Anda di halaman 1dari 10

Financial Management

Friday 15 June 2012

Time allowed
Reading and planning:
Writing:

15 minutes
3 hours

ALL FOUR questions are compulsory and MUST be attempted.


Formulae Sheet, Present Value and Annuity Tables are on
pages 8, 9 and 10.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet until
instructed by the supervisor.
This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

Paper F9

Fundamentals Level Skills Module

This is a blank page.


The question paper begins on page 3.

ALL FOUR questions are compulsory and MUST be attempted


1

Ridag Co is evaluating two investment projects, as follows.


Project 1
This is an investment in new machinery to produce a recently-developed product. The cost of the machinery, which
is payable immediately, is $15 million, and the scrap value of the machinery at the end of four years is expected to
be $100,000. Capital allowances (tax-allowable depreciation) can be claimed on this investment on a 25% reducing
balance basis. Information on future returns from the investment has been forecast to be as follows:
Year
Sales volume (units/year)
Selling price ($/unit)
Variable cost ($/unit)
Fixed costs ($/year)

1
50,000
2500
1000
105,000

2
95,000
2400
1100
115,000

3
140,000
2300
1200
125,000

4
75,000
2300
1250
125,000

This information must be adjusted to allow for selling price inflation of 4% per year and variable cost inflation of 25%
per year. Fixed costs, which are wholly attributable to the project, have already been adjusted for inflation. Ridag Co
pays profit tax of 30% per year one year in arrears.
Project 2
Ridag Co plans to replace an existing machine and must choose between two machines. Machine 1 has an initial
cost of $200,000 and will have a scrap value of $25,000 after four years. Machine 2 has an initial cost of $225,000
and will have a scrap value of $50,000 after three years. Annual maintenance costs of the two machines are as
follows:
Year
Machine 1 ($/year)
Machine 2 ($/year)

1
25,000
15,000

2
29,000
20,000

3
32,000
25,000

4
35,000

Where relevant, all information relating to Project 2 has already been adjusted to include expected future inflation.
Taxation and capital allowances must be ignored in relation to Machine 1 and Machine 2.
Other information
Ridag Co has a nominal before-tax weighted average cost of capital of 12% and a nominal after-tax weighted average
cost of capital of 7%.
Required:
(a) Calculate the net present value of Project 1 and comment on whether this project is financially acceptable
to Ridag Co.
(12 marks)
(b) Calculate the equivalent annual costs of Machine 1 and Machine 2, and discuss which machine should be
purchased.
(6 marks)
(c) Critically discuss the use of sensitivity analysis and probability analysis as ways of including risk in the
investment appraisal process, referring in your answer to the relative effectiveness of each method.
(7 marks)
(25 marks)

[P.T.O.

The following financial information relates to Wobnig Co.


Income statement extracts

Revenue
Cost of sales
Profit before interest and tax
Interest
Profit before tax
Taxation
Distributable profit

2011
$000
14,525
10,458

4,067
355

3,712
1,485

2,227

2010
$000
10,375
6,640

3,735
292

3,443
1,278

2,165

Statement of financial position extracts


2011
$000
Non-current assets
Current assets
Inventory
Trade receivables

2,149
3,200

$000

5,349

20,633

2,865
1,500

2,826

17,428

1,637
250

4,365
Equity
Ordinary shares
Reserves

$000
14,602

1,092
1,734

Total assets
Current liabilities
Trade payables
Overdraft

2010
$000
15,284

8,000
4,268

1,887
8,000
3,541

Long-term liabilities
7% Bonds
Total liabilities

12,268

11,541

4,000

20,633

4,000

17,428

Average ratios for the last two years for companies with similar business operations to Wobnig Co are as follows:
Current ratio
Quick ratio
Inventory days
Trade receivables days
Trade payables days
Sales revenue/net working capital

17 times
11 times
55 days
60 days
85 days
10 times

Required:
(a) Using suitable working capital ratios and analysis of the financial information provided, evaluate whether
Wobnig Co can be described as overtrading (undercapitalised).
(12 marks)
(b) Critically discuss the similarities and differences between working capital policies in the following areas:
(i) Working capital investment;
(ii) Working capital financing.

