CIMA P9 SLFS Revision Notes

May 2009

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Strategic Level
CIMA
P9 Financial Strategy

Exam Focused
Revision Notes
May 2009
These notes are not intended to cover the whole syllabus, but target key examinable areas.

Tutor:

Sunil Bhandari

Tutor Contact Details

Mobile: 07833 096979
E-mail: via
www.IntelligentAccountancyTutorsLtd.co.uk

Copyright to Intelligent Accountancy Tutors Ltd

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 Sunil Bhandari – IAT Ltd

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CIMA P9 SLFS Revision Notes

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CIMA P9 SLFS Revision Notes

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CIMA P9 SLFS Revision Notes

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CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 5 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 6 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 7 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 8 .

cross out 2  Rank them  Jot down / plan them Next 180 minutes  Do section B questions first  Don’t exceed 90 minutes. target 85 minutes  Target marks 2 x 15 = 30  Do section A last  Should have 95 minutes  Target marks 1 x 25 = 25 ________________________________________________________________________  Sunil Bhandari – IAT Ltd 9 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Exam Technique First 20 minutes  Read section B questions  Pick 2.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ General Numerical Questions  State formula  Show method  Explain as you go  Make assumptions if in doubt Written Questions  Check format – report / essay  Headings / subheadings / columnar  Simple short paragraphs  Number points / paragraphs (report)  Use a “catch-all” paragraph if under time pressure  Use bullet points as matter of very last resort (unless requirements says “list” – then this format is OK) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 10 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Tips These will be distributed to on the last day of revision. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 11 . If you are not attending one of my revision courses please let me know and I will email them out to you.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 12 .

1 For profit making business “Maximise Shareholder(S/H) Wealth” 1.3 To find Po:  Given in the Question if it is a multinational corporation or listed company  Compute Using:    Asset Valuation Models Dividend Valuation Model(DVM) Earnings Based Models Discounted Cash Flow Approach(DCF) 1.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter One Financial Objectives 1 Primary Financial Objective 1.2 To Measure S/H wealth Value of Equity (Ve) =Number of issued Equity/Ordinary Shares X Current Market Price (Po) 1.4 Check the question very carefully for the size of the company is it: Multinational Company(MNC) *  Listed*  Private Company *Only for these will a market value exist on a stock exchange ________________________________________________________________________  Sunil Bhandari – IAT Ltd 13 .

2. External Factor Affecting Ve & Po 3. Two major external factors are: Economic Variables  Regulators 3.1 The Board cannot control all aspects that effect Ve and/or Po.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2 Indicators 2.If they fall: Stimulate Demand and Revenue  Lower the cost of debt and improve profits ________________________________________________________________________  Sunil Bhandari – IAT Ltd 14 . (Board) 3.1 Interest Rates.1 Financial indicators pointing towards maximising S/H wealth include:      Earning per share(EPS) Dividend per share(DPS) Return on Capital Employed(ROCE) Return on Shareholder Capital(ROSC) Profit after tax Revenue 2.2 Non-Financial Indicators include:  Market Share  Customer Satisfaction  Quality Measures The above are all Key Performance Indicators (KPI’s) that need to be measured and reviewed on a regular basis by the board of directors.2 Economic Variables 3.

If it rises: Costs rise causing a drop in profits  Cause interest rates to rise.2 Inflation Rates.3.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------  Investors switch to share market for better returns 3.1 Are there to control the excesses of natural monopolies like utility companies.5 General Taxation –If it rises: Damage company profits  Not encourage investment by companies Important to relate your comments to the effect upon Po & Ve.2.  Devalues the home currency 3.4 Gross Domestic Product.2.3 Regulators 3. 3.3 Foreign Exchange Rate(FOREX).If it falls: Reduce demand and revenue  Cause interest rates to fall to stimulate demand 3.2.2.If it rises: Reduce cash receipts for exporters  Lowers the cost for importers  Discourage exporting 3. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 15 .

3.2.e. effect upon variability of the cash flows and profits.2. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 16 .2 Regulator actions generally reduce S/H wealth via:  Fines  Restricting Dividends  Capping Selling Price Increases  Enforcing Reinvestment of Cash.2 Must always consider how investments impact upon: Company Liquidity  Future Profits and Asset values  Business Risk Profile i.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3. 4 The Three Key Decisions 4.1 Allocate cash for: Organic Growth (Projects)  Acquisitions 4.1 To maximize S/H wealth the board must take  Investment  Finance  Dividend 4.2 Investment 4.

