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(2½ hours)

This paper consists of FIFTEEN objective test (OT) questions (20 marks) and THREE written
test questions (80 marks).

1. Ensure your candidate details are on the front of your answer booklet.

2. Answer each question in black pen only.

Objective Test Questions (1 – 15)

3. Record your OT responses on the separate answer sheet provided: this must not be
folded or creased. Your candidate details are printed on the sheet.

4. For each of the 15 OT questions there are four options: A, B, C, D. Choose the
response that appears to be the best and indicate your choice in the correct box, as
shown on the answer sheet.

5. Attempt all questions: you will score equally for each correct response. There will be
no deductions for incorrect responses or omissions.

Written Test Questions (1 – 3)

6. Answers to each written test question must begin on a new page and must be clearly
numbered. Use both sides of the paper in your answer booklet.

7. The examiner will take account of the way in which answers are presented.

A Formula Sheet and Discount Tables are provided with this examination paper.


Question papers contain confidential Place your label here. If you do not have a label
information and must NOT be you MUST enter your candidate number in this box
removed from the examination hall.


© The Institute of Chartered Accountants in England and Wales 2011 Page 1of 6

050 stretchers pa. © The Institute of Chartered Accountants in England and Wales 2011 Page 2 of 6 . using existing production facilities. The cost of labour is therefore expected to remain constant over the life of the contract at £300 per stretcher. Due to the highly competitive nature of the market for these component parts. but the company is considering making an investment in production facilities that would see its annual capacity rise to 1. In order to achieve the proposed increase in production capacity. HealthTrans is currently experiencing rapid growth in business levels. However. and it can be assumed that tax payments occur at the end of the accounting year to which they relate.500 stretchers pa. Southsea will only ever produce sufficient stretchers to meet that year’s annual demand ie. Labour costs are also expected to be subject to efficiency gains which will be sufficient to cancel out the effect of any wage inflation. However. Southsea plc (Southsea) manufactures high specification stretchers for its sole customer. HealthTrans plc (HealthTrans). which supplies ambulances and ancillary products to the UK National Health Service and a range of private hospitals and firms. As a result. At the present time Southsea has a production capacity of 1.000 stretchers. The company’s corporation tax rate is expected to be 28% for the foreseeable future. Sufficient profits are available for the firm to claim all such tax allowances in the year they arise. but rather is expected to fall at a compound rate of 1% pa over the life of the contract due to the economies of scale that would arise from the increased levels of production.1. this cost will not be subject to annual inflation. the new contract with HealthTrans will go ahead. investment in production facilities of £2 million would be required and this would take place on 31 December 2011. In the year ending 31 December 2011. In any one year. whether or not Southsea decides to increase its production capacity. HealthTrans forecasts that this demand will rise at a compound rate of 10% pa over the five years of the new contract. the price per stretcher is £2. Demand from HealthTrans under the existing contract in the year ending 31 December 2011 is expected to be 1. Anticipated efficiency gains associated with the increased production levels also mean that the impact on working capital requirements and fixed costs will be negligible and can be ignored. it will not hold inventory. assuming that Southsea were able to supply all of its needs. The directors are also assuming that the new facilities will attract full capital allowances at 20% pa on a reducing balance basis commencing in the year of purchase and continuing throughout the company’s ownership of the new facilities. The total cost of the component parts of each stretcher during the year ending 31 December 2011 is £1. Under this contract HealthTrans would guarantee to buy its entire stretcher requirements from Southsea.500. Southsea has recently been offered a new five-year contract with HealthTrans which will start on 1 January 2012.200. which is expected to be 2% pa up to 31 December 2014 and 3% pa thereafter. A balancing charge or allowance will arise on disposal of the new facilities which can be assumed to be on 31 December 2016. The new facilities would have an estimated useful life of five years at the end of which they are estimated to have no residual value. but the contract on offer contains a commitment from HealthTrans to accept an increase in this price over the period of the contract at the UK rate of inflation.

(3 marks) (22 marks) PLEASE TURN OVER © The Institute of Chartered Accountants in England and Wales 2011 Page 3 of 6 . As the relationship between Southsea and HealthTrans has developed. and its accounting year end is 31 December.The company’s real after-tax cost of capital is 7% pa. Assume that all annual operating cash flows arise at the year end. on the basis of your calculation. (16 marks) (b) Identify and explain the type of real option that might be most relevant to Southsea’s consideration of its investment decision. directors of both companies have increasingly considered the possibility of a merger between the two companies. state whether or not Southsea should proceed. Requirements (a) Calculate the net present value at 31 December 2011 of the proposed investment in increased production facilities and. (3 marks) (c) Outline in general terms the potential advantages of a merger between Southsea and HealthTrans.

