ACCA F9 (FINANCIAL MANAGEMENT)

Chapter 02 - Basic investment appraisal techniques

ROCE = Average accounting profit before interest and tax

Initial investment
or
ROCE = Average accounting profit before interest and tax
average investment

TYU01
(a)
Initial investment = 110000
Annual cahflows = 24400
Scrap Value = 10000

Depreciation = Initial investment - scrap value

Project life

Depreciation = 110000 - 10000

5

Annual Depreciation = 20000

Annual Profit = Annual cashflow - Annual Depreciation

Annual Profit = 24400 - 20000
Annual Profit = 4400

ROCE = 4400
110000

ROCE = 4%
(b)
Average Investment = Initial Investment + scrap Value
2

Average Investment = 110000 + 10000

2

Average Investment = 60000

ROCE = 4400
60000
 ROCE = 7.33%

TYU02
$000
Yrs Cash inflows
0 (800)
1 100
2 200
3 400
4 400
5 300
6 200
7 150

Average Annual Cashflows = $ 250,000

Depreciation = Initial Investment - scrap value

project life

Depreciation = 800000 - 100000

7

Annual Depreciation = 100000

Annual Profit = Annual Cashflow - Depreciation

Annual Profit = 250000 - 100000
Annual Profit = 150,000

(a) ROCE = 150000

800000

ROCE = 18.75%

(b)
Average Investment = initial capital + scrap value
2

Average Investment = 800000 + 100000

2

Average Investment = 450000

ROCE = 150,000
450000
 ROCE = 33.33%

Advantages of ROCE :
Simplicity
links with other accounting measures
Disadvantages of ROCE :
No account of TVM
Uses profits which are subjective
Not a measure of Absolute Gain
May ignore W.C
No definitive Investment Signal
No account is taken of project life

Significance of Cashflows over profits

Appraisal is more appropriately done through profits than cashflows because :
Profits can't be spent
Profits can't be paid out as dividends
Profits are subjective

TYU03
Only the incremental fixed costs are relevant which is the salary of the supervisor in this case
Fixed overheads are apportioned costs and are not relevant

Additional Question
Only the initial investment in future and the annual cashflows are relevant
Initial investment = 160000
annual cashflow = annual profits + annual depreciation
annual cashflow = 8000 + 40000 48000
The technical feasibility study has already been carried out and is a sunk cost
The share of fixed costs are allocated costs and are not relevant

TYU04

Payback period = Initial Investment

Annual cashflows

Payback period = 2000000

500000

Payback period = 4 years

TYU05
Payback period = 1800000
350000
 Payback period = 5.14285714286 yrs
Payback period = 5 years 1.71428571428572 months
or 5 years 2 months

TYU06 $000
Yrs Cashflow Cumulative
0 (1900) (1900)
1 300 (1600)
2 500 (1100)
3 600 (500)
4 800 300
5 500 800

Payback period lies between 3rd and 4th year

payback period = 3 years and 500/800 months

3.0625years
or 3 years 8 months

TYU07 $000
Yrs Cashflow Cumulative
0 (3100) (3100)
1 1000 (2100)
2 900 (1200)
3 800 (400)
4 500 100
5 500 600

Payback period lies between 3rd and 4th year

payback period = 3 years and 400/500 months

3.8years
or 3 years 10 months

Advantages of payback
simple
uses cashflows and not accounting profit
useful in certain situations (rapidly changing technology & improving investment decisions)
favours quick return (helps company growth, minimises risk and maximises liquidity)
Disadvantages of payback
ignores returns after payback period
ignores timing of cashfows
it is subjective - no definitive investment signal
it ignores project profitability
TYU12
Yrs Cashflow Cumulative
0 (110400) (110400)
1 64800 (45600)
2 44800 (800)
3 47600 46800
4 57600 104400

PP = 2 years + 0.02
PP = 2.02 years

Depreciation = initial investment - scrap value

project life

Depreciation = 110400 - 9600

4

Depreciation = 25200

Average Annual Profit = 28500

Average Investment = Initial Investment + scrap value

2

Average Investment = 60000

ROCE = Annual Profit

Average investment

ROCE = 28500
60000

ROCE = 47.50%

Chapter 03 : Discounted Cashflow Techniques

Time value of money

potential for earning interest/cost of finance
impact of inflation
effect of risk

Compounding
 FV = P(1 + r)n
TYU01

FV = 5000(1 + 0.05)6
FV = 6700

Discounting

FV
PV =
(1 + r)n

TYU02
FV
PV =
(1 + 0.06)9

PV = 68068

Net Present Value

NPV = PV of cash inflows - PV of Cash outflows

Assumptions
All cashflows occur at the start or the end of the period
Initial investments occur at T0
Other cashflows start one year after that (T 1)

TYU 03
Yrs cashflow DF @ 6% PVs
0 (25000) 1 (25000)
1 6000 0.943 5658
2 10000 0.890 8900
3 8000 0.840 6720
4 7000 0.792 5544
NPV = 1822

TYU 04

Yrs cashflow DF @ 6% PVs

0 (240000) 1 (240000)
1 80000 0.917 73360
2 120000 0.842 101040
3 70000 0.772 54040
4 40000 0.708 28320
5 20000 0.650 13000
 NPV = 29760

Advantages of NPV
Considers whole life of project
Considers time value of money
absolute gain
increase in shareholder wealth
uses cashflows instead of acounting profits
Disadvantages of NPV
Difficult to explain to managers
Requires knowledge of cost of capital
Relatively complex
TYU 05
Method 01 Method 02
FV PV = FV *DF
PV =
(1 + r)n
PV = 10000 * 0.735
10000
PV =
(1 + 0.08)4 PV =

PV = 7350

Annuity Annual constant cashflows for a definite period of time

PV of annuity = Cashflow * AF

AF = 1 - (1+r)-n
r
TYU 06

AF = 1 - (1+0.08)-7
0.08

AF = 5.206

PV of Annuity = Cashflow* AF
18741.60

TYU 07

AF = 1 - (1+0.05)-13 PV of Annuity =
0.05 PV of Annuity =

AF = 9.394
 PV of Annuity = Cashflow* AF
PV of Annuity = 107091.60

Perpetuity Annual constant cashflows for an indefinite of time

PV of perpetuity = Cashflow
r

PV of growing perpetuity = Cashflow where g = growth rate

r-g

TYU 08
(i)
PV of perpetuity = Cashflow
r

PV of perpetuity = 3000
0.1

PV of perpetuity = 30000

(ii) PV of growing perpetuity = Cashflow

r-g

PV of growing perpetuity = 3000

0.1-0.02

PV of growing perpetuity = 37500

Advanced and delayed annuities and perpetuities

Advanced Annuities
PV of advanced annuities = PV * (1 + AF)

Illustration

PV of advanced annuities = 600 * (1 + 3.170)

PV of advanced annuities = 2502

Advanced Perpertuity

PV of Advanced Perpetuity = Cashflow + cashflow

r
 or = Cashflow (1 + 1/r)

Illustration
PV of Advanced Perpetuity = 2000 + 2000
0.09

PV of Advanced Perpetuity = 24222.22

Additional Question
(i)
PV of advanced annuities = PV * (1 + AF)
3088.5
(ii)
PV of advanced annuities = PV * (1 + AF)
2353.95
(iii)
PV of Advanced Perpetuity = Cashflow + cashflow
r
PV of Advanced Perpetuity = 33000 + 33000
0.22
183000
(iv)
PV of Advanced Perpetuity = Cashflow + cashflow
r
126000
Delayed Annuity & Perpetuity

PV of Delayed Annuity = PV of of annuity at Yn discounted back to Y0

illustration

PV of Annuity = 709.2
PV of Delayed Annuity = 643

Additional Question

(i)
PV of Annuity = 2913.60
PV of Delayed Annuity = 2593.10

(ii)
PV of Annuity = 2120.40
PV of Delayed Annuity = 1397.34

(iii)
 PV of perpetuity = 150000 DF @ 22% =
PV of Delayed perpetuity = 122950.82

(iv) DF @ 22% =
PV of perpetuity = 112000
PV of Delayed perpetuity = 38801.21 DF @ 12.5% =