2 They will consider: Cash available within the company  Access to new sources of finance  Impact on KPI’s like gearing ratio(Debt:Equity)  Cost of Finance (WACC or Ko) 4.1 To finance investments the board have to decide the best balance of equity and debt. 4.4.4 Dividends 4.3 Finance 4.1 The Board needs to establish a dividend policy – see Chapter 2 4.3. Example:New projects need new finance but must generate cash to service the finance providers including paying dividends to the shareholders.3.5 The three decisions are interlinked.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 17 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 5 Objectives of Not-For-Profit.Organisations (NFP’S) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 18 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 19 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 20 .

________________________________________________________________________  Sunil Bhandari – IAT Ltd 21 . 2 Theories Several theories have been put forward to assist:2. The Ve will rise and the S/H can sell shares to create the cash the need(Manufacture Dividends). b) Maintain the payout ratio (DPS/EPS) c) Maintain the same year-on-year growth rate in dividends.1 Residual – If spare cash exists at the end of the year pay dividend.2 Pattern – Be consistent with dividend payments. 2.3 Irrelevancy (M&M) In a perfect capital market providing the directors can invest in projects with a positive NPV no dividends are required. Either a) Pay the same dividend per share (DPS) each year.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Two Dividend Policy 1 Introduction To maximise S/H wealth the Board should establish a dividend policy-the payment pattern to the equity investors.The latter links into the Po via the dividend valuation model (DVM) 2.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3 Practical Considerations There are many to consider:  Availability of Cash  What dividends to S/H want (clientele effect)?  Signalling effect –payment of dividends indicates a healthy company  Retaining cash is a key source of Finance.  Risk-paying now is safer than promising to pay next year  Is the dividend within the company law regulations? 4 Alternatives to Cash Dividends 4.1.1. 4.2 This will allow the S/H to sell extra shares for cash and the gain will be subject to CGT.1.3 The effect will:a) Increase the issued equity capital b) Dilute EPS and Po values c) Create pressure for the board to pay more total dividends in the future as more shares are in issue ________________________________________________________________________  Sunil Bhandari – IAT Ltd 22 .1 Scrip Dividends 4. 4.  Dividend growth should be greater than inflation  Tax impact upon S/H  Effect the dividend will have on dividend cover(EPS/DPS)  Number of investment opportunities will restrict dividend payments.1 The S/H will receive extra shares instead of cash on a pro rata basis.

c) Tax implications for the S/H(CGT) d) Reduced number of shares will cut supply for trading purposes.2 Considerations:a) Allowable under company law. i. f) Criticism-is this the best use of company cash.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4.1 If the board has “one off” period of excess cash. Buy back shares at Po and cancel them. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 23 .2 Share Buy Back 4.e. e) Less dividend pressure on the board in future. they could consider a share buy back. b) Increase gearing as Ve may fall. 4.2.2.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 24 .

g.3 Alternative Presentations a) Ratio (Vd:Ve) e. 1:4 b) Gearing Percentage e. 35% Hence Vd=35.2 Vd=Total Book value of the Debt X Po $100 2.g.Ve=65 For WACC equation ________________________________________________________________________  Sunil Bhandari – IAT Ltd 25 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Three Cost of Capital 1 Weighted Average Cost of Capital (WACC or Ko) Ke=Cost of Equity Kd=Should be “Kd(1-t)”=Cost of Debt Ve=Market Value of Equity Vd=Market Value of Debt 2 Market Values 2.1 Ve=Total Number of Issued Shares X Po 2.

3 DVM Where Po=Ex Dividend Share Price d1=The DPS at Time 1 do=The DPS at Time 0 g =Constant annual future growth rate in the DPS 3.4 Other Ke Formulae ________________________________________________________________________  Sunil Bhandari – IAT Ltd 26 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3 Cost of Equity (Ke) 3. 3.2 CAPM Ke=Rf+ (Rm-Rf)βe where Rf=Risk free return Rm=Return on the market portfolio (Rm-Rf)=Market premium βe=Risk measure for the risks being faced by the S/H 3.1 The minimum return required by the S/H to compensate for the risks they face from the equity investment.