(9 marks)

(c) Wobnig Co is considering using the Miller-Orr model to manage its cash flows. The minimum cash balance would
be $200,000 and the spread is expected to be $75,000.
Required:
Calculate the Miller-Orr model upper limit and return point, and explain how these would be used to manage
the cash balances of Wobnig Co.
(4 marks)
(25 marks)

[P.T.O.

Zigto Co is a medium-sized company whose ordinary shares are all owned by the members of one family. It has
recently begun exporting to a European country and expects to receive 500,000 in six months time. The prospect
of increased exports to the European country means that Zigto Co needs to expand its existing business operations in
order to be able to meet future orders. All of the family members are in favour of the planned expansion, but none are
in a position to provide additional finance. The company is therefore seeking to raise external finance of approximately
$1 million. At the same time, the company plans to take action to hedge the exchange rate risk arising from its
European exports.
Zigto Co could put cash on deposit in the European country at an annual interest rate of 3% per year, and borrow at
5% per year. The company could put cash on deposit in its home country at an annual interest rate of 4% per year,
and borrow at 6% per year. Inflation in the European country is 3% per year, while inflation in the home country of
Zigto Co is 45% per year.
The following exchange rates are currently available to Zigto Co:
Current spot exchange rate
Six-month forward exchange rate
One-year forward exchange rate

2000 euro per $


1990 euro per $
1981 euro per $

Required:
(a) Discuss the reasons why small and medium-sized entities (SMEs) might experience less conflict between the
objectives of shareholders and directors than large listed companies.
(4 marks)
(b) Discuss the factors that Zigto Co should consider when choosing a source of debt finance and the factors
that may be considered by providers of finance in deciding how much to lend to the company. (8 marks)
(c) Explain the nature of a mudaraba contract and discuss briefly how this form of Islamic finance could be used
to finance the planned business expansion.
(5 marks)
(d) Calculate whether a forward exchange contract or a money market hedge would be financially preferred by
Zigto Co to hedge its future euro receipt.
(5 marks)
(e) Calculate the one-year expected (future) spot rate predicted by purchasing power parity theory and explain
briefly the relationship between the expected (future) spot rate and the current forward exchange rate.
(3 marks)
(25 marks)

Corhig Co is a company that is listed on a major stock exchange. The company has struggled to maintain profitability
in the last two years due to poor economic conditions in its home country and as a consequence it has decided not
to pay a dividend in the current year. However, there are now clear signs of economic recovery and Corhig Co is
optimistic that payment of dividends can be resumed in the future. Forecast financial information relating to the
company is as follows:
Year
Earnings ($000)
Dividends ($000)

1
3,000
nil

2
3,600
500

3
4,300
1,000

The company is optimistic that earnings and dividends will increase after Year 3 at a constant annual rate of 3% per
year.
Corhig Co currently has a before-tax cost of debt of 5% per year and an equity beta of 16. On a market value basis,
the company is currently financed 75% by equity and 25% by debt.
During the course of the last two years the company acted to reduce its gearing and was able to redeem a large
amount of debt. Since there are now clear signs of economic recovery, Corhig Co plans to raise further debt in order
to modernise some of its non-current assets and to support the expected growth in earnings. This additional debt
would mean that the capital structure of the company would change and it would be financed 60% by equity and
40% by debt on a market value basis. The before-tax cost of debt of Corhig Co would increase to 6% per year and
the equity beta of Corhig Co would increase to 2.
The risk-free rate of return is 4% per year and the equity risk premium is 5% per year. In order to stimulate economic
activity the government has reduced profit tax rate for all large companies to 20% per year.
The current average price/earnings ratio of listed companies similar to Corhig Co is 5 times.
Required:
(a) Estimate the value of Corhig Co using the price/earnings ratio method and discuss the usefulness of the
variables that you have used.
(4 marks)
(b) Calculate the current cost of equity of Corhig Co and, using this value, calculate the value of the company
using the dividend valuation model.
(6 marks)
(c) Calculate the current weighted average after-tax cost of capital of Corhig Co and the weighted average
after-tax cost of capital following the new debt issue, and comment on the difference between the two values.
(6 marks)
(d) Discuss how the shareholders of Corhig Co can assess the extent to which they face the following risks,
explaining in each case the nature of the risk being assessed:
(i) Business risk;
(ii) Financial risk;
(iii) Systematic risk.