DF @ 22% =
(v)
PV of perpetuity = 28571
PV of Delayed perpetuity = 17742.86

Internal Rate of Return

NPV @ L.R
IRR = L.R +
NPV @ L.R - NPV @ H.R

TYU 09
IRR = 50000
10 +
50000 - (-10000)

IRR = 14.17 %

TYU 10
Yrs Cashflow DF @ 15% PV DF @ 20%
0 (50000) 1 (50000) 1
1 18000 0.870 15660 0.8330
2 25000 0.756 18900 0.6940
3 20000 0.658 13160 0.5790
4 10000 0.572 5720 0.4820
NPV = 3440 NPV =

3440
IRR = 15+
3440 - (-1256)

IRR = 18.66 %
since the IRR of the project is greater than the minimum required rate of return so it is financi

IRR of a annuity

(i) Find cummulative DF (initial investment / annual inflow)

(ii) Find the life of project
(iii) Look along the n year of the PV table until closest DF value is found
 (iv) The column in which this figure is found is the IRR

IRR of a perpetuity

Annual inflow
IRR of a perpetuity = x 100
Initial investment
TYU 11
(a) Annual inflow
IRR of a perpetuity = x 100
Initial investment

5000
IRR of a perpetuity = x 100
50000

= 10%
(b)
Cummulative DF = Initial Investment
Annual inflows

Cummulative DF = 50000
8060

Cummulative DF = 6.203

Life of project = 8 years

looking along the 8 year line in the anuity table, the value closest to 6.203 is 6.210
this figure belongs to the 6% column of the annuity table suggesting that this is the closest ap
IRR

Advantages of IRR
Considers time value of money
Considers whole life of the project
considers cashflows rather than profits
is a % therefore easily understood
a means of increasing shareholder's wealth
Disadvantages of IRR
Is not a measure of absolute profitability
interpolation provides only an estimate and accurate estimate requires the use of spreadshee
fairly complicated to calculate
non conventional flows may give rise to multiple IRRs
contains an inherent assumption that cash obtained from the project maybe reinvested at the
unrealistic

NPV versus IRR

NPV is better than IRR as it provides the absolute return of the project
 TYU 12
(ii) Payback Period
Project E Project F
$000 $000
yrs Cashflows Payback Cashflows
0 -125 -125 -120
1 50 -75 15
2 50 -25 15
3 50 25 15
4 75 100 15
5 0 100 200
5 0 0 24

Payback period = 2 and 25/50 years Payback period =

Payback period = 2.5 years Payback period =

(iii) NPV
Project E
yrs Cashflows A.F 10% PV
0 -125 1 -125
1 -- 4 50 3.17 158.5
4 25 0.683 17.075
NPV = 50.6
Project F

yrs Cashflows D.F 10% PV

0 -120 1 -120
1 -- 4 15 3.17 47.55
5 224 0.621 139.104
NPV = 66.7
Project G

yrs Cashflows D.F 10% PV

0 -170 1 -170
1 120 0.909 109.08
2 114 0.826 94.164
NPV = 33.2
(iii) IRR
IRR of Project E = 24.8%
IRR of Project F = 21.5%
IRR of Project G =23.8%

Chapter 04 Investment Appraisal - Further aspects of Discounted Cashflow Techniques

 The impact of inflation on interest rate

The fisher formula for nominal/money cost of capital:

(1 + i) = (1 + r)(1 + h)

TYU 01

r =?
h=7%
i=10%
(1 + i) = (1 + r)(1 + h)
(1 + 10%) = (1+r)(1+7%)
(1 + r) = 1.02803738317757
i= 2.8%

TYU 02
r =8%
h=5%
i=?
(1 + i) = (1 + r)(1 + h)
(1 + i) = (1+8%)(1+5%)
(1 + r) = 1.134
i= 13.4%

Methods of dealing with inflation

(i) Real Method ( Don't inflate - real flows - discount using real rate)
(ii) Money/Nominal Method (inflate - money flows - discount using money rate)

TYU 03
(a) money method

Yr Cashflow Inflation Money Flows DF @ 15%

0 (50000) 1 (50000) 1
1 20000 1.055 21100 0.870
2 20000 1.113 22261 0.756
3 20000 1.174 23485 0.658
4 20000 1.239 24776 0.572
NPV =

(b) Real Method

(1 + r)= (1 + i)
(1 + h)
 (1 + r)= (1 + 15%)
(1 + 5.5%)

(1 + r)= 1.09004739336493

r= 9%

Yr Cashflow AF @ 9% PV
0 (50000) 1 (50000)
1 -- 4 20000 3.240 64800
NPV = 14800

TYU 04 (A) Real Method

(1 + r)= (1 + i)
(1 + h)

(1 + r)= (1 + 15%)
(1 + 5%)

(1 + r)= 1.0952380952381

r= 10%

Yr Cashflow DF @ 10% PV
0 (750) 1 (750)
1 330 0.909 300
2 242 0.826 200
3 532 0.751 400
NPV = 150

(B) Money Method

Yr Cashflow Inflation Money Flows DF @ 15.5%

0 (750) 1 (750) 1
1 330 1.050 347 0.866
2 242 1.103 267 0.750
3 532 1.158 616 0.649
NPV =

inflate using specific rate

Current Cashflows Money cashflows

Deflate using general rate

 Money cashflows Real Cashflows

TYU 05
Yrs 0 1 2 3
Initial investment (7000)
Wages (W1) 1100 1210 1331
Material Costs (W2) 420 441 463
Net Flows (7000) 1520 1651 1794
DF @15% (W3) 1 0.87 0.756 0.658
PV (7000) 1322 1248 1180

W3: (1 + i) = (1 + r)(1 + h)
(1 + i) = (1 + 8.5%)(1 + 6%)
(1 + i) = 1.1501
i= 15%

Dealing with Tax in NPV Calculations

TYU 08 (a)
yrs $ Tax Relief
0 initial inv 10000
1 Tax Allowable Dep 2500 750
Written down value 7500
2 Tax Allowable Dep 1875 563
Written down value 5625
3 Tax Allowable Dep 1406 422
Written down value 4219
4 Disposal value 2500
4 Balancing Allowance 1719 516

2250

(b)
yrs $ Tax Relief
0 initial inv 10000
1 Tax Allowable Dep 2500 750
Written down value 7500
2 Tax Allowable Dep 1875 562.5
Written down value 5625
3 Tax Allowable Dep 1406 421.875
Written down value 4219
4 Disposal value 5000
4 Balancing charge (781.25) (234.375)
 1500

(c) Yrs 0 1 2 3
income 8000 8000 8000
Tax @30% (2400) (2400)
Tax Allowable Dep 750 563
Initial investment (10000)
Scrap value
Net Flows (10000) 8000 6350 6163
DF @10% 1 0.909 0.826 0.751
PV (10000) 7272 5245.1 4628.413

Incorporating Working Capital

TYU 07
yrs 0 1 2 3
Sales 225000 236250 248063
Working Capital 22500 23625 24806 26047
Incremental Cashflows (22500) (1125) (1181) (1240)

TYU 08
yrs 0 1 2 3
Sales 300000 324000 349920
Working Capital 30000 32400 34992 0
Incremental Cashflows (30000) (2400) (2592) 34992

TYU 09
yrs 0 1 2 3
Sales revenue 0 520 1082 675
Variable Costs 0 -158 -331 -208
Net trading inflows 0 362 751 467
Tax Payable @ 30% -109 -225
initial investment -1000
scrap proceeds 200
Tax relief 75 56
Working capital -52 -56 40 68
Net Cashflows -1052 306 757 566
DF @10% 1 0.909 0.826 0.751
PV -1052 278 625 425