4.2.1 These are issued and traded in blocks of $100 or £100. the yield)  “Kd (1-t)”=Interest Rate X (1-t) 4.Do all computations per block of “100”.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4 Cost of Debt (Kd (1-t)) Depends upon the type of Debt Also note:a) Kd=Called Yield b) “Kd (1-t)”=Cost of Debt 4.2 Undated Bonds-the process is:a) Establish the Kd(Yield)  Given in the question  Kd(Yield)= Ints Po b) “Kd (1-t)”= Yield X (1-t) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 27 .e.2.1 Non traded debt (Bank Loans)  Kd is the Interest rate on the loan(i.2 Traded Bonds 4.

3.1 The Ko is the money or nominal cost of capital to use in project DCF approaches.3 Redeemable Bonds-the process is via IRR computation Time To Po $ (X) Ti-Tn Ints x (1-t) X Tn Capital Repayment Take two guesses at the Kd(1-t) like 10% & 1% and Perform IRR computation X 5 Uses of the WACC(Ko) 5. Ke ________________________________________________________________________  Sunil Bhandari – IAT Ltd 28 .2 The Ko is useable if the new project under consideration:a) Is a core activity –same as the company’s normal activities b) Does not alter the capital structure of the company (Vd:Ve) 6 What if’s? 6. 5.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4.g.1 Extend the WACC formula for all extra methods of company finance. So you could have a WACC with:    Equity Preference Capital Bank loans Traded Bonds 6.2 Be ready to rearrange the WACC to find missing figures e.

3 Redeemable Bonds Time $ Yield% PV T1-Tn Ints X X X Tn X X X Capital Repayment* Po = XX ________________________________________________________________________  Sunil Bhandari – IAT Ltd 29 .1 The market value is Po/$100 and can be established via the DVM “The present value of future cash flows received by the investor and discounted at the yield(Kd)” 2.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Four Bonds –Yields and Market Values 1 Bonds Debt which is issued in blocks of “100” and trades on the stock exchange. 2 Market Value 2.2 Undated Debt Po= Ints Yield 2.

1 Undated Bonds Yield = Ints Po 3.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2. 3 Yield 3.2 Redeemable Bonds Time To Po $ (X) T1-Tn Ints X Tn Capital Repayment X Take two guesses at the yield say 10% & 1% and perform IRR computation 4 Bank Loans  Yields=Interest Rate  No Market value ________________________________________________________________________  Sunil Bhandari – IAT Ltd 30 .4 Convertible Bonds Replace the * Capital repayment with the share value if higher than the cash repayment.

Risk adjusted WACC= Project Ke (Ve/Ve+Vd) + Kd(1-t)(Vd/Ve+Vd) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 31 . Put the Project βe into CAPM Project Ke =Rf + (Rm-Rf) Project βe d. Take the Proxy Company Beta equity and degear via b. 2 Process a. Establish the company’s “Kd (1-t)”-See Chapter 3 e.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Five Risk Adjusted WACC 1 Uses This is the money cost of capital for DCF project appraisal when: Project is non-core  No change in company’s capital structure or told a specified project gearing ratio. Re-gear βa to find the project βe c.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3 Concerns  Will the project finance truly have no effect upon the company’s gearing?  Proxy company βe:a) Does it exist? b) Does the proxy company specialise in the noncore field or does it have many different business activities c) If we are not listed-how do we gear up the βa ________________________________________________________________________  Sunil Bhandari – IAT Ltd 32 .

3 Combining Equities a) Created a weighted average portfolio Beta i.e (Cash in Share (1)/Total Cash in Equities X β1) + (Cash in Share (2)/Total Cash in Equities X β2 ) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 33 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Six CAPM 1 CAPM Equation Minimum return = Rf+ (Rm-Rf) β There are several uses of the CAPM equation: To find the company’s Ke(Chapter 3)  Risk Adjusted WACC(Chapter 5)  Assist a stock market investor to buy or sell equities 2 CAPM & Buy/Sell Equities 2.1 Single Equity  Take/Find βe  Put into CAPM Minimum Return = Rf+(Rm-Rf)βe  Forecast a return for the investment (could use past returns)  Forecast exceeds/equals minimum return-Buy or Keep the share 2.