(9 marks)
(25 marks)

[P.T.O.

Formulae Sheet
Economic order quantity
2C0D

Ch

MillerOrr Model
Return point = Lower limit + (

1
spread)
3
1

3 transaction cost variance of cash flows 3

Spread = 3 4

interest rate

The Capital Asset Pricing Model

(( ) )

()

E ri = Rf + i E rm Rf

The asset beta formula

Vd 1 T
Ve

a =
e +
d

V
+
V
T
V
V
1

+
1

T
d
d
e
e

))

))

The Growth Model

Po =

D0 1 + g

(r

Gordons growth approximation


g = bre
The weighted average cost of capital
V

e
d
ke +
k 1 T
WACC =
Ve + Vd
Ve + Vd d

The Fisher formula

(1 + i) = (1 + r ) (1 + h)
Purchasing power parity and interest rate parity

S1 = S0

(1 + h )
(1 + h )
c

F0 = S0

(1 + i )
(1 + i )
c

Present Value Table


Present value of 1 i.e. (1 + r)n
Where

r = discount rate
n = number of periods until payment
Discount rate (r)

Periods
(n)

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4

0990
)
0980
) 
0971
) 
0961
) 
0951
)


0980
) 
0961
) 
0942
) 
0924
)
0906
)

0971
) 
0943
) 
0915
)

0888
)
0863
) 

0962
) 
0925
)

0889
) 
0855
)

0822
) 

0952
)

0907
)
0864
)
0823
) 
0784
)

0943
) 
0890
) 
0840
) 
0792
) 
0747
)

0935
)

0873
) 
0816
) 
0763
) 
0713
) 

0926
)
0857
)

0794
) 
0735
) 

0681
) 

0917
)
0842
) 
0772
) 
0708
) 
0650
)


0909
)
0826
) 
0751
)

0683
) 
0621
) 

1
2
3
4

6
7
8
9
10


0942
) 
0933
)
0923
)
0941
)
0905
)

0888
)
0871
) 
0853
)

0837
) 
0820
) 

0837
) 
0813
) 
0789
) 
0766
)
0744
)

0790
) 
0760
) 
0731
) 
0703
) 
0676
)

0746
)
0711
) 
0677
)
0645
)

0614
) 

0705
) 

0665
)

0627
) 
0592
)

0558
)

0666
)
0623
) 
0582
)

0544
)

0508
)


0630
) 
0583
)

0540
)

0500
)

0463
) 

0596
)

0547
)

0502
)

0460
) 
0422
) 

0564
)

0513
)

0467
)
0424
) 
0386
)

6
7
8
9
10


11

12

13

14

15


0896
) 
0887
)
0879
) 
0870
) 
0861
) 

0804
) 
0788
)
0773
) 
0758
)

0743
) 

0722
) 
0701
) 
0681
) 
0661
) 
0642
) 

0650
)

0625
) 

0601
) 
0577
)

0555
)

0585
)

0557
)


0530
)

0505
)


0481
) 

0527
)

0497
) 
0469
) 
0442
) 
0417
) 

0475
)

0444
)
0415
) 

0388
)
0362
) 

0429
) 
0397
)
0368
)
0340
) 
0315
)

0388
)
0356
)

0326
)
0299
)
0275
)

0305
)

0319
)
0290
)
0263
) 
0239
)

11

12

13

14

15


(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4

0901
)
0812
) 
0731
) 
0659
)

0593
)


0893
) 
0797
) 
0712
) 
0636
) 
0567
)

0885
)

0783
) 
0693
) 
0613
) 
0543
)


0877
)
0769
) 
0675
)

0592
)

0519
)


0870
) 
0756
)

0658
)

0572
)

0497
) 

0862
) 
0743
) 
0641
) 
0552
)


0476
)

0855
)

0731
) 
0624
) 
0534
)

0456
)

0847
)
0718
) 
0609
) 
0516
)

0437
) 

0840
) 
0706
) 
0593
)

0499
) 
0419
) 

0833
) 
0694
) 
0579
)

0482
) 
0402
) 

1
2
3
4

6
7
8
9
10


0535
)


0482
) 
0434
) 
0391
)
0352
)