NPV = 255

(1 + i) = (1 + r)(1 + h)
 (1 + i) = (1 + 6.8%)(1 + 3%)
(1 + i) = 1.10004
TYU 10 i= 10%

yrs 0 1 2
Net trading inflows 0 3150 3308
Tax @30% -945 -992
Initial Investment -3500
Net cashflows -3500 2205 2316
DF @ 15.5% 1 0.866 0.75
PV -3500 1910 1737

NPV = 147

TYU 13
$
40000
10000 3000
30000
7500 2250
22500
5625 1687.5
16875
TYU 14

yrs 0 1 2
Sales revenue 0 192500 204050
Working Capital 23100 24486 25955.16
incremental investment -23100 -1386 -1469.16

Chapter 05 : Asset Investment Decisions

Lease VS Buy

TYU 01
Yrs Cashflows DF @ 10% PV
Lease payments 0- 3 -36000 3.487 -125532
Tax relief 2 -- 5 10800 2.88153 31120.524
-94411.476
LEASE VS BUY
TYU 02
IF WE BUY THE MACHINE
Post Tax cost of borrowing = pre tax cost of capital * (1 - Tax Rate)
Post Tax cost of borrowing = 11.4 * (1 - 30%) = 8.0
 yrs 0 1 2 3
Investment -6400
Tax Relief 480 360
Net flows -6400 0 480 360
DF @ 8% 1 0.926 0.857 0.794
PV -6400 0 411.36 285.84
NPV = -4983

yrs $ Tax Relief

0 initial inv 6400
1 Tax Allowable Dep 1600 480
Written down value 4800
2 Tax Allowable Dep 1200 360
Written down value 3600
3 Tax Allowable Dep 900 270
Written down value 2700
4 Tax Allowable Dep 675 203
Written down value 2025
5 Disposal proceeds 0
5 Balancing Allowance 2025 608

IF WE LEASE THE MACHINE

Yrs Cashflows DF @ 8% PV
Lease payments 0- 4 -1420 4.312 -6123.04
Tax relief 2 -- 6 426 3.697518 1575.142668
NPV = -4548

Replacement Decisions

Equivalent Annual Costs (EAC)

EAC = PV of Costs
Annuity Factor
TYU 03

Replace after 1 years

Yrs 0 1
initial inv -20000
running cost -5000
scrap value 16000
Net flows -20000 11000
 DF @ 10% 1 0.909
PV -20000 9999

PV of costs = -10001

EAC1 = PV of Costs
Annuity Factor

EAC1 = 10001
0.909

EAC1 = 11002.20

Replace after 2 years

Yrs 0 1 2
initial inv -20000
running cost -5000 -5500
scrap value 13000
Net flows -20000 -5000 7500
DF @ 10% 1 0.909 0.826
PV -20000 -4545 6195

PV of costs = -18350

EAC2 = PV of Costs
Annuity Factor

EAC2 = 18350
1.736

EAC2 = 10570.28

since EAC2 is lower than EAC1, replace asset after every 2 years

TYU 04 Replace after 1 years

Yrs 0 1
initial inv -12000
running cost 0
scrap value 9000
Net flows -12000 9000
DF @ 10% 1 0.87
PV -12000 7830
 PV of costs = -4170

EAC1 = PV of Costs
Annuity Factor

EAC1 = 4170
0.87

EAC1 = 4793

Replace after 2 years

Yrs 0 1 2
initial inv -12000
running cost -1500
scrap value 7500
Net flows -12000 -1500 7500
DF @ 10% 1 0.87 0.756
PV -12000 -1305 5670

PV of costs = -7635

EAC2 = PV of Costs
Annuity Factor

EAC2 = 7635
1.626

EAC2 = 4696

Replace after 3 years

Yrs 0 1 2
initial inv -12000
running cost -1500 -2700
scrap value
Net flows -12000 -1500 -2700
DF @ 10% 1 0.87 0.756
PV -12000 -1305 -2041.2

PV of costs = -10740.2

EAC3 = PV of Costs
 Annuity Factor

EAC3 = 10740.2
2.283

EAC3 = 4704

Since the lowest EAC is EAC 2, so replace asset after every 2 years

Capital Rationing

Hard Capital Rationing Soft Capital Rationing

imposed by lending institutions imposed by company itself
Reasons: Reasons:
Industry wide factors limited management skills
company specific factors
lack of/poor track record Desire to maximise returns of a limi
lack of asset security limited exposure to external finance
poor management team acceptance of only substancially pro
improving investment conditions
The profitablity Index (PI) and divisble projects

AIM: Maximise NPV /$ of investment

NPV
PI =
Initial Investment
(a) Calculate the PI of each project
(b) Rank the projects on the basis of PI
(c) Allocate funds according to the ranking until fully used up

TYU 05 Divisible Projects

Project initial Inv NPV PI
$000 $000
C 40 20 0.5
D 100 35 0.35
E 50 24 0.48
F 60 18 0.3
G 50 -10 Not Viable
NPV
Investment Available = 100000
C -40000 20000
Investment Available = 60000
E -50000 24000
Investment Available = 10000
 D -10000 3500
0
47500
TYU 10

Project Initial outlay Inflow/year PV

E 6000 900 9000
F 8000 1000 10000
G 10000 3500 35000
H 12000 3600 36000
I 20000 4600 46000

Available 20000

Combinations NPV
E,F 5000
E,G 28000
E,H 27000
F,G 27000 Choose this combination
F,H 26000
I 26000

TYU 11
yrs cashflow DF @20% PV
0 -150000 1 -150000
1-3 -6000 2.106 -12636
4-8 -8000 1.732 -13856
8 30000 0.233 6990
PV of costs = -169502

EAC1 = PV of Costs
Annuity Factor

EAC1 = 169502
3.837

EAC1 = 44176

Chapter 06 : Investment Appraisal under uncertainity

Investment appraisal faces the following problems:

All decisions are baased on forecasts

All forecast are subject to uncertainty
 This uncertainty needs to be reflected in the financial evaluation

Diiference between risk & uncertainty

Risk - Quantifiable - possible outcomes have assocaited probabilities, allowing the use of math

Uncertainty - unquantifiable - outcomes cannot be mathematically modelled

Investment Appraisal under

uncertainity

Uncertainity Risk

• Set Shorter Paybacks • Expected Values

• • Simulation Models
Make prudent estimated of Cashflows • Adjusted Payback
• • Risk - Adjusted discount rates
Assess both best and worst possible situtations
to obtain a range of Net Present Values
• Use Sensitivity Analysis to measure the margin
of safety

Sensitivity Analysis
How much a variable can change before the project is classified as financially

NPV
Sensitivity Margin =
PV of cashflow under consideration

TYU 01 (a)
Yrs Cashflow DF @ 10% PV
Initial INV 0 -40000 1 -40000
Sales Revenue 1 -- 4 125000 3.170 396250
Variable Costs 1 -- 4 100000 3.170 317000
Contribution 1 -- 4 25000 3.170 79250
Annual Fixed Costs 1 -- 4 -10000 3.170 -31700
NPV = 7550
(b)
(i) Initial investment

7550
Sensitivity Margin =
40000
 Sensitivity Margin% = 18.9%

(ii) Selling Price per unit

7550
Sensitivity Margin =
396250

Sensitivity Margin% = 1.9%

(iii) Variable Price per unit

7550
Sensitivity Margin =
317000

Sensitivity Margin% = 2.4%

(iv) Sales Volume

7550
Sensitivity Margin =
79250

Sensitivity Margin% = 9.5%

(v) Fixed Costs

7550
Sensitivity Margin =
31700

Sensitivity Margin% = 23.8%

(vi) Discount Rate

First find the IRR of the project

Yrs Cashflow
Initial INV 0 -40000
Contribution 1 -- 4 25000
Annual Fixed Costs 1 -- 4 -10000

