that can be closed out at any time. 2. In relation to hedging interest rate risk. D. Matching is where a balance is maintained between fixed rate and floating rate debt Answer C 2.

Which of the following statements about the yield curve is correct? 1. The flexible nature of interest rate futures means that they can always be matched with a specific interest rate exposure B. Expectations theory explains the yield curve as the market generally expects interest rates to be lower in the future. 4. In relation to hedging interest rate risk. which of the following statements is correct? A. In normal circumstances the curve is upward sloping.ACCA F9 Financial Management Full Course Workbook Solutions! 4. Forward rate agreements are the interest rate equivalent of money market hedging of foreign exchange risk D. The yield curve can be used to predict interest rates. 2 and 3 only 1 and 3 only 2 and 3 only 1. Smoothing is where a balance is maintained between fixed rate and floating rate debt Answer D 5. Interest rate options carry an obligation to the holder to complete the contract at maturity C. A B C D 1. Liquidity preference theory explains the yield curve on the basis that investors generally prefer cash. 3. 2. 2 and 4 only Answer D .

In what way does a Yield Curve slope? In normal circumstances the curve is upward sloping. Effectively this is a forward interest rate agreed with a bank.ACCA F9 Financial Management Full Course Workbook Solutions! Short Form Questions 1. 2. 6. but secure against high rates. Matching. What are the disadvantages of an interest rate swap? There is a risk that one of the parties fails to pay their side of the swap. What does a Yield Curve plot? Interest rates against the length of time or term of the debt. What internal methods may a firm use to manage interest rate risk? Smoothing. What is an Interest Rate Swap? Sn arrangement organised through a bank whereby two parties swap interest rate commitments. . Netting. Why might a firm use an interest rate option to manage interest rate risk? It means that they can take advantage of low rates. 3. 7. The decision to move into the swap may be the wrong decision as interest rates may change unexpectedly. It is a binding agreement. 5. What is an FRA? A forward rate agreement. The transactions can be complex. 4.

Market segmentation theory suggests that different investors have different requirements based on their own circumstances and that long term investors want higher yields leading to the upward sloping curve.ACCA F9 Financial Management Full Course Workbook Solutions! 8. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Now do it! . if they are going to tie capital up by lending it out for the longer term they will demand higher interest rates to compensate = upward sloping curve. What are the three ways in which theorists have sought to explain the slope of the yield curve? Expectations theory states that if debt is to be held for longer terms it is more likely that it won’t get paid back so higher interest rates are demanded to compensate so as the term gets longer the interest rate rises = upward sloping curve. Liquidity preference theory states that because investors prefer cash.

ACCA F9 Financial Management Full Course Workbook Solutions! Lecture 23 Islamic Finance .

halaal. C.ACCA F9 Financial Management Full Course Workbook Solutions! Test Your Knowledge If you can’t answer all of the questions below without looking at the answer then you need to do some more work on this area! Multiple Choice 1. It is possible under certain circumstances to charge interest on an Islamic Finance product. How will a mortgage work under islamic financial principles? The lender will own the property and the borrower will pay a rental amount and a capital repayment amount until the asset is owned.e. B. It is not possible for a financial product to be compatible with Sharia law. What is the main principle behind islamic finance? Money should not generate money i. What are the Islamic terms for ‘forbidden’ and ‘permitted’? Forbidden . D. 2. Answer B Short Form Questions 1. There is a lot of use of partnerships and joint ventures under Islamic Finance. which of the following statements is correct? A. What should money only be generated by? Labour. In relation to Islamic Finance. What is the islamic term for a bank loan? . 4. 5.haraam. Islamic Finance is only available to those of the muslim faith. 3. Permitted . no interest is allowed.

What is the islamic finance term for a joint venture? Musharaka. B takes care of minor maintenance. Rent will be paid from B to A. If you’ve successfully answered all of the above questions then you’re ready to do the exam questions below: Now do it! . What must debt finance relate to under islamic finance principles? An asset. A is responsible for the major maintenance of the asset.ACCA F9 Financial Management Full Course Workbook Solutions! Murabaha transaction. 8. 7. 6. How will lease finance (ijara) work under islamic finance? Party A will let party B use the asset.