# Financial Management - Professional Stage – December 2011

MARK PLAN AND EXAMINER’S COMMENTARY
The marking plan set out below was that used to mark this question. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication.
More marks were available than could be awarded for each requirement. This allowed credit to be given for a
variety of valid points which were made by candidates.

Question 1
Total Marks: 24
A question that exposed weaknesses in both technical knowledge and in the ability of candidates
to reflect accurately on the methodologies they have employed.
(a)(i)
Ordinary shares
Ke = D0 (1 + g) / P0 + g
Ke = 0.104(1 + 0.04)/(2.42 – 0.104) + 0.04
Ke = 8.7%
MVe = £138.96m (ex-div share price 231.6p x 60m)
5% irredeemable preference shares
Kp = D / P0
Kp = 5 / 103.5 x 100
Kp = 4.83%
MVp = £25.875m (£103.50 x 25m)
9% redeemable loan stock
T0
T1-7
T7

Cashflows
Ex-interest market price (117.00)
Interest (after-tax 9 x 0.72) 6.48
Repayment of capital
100.00

1%df
1
6.728
0.933

PV
(117.00)
43.60
93.30
19.90

5%df
PV
1
(117.00)
5.786
37.49
0.711
71.10
(8.41)

Kd = 0.01 + {(19.90/(19.90 + 8.41) x 0.04}
Kd = 3.8%
MVd = £23.4m
WACC
(MVe x Ke) + (MVp x Kp) + (MVd x Kd) / MVe + MVp + MVd
(12,089,520 + 1,249,763 + 889,200) / 188,235,000
WACC = 7.56%
(a) (ii) There are some problems with the DVM’s underlying assumptions, as follows:
1. Shares have value because of the dividends, which is not always true – some firms have a deliberate
policy of no or low dividend payouts, which would render any valuations using the methodology rather
unrealistic
2. Dividends do not grow or grow at a constant rate, but the former is unrealistic, and whilst the latter may
be realistic in the long term it can be subject to short-term fluctuations which undermine calculations of
the cost of equity
3. Estimates of dividend growth rates tend to be based on historic patterns rather than the actual future
facing the firm and its likely future earnings, consideration of which might produce more meaningful
cost of equity calculations
4. Share prices are constant, which is clearly not the case
In the first section, the most common error in calculating the cost of equity was failure to deduct
the dividend from the cum-dividend share price. In calculating the cost of the irredeemable
preference shares, many candidates incorrectly incorporated tax into their answers. Most
candidates coped well with the remaining sections of this part of the question.
Total possible marks
11
Maximum full marks
10