IRR = LR + (NPV@LR/(NPV@LR-NPV@HR))*(LR-HR)

IRR = 18.66 %

8.66%
Sensitivity Margin =
 Sensitivity Margin =
0.1

Sensitivity Margin% = 86.6%

TYU 02 (a)
Yrs Cashflow DF @ 15% PV
Initial INV 0 -500000 1 -500000
Sales Revenue 1 -- 3 600000 2.283 1369800
Variable Costs 1 -- 3 350000 2.283 799050
Contribution 1 -- 3 250000 2.283 570750
Annual Fixed Costs 1 -- 3 -40000 2.283 -91320
Scrap Value 3 80000 0.658 52640
NPV = 32070
(b)
(i) Initial investment

32070
Sensitivity Margin =
500000

Sensitivity Margin% = 6.4%

(iii) Selling Price per unit

32070
Sensitivity Margin =
1369800

Sensitivity Margin% = 2.3%

(iv) Variable Price per unit

32070
Sensitivity Margin =
799050

Sensitivity Margin% = 4.0%

(vi) Sales Volume

32070
Sensitivity Margin =
570750

Sensitivity Margin% = 5.6%

(v) Fixed Costs

32070
Sensitivity Margin =
 Sensitivity Margin =
91320

Sensitivity Margin% = 35.1%

(ii) Scrap value

32070
Sensitivity Margin =
52640

Sensitivity Margin% = 60.9%

(viii) Discount Factor

First calculate the IRR of the project

Yrs Cashflow DF @ 15%

Initial INV 0 -500000 1
Contribution 1 -- 3 250000 2.283
Annual Fixed Costs 1 -- 3 -40000 2.283
Scrap Value 3 80000 0.658
NPV =

IRR = LR + (NPV@LR/(NPV@LR-NPV@HR))*(LR-HR)

IRR = 18.7 %

3.70%
Sensitivity Margin =
0.15

Sensitivity Margin% = 24.7%

Advantages of sensitivity Analysis:

Simple
Provides more information to allow subjective decisions
identifies critical estimates
Disadvantages of sensitivity Analysis:
Assumes independency of changing variables
does not assess the likelihood of variable changing
does not directly Identify a correct decision

Probability Analysis

Expected Value

The weighted average of all possible outcomes, with the weightings based on
 EV = ∑PV
TYU 03
Recession Stable Growing
Probability 0.5 0.4 0.1
Project A 100 200 1400
Project B 0 500 600
Project C 180 190 200

TYU 04
A. Cashflow Probability Px
50000 0.3 15000
100000 0.5 50000
150000 0.2 30000
EV = 95000

yrs cashflows DF @5% PV

0 -460000 1 -460000
1 -- 5 95000 4.329 411255
5 40000 0.784 31360
NPV = -17385
illustration

(a) Demand Probability Px

10 0.2 2
15 0.55 8.25
20 0.25 5
EV = 15.25
(b)
Contribution per magazine= 25 -10 = 10

Demand
Probability 0.2 0.55 0.25
10 15 20
10 100 100 100
Bought 15 25 150 150
20 -50 75 200

Strengths weaknesses
• Deals with multiple outcomes • Subjective probabilities
• quantifies probabilities • Answer is only a long - run average
• Relatively simple calculation • Ignores variability of profits
• assists decision making • Risk neutral decision (ignores investors attitude to risk

TYU 05
 Year 1 Year 2
PV(inflow) Probability PV(inflow) Probability Total PV
100000 0.2 200000 0.3 300000
100000 0.2 300000 0.7 400000
200000 0.8 200000 0.3 400000
200000 0.8 300000 0.7 500000

Simulation
the effect of changing many variables at the same time

Steps:
Specify major variables
identify relationship between variables
simulate the environment
results will be a probability distribution of NPVs

Advantages of Simulation:
includes all possible outcomes in the decision making process
relatively easily understood technique
wide variety of applications
Disadvantages of Simulation
models can become very complex and the time and costs involved in their construction can be
gained from improved decisions
Probability distribution maybe difficult to formulate

Discounted payback

Illustration
Yrs Cashflows DF @ 8% PV
0 -20000 1 -20000
1 8000 0.926 7408
2 12000 0.857 10284
3 4000 0.794 3176
4 2000 0.735 1470

Payback period = 2 & 2308/3176 years

= 2.73 years
TYU 06
Yrs Cashflows DF @15% PV
0 -12000 1 -12000
1 -4800 0.87 -4176
2 16800 0.756 12700.8
3 14400 0.658 9475.2
 NPV = 6000

Payback period = 2 & 3475.2/9475.2 years

= 2.37 years
TYU 07
Yrs Cashflows DF @10% PV
0 -275000 1 -275000
1 -- 5 200000 3.791 758200
1 -- 5 -95000 3.791 -360145
NPV = 123055

PV of contribution must fall by 123055 for the project to be mot worthwhile

in current terms contribution must fall by:

fall in sale units :
Chapter 07 : Working Capital Management

Raw material holding period X

Payables payment period (X)
WIP holding period X
Finished Goods Holding period X
Receivables Collection Period X
X

TYU 01 :
Raw material holding period 21
Payables payment period -42
WIP holding period 14
Finished Goods Holding period 28
Receivables Collection Period 56
77

Factors affecting length of cash operating cycle

Liquidity vs Profitability decisions

Terms of trade
Management Efficiency
Industry norms e.g, retail construction

Working Capital Ratios - Operating Cycle:

Inventory Holding period = Inventory *365

COS

Raw Material Holding period = Raw Material *365

 Material usage/Purchases

WIP Holding Period = WIP *365

production cost

Finished Goods Holding Period = Finished goods *365

COS

Receivables Collection period = Receivables *365

Credit Sales

Payables Payment period = Payables *365

Credit Purchases/COS

Illustration

Inventory Holding period = 1569.5

25

Inventory Holding period = 63 Days

Raw Material Holding period = 365

20

Raw Material Holding period = 18 Days

WIP Holding Period = 474.5

23

WIP Holding Period = 21 Days

WIP Holding Period = 730

25

WIP Holding Period = 29 Days

Receivables Collection period = 1460

24

Receivables Collection period = 61 Days

Payables Payment period = 730

18
 Payables Payment period = 41 Days

TYU 02
Raw Material Holding period = 54750000
2160000

Raw Material Holding period = 25 Days

WIP Holding Period = 127750000

2,700,000

WIP Holding Period = 47 Days

Finished goods Holding Period = 73000000

2,700,000

Finished goods Holding Period = 27 Days

Receivables Collection period = 111690000

3,600,000

Receivables Collection period = 31 Days

Payables Payment period = 47450000

2160000

Payables Payment period = 22 Days

Raw material holding period 25

Payables payment period -22
WIP holding period 47
Finished Goods Holding period 27
Receivables Collection Period 31
108
TYU 03
Liquidity Ratios :

Current Ratio = Current Assets

Current Liabilities

Quick Ratio = Current Assets - Inventory

Current Liabilities
 20X6 20X7
Current Assets:
inventory 37 42
receivables 23 29
bank 5 3
Current Assets:
Trade Payables 55 36
Taxation 10 10

Current ratio 1.0 1.6

Quick Ratio 0.4 0.7

Sales 196 209

opening inv 29 37
purchases 159 162
closing inv 37 42
cost of sales 151 157
gross profit 45 52

Inventory Days 89 98
Receivable Days 43 51
Payable Days 126 81
Operating Cycle 6 67

Working Capital Investment Levels

SOFP figures by rearranging the WC ratios

Factors affecting working capital required:

• Nature of business
• Uncertainty in supplier deliveries
• Overall level of acivity of business
• Company's credit policy
• Length of the cash operating cycle
• Credit policy of suppliers