2 βe can be split into: Systematic Business Risk-measured by βasset  Financial Risk 3.3 Sytematic risk is how market factors effect that investment.3 CAPM assumes that the investor eliminated the unsystematic risk. 3.1 A βe is the measure of risk being faced by equity shareholders 3. Market factors are: Macroeconomic variables  Political factors The measure is relative to the benchmark of the market portfolio.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ b) Put into CAPM Minimum Return = Rf+(Rm-Rf)Weighted Average β 3 Meaning of a βe 3. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 34 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 35 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4 Criticisms of CAPM ________________________________________________________________________  Sunil Bhandari – IAT Ltd 36 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 5 Arbitrage Pricing Theory ________________________________________________________________________  Sunil Bhandari – IAT Ltd 37 .

e Tax Shield Constraints on the level of debt from a) Articles Of Association b) Loan Agreements. Level of Tangible Assets on which secure the loans. Interest will lead to tax savings i.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Seven Capital Structure 1 Introduction How should the company decide the mix of equity and debt capital? 2 Practical Issues If the company uses Debt capital funding it should consider:       Credit Rating of the company Rate of interest it will pay Market conditions.access to Debt capital Forecast Cash Flows-to service and repay the debt.  Effect upon the company gearing ratio Debt/Equity+Debt OR Debt/Equity  Will the debt providers exercise influence over the company?  The chance of bankruptcy. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 38 .

2 Traditional View Key Points:1) Ke rises due to financial risk caused by gearing.1 Common Ground-both major views accept two facts:a) Yield<Ke b) Gearing causes Ke to rise 3. 2) Kd is initially uneffected by gearing but rises at “high” gearing levels due to the perception of the possibility of bankruptcy.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3 Theories of Optimal Capital Structure 3. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 39 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3) Ko-trade off of Ke and Kd.3 MM and Tax Key points:1) Assumption behind the model:All debt is risk free Only corporation tax exists Debt is issued to replace Equity All types of debt carry one yield. 4) Once point X is reached via trial and error it must be maintained. Point X is the optimum gearing level where WACC is lowest. 3. the risk free rate  Full distribution of profits  Perfect Capital Market     ________________________________________________________________________  Sunil Bhandari – IAT Ltd 40 .

3) Specific Equations under MM and tax. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 41 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2) MM concluded companies should gear up to the maximum levels.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 42 .

3 Decision rule is:ARR> Target return-accept the project OR Take the project with the highest ARR ________________________________________________________________________  Sunil Bhandari – IAT Ltd 43 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Eight Project Appraisal 1 Accounting Rate of Return (ARR) 1.1 Average Annual Post Depreciation Profit Investment X 100 1.2 Investment is:a) Initial Investment b) (Initial Investment +Scrap Value) 2 1.

4 Limitations and Strengths ________________________________________________________________________  Sunil Bhandari – IAT Ltd 44 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1.

2.1 NPV is the increase in S/H wealth arising from the project.0 X X (X) X X $XXX ________________________________________________________________________  Sunil Bhandari – IAT Ltd 45 .2 Two formats to consider Format (A) Format B Time To T1-Tn T2-Tn CF R% PV$’000 (X) X X NPV 1.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2 Net Present Value (NPV) 2.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2. Money Cash Flow=Real Cash flow X(1+i)n b) Cost of Capital-Money/Nominal Cost of Capital. ii.5 Inflation-incorporate into:a) Cash Flows i.3 Incremental Cash Flows  Result from/caused by the project  Include opportunity cash flows  Ignore: Non-Cash Flows  Sunk Costs  Interest /Dividend payments 2. Given Ko or Risk Adjusted Ko (1+m)=(1+r)(1+i) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 46 . This can be:i.e. iii.4 Financial Maths Required:1) Compounding 2) Discounting(tables) 3) Annuity Discounting(tables) 4) Delayed Annuity 5) Perpetuity 6) Delayed Perpetuity 7) Perpetuity with Growth 8) Delayed Perpetuity with Growth 2.

CIMA P9 SLFS Revision Notes

May 2009

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2.6 Working capital-think of as a project bank account:i.
ii.
iii.

Invest at To
Adjust each year
Close at end of the project.

