PLFM D22 Student Mark Plan PDF

Professional Level – Financial Management – December 2022
MARK PLAN AND EXAMINER’S COMMENTARY
The marking plan set out below was that used to mark this question. Markers were encouraged to use
discretion and to award partial marks where a point was either not explained fully or made by implication.
More marks were available than could be awarded for each requirement. This allowed credit to be given for a
variety of valid points which were made by candidates.
Question 1
Total Marks: 35
General comments
The scenario of the question is that a company is considering whether to build a plant to recycle electric
vehicle batteries.
1. Requires candidates to revise the project cash flows prepared by a trainee and then complete the NPV
analysis of the project.
2. Requires candidates to calculate the sensitivity of the project to certain inputs into the NPV analysis.
3. Requires candidates to explain an alternative to sensitivity analysis.
4. Requires candidates to identify real options available to the company.
5. Requires candidates to outline how SVA could be applied to the project.
1.
Year to 31 December 2022 2023 2024 2025 2026

t0 t1 t2 t3 t4
000s 000s 000s 000s 000s
Number of batteries purchased 11 18 27 46
Power packs sold 8.25 13.50 20.25 34.50
Batteries ground down 2.75 4.50 6.75 11.50
£000s £000s £000s £000s £000s
Selling price of power packs 6.50 6.50 6.50 6.50
Selling price of raw materials 0.50 0.45 0.41 0.36
£m £m £m £m £m
Total revenue 55.00 89.78 134.36 228.44
Processing costs -38.50 -62.84 -94.05 -159.91
Contribution 16.50 26.93 40.31 68.53
Labour costs -5.00 -8.00 -12.00 -24.00
Add back spare capacity 1.00 1.60 2.40 4.80
Fixed production overheads -15.00 -16.00 -18.00 -19.00
Add back depreciation 5.00 5.00 5.00 5.00
Marketing expenses -1.00 -1.00 -2.00 -4.00 -4.00
Net operating cash flows -1.00 1.50 7.53 13.71 31.33
Tax @ 25% 0.25 -0.38 -1.88 -3.43 -7.83
Sale to the MBO team 102.80
Equipment -24.00
Disposal proceeds 4.00
Tax saved on C.As. 1.08 0.89 0.73 0.60 1.71
Copyright © ICAEW 2022. All rights reserved Page 1 of 12

Working capital -5.00 -3.16 -4.05 -8.55 20.77

Net cash flows -28.67 -1.15 2.32 2.32 152.78
£m
Present value t1 to t4 @ 12% 99.57
Less t0 -28.67
NPV 70.90
CleanUp has a positive NPV, therefore accept the project and increase shareholders' wealth
Depreciation is not a cash flow and should be added back
Spare capacity in labour costs are sunk and added back
The cost of the firm of analysts is a sunk cost and ignored
The raw material selling price should be reduced by 10% pa for the three years to 31/12/26
Depreciation of equipment
£m pa
(Cost - proceed)/4 (24-4)/4 5.00
Sale to the MBO team

£m
Contribution at 31/12/22 x 2 137.07
Tax @ 25% -34.27
Net proceeds 102.80
Capital Allowances
Cost/WDV C.As. Tax

£m £m £m
t0 24.00 4.32 1.08
t1 19.68 3.54 0.89
t2 16.14 2.91 0.73
t3 13.23 2.38 0.60
t4 10.85
Proceeds 4.00 6.85 1.71
Working Capital
Total Increment
£m £m
t0 -5.00 -5.00
t1 -8.16 -3.16
t2 -12.21 -4.05
t3 -20.77 -8.55
20.77
Examiner comments
Common errors were:

• Not adjusting selling price when the question clearly stated it needed to be
• Not adjusting labour costs for non-incremental element
• Calculating depreciation as cost/life instead of (cost-scrap)/life. Worryingly this applied to the vast
majority of candidates.
• Leaving in sunk analysts costs

• Not adding in additional marketing or adding it in but removing subsequent marking from future
years
• Ignoring MBO sale proceeds despite requirement stating it was going ahead
• Starting WDAs too late or not calculating BA correctly
• Poor calculation of wc by significant minority
• Not explaining adjustments (simply saying its irrelevant but not why)
• Not showing NPV workings as instructed in LMs
Total possible marks 17