TYU 04

Trade Receivable balance = receivable days * credit sales

365

Trade Receivable balance = 600

365
 Trade Receivable balance = $ 1.64 m

Trade Payable balance = payable days * credit purchases

365

Trade Payable balance = 240

365

Trade Payable balance = $ 0.66 m

Inventory balance = Inventory days * cost of sales

365

Inventory balance = 180

365

Inventory balance = $ 0.49 m

Working Capital Required = $ 1.48

Additional Question:

Sales 1500000
Direct material 450000
Direct Labour 375000
Variable Overheads 150000
Fixed Overheads 225000
Selling & Distribution 75000

Trade Receivable balance = receivable days * credit sales

365

Trade Receivable balance = 3750000

12

Trade Receivable balance = $ 312,500.00

Raw Material balance = Raw Mat days * Mat purchases

365

Raw Material balance = 1350000

12
 Raw Material balance = $ 112,500.00

WIP balance = WIP days * Production cost

365

WIP balance = 975000

12

WIP balance = $ 81,250.00

Finished Goods balance = F. Goods days * COS

365

Finished Goods balance = 975000

12

Finished Goods balance = $ 81,250.00

Average Value of current Liabilities

Average Value of current Liabilities

Material 75000
Labour 7500
VOH 12500
FOH 18750
S&D 3125
116875

Working Capital Required =

Additional Question:

Sales: 8000000
Gross profit 3000000
COS 5000000
Cash balance 1250000
Receivable days 1.5 months
Payable days 2 months
inventory days 1 months

Receivable balance 1000000

 Payables balance 833333
Inventory Balance 416667

Current Ratio 3.2

Quick Ratio 2.7

TYU 08

Raw material holding period 2

Payables payment period -2.5
WIP holding period 2
Finished Goods Holding period 0
Receivables Collection Period 1.5
3

Chapter 08 :Working Capital Management - Inventory Control

Costs of high inventory levels

• holding costs
- storage
- risk of theft/damage/obsolescence
- stores administration
• forgone interest from tying up capital

Costs of low inventory levels

• stockout costs
- lost contribution
- production stoppages
- emergency orders
• high re-order costs
• Lost quantity discounts

Economic Order Quantity

√(2 ∗𝐶𝑜
EOQ∗𝐷/𝐶ℎ)
=

TYU 01
Co 30
Ch 2.88
D 12000

EOQ = 720000
 2.88

EOQ = 500
units
Total cost = 1476 400
Total cost = 1440 500
Total cost = 1464 600

TYU 02

EOQ = 48000000
3.5

EOQ = 3703

TYU 03
EOQ = 12000000
1.2

EOQ = 3162

Total cost = 63794.7

Total cost = 63000.0
Total cost = 63800.0

TYU 04
EOQ = 9000000
0.65

EOQ = 3721

Total cost = 203906

Total cost = 203681 choose to buy 6000 units
225

TYU 06
(a)
30.18 Days

(b)
2596

Chapter 09 : Working capital Management - Accounts receivable and payables

Accounts receivable

Establishing a credit policy

factors that affect the credit policy:
• Demand for products
• competitor's terms
• risk of irrecoverable debts
• financing costs
• costs of credit control

A credit policy has four key aspects:

(1) Assessing creditworthiness
(2) credit Limits
(3) invoicing promptly and collecting overdue debts
(4) monitor the credit system

Assessing creditworthiness
information may come from :
• competitors
• trade references
• bank references
• published information
• credit scoring
• company records
• credit reference agencies

Credit limits
Amount of credit
Length of time

Invoicing and collecting overdue debts

System of 'Follow up' Procedure
1 Reminder Letter
2 Telephone Calls
3 Withholding supplies
4 Debt Collectors
5 Legal Action

Monitoring the system

Methods include:
• Age Analysis
• Ratios
• Statistical Data
 Accounts Receivables - Calculations

Cost of financing receivables:

Finance Cost = Receivables Balance * rate of interest

Receivables Balance = Receivables * Credit Sales

365
TYU 01

(a)
Receivables Days = Receivables * 365
Credit Sales

Receivables Days = 4m * 365

20

Receivables Days = 73 Days

(b)
Finance Cost = Receivables Balance * rate of interest

Finance Cost = $4m * 125

Finance Cost = $ 480,000

Early Settlement Discounts

Annual Cost of Discount = (1 + Discount/amount Let to pay)no. of periods

No. of period 365

no of days/weeks/months

If the cost of offering the discount exceeds the rate of interest, then the discount should not b

TYU 02
Cash discount 2.50%
if pay within 1 month
usual credit period is 3 months
rate of interest = 18%
Should the discount be offered or not?

No. of period 365/52/12

 no of days/weeks/months earlier the mon

No. of period 12
2

No. of period = 6

Annual Cost of Discount = (1 + Discount/amount Let to pay)no. of periods

Annual Cost of Discount = (1 + 2.5/97.5)6 -1

Annual Cost of Discount = 16.41%

Cost of interest = 18%

since the cost of discount is less than the cost of interest rate, so the discount should be offer

TYU 03
credit sales $20m
receivables balance = $4m
rate of interest = 12%
cash discount = 2%
within 10 days
40% will take up the offer

Costs
cost of offering the discount= 160000

Benefit

Receivable days 73
current receivable balance = 4000000 m

if 40% take up the offer:

Receivables paying within 10 days= 219178.082191781

Receivables paying within 73 days= 2400000
New Receivable Balance= 2619178

Reduction in receivables balance = 1380822

Cost of financing reduced = 165699

Net benefit= 5699

Chapter 10 : Working Capital Management : Cash Funding Strategies

Reasons for holding cash

• transaction motive ( Day to Day expeenses)
• Precautionary Motive (for unplanned expenditure)
• Investment/speculative motive (To take advantage of market opportunities)
Failure to keep cash can lead to:
• lost settlement discounts
• loss of supplier goodwill
• Poor industry relations
• Potential liquidation

Cash Budgets and Cashflow Forecasts

Cash forecast
An estimate of cash receipts and payments for a future

Cash Budget
A commitment to a payment for cash receipts and paym
any necessaary action to bring the forecast into line wit

Cashflow forecasts can be prepared based on:

• Receipts and payments forecast.

• SOFP forecast
• Working Capital Ratios

Receipts and payments forecast.

Step 01: Prepare a proforma

Month: 1 2
$ $
Receipts X X
(few lines) X X
Sub total X X
Payments X X
(many lines) X X
Sub total X X
Net cashflow X X
Opening Balance X X
Closing Balance X X

Step 02: Fill in the simple figures

Step 03: Work out more complex figures
Additional Question - Full cashflow forecast

Month: 1 2
$ $
Receipts:
Sales (W1) 24000 93600
Sub total 24000 93600
Payments:
Purchases(W2) 44375
Labour (W2) 27000 17250
Fixed Overheads (W3) 10500 10500
Selling & Dist. (W4) 39875 14875
Business purchase 315000
Van purchase 15000
Sub total 392375 102000
Net cashflow -368375 -8400
Opening Balance 0 -368375
Closing Balance -368375 -376775

W4: Annual overheads 150000

Depreciation 24000
Annual Cash outflow 126000
Monthly outflow 10500

Annual overheads 208000

Depreciation 4500
Annual Cash outflow 203500
Rent & Rates 178500
Monthly Cashflow 14875
Month 1 39875

Using a SOFP: Additional Question

Statement of Financial Position 20X4

$
Non current Assets
Plant & machinery
Current Assets
Inventory 16800
Receivables 88000
Bank (balancing figure) 67200

Total Assets
 Equity & Liabilities
Share Capital
Retained Earnings

Current Liabilities
Trade Payables 10000
Dividends Payable 30000

Total Equity & Liabilities

Using working capital ratios:

Operating profit
Add: Depreciation
Cashflow from operations
Add : Cash from sale of NCA
Long-term financed raised
Less: Purchase of NCA
Redemption of Long-term funds
Interest Paid
Tax Paid
Dividend Paid
Increase in working capital
Net Cashflow