2.7 Forecasting Exchange rates can use either:a. PPPT

b. IRPT

2.8 Taxation-relevant cash flows to be included in the NPV
computation.
1) Operating Flows x Tax rate
2) Tax saved on Capital allowances or Tax Allowable
Depreciation(TAD):-

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a) Tax saved on Capital Allowances
To

T1

Buy Asset

T2

CLAIM
WDA

Time
T2 asset value X 25%
X Tax %

Save Tax

Tax Saved
$’000
X

T3 last year tax saved
X 75%

X

T4 last year tax saved
X 75%

X

(Sell Asset) T5 last year tax saved
X 75%

X

T6

Balance figure

X

Tax %( Asset Value-Scrap)

XX

b) TAD normally straight line
(Asset Value-Scrap Value)
Life of Asset

=TAD

TAD x Tax Rate=Tax Saving

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3) Double tax –Regular issue with Forex NPV
Example-Taxable flow abroad in year 2 is
$100K.Tax abroad is 20% and in the UK
is 30% Spot rate at T2 is $1.60/£.
Foreign tax = $100K X 20% = $20K
Additional UK Tax = $100K X 10% =£6.25K
$1.60

3 Internal Rate of Review (IRR)
3.1 The cost of capital that gives an NPV=Nil
3.2 Approach-Take the following example:
NPV@ 10% =$200K
NPV@ 20% = ($15K)
IRR= 10+ (200/200-(-15)) x (20-10) =19.30%
3.3 Decision Rule
IRR>Project Cost of Capital-Accept

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3.4

PROS

CONS

*Easier to explain
*Simple decision rule

*Will mislead if comparing
projects
* If cash flows are nonregular (-, +, +, +,-)
IRR computed above is
incorrect

4 Modified IRR (MIRR)
4.1 Solves the weakness of IRR
4.2 Approach via example
Time
To
T1
T2
T3

$’000
(50)
40
40
(5)

R =10%
i.

Terminal Value of Future cash flows
Time
T1 40 x 1.10 x 1.10
T2 40 x 1.10
T3

$’000
48.4
44
(5)
87.4

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20% 4.e. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 51 .Credit Crunch Crisis Internal within the Company Eg:.Capex Budget 5.2 Causes: Hard Soft External constraint on Raising cash.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ii) Effective Discount Rate $50K = 0.572 $87.3 Period –only single period is examinable i.572 i.e.1 A restriction of cash preventing the Co from accepting all projects with a positive NPV 5.4K iii) Check the tables for a T3df aprrox equal to 0.Eg:.3 Decision Rule MIRR>Project cost of capital-Accept 5 Capital Rationing 5. cash may Be restricted at T0 or T1.

2 E. 6.NPV = NPV Annuity Factor for life of the project @cost of capital ________________________________________________________________________  Sunil Bhandari – IAT Ltd 52 .4 Divisible projects –can invest in proportions of a project from 0% to 100% maximum. Approach:1) Compute Project NPV’S 2) Take best combination of projects that maximise The total NPV but spend less than or equal to cash available in the critical period.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 5. Approach:1) Compute Project NPV’s 2) Compute Profitability Index(PI) = NPV Cash available at critical Period 3) Rank-High to Low PI 5.5 Non-Divisible –take all or none of any project. 6 Equivalent Annual NPV 6.A.1 If projects are mutually exclusive and of unequal lives – basis of comparison.

0 Sales in T1 for NPV= (2000 X 0.0 0.E Factor 1.Example:Time T0 T1 T2 $’000 (1000) 700 900 C.90 0.85 Adj CF (1000) 630 765 RF% 1.30 1.70)+ (1000 X 0.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 7 Accruing for Risk or Uncertainty within NPV Several methods. the best are:1) Certainty Equivalents-Reduce cash flows by C.30) =$1700K 3) Risk adjusted WACC –See Chapter 5 4) Real if:    Options – may exist for a project Option to have a follow on project Option to abandon early Option to wait and see Strategic option-open up new markets ________________________________________________________________________  Sunil Bhandari – IAT Ltd 53 .0 X X 2) Probabilities –One project cash flow may be uncertain.70 0. Example Sales in year 1 $’000 2000 1000 P 0.E factor prior to discounting .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 8 Post Completion Audit (PCA) 9 Adjusted Present Value (APV) 9.3 Stage One 1. 9.1 Used when project: Core of non-core  Specific project Finance including Debt 9. Ascertain Keu for the project: Given  Use βasset & CAPM  Rearrange 2.2 Two stages  Stage one NPV@Keu  Stage two PV of finance cash flows APV is combined stage one plus two. Compute NPV@ Keu ________________________________________________________________________  Sunil Bhandari – IAT Ltd 54 .

