SECTION A – ANSWER QUESTION ONE (COMPULSORY QUESTION)

Question 1 Answer both parts a) and b):

a) In assessing drivers of a firm profitability, it is important to understand its core

competitive strategies. Two basic competitive strategies are (i) cost leadership;
and (ii) product/service differentiation. Using examples, critically explain five
characteristics of cost leadership strategies.

(20 marks)

b) Below is the reformulated financial statement for Pontio plc:

Reformulated Income Statement for the year ended 31/03/2018

2018
£
Sales 56355
less: Cost of Sales 32623
Gross profit 23732
less: Advertising
expenses 6200
General and Administrative Expenses 8532
Other expenses 206
Operating Income from sales (before tax) 8794
less: Tax 2598
Operating income from sales (after tax) 6196
Equity income from subsidiaries 668
Operating income 6864
less: Net Financial Expense (after tax) 897
Earnings 5967

Summary of reformulated Balance Sheets are as follows:

2018 2017
£ £
Net Operating Assets 30050 29550
Net Financial Obligation 6430 5320
Common Shareholders' Equity 23620 24230

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 For following questions, use average Balance Sheet figures:

(i) Using the first level decomposition approach, calculate the Return on
Common Equity (ROCE) and discuss your result.
(10 marks)

(ii) Calculate the Return on Common Equity using the first level of
decomposition approach if the Return on Net Operating Assets (RNOA)
fell to 3.5%. Discuss your new result.
(10 marks)

(iii) Calculate the the Return on Net Operating Assets ratio using the second
level decomposition approach, and discuss your result.
(5 marks)

(iv) Calculate the Gross Profit Margin, Operating Profit from Sales Margin
and Operating Profit Margin, and discuss your result.
(5 marks)

(Total = 50 marks)

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SECTION B - ANSWER ONE QUESTION ONLY

2. Answer both parts a) and b):

a) ‘Assessing accounting quality is an important aspect of financial analysis’

Critically discuss relevant aspects of accounting quality to be considered by
financial analysts (Discuss the concept of accounting quality, as part of your
answer).
(25 marks)

b) Critically discuss five incentives that might cause management to issue

financial reports that are not of high quality.

(25 marks)

(Total = 50 marks)

3. Answer both parts a) and b):

a) The following provides both accounting and market data for two firms
operating in consumer services industry:

Sun plc Moon plc

£ £

Current Assets 8,717,900 20,506,640

Current Liabilities 7,043,700 17,625,680

Total Assets 62,073,340 64,448,184

Retained Earnings 10,245,200 12,184,016

Earnings Before Interest and Taxes 2,866,100 6,854,584

Market Capitalisation 5,707,200 7,281,840

Long term debt 11,222,750 2,643,280

Sales (Revenue) 25,270,200 48,562,604

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 (i) Calculate the Z-score for both firms using the original Altman technique.
(15 marks)

(ii) Based on the above dataset and Z-score calculated in (i), explain
whether the above firms are facing the likelihood of financial distress.
(10 marks)

b) Critically appraise possible steps taken by a firm which experiencing financial

distress.
(25 marks)

(Total = 50 marks)

4. Answer all parts

a. From the perspective of shareholders, why do you agree (or disagree) that the
residual earnings (RE) is a more accurate measure compared to the
conventional earnings (ROCE)? Discuss the drivers of residual earnings as part
of your answer.
(10 marks)

b. Using examples, critically explain factors to be considered in estimating the

growth rate (g) of the residual earnings model at the end of the forecast
period.
(10 marks)

c. The following provides Orange’s earnings per share (EPS) and dividends per
share (DPS) for the years 2019 – 2023. Suppose these numbers were given
to you at the end of 2018, as forecasts, when the book value per share (BPS)
was £6.59.

2019E 2020E 2021E 2022E 2023E

EPS 2.80 3.20 3.36 3.53 3.71
DPS 1.20 1.20 1.20 1.20 1.20

Use a required return of 8 percent for calculations below:

i. Using the residual earnings valuation model, value the firm at the end
of 2018. Would you call this a Case 1, 2 or 3 valuation?
(20 marks)
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ii. Based on your analysis, provide a recommendation to a potential
investor if the share price of the company is traded at £25 per share.
(5 marks)

iii. Based on your analysis, forecast the target price at the end of 2023.

(5 marks)

(Total = 50 marks)

END