Additional Question

Cashflow from operations

Cash from sale of NCA
Long-term financed raised
Purchase of NCA
Redemption of Long-term funds
Interest Paid
Tax Paid
Dividend Paid
Increase in working capital
Net Cashflow

Cash Management Models

The baumol Cash Management Model

Assumtions:
 Cash use is steady and predictable
Cash inflows are known are regular

Tyu 06

Months jan feb

sales 42000 28000
50% in month
45% in following
Cash Receipts

Chapter 01: The Financial Management Function

The nature and purpose of financial management

Efficient acquisition and deployment of both long term and short term financ
ensure the objectives of enterprise are achieved

Decisions must be taken in three key areas:

Investments
Finance
Dividends

Financial manager will need to take account of the:

the organisation's commercial and financial objective
the broader economic in which the business operates
the potential risks associated with decision and methods on managing that ri

The investment Decision

investment appraisal
working capital management
risk
The Financing Decision
sources of finance
cost of capital
capital structure
risk
The Dividend Decision
Business Valuations
efficient markets

Management accounting providing information about more day to day functiond

Financial accounting providing information about historical results of past pla
Financial management long term raising of finance and allocation & control of
Management accounting improves budgeting, cost accounting , bariance analysis
short-term finance.

Financial Roles

Management Financial
accounting management
Review of overtime spending
Depreciation of NCA
Established Dividend policy
evaluation of explansion plans

apportioning overheads to cost units

Identifying accruals & prepayments

Financial Objectives

Shareholder's wealth maximisation

other objectives:
Profit maximisation
Growth
Market Share
Social Responsibilties

problems with adopting a profit maximisation objective:

Long-run versus short-run issues

quality (Risk) of earnings
Cash

Maximising seeking maximun level of returns inloves exposure to ri

Satisficing Seeking satisfactory level of returns, avoiding risky vent

Chapter 11 : The Economic Environment for business

Macroeconomic policy
is the management of economy by the government in s
performance and behaviour of the economy as a whole
Objectives of Macroeconomic Policy
• Full employment of resources
• price stability (low inflation)
 • Economic growth
• balance of payments equilibrium
• an appropraite distribution of wealth & income
Potential for Conflict

Full employment versus price stability

Economic growth versus Balance of Payments

Making an Impact - How Macroeconomic policy affects the business sector

Macroeconomic Policy

Maintain stable aggregate demand

Helps business plan:
• Investment
• Employment
• Output Exchange rates

Aggregate Demand (AD)

Total demand of goods are services in the economy

low demand ----> unemployment

high demand ----> Inflation

Business Costs
Affects not only demand of goods and services but also has implications for t
Three important areas maybe identified

Exchange rates
macroeconomic policy involves changing the exchange rates affecting the pri

Taxation
Fiscal policy involves the uses of taxation; changes in tax rates
Interest rates
involves changes in interest rates. Affects firms in two ways:
• costs of servicing debts will increase
• the viability of investments wil be aff

Monetary Policy
influences overall monetary conditions in the economy:
 • the volume of money in circulation - the money supply
• the price of money - interest rates

Chapter 15: Sources of Finance

Completed
Chapter 16: Dividend Policy
Completed
Chapter 17: Cost of Capital

Estimating Cost of Equity - Dividend Valuation Model

Assumptions:
Future income stream is the dividends paid out by the company
dividends will be paid out in perpetuity
dividends will be fixed or goowing ata constant rate

Cost of equity (no growth)

Ke = Do
Po
Cost of equity (constant growth)

Ke = Do(1-g) +g
Po

Yrs Cashflow DF @ 5% PV
MV of Debt 0 -98 1 -98
Interest payments 1 -- 5 7 4.329 30.303
redemption value 5 100 0.784 78.4
NPV = 10.703

IRR = 7.7

TYU 17
Ke 18%
Kp 12%
Kd 9%
MV of Debt 500000
MV of Equity 1250000
MV of P.shares 250000
BV of Debt 500000
BV of Equity 1000000
BV of P.shares 187500

WACC using MV
 15%

WACC using BV
14.67%

TYU 18
MV of shares 14600000
Ke 12.53%
Kd 8%
MV of debt 7350000

Yrs Cashflow DF @ 5%
MV of Debt 0 -105 1
Interest payments 1 -- 5 8.71 4.329
redemption value 5 100 0.784
NPV =

IRR =

WACC = 10.90%

Re = D1
+g
Po

Chapter 18 : Capital Stucture

Operating gearing:

Fixed costs Fixed costs

variable vosts Total Costs

% change in EBIT Contribution

% change in revenue EBIT

TYU 01

Firm A Firm B
Sales 5 5
Variable costs 3 1
Fixed Costs 1 3
EBIT 1 1
 operating gearing 33.33% 300.00%

Firm A 10% increase Firm B

Sales 5 5.5 5
Variable costs 3 3.3 1
Fixed Costs 1 1 3
EBIT 1 1.2 1
20%

TYU 02
DEBT = 1.5 + 8 9.5
Equity = 10 + 3 + 2.5 15.5
Debt + Equity = 25
Equity Gearing = Debt
Equity

Equity Gearing = 9.5

15.5

Equity Gearing = 61.3%

Capital Gearing = Debt

Debt + Equity

Capital Gearing = 9.5

25

Capital Gearing = 38%

Book Values or Market Values?

Market Values
• are more relevant to the level of investment made
• represend the opportunity cost of investment made
• are consistent with the way investors measure debt and equity
Book Values
• are how imposed gearing restrictions are often expressed
• are not subject to a sudden change in market conditions
• are readily available

TYU 03
Firm C 10% fall in sales
Sales 10 9
Variable costs 2 1.8
Fixed Costs 5 5
 Operating Profit 3 2.2
interest 2 2
profit before tax 1 0.2

The problems of High Gearing:

• Agency costs
• Difference in risk tolerance of shareholders and directors
• Bankruptcy
• Tax exhaustion
• restrictions on borrowing/debt capacity
• Restrictions in articles of association
• increases in the cost of borrowing as gearing increases

Asset Beta and Equity Beta

Illustration
company Project
Ve 5 Ve 2
Vd 2 Vd 1
Rf 11% Tax 30%
βe of company 1.1 βe of project 1.59
Rm 16%

βa = βe * Ve
Ve + Vd(1 - T)

1.18 = βe * 5
5 + 2(1 - 0.3)

βe = 1.51

Chapter 19: Financial Ratios

Statement of Financial Position

20X6 20X5
$000 $000
Non Current Assets 1800 1400
Current Assets
Inventory 1200 200
Receivables 400 800
Cash 100 100
 Total Assets 3500 2500

Equity & Liabilities

Ordinary Share Capital (50c shares) 1200 500
Share premium 600 0
Reserves 200 100

Non Current Liabilities

10% Loan notes 1000 600
Current Liabilities
Loans & other borrowing 200 500
other Payables 300 800

Total Equity & Liabilties 3500 2500

Statement of Profit & Loss

20X6 20X5
$000 $000
Revenues 2000 1000
Cost of Sales 1300 700
Gross Profit 700 300
Distribution Costs 260 90
Administration Expenses 100 60
operating Profit 340 150
Interest 100 60
Profit before taxation 240 90
Taxation 50 20
Profit after taxation 190 70
ordinary dividends 90 50
Retained profit for year 100 20
Profit/loss b/fwd 100 80
Profit/loss c/fwd 200 100

Share Price ($) 1.3 1.26

Market Value of Debt 130 120
Industry information
Industry PE ratio 22 20
Industry Average EPS (%) 12 8
Industry Average ROCE(%) 15 12

Categories of Ratios:
• Profitability & Return
• Debt & Gearing
• Liquidity
• Investor Ratios
(A) Profitability & Return
Return on Capital Employed