0507
)

0452
)

0404
) 
0361
) 
0322
)

0480
) 
0425
) 

0376
)
0333
)
0295
)

0456
)

0400
) 
0351
)

0308
)
0270
) 

0432
) 
0376
)
0327
)
0284
)
0247
)

0410
) 
0354
)

0305
)

0263
) 
0227
)

0390
)
0333
)
0285
)

0243
) 
0208
)

0370
) 
0314
)
0266
)
0225
)

0191
)

0352
)

0296
)
0249
) 
0209
)
0176
)

0335
)

0279
) 
0233
)
0194
)
0162
) 

6
7
8
9
10


11

12

13

14

15


0317
)
0286
)
0258
)

0232
)
0209
)

0287
)
0257
)

0229
)
0205
)

0183
) 

0261
) 
0231
)
0204
)
0181
) 
0160
) 

0237
)
0208
)
0182
) 
0160
) 
0140
) 

0215
)

0187
)
0163
) 
0141
) 
0123
)

0195
)

0168
)
0145
)

0125
)

0108
)

0178
)
0152
)

0130
)
0111
)
0095
)

0162
) 
0137
)
0116
)
0099
)
0084
)

0148
)
0124
)
0104
)
0088
)
0074
)

0135
)

0112
)
0093
)
0078
)
0065
)

11

12

13

14

15


[P.T.O.

Annuity Table
(1 + r)n
Present value of an annuity of 1 i.e. 1
r
Where

r = discount rate
n = number of periods
Discount rate (r)

Periods
(n)

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

1
2
3
4
5

0990
1970
2941
3902
4853

0980
1942
2884
3808
4713

0971
1913
2829
3717
4580

0962
1886
2775
3630
4452

0952
1859
2723
3546
4329

0943
1833
2673
3465
4212

0935
1808
2624
3387
4100

0926
1783
2577
3312
3993

0917
1759
2531
3240
3890

0909
1736
2487
3170
3791

1
2
3
4
5

6
7
8
9
10

5795
6728
7652
8566
9471

5601
6472
7325
8162
8983

5417
6230
7020
7786
8530

5242
6002
6733
7435
8111

5076
5786
6463
7108
7722

4917
5582
6210
6802
7360

4767
5389
5971
6515
7024

4623
5206
5747
6247
6710

4486
5033
5535
5995
6418

4355
4868
5335
5759
6145

6
7
8
9
10

11
12
13
14
15

10368
1037
11255
1126
12134
1213
13004
1300
13865
1387

9787
10575
1058
11348
1135
12106
1211
12849
1285

9253
9954
10635
1063
11296
1130
11938
1194

8760
9385
9986
10563
1056
11118
1112

8306
8863
9394
9899
10380
1038

7887
8384
8853
9295
9712

7499
7943
8358
8745
9108

7139
7536
7904
8244
8559

6805
7161
7487
7786
8061

6495
6814
7103
7367
7606

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

0901
1713
2444
3102
3696

0893
1690
2402
3037
3605

0885
1668
2361
2974
3517

0877
1647
2322
2914
3433

0870
1626
2283
2855
3352

0862
1605
2246
2798
3274

0855
1585
2210
2743
3199

0847
1566
2174
2690
3127

0840
1547
2140
2639
3058

0833
1528
2106
2589
2991

1
2
3
4
5

6
7
8
9
10

4231
4712
5146
5537
5889

4111
4564
4968
5328
5650

3998
4423
4799
5132
5426

3889
4288
4639
4946
5216

3784
4160
4487
4772
5019

3685
4039
4344
4607
4833

3589
3922
4207
4451
4659

3498
3812
4078
4303
4494

3410
3706
3954
4163
4339

3326
3605
3837
4031
4192

6
7
8
9
10

11
12
13
14
15

6207
6492
6750
6982
7191

5938
6194
6424
6628
6811

5687
5918
6122
6302
6462

5453
5660
5842
6002
6142

5234
5421
5583
5724
5847

5029
5197
5342
5468
5575

4836
4988
5118
5229
5324

4656
4793
4910
5008
5092

4486
4611
4715
4802
4876

4327
4439
4533
4611
4675

11
12
13
14
15

End of Question Paper

10