Maximum full marks 17
2.
Sensitivity to:
Changes in total revenue if the sale to the MBO team goes ahead:
Sensitivity to:
Changes in total revenue if the sale to the MBO team goes ahead:
Year to 31 December 2023 2024 2025 2026

t1 t2 t3 t4
£m £m £m £m
Contribution 16.50 26.93 40.31 68.53
Tax -4.13 -6.73 -10.08 -17.13
Sale to the MBO team 102.80
Total 12.38 20.20 30.23 154.20
Present value @ 12% 146.67
Sensitivity (70.90/146.67) 48%
Changes in total revenue if the sale to the MBO team does not go ahead:
£m
PV of sale proceeds £102.8m/1.12^4 65.33
NPV PV
Contribution
£m £m
Original figures 70.90 146.67
Less pv of sale proceeds -65.33 -65.33
5.57 81.33
Sensitivity (5.57/81.33) 7%
Comment:
With the sale proceeds the project is not very sensitive at 48% to changes in total revenue.

However, without the sale proceeds the project is very sensitive at 7% to

changes in total revenue.
Examiner comments
Answers were extremely mixed often because candidates failed to include the MBO I part 1. The vast
majority used sales revenues and not contribution despite this being examined many times before. Lack of
workings – figures appearing from nowhere.
3.
The disadvantages of sensitivity analysis are:
• It assumes that changes to variables can be made independently.

• It ignores probability. It only identifies how far a variable needs to change to result in a zero NPV,
it does not look at the probability of such a change.
• It is not an optimising technique and does not point directly to a correct decision.
Simulation goes some way to address the weaknesses of sensitivity analysis. The main advantage is that
it allows the effect of more than one variable changing at the same time to be assessed. This gives more
information about the possible outcomes and their relative probabilities and it is useful for problems that
cannot be solved analytically. However it should be noted that simulation is also not an optimising
technique and does not point directly to a correct decision.
Examiner comments
A common error was not answering the question by writing everything they knew about sensitivity and
simulation.
4.
Without selling to the team on 31 December 2026 NT has the following two real options:
A follow-on option. By keeping the CleanUp project NT will have later opportunities to sell batteries and
raw materials, which could be highly profitable. This is likely given the large increase in sales in the two
years to 31 December 2026 assuming the German company does not enter the market. If it does,
CleanUp may still have a first mover advantage.
Candidates might also mention and discuss Growth options, which will be awarded marks.
An abandonment option. Since the German manufacturer may enter the market by 31 December 2026,
and the fact that the CleanUp project is very sensitive (at 7%) to changes in sales revenue, NT also has
the option to abandon the project after the initial 4 years and sell any intellectual property etc to its
German competitor.
Examiner comments
Weak answers, the requirement asked for real options at the end of the project so an option to delay the
start was inappropriate. Very vague descriptions of abandonment, follow on and growth not applied to the
scenario.

5.
SVA is useful to highlight the key drivers of value, namely: Cost of capital; Life of projected cash flows;
Sales growth rate; Investment in working capital; Investment in non-current assets; Corporation tax rate;
Operating profit margin.
This enables managers to set targets for achieving value-enhancing strategies in each area. By
examining each area for the CleanUp project managers can ensure that shareholder’s wealth is increased.
Examiner comments
Many candidates just listed the drivers and sometimes not all of them.

Question 2
Total Marks: 35
General comments
The scenario of the question is that a company is diversifying. The board of the company would like the
finance director to give advice on certain matters connected to the diversification.
1. Requires candidates to calculate the current cost of equity of the company using two methods.
2. Requires candidates discuss a particular input in one of the methods used in the first part of the
question.
3. Requires candidates to calculate the current WACC of the company ignoring the diversification.
4. Requires candidates to calculate a risk adjusted WACC that should be used to discount the cash flows
of the diversification.
5. Requires candidates to calculate and discuss the overall beta and WACC of the company if the
diversification goes ahead.
6. Requires candidates to calculate and discuss the issue price of a debenture issue.
7. Requires candidates to discuss the political risk that could affect the company because of the
diversification.
8. Requires candidates to discuss ethical issues relating to the diversification.
1.
SU’s cost of equity:
Using the dividend valuation model
The special dividend is ignored since it is a one-off. Ordinary dividend for 2022 = total dividend – special
dividend = 20 – 4 = £16m
g = 4√(16/14) -1 = 3.39%
Ke = (16(1+0.0339)/600) + 0.0339 = 6.15%
If dividends per share used:

Dividends per share = 16/200 = 8p and 14/200 = 7p
Using the CAPM:
Ke = 2 + 1.25(7 – 2) = 8.25%
Examiner comments
Common errors were:
Not removing the special dividend despite this complication being on numerous past exams. Fudging the
maths – using total dividend of £20m and share price of £3 in ke and still, apparently, getting a sensible
answer. Poor maths even with correct figures. Some candidates could not calculate Ke using the CAPM.