ROCE = Profit Before Interest & Tax

Capital Employed

Capital Employed = NCA + CA - CL

= Equity and Long term liabilities

Disadvantage:
uses profit which is not directly linked to the maximisation of shareholder's w
20X6 20X5
Capital Employed = 3000 1200
ROCE = 11.33% 12.50%

Return on Equity

ROE = Profit after tax & preference div

Ordinary Share capital + Reserves

Disadvantages :
• uses profit which is not directly linked to the maximisati
• sensitive to gearing levels; ROE will increase as gearing

20X6 20X5
ROE = 9.5% 11.7%

Profit Margins
Gross Profit Margin = Gross Profit
Sales Revenue

Operating Profit Margin = Operating Profit

Sales Revenue

20X6 20X5
Gross Profit Margin = 35% 30%
Operating Profit Margin = 17% 15%

(B) Debt & Gearing

Interest Cover = Profit before Debt interest & tax

Debt Interest

20X6 20X5
 Interest Cover = 3.4 2.5

(C) Liquidity ratios

All were covered in Working Capital management

(D) Investor Ratios

For an Ordinary shareholder:

Dividends Earnings
Dividends/share Earnings/share
Dividend cover ROE
Dividend Yield PE ratio
Also want information about Total Shareholder Return (TSR)
Debt investor will be interested in interest yield ratio

Earnings per share (EPS)

EPS = Profit after tax & preference div

Total Ordinary Shares in issue
Disadvantages:
Does not represent the actual income of the shareholder.
uses profit which is not directly linked to the maximisation of shareholder's w

20X6 20X5
Total ordinary shares 2400 1000
EPS = 7.92 7.00

Price Earnings (PE)

PE Ratio = Share price

EPS

20X6 20X5
PE Ratio = 16.4 18

Dividends per share (DPS)

DPS = Total Ordinary Dividend

Total no. of shares issued

20X6 20X5
DPS = 3.75 5

Dividend Cover
 Dividend cover = Profit available for ordinary share holders
Dividend for the year (interim + final)

20X6 20X5
Dividend cover = 2.11 1.40

Dividend Yield

Dividend Yield = DPS

Market price/share

20X6 20X5
Dividend Yield = 2.9 4.0

Total shareholder Return (TSR)

TSR = DPS + Change in Share price

Share price at the start of the period

Assume share price was $1.2 at 31 May 20X4

20X6 20X5
TSR = 6.15% 9.17%

Interest Yield

Interest Yield = Interest

MV of DEBT

20X6 20X5
Interest Yield = 7.69% 8.33%

Combining Ratios

PE ratio x dividend cover = 1

Dividend Yield

1 x Dividend payout ratio = dividend yield

PE ratio

Tyu 01
1 ROCE
Roce= 15.4%
 2 EPS
EPS = 14
growth in EPS 3.7%

3 PE ratio
PE = 10%

4 ROE
ROE = 7.78%

5 DPS
DPS = 0.125

6 Dividend Yield

Dividend Yield = 8.9%

7 TSR

TSR = 25%

Chapter 20 : Business Valuations

Valuing business & financial assets

Purposes:
To establish terms of takeover and merges etc
to be able to make buy & hold decisions in general
to value companies entering stock market
to establish value to shares held by retiring directors, which the article of a co
for fiscal purposes (capital gains tax(CGT), inheritance tax)
for divorce settlements, etc.

Approaches to Valuations:

The three main approaches are:

Asset Based based - Based on the tangible assets owne

Income/Earnings based - Based on the returns earned b
Cashflow based - Based on the cashflows of the compa

Market Capitalisation: current share price x no of shares in issue

1 share price change in response to supply & demand so d
2 when one company launches takeover bid for another a
Asset Based Valuations

Measure Strengths Weakness

Book values (total books values are Historic Cost value
assets - total relatively easy to (although could be
liabilities) obtain a fair value which is
less of a problem)

Net realisable minimum Valuation problems

Values - assumes a acceptable to especially if quick
breakup basis owners sale

Asset stripping Ignores goodwill

Replacement Cost Maximum to be
paid by buyers
Valuation problems
- similar assets for
comparison?
ignores goodwill

Problems with asset - based valuations

The fundamental weakness

• investors normally do not buys for the SOFP assets, but
that all of its assets can produce in the future
• we should value what is bein purchased, i.e. the future
Subsidiary Weakness
it ignores Non-SOFP intangible assets:
• Highly-skilled workforce
• Strong Management team
• competetive positioning of compna

When asset based measures are useful

• For Asset Stripping

• To identify a minimum price for take
• To value property investment comp

TYU 01
calculation of value of 200000 shares based on Asset b

Non current Assets per SOFP

Add: Revauation of property
Adjusted Value of fixed assets
Net Current Assets
Total assets
 Less: Payable to loan note holders on redemption

Valuation of 80% holding =

Income/earnings Based methods

useful when:
• ownership bestows aditional benefi
• majority of shareholders can influen
are more interested in earnings
PE ratio Method

Value of company =
Value of a Share =
TYU 02
Ke 13.60%
g 12%
dividend 0.24
Share price ?

Po = D (1 + g)
Ke - g

Po = $ 16.80

Market Capitalisation = $ 67,200,000

Valuation Post takeover
TYU 08

(a) The Value of Boston Post takeover:

Value of Boston before takeover

Value of Red Socks before takeover
Value of Synergy
Cash paid
Value of Boston post takeover

Share price

(b) boston will offer share 16200000 to finance the takeove

Value to consideration given to Red

Value of Red Socks before takeover
Value of synergy gained by Red Socks
 Boston's share of synergy

Value of existing 10m Boston shares post takeover

Share price

New share issue for consideration

Valuation of Debt & Preference shares:

Type of Finance MV
preference Shares D/Kp
Irredeemable debt I/r
Redeemable Debt MV = PV of future interest and
discounted at the investor's re
TYU 09 Preference Shares

D= $ 0.12
Kp = 14%
MV = $ 0.86

TYU 10 Irredeemable Debt

I= 7
r= 4%
MV = 175
TYU 11 Redeemable Debt

Yrs Cashflow
MV 0 Balancing Figure
Interest 1 -- 10 9
Redemption 10 100

TYU 13

I=
Redemption at nominal value =
Conversion into shares =
Market Value
Yrs Cashflow
MV 0 Balancing Figure
Interest 1 -- 10 8
Redemption 10 114.6
 Floor Value
Yrs Cashflow
MV 0 Balancing Figure
Interest 1 -- 10 8
Redemption 10 100

Coversion premium = Market value - current conversion value

Current Conversion value = 99
Coversion premium = 18.65
Coversion premium/share = 0.62

Chapter 12: Financial Markets & the treasury function

Financial Markets

Capital Markets Money Markets

Stock market for shares & bond markets Short term debt financing & investment

Other types of markets

Derivatives markets (Financial Risk instruments:Futures & options)
Insurance markets (Redistribution of Various risks)
Foreign exhange markets (Facilitate the trading of foreign exchange)
commodity markets (Facilitate the trading of commodities: oil,metal etc.)
d tax

d tax
ws because :

isor in this case

ent decisions)
 7350

Cashflow* AF
107091.60
 1
1.22

0.8197

1
2.8865075782

0.3464

x (H.R - L.R)

x (15 -10)

PV
(50000)
14994
17350
11580
4820
(1256)

x (20-15)

ate of return so it is financially acceptable

 o 6.203 is 6.210
ng that this is the closest approximation to

uires the use of spreadsheet program

ect maybe reinvested at the project's IRR which maybe

Project F Project G
$000
Payback Cashflows Payback
-120 -170 -170
-105 120 -50
-90 114 64
-75
-60 Payback period = 1 and 50/114 years
140 Payback period = 1.439 years
164