4 Other Finance Cash Flows to be aware of:a) PV of tax shield may be bared upon debt capacity and not loan raised . PV of Tax Sheild i. an additional benefit is Subsidised Loan X Ints saved X(1-T)X Annuity factor at RF% or Kd% for relevant period ________________________________________________________________________  Sunil Bhandari – IAT Ltd 55 .Hence Debt capacity X Kd X Tax rate X Annuity factor at RF% or Kd% for relevant period b) Subsidised loan-if a loan is at a subsidised rate. PV of issue costs .e. Choose discount rate from: RF% or  Kd% 2. Debt Raised X Kd X Tax Rate X Annuity factor at RF% or Kd% for relevant period 9.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Stage Two 1.Take care with: Timings  Tax deductible 3.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ ________________________________________________________________________  Sunil Bhandari – IAT Ltd 56 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Nine Business Valuations & Mergers &Acquisitions 1 Pre-Acquisition Values 1.2 The Net Asset value equals the Ve and can be based on:a) Book Values b) Net Realisable Value c) Replacement cost 1.2 Net Asset Valuation 1.1 The aim is to find a range of values for a company.2.1 Business is worth just the value of it’s Net Assets. To establish the net assets:Total Assets-(Total Liabilities +Preference Shares) 1.2.Eg: Property Investment company ________________________________________________________________________  Sunil Bhandari – IAT Ltd 57 .2.3 Useful For:a) “Seller “ to set minimum value of the company (NRV) b) Companies with lots of tangible high value assets. The answer can be presented:a) Ve b)Po 1.

3 Price –Earnings Model 1.2 Ve = Total Do(1+g) (Ke-g) OR Po = Do(1+g) (Ke-g) 1.3.3 Major Weaknesses are:a) Not include non-tangible assets b) Excludes what all assets generate future:i.2. Dividends ii.4 Dividend Valuation Model 1.2 Ve=Sustainable PAT X Suitable P/E Po=Sustainable EPS X Suitable P/E ________________________________________________________________________  Sunil Bhandari – IAT Ltd 58 .4.3.4.3 Take Care:Growth may not be constant forever Where to we get “g” from? CAPM may be needed to find Ke Often better for valuing a small shareholding 1.2. Cash Flows 1.1 The company is worth the present value of it’s future dividends discounted at the cost of equity 1.3.1 A business is worth a multiple of it’s profits. Profits iii. 1.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1.

2 Establish:a) Future Cash flows and timescales b) Cost of capital (WACC or Risk adjusted WACC) 1.4. Non-listed PLC’s-add/deduct 10% to proxy Co P/E 1.4.3 Weaknesses are:- ________________________________________________________________________  Sunil Bhandari – IAT Ltd 59 .4.1 A business is worth the discounted value of the future cash flows.5 Concerns are: Finding a proxy Co P/E  Adjustments are arbitrary  Sustainable profits needs forecasting adjustments. 1.5.5. 1.4 Suitable P/E:a) Take a proxy Company P/E b) Adjust to suit the company we are valuing.4 Present value of Future Cash Flows 1.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1.5. Ltd Co’s – deduct 30%off proxy Co P/E ii.3 Sustainable PAT-have to adjust the latest reported reports for non-reoccurring items (post tax) 1. c) Simple rules i.

Ve is (a) plus (b).6.5.2 Simple estimate Ve under DVM or P/E Or PV of CF’s method - Book value of Net Assets ________________________________________________________________________  Sunil Bhandari – IAT Ltd 60 .6. 1. Therefore.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1. b) PV of the cash flows for the remaining period.1 There are two methods of valuing IC and /or other non-tangible assets. 1.5 Intellectual Capital(IC) 1.4 Rapid initial growth The approach is:a) PV of the cash flows for the rapid initial growth period.