2.
DVM uses future growth to calculate the cost of equity. Past growth is often used to estimate this future
growth but may be unreliable. Clearly from the total dividend chart growth has not been smooth at 3.4%
pa. 2019 and 2021 have large dips in dividends paid. This may create uncertainty in the minds of
shareholders (signalling) and result in a higher cost of equity than that calculated in 1. above.
Examiner comments
Most candidates spotted the issues from the graph but a small minority incorrectly focussed on the special
dividend and mentioned nothing else.
3.
Kd:
The redemption yield of SU's five year debentures

Using the RATE function the inputs are:
Number of payments (6 x 2) 12
Six-month coupon (6/2) 3
Price (105 - 3) -102
Redemption 100
Annual redemption yield using the RATE function 2x2.8% 5.60%
Tax rate 25%
Kd = GRY (1 - t) 4.20%
Ke as above 8.25%
Market values:
Equity 200m x 300p = £600m
Debt:
Using the ex-interest price as above of £102 = 2m x 102 = £204m
Total: 600 + 204 = £804m
WACC = (8.25 x 600 + 4.20 x 204)/804 = 7.22%
Examiner comments
The majority of candidates read 2m debentures as £2m. Poor inputs to the kd calculation eg wrong
number of 6m periods, doubling not halving the coupon, wrong ex interest, not doubling the output for
annual cost.

4.
Degear the Be of 1.59:
1.59 = Ba (1 + (3 x 0.75/7))
Ba = 1.20

Regear using SU’s capital structure:
Be = 1.20 (1 + (204 x 0.75/600))

Be = 1.51
Ke = 2 + 1.51 (7 - 2) = 9.55%
The WACC to discount HF’s free cash flows = (9.55 x 600 + 4.20 x 204)/804 = 8.19%
The WACC of 8.19% is higher than the SU’s existing WACC of 7.22% and reflects the higher systematic
business risk of HFs industry sector.
This is because, after making gearing adjustments, the Be of 1.51 used to calculate the value of HF is
higher than SU’s Be of 1.25. Beta incorporates systematic risk (both financial and business). The change
is not due to a change in systematic financial risk as gearing remains constant.
Examiner comments
Poor maths on degearing regearing. Changing kd in the WACC when it hadn’t changed.

5.
The overall equity beta of SU if it purchases HF will be:
1.25 x 0.60 + 1.51 x 0.40 = 1.35
The overall Ke will be: 2 + 1.35 x (7 – 2 ) = 8.75%
The overall WACC will be: (8.75 x 600 + 4.2 x 204)/804 = 7.60%
{overall wacc could also be arrived at by weighting the 2 individual waccs in 3 and 4 so give 2 marks
(overall ke mark and overall wacc mark)]
The overall WACC of the enlarged company should only be used for future projects if the project has the
average systematic risk reflected in the overall Be of 1.35. If the future project does not have this average
systematic risk a new risk adjusted WACC should be calculated.
Examiner comments
Despite many previous examples in exams a sizeable minority didn’t seem to know what to do here.
6.
The issue price of the new ten-year debentures:

Using the PV function the inputs are:
Rate (5.60/2) 2.80%
Number of payments (10 x 2) 20
Coupon (4/2) 2
Redemption 100
The issue price using the PV function 87.85
It is not appropriate to use the redemption yield of SU’s existing six year 6% debentures to calculate the
issue price of the new ten year 4% debentures since they have different coupon rates and maturities. Also,
since SU is diversifying the debt markets may require a higher return for the additional systematic

business risk of buying HF (see above).
Examiner comments
Variable answers – minority calculated a % cost not issue price. Not using answer to part 2 correctly as
GRY. The narrative part of the question was quite well answered.
7.
Since SU’s head office is in the UK political risk in the country where HF’s operations are could cause
difficulties for SU and it could face the risk of action by the foreign country’s government. If the foreign
government tries to prevent the exploitation of its country, it may take various measures. These include:
• Quotas: Limiting the quantities of goods that can be exported.

• Tariffs: A tariff on materials imported by HF therefore making locally produced goods more
competitive.
• Non-tariff barriers: Legal standard of safety or quality could be imposed on HF.
• Restrictions: Restricting HF from employing foreign experts.
• Nationalisation: A government could nationalise HF’s assets in its country.
• Minimum shareholding: The foreign government might insist on HF allowing locals to own shares
in its subsidiary.
Examiner comments
Answers were generally fine.