4 and 60/224 years

4.268 years

A.F 20% PV
1 -125
2.589 129.45
0.482 12.05
NPV = 16.5

A.F 20% PV
1 -120
2.589 38.835
0.402 90.048
NPV = 8.9

D.F 20% PV
1 -170
0.833 99.96
0.694 79.116
NPV = 9.1
 PV
(50000)
18357
16829
15453
14172
14811
 PV
(750)
300
200
400
150
 4 5 NPV W1: Inflated Wages:
1000 * 1.1^1 = 1100.00
1464 1611 1000 * 1.1^2 = 1210.00
486 511 1000 * 1.1^3 = 1331.00
1950 2122 1000 * 1.1^4 = 1464.10
0.572 0.497 1000 * 1.1^5 = 1610.51
1115 1055 (1079)
W2: Inflated Material:
400 * 1.05^1 = 420.00
400 * 1.05^2 = 441.00
400 * 1.05^3 = 463.05
400 * 1.05^4 = 486.20
400 * 1.05^5 = 510.51

Tax Relief yr

Tax Relief yr

5
 4 5 NPV
8000
(2400) (2400)
422 516

2500
8522 (1884)
0.683 0.621
5820.526 (1170) 11796.08

4
260466

26047

4 yrs $ Tax Relief Tax Relief yr

0 initial inv 1000
1 Tax Allowable Dep 250 75.00 2
0 Written down value 750
-140 2 Tax Allowable Dep 187.5 56.25 3
Written down value 562.5
3 Disposal value 200 4
109 Balancing charge 363 108.75

-31 240.00
0.683
-21 yrs 0 1 2.00 3
Sales revenue 0 520 1082.00 675
Working Capital 52 108.2 67.50
incremental investment -52 -56.2 40.70 67.5
 3
216293

25955.16
 4 5 6

270 203 608

270 203 608
0.735 0.681 0.63
198.45 138.243 383.04

Tax Relief yr

7
 3

7000
7000
0.658
4606
management skills

maximise returns of a limited range on investments

xposure to external finance
nce of only substancially profitable business
g investment conditions

Note:
When the projects are divisble,
any portion of them can be undertaken
with the aim to choose such projects
which maximize the shareholder's wealth
in the best way possible.

Rank

1st
3rd
2nd
4th
 NPV
3000
2000
25000
24000
26000
cial evaluation

es, allowing the use of mathematical techniques

justed discount rates

ct is classified as financially unacceptable

V
x100
der consideration

50
x100
00
50
x100
250

50
x100
000

50
x100
50

50
x100
00

DF @ 10% PV DF @ 20% PV
1 -40000 1 -40000
3.170 79250 2.589 64725
3.170 -31700 2.589 -25890
NPV = 7550 NPV = -1165

LR-NPV@HR))*(LR-HR)

6%
x100
 x100
1

70
x100
000

70
x100
800

70
x100
050

70
x100
750

70
x100
 x100
20

70
x100
40

PV DF @ 20% PV
-500000 1 -500000
570750 2.106 526500
-91320 2.106 -84240
52640 0.579 46320
32070 NPV = -11420

LR-NPV@HR))*(LR-HR)

0%
x100
15

ith the weightings based on the probabilites estimated

 EV

270
260
186

EV
100
125 Choose to buy 15 magazines
81.25

res investors attitude to risk)

 Joint Prob EV NPV
0.06 18000 -100000
0.14 56000 0
0.24 96000 0
0.56 280000 100000
PV(Inflow) 450000
initial INV -400000
NPV = 50000

in their construction can be more than the benefit

Cummulative
-20000
-12592
-2308
868
2338

/3176 years

Cummulative
-12000
-16176
-3475.2
6000
ject to be mot worthwhile

32460
8115
 $
Sales 3,600,000
COS 2,700,000
Gross profit 900,000
COS 975000
$ 587,500.00

$ 116,875.00

$ 470,625.00
pay)no. of periods -1

365/52/12
no of days/weeks/months earlier the money is received

n the discount should not be offered

365/52/12
eks/months earlier the money is received

12
2

pay)no. of periods -1

he discount should be offered.

e of market opportunities)

and payments for a future period under existing conditions

t for cash receipts and payments froa future period after taking
ng the forecast into line with the overall business plan

3 4
$ $
X X
X X
X X
X X
X X
X X
X X
X X
X X
 3 4 W1: Sales
$ $
Month 1 2 3
92600 90700 Cash Sales( 25%) 24000 24000 23000
92600 90700 In the month following sale 72000 72000
Discounts 2400 2400
29375 30625 Sales receipts 24000 93600 92600
18000 18750
10500 10500
14875 14875 W2: Month 1 2 3
Sales 96000 96000 92000
Sales units 12000 12000 11500
72750 74750 Closing inventory 12000 11500 12000
19850 15950 less : opening inventory 6000 12000 11500
-376775 -356925 Production units 18000 11500 12000
-356925 -340975 Raw Material Usage 45000 28750 30000
Closing Raw Material 14375 15000 15625
less : opening raw material 15000 14375 15000
Raw Material Purchases 44375 29375 30625
Labour 27000 17250 18000

160000

172000
332000
216000
76000
292000

40000
332000

$
X
X
X
X
X
(X)
(X)
(X)
(X)
(X)
(X)
X

$
110
0
0
-12
0
-5
-22
-10
-16
45
 mar apr
28000 28000
14000
12600
26600

term and short term financial resources to

ethods on managing that risk

more day to day functiond of control & decision making

historical results of past plans and decisions
and allocation & control of resources
counting , bariance analysis and evaluation of alternative uses of

Fianancial
accounting

urns inloves exposure to risk and much higher management workloads

returns, avoiding risky ventures and workloads.

my by the government in such a way as to influence the

of the economy as a whole
of wealth & income

ance of Payments

affects the business sector

Influence Costs
Methods include

Monetary Policy
Interest rates
Fiscal Policy
Taxation

t also has implications for the costs & reveues of the business

ange rates affecting the price of imported goods

s in tax rates

servicing debts will increase

lity of investments wil be affected
ulation - the money supply

DF @ 10% PV
1 -98
3.791 26.537
0.621 62.1
NPV = -9.363
 PV DF @ 10% PV
-105 1 -105
37.70559 3.791 33.01961
78.4 0.621 62.1
11.10559 NPV = -9.88039

8%
10% increase
5.5
1.1
3
1.4
40%
misation of shareholder's wealth

tly linked to the maximisation of shareholder's wealth

OE will increase as gearing increases

Gross Profit
Sales Revenue

Operating Profit
Sales Revenue
misation of shareholder's wealth
dinary share holders
ar (interim + final)
ors, which the article of a company specify must be sold

n the tangible assets owned by the company

sed on the returns earned by the company
he cashflows of the company

hares in issue
se to supply & demand so does the market capitalisations
s takeover bid for another and pays a premium over pre bid price.
 ys for the SOFP assets, but for the earnings/cashflows
uce in the future
n purchased, i.e. the future income cashflows

illed workforce
Management team
tive positioning of compnay's products

fy a minimum price for takeover

property investment companies

00 shares based on Asset basis

$
450000
30000
480000
100000
580000
olders on redemption -102000
478000
382400

ip bestows aditional benefits of control not reflected in DVM

of shareholders can influence the dividend policy so
e interested in earnings

Total Earnings x PE Ratio

EPS x PE Ratio

$000
54000
13500
5000
16200
56300

$ 5.63 /share

0000 to finance the takeover

$000
16200
13500
2700
 2300

56300

$ 5.63 /share

$ 2,877,442

= PV of future interest and redemption proceeds

counted at the investor's required rate of return

DF @ 16% PV
1 -66.197
4.833 43.497
0.227 22.7
0

8
100
114.6

DF @ 6% PV
1 -117.648
2.673 21.384
0.84 96.264
 0

DF @ 6% PV
1 -105.384
2.673 21.384
0.84 84
0
ersion value

investment
 4
24000
69000
2300
90700

4 5 6
96000 100000 104000
12000 12500 13000
12500 13000
12000 12500 13000
12500 13000
31250 32500
16250
15625 16250
31875
18750