Approach:$ ‘000 1) Last reported profit before tax Less: Industry of Proxy x Co’s total Return on assets assets X (X) Value Spread X 2) Take value spread X Tax @X% (X) Post tax value spread X 3) Assume post tax value spread will stay constant From time 1 to perpetuity.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1.to compute this an industry /proxy return on total assets % must be given in the question.3 Computed Intangible value (CIV). Value of IC=Post tax value Spread x 1/r r =Cost of Capital 4) Value of Equity is Value of IC + Book value of the Assets ________________________________________________________________________  Sunil Bhandari – IAT Ltd 61 .6.

2 Post Acquisition value of Predator a) Using Bootstrap $000 Predator PAT X Target PAT X Total PAT X Total PAT X PREDATOR P/E = Ve* ________________________________________________________________________  Sunil Bhandari – IAT Ltd 62 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2 Post Acquisitions Values Follow a 3 step approach 2.1 PreAcquisition Data Predator Target No of Equity shares in Issue X X PAT X X EPS X X Pre acquisition Po X X P/E Ratio X X If the P/E ratio of Predator is greater than target then a bootstrap method is possible 2.

3 Assess the Takeover Predator Check the KPI’s post acquisition against pre acquisition:a) Po risen? b) EPS risen? ________________________________________________________________________  Sunil Bhandari – IAT Ltd 63 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ b) Using Add Together $000 Predator Preacquisition Ve X Target Preacquisition Ve X X PV of Synergy Cash flows X Ve * *Divide this by the new number of total issued shares in Predator to find Post Acquisition Po 2.

d) Diversify to stabilise profits and cash flows.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Target Compute the Bid Premium:Per Share $ Value received post acquisition Per target share Preacquisition price X (X) X 3 Factors to consider in Mergers and Takeovers 3. Both are feasible. cut out the middle man. b) Buying suppliers can reduce profit charged on purchases i.Many sources exist: a) Economies of scale from horizontal combinations reduces costs and increase profits. c) Improve badly managed /inefficient businesses.1 Assets of shares-most companies buy the victim company’s shares rather than transferring their assets. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 64 . 3.2 Synergies-concept of “2+2=5”.e. e) Access companies that generate cash (Cash Cow) f) Use the managerial talent of the victim in a more productive way.

3 Finance-to fund the takeover the predator company Could use:a) Cash b) Shares c) Loan Stock ________________________________________________________________________  Sunil Bhandari – IAT Ltd 65 . 3.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ g) Market power may allow consumer price increases and more profits.

4 Regulation of Takeovers ________________________________________________________________________  Sunil Bhandari – IAT Ltd 66 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3.

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3.5 Defences-The victim company could defend a take-over in several ways:a) Appeal to the Competition Commission indicating the takeover is anticompetitive. d) Super majority-set up in the Articles requiring a high proportion of S/H to agree on takeovers. b) Find an alternative/Friendly buyer (White Knight) c) Appeal to the shareholders and manage a defence showing that the takeover will not benefit them. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 67 .

CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ e) Poison pill strategy –creation of “tripwires” invoked on a takeover causing the acquirer to spend more money. 4 Efficient Market Hypothesis Data Reflected in Po 3 forms exists Weak Past Data Semi-Strong Past Data Public Data Strong Past Data Public Data Insider Data ________________________________________________________________________  Sunil Bhandari – IAT Ltd 68 .

1 Ordinary shares of the company with voting rights. 2.2 Carry the greatest risk but also the best possible returns.3 Could be traded on the stock exchange if company is listed. 2. 2 Equity –General Factors 2.4 “A Stock Exchange listing” ________________________________________________________________________  Sunil Bhandari – IAT Ltd 69 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Ten Sources of Finance 1 Introduction Where and how to companies raise long term capital. 2.

2 Rights Issue-Pro Rata issue to existing S/H. Hold back the payment of dividends. Will effect the dividend policy and can raise a small amount of cash. 3.Raising New Capital 3.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3 Equity.1 Retained Earnings-First source of cash. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 70 .

3 From the exam questions will need to obtain or compute:a) Po just before the rights issue (Cum Rights price) b) Issue Price c) Ex Rights Price-price directly after the share issue (TERP) For Example: 1 for 3 rights issue at 550p and cum rights is 600p No 3 at 600p 1 at 550p 4 £ 18.Sell a large batch of new shares to institutions.3 Placing.50 =38p 3. 3.50/4 =£5.00 5.50 TERP =£ 23.2.Sell shares to investors at a fixed price after issuing a prospectus.88.Request investors to tender for the shares at a price they would want to pay.4 Prospectus.£5.5 Tender.88 d) Value of the right £ 5. 3.2.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 3. 3. The board then ________________________________________________________________________  Sunil Bhandari – IAT Ltd 71 .50 £ 23.4 Shareholder can sell the rights to another shareholder at the value of the rights.