8.
The adverse reports in the press regarding HF’s activities overseas should cause concern for the board of
SU ie reputational risk.
When advising the board of SU the finance director should act with integrity and should behave in a
professional manner. With this in mind an ethical employment policy will need to be implemented should
the purchase of HF go ahead. If it is felt that an ethical employment policy cannot be implemented, they
should advise SU against the purchase of HF.
Examiner comments


Question 3
Total Marks: 30
General comments
The scenario of the question is that you work for a firm of financial analysts that is giving advice to a client.
You are currently working on two tasks:
Task one: 1 Foreign exchange rate risk
a. Requires candidates to calculate the sterling cost of a payment in € using various hedging techniques.
b. Requires candidates to explain and give advice on the techniques used in the first part of the question.
Task two: 2 Interest rate risk
a. Requires candidates to calculate the cost in £ of a loan that the client intents to take out.
b. Requires candidates to explain and give advice on the techniques used in the first part of the question.
3.1(a)
Forward contract:
The forward rate is €1.1900 + €0.0018 = €1.1918
The sterling payment is: €2,200,000/€1.1918 = £1,845,947
Money market hedge:
Deposit in €: €2,200,000/(1+0.034 x 4/12) = €2,175,346
Buy € spot = €2,175,346/€1.1900 = £1,828,022
Borrow in the UK, total payment = £1,828,022x (1 + 0.033 x 4/12) = £1,848,130
OTC currency options:
Call options will be used to buy € at €1.1930
The premium will be €2,200,00 x £0.05 = £110,000

(Note: the question states ignore interest on the premium)
If the spot rate on 30 April 2023 is €1.1925 and the exercise price is €1.1930 it will be beneficial to
exercise the options.
The total payment will be:
Exercise of options: €2,200,000/€1.1930 = £1,844,091
Plus the premium paid: £1,844,091 + £110,000 = £1,954,091
Examiner comments
The usual errors from weaker candidates for example: wrong spot rate, subtracting discount, wrong
interest rates, using a put, using a call with put premium, not showing why option is exercised

3.1(b)
£
Forward 1,845,947
Money market 1,848,130
OTC option 1,954,091
No hedge €2,200,000/€1,1925 1,844,864
Advantages and disadvantages:
The forward contract and money market hedge lock Tyrol into an exchange rate and do not allow for
upside potential.
Forwards:
Tailored specifically for Tyrol
However, there is no secondary market
Money Market:
Tailored specifically for Tyrol.
However:
In the case of a payment means using funds or credit lines earlier than a forward contract. There is no
secondary market.
OTC currency options:

The options are expensive
There is no secondary market
However, the options allow Tyrol to exploit upside potential and protect downside risk
Advise:
Both the forward contracts and the money market hedge result in a lower payment than the OTC options.
The OTC options would only be beneficial if the € weakened against the £ above the exercise price of
€1.1930. Unless Tyrol is willing to take the risk of the € weakening against the £ more than the forward
market suggests it is recommended to use either a forward contract or a money market hedge rather than
the options.
No hedge results in the lowest payment, however not hedging is risky and it is recommended to use either
a money market hedge or a forward contract since both techniques are not materially different in terms of
sterling cost. However, the fact that a money market hedge uses funds earlier than a forward contract
might influence the decision.
Examiner comments

3.2(a)
Forward rate agreement
Since the loan will be for six months commencing in three months a 3v9 agreement will be used at 4.00%
pa.
If SONIA rises from its current level of 1% to 1.25% the cost of the £3,150,000 loan will be:
£
Tyrol pays 1.25% + 3.00% = 4.25%
£3,150,000 x 0.425 x 6/12 66,938
The FRA pays Tyrol 4.25% - 4.00% = 025%
£3,150,000 x 0,0025 x 6/12 3,938
Interest cost of the loan 63,000

Check: £3,150,000 x 0.04 x 6/12 = £63,000
Sterling interest rate futures
Tyrol will SELL interest rate futures on 31 December 2022 at 98.90
The number of contracts to sell = £3,150,000/£500,000 x 6/3 = 12.60 Round to 13.
When the futures are closed out on 31 March 2023 the net interest cost will be:
Futures sold at 98.90