The most recent management accounts for HH can be summarised as follows: Income Statement for the year ended 31 May 2011 £’000 Revenue 11.250 4. the consideration paid for these shares was based on an estimated valuation provided by HH’s auditors of £4 per share. the residential courses on offer and the range of activities included in them have been restricted by the level of accommodation available in Havant Hall itself and by the fact that HH has never used long-term external finance to invest in developing the available facilities. the family is now keen to expand both the accommodation on the estate and the range of activities on offer to clients. A recently commissioned report by a firm of management consultants has estimated that HH’s proposed expansion plans will cost £2. sold his shares to other members of the family. However. all of its shares have been owned by members of the Elliot family.281 Tax (359) Profit after tax 922 Dividends (433) Retained profit for the year 489 Balance Sheet as at 31 May 2011 £’000 Non-current assets 4. team-building and management development. The company’s client base comprises principally of local government bodies who send groups of disadvantaged children for residential stays at the estate and private firms who send employees on people development programmes centred on all aspects of leadership. Upon his retirement. © The Institute of Chartered Accountants in England and Wales 2011 Page 4 of 6 .8 million. Havant Hall Ltd (HH) is a small private company that runs a residential activity centre from a stately home.250 Share capital (ordinary £1 shares) 2. Havant Hall. Within its current assets HH has only a small cash balance and within its current liabilities it has no borrowings. John Elliot.000 Retained profits 2. and its 125-acre estate in southern England. In addition. who has retired.2.228 Current assets 616 Current liabilities (594) 4. At the time. following the recent appointment of Andrew Elliot as chief executive in succession to his father.250 Returns on invested funds and the proportion of profits retained are consistent with previous years. Since HH was established almost 15 years ago.024 Profit from operations 1. John Elliot. the former chief executive.

(7 marks) (d) Without using calculations. and (ii) explain the implicit assumptions underlying the use of HH’s resultant weighted average cost of capital as a discount factor in appraising the proposed expansion. identify the methods that the company’s auditors might have used to value HH’s shares. (8 marks) (c) If debt finance were to be used: (i) explain the benefits that might accrue to HH if the proposed expansion was financed by convertible loans rather than an ordinary bank loan. Requirements (a) Calculate HH’s cost of capital. given HH’s particular circumstances. as an alternative to a rights issue.There has been much debate among the directors regarding the source of finance for the firm’s proposed expansion. and. (7 marks) (b) Discuss the advantages and disadvantages of a rights issue to fund the proposed expansion. stating and justifying the assumptions and methodology you employ. with some directors wishing to continue with the policy of no long-term debt and others believing that debt finance should be the preferred option. (6 marks) (28 marks) PLEASE TURN OVER © The Institute of Chartered Accountants in England and Wales 2011 Page 5 of 6 . whether a listing on the Alternative Investment Market (AIM) would be appropriate.

35. The following information is available: (1) The quotation for a ‘3-6’ forward rate agreement is currently 2.000 in three months’ time.1. in three months’ time.000) is currently trading at 97.1185 . the spot rate of interest is 3% pa and the price of the interest rate futures contract has fallen to 97.3.1200/£. the money market. (4 marks) (ii) Explain how Fratton could use sterling interest rate futures to hedge its exposure to interest rate risk and show the effect if.40 3.2000/£.18 2.0.60 – 1.40% pa and the relevant three-month sterling interest rate futures contract (standard contract size £500. (2) The spot rate of interest today is 2.1. . and.(a) Fratton plc (Fratton) trades extensively in Europe. the spot rate of interest is 3% pa. (5 marks) (30 marks) © The Institute of Chartered Accountants in England and Wales 2011 Page 6 of 6 . (2) €1. the forward market.15% 2.960. The firm is due to receive €2. The following information is available: (1) The spot exchange rate is currently €1. (14 marks) (ii) Discuss the advantages and disadvantages of using futures contracts as opposed to forward contracts when hedging foreign currency exposure.59 cent premium.1. in three months’ time Fratton will be drawing down a three-month £2.(b) In addition.500) are as follows: Exercise price Calls Puts €1.1856/£.79 . Requirements (i) Explain how Fratton could use a forward rate agreement to resolve the uncertainty surrounding its future borrowing costs and show the effect if. in three months’ time.40% Eurozone 0. (7 marks) 3.5 million loan facility which is granted each year by its bank to see the firm through its peak borrowing period.60 (4) Annual interest rates at the present time are as follows: Deposit Borrowing UK 1. (2) The three-month forward rate of exchange is currently at a 0. the options market. (3) The prices of three-month sterling traded option contracts (premiums in cents per £ are payable up front.20. .1985 .75% 1. assuming the spot exchange rate in three months is: (1) €1.60% Requirements (i) Calculate the net sterling receipt that Fratton can expect in three months’ time if it hedges its foreign exchange exposure using: .1845 . with a standard contract size of £62.