4.3 Traded Bonds 4. 4.2 Terms & Conditions depend upon market conditions and credit rating. 4.1 Loan is split into blocks of $100 and issue on the market. Debt holders will:a)Interest paid from pre-tax profits b) Security via  Fixed charged  Floating charge  Securitisation of future income.3.2.2. 4.3.3 Bond has a yield and market value (Chapter 4) ________________________________________________________________________  Sunil Bhandari – IAT Ltd 72 .2 Bank Loans 4. c) Covenants-restrict company activity in areas such as:  Dividend payments  Issues of further debt 4.3. 4 DEBT 4.1 Loans provided to the company on a long term basis.1 Funds come from one bank or group of banks.2 Can be undated or redeemable.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ establishes final price.

4 Other Types of Debt a) Convertible Bonds-Debt that can be converted to shares. d) Grants-Free government finance providing conditions are met. 5 Leases ________________________________________________________________________  Sunil Bhandari – IAT Ltd 73 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 4. c) Mezzanine Loan-Loan used in MBO’s. Used by MNC’s and minimum values normally $1m. Loan that carries high interest but normally only paid if profits are made. b) Eurobonds-Rare large foreign currency loan in the home country. normally at redemption.

Ascertain the post tax cost of debt i.2 Lease Vs Buy Evaluation 3 Step approach 1. 3. NPV of the lease cash flows using (1) Lease cash flows are:  Payments/Rental  Tax savings caused by rentals. NPV of buy cash floes using (1) Relevant flows are: Capital Cost  Scrap value  Tax saved on Capital allowances or Tax allowable depreciation.e Pretax % X (1-t) 2.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 5. ________________________________________________________________________  Sunil Bhandari – IAT Ltd 74 .

________________________________________________________________________  Sunil Bhandari – IAT Ltd 75 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 6 The role of Treasury Function 6. 6.  Deciding upon investment policy. Advising on Heading strategies for: Forex Risk  Interest Rate Risk Establishing source of Finance and cost of capital for the group.2 Roles include:Managing the groups cash resources Liaise with the banks.1 Treasury functions mainly exist in Large MNC.

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Ratios 1.2 Gearing Capital Gearing= Debt or Debt X 100 Equity Debt+Equity NB Preference shares are debt if dated!! Interest Cover = Operating Profit Interest ________________________________________________________________________  Sunil Bhandari – IAT Ltd 77 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Eleven Ratios & Financial Forecasting 1.1 Investor ratios EPS = PAT less Preferred Dividends No of ordinary shares in issue P/E = Po EPS Dividend Cover= EPS DPS Payout Ratio = DPS EPS Dividend Yield = DPS Po 1.

3 Profitability ROCE = Operating Profit X 100 Equity +Debt ROE = PAT X 100 Equity Margin = Operating Profit X 100 Turnover 1.4 Liquidity ________________________________________________________________________  Sunil Bhandari – IAT Ltd 78 .CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 1.

2.3 Cash flow Statement Proforma Operating profit Add: Depreciation (Increase)/Decrease in Inventory (Increase)/Decrease in Receivables (Decrease)/Increase in Payables Cash from Operations ‘$000 X X (X)/X (X)/X (X)/X X Other sources of Cash: Share issue Loan issue/Raised Sale of NCA X X X Payments from cash Finance Charges Tax Dividends Purchase of NCA Loans Repaid (X) (X) (X) (X) (X) Net cash for the year Balance B/F Balance C/F X X X ________________________________________________________________________  Sunil Bhandari – IAT Ltd 79 . 2.2 Proforma’s for the Income Statement and Statement of Financial Position are normally given in the question.1 “Technique” type question which requires you to Follow the rules of the question.CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ 2 Financial Forecasting 2.

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CIMA P9 SLFS Revision Notes May 2009 ------------------------------------------------------------------------------------------------------------ Chapter Twelve Working Capital ________________________________________________________________________  Sunil Bhandari – IAT Ltd 81 .

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