Futures bought at 98.75
Gain 00.15
£
Interest paid on the loan as above
66,938
Futures gain:
13 x £500,000 x 0.0015 x 3/12
2,438
Interest cost of the loan 64,500
Examiner comments
Picking wrong FRA and calculating annual cost not 6m. Incorrect number of futures contracts and not
calculating £ profit correctly (using 6m not 3m). Not stating that futures should be sold on 31 December
2022. Unusually some candidates calculated the interest implied by the futures contracts (98.90 = 1.10%
and 98.75 = 1.25%) and the stated that there was a loss on futures ie. Selling at 1.10% and buying back at
1.25%.
3.2(b)
Both the FRA and interest rate futures lock Tyrol into an interest rate.
However, both hedging techniques do not allow Tyrol to take advantage of the upside potential of SONIA
falling, options would allow Tyrol to take advantage of this.
The exact amount of the loan can be hedged using a FRA, however the interest rate futures are bought
and sold in standard contract sizes, and it is not possible to hedge an exact amount. In this case the
contracts have been rounded from 12.60 to 13.00 contracts, which is slightly over hedging.
The FRA does not have any basis risk unlike the interest rate futures. In this case SONIA on 31 December
2022 is 1%. The March future are predicting that SONIA will be 100 – 98.90 = 1.1%.
In this case it is recommended to use FRA agreements which will result in a lower interest cost of £63,000
compared to the interest rate futures which have a cost of £64,500.
Examiner comments


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Professional Level – Financial Management – December 2022

MARK PLAN AND EXAMINER’S COMMENTARY

3. Requires candidates to explain an alternative to sensitivity analysis.

4. Requires candidates to identify real options available to the company.

5. Requires candidates to outline how SVA could be applied to the project.

Year to 31 December 2022 2023 2024 2025 2026

Copyright © ICAEW 2022. All rights reserved Page 1 of 12

Working capital -5.00 -3.16 -4.05 -8.55 20.77

Sale to the MBO team

Cost/WDV C.As. Tax

Common errors were:

Copyright © ICAEW 2022. All rights reserved Page 2 of 12

Total possible marks 17

Year to 31 December 2023 2024 2025 2026

Present value @ 12% 146.67

Sensitivity (70.90/146.67) 48%

Copyright © ICAEW 2022. All rights reserved Page 3 of 12

However, without the sale proceeds the project is very sensitive at 7% to

The disadvantages of sensitivity analysis are:

• It assumes that changes to variables can be made independently.

Copyright © ICAEW 2022. All rights reserved Page 4 of 12

Copyright © ICAEW 2022. All rights reserved Page 5 of 12

8. Requires candidates to discuss ethical issues relating to the diversification.

SU’s cost of equity:

Using the dividend valuation model

Ke = (16(1+0.0339)/600) + 0.0339 = 6.15%

If dividends per share used:

Using the CAPM:

Common errors were:

Total possible marks 4

Copyright © ICAEW 2022. All rights reserved Page 6 of 12

The redemption yield of SU's five year debentures

Equity 200m x 300p = £600m

Total: 600 + 204 = £804m

WACC = (8.25 x 600 + 4.20 x 204)/804 = 7.22%

Total possible marks 6

Degear the Be of 1.59:

Copyright © ICAEW 2022. All rights reserved Page 7 of 12

Regear using SU’s capital structure:

Be = 1.20 (1 + (204 x 0.75/600))

Total possible marks 7

The overall equity beta of SU if it purchases HF will be:

1.25 x 0.60 + 1.51 x 0.40 = 1.35

The overall Ke will be: 2 + 1.35 x (7 – 2 ) = 8.75%

The issue price of the new ten-year debentures:

Copyright © ICAEW 2022. All rights reserved Page 8 of 12

business risk of buying HF (see above).

• Quotas: Limiting the quantities of goods that can be exported.

Answers were generally fine.

Answers were generally fine.

Copyright © ICAEW 2022. All rights reserved Page 9 of 12

Task one: 1 Foreign exchange rate risk

Task two: 2 Interest rate risk

The forward rate is €1.1900 + €0.0018 = €1.1918

The sterling payment is: €2,200,000/€1.1918 = £1,845,947

Money market hedge:

Deposit in €: €2,200,000/(1+0.034 x 4/12) = €2,175,346

Buy € spot = €2,175,346/€1.1900 = £1,828,022

Borrow in the UK, total payment = £1,828,022x (1 + 0.033 x 4/12) = £1,848,130

OTC currency options:

Call options will be used to buy € at €1.1930

The premium will be €2,200,00 x £0.05 = £110,000

The total payment will be: