Monitoring Test MT1A

Financial
Management

F9FM-MT1A-Z08-A

Answers & Marking Scheme


Accountancy Tuition Centre Ltd

ATC
INTERNATIONAL

Accountancy Tuition Centre (International Holdings) Ltd 2008 2
1 REXEL PLC
(a) WDA calculations
TJ Project
$m WDA Tax relief Year
1.00 0.25 = 0.25 0.35 = 0.087 2
0.25
____
0.75 0.25 = 0.188 0.35 = 0.066 3
0.188
____
0.562 - 0.40 = 0.162 0.35 = 0.057 4
CSM Project
$m WDA Tax relief Year
1.75 0.25 = 0.437 0.35 = 0.153 2
0.437
____
1.313 0.25 = 0.328 0.35 = 0.115 3
0.328
____
0.985 - 0.80 = 0.185 0.35 = 0.065 4
Incremental cash flow of TJ Project ($000s)
Year 0 1 2 3 4
Outlay (1,000)
WDA tax saving 87 66 57
Revenues 502 760 930
Operating costs (200) (350) (420)
Corporation tax (106) (143) (178)
Sale proceeds 400
______ ___ ___ ___ ___
Net (1,000) 302 391 833 (121)
______ ___ ___ ___ ___
Incremental cash flow of CSM Project ($000s)
Year 0 1 2 3 4
Outlay (1,750)
WDA tax saving 153 115 65
Revenues 1,114 1,050 1,030
Operating costs (346) (585) (650)
Corporation tax (269) (163) (133)
Sale proceeds 800
______ ___ ___ _____ ___
Net (1,750) 768 349 1,132 (68)
______ ___ ___ _____ ___

Accountancy Tuition Centre (International Holdings) Ltd 2008 3
NPV Analysis
TJ project
0 (1,000) = (1,000)
1 302 0.926 = 280
2 391 0.857 = 335
3 833 0.794 = 661
4 (121) 0.735 = (89)
_____
NPV +187
_____
CSM project
0 (1,750) = (1,750)
1 768 0.926 = 711
2 349 0.857 = 299
3 1,132 0.794 = 899
4 (68) 0.735 = (50)
_____
NPV +109
_____
This analysis has estimated the tax charge in two separate components: (i) the tax relief on the
capital expenditure, and (ii) the tax charge on the net operating cash flow (revenues less
operating costs).
The loan interest cash flow, the loan repayment cash flow and the tax relief on loan interest
have all been excluded from the analysis. Financing cash flows are taken into account by the
discounting process itself and tax relief on interest is implied by using of an after-tax discount
rate
Depreciation has been excluded from the analysis as it is a non-cash item.
On the basis of the NPV analysis and, under the assumption of no capital rationing, the Trade
Journals project (code-named TJ) should be undertaken as this will lead to the greatest
increase in shareholder wealth of approximately $187,000.
(b) The main items of useful further information would be:
(i) Information on the systematic risk of the projects. Are they of equal risk and have
they got a level of systematic risk for which 8% is an appropriate discount rate?
(ii) Are there any non-financial reasons, such as competitors activity, existing
marketing abilities, etc, which would favour one project rather than the other?
(iii) How accurate are the cash flow forecasts, particularly with regard to revenues and
operating costs? Has any market research or sensitivity analysis been undertaken?
Has inflation been taken into account?
(iv) Given the constraint on management resources, are there any other projects that
should also be considered?

Accountancy Tuition Centre (International Holdings) Ltd 2008 4
(c) Not a great deal is known about the business and hence only general recommendations can be
made. The projects are not expected to last very long and hence both long and medium-term
finance could be suggested. The following may be suitable:
(i) A listing on the AIM.
(ii) Venture capital
(iii) Retained profits
(iv) Leasing
(v) Government grants or grants from other agencies
(vi) Merger/Partnership/Business Angel
2 JESSY PLC
(a) (i) New born Toddler
$ $
If the advertising campaign goes ahead

Sales $300,000 1.25 = $375,000 (50%) 187,500 (50%) 187,500

Receivables
One month 30/360 days 187,500 10% 1,563
One and half months 45/360 days 187,500 20% 4,688
Three months 90/360 days 187,500 67% 31,406

One month 30/360 days 187,500 10% 1,563
One and half months 45/360 days 187,500 10% 2,344
Two months 60/360 days 187,500 79% 24,688
______ ______
37,657 28,595
If the advertising campaign does not go ahead

Sales $300,000 total
New born (40%) $120,000
Toddler (60%) $180,000
Receivables 90/360 $120,000 30,000
45/360 $180,000 22,500
______ ______
Increase in receivables 7,657 6,095
______ ______

Total increase in receivables = $7,657 + $6,095 $13,752

Accountancy Tuition Centre (International Holdings) Ltd 2008 5
(ii)
Extra sales = 25% $300,000 = $75,000 a year
$ $
Extra contribution from extra sales (40% $75,000) 30,000
Less bad debts
New born 3% $187,500 5,625
Toddler 1% $187,500 1,875
_____
(7,500)
Less cost of extra investment in receivables (10% of $13,752) (1,375)
______
Incremental benefit 21,125
______
The maximum amount that should be paid for the advertising campaign is about $21,000.
(b) (i) Overdraft - a bank might be prepared to grant overdraft facilities against the security
of a floating charge over Jessys receivables. However, the maximum secured
advance might be no more than about 70% of the invoice value of the receivables.
(ii) Bills of exchange - Jessy might arrange with its customers that the method of
payment should be a bill of exchange. The company would draw a bill of exchange
on the customer, who would then accept it, that is, agree to pay it on maturity.
The company might then arrange with its bank to obtain finance against the security
of the accepted bills. Finance could be provided either by discounting the bill (the
bank would in effect purchase the bill at less than its face value) or by means of a
bank advance against the security of the bill (which is a common method for
exporters to obtain short term finance).
(iii) Invoice discounting - an invoice discounter provides finance, typically 80% of the
value of an unpaid debt, against the security of the debt. However although the
invoice discounter will only agree to do this for debts that it approves of. Jessy
must collect the debt itself, and on receipt of payment from the customer, repay the
advance from the invoice discounter plus a finance charge.
(c) The problems faced by a small business include the following:
(i) Management skills
The lack of experienced managers in all areas of the business may result in one individual
having to work in areas in which he/she is unqualified or uninterested.
This problem is compounded by small firms often having a lack of formal controls and
procedures and insufficient and informal training of staff.
The above problems often result in an impulsive and unpredictable management style, a
preoccupation with day to day problems and an emphasis on survival rather than long term
planning and future expansion.

Accountancy Tuition Centre (International Holdings) Ltd 2008 6
(ii) The business
Even though management is a key feature of any business, it is possible to outline other
problems that a small business may face:
If the company is just starting up, it will often have to finance itself through a
number of loss making years, while its sale volume and reputation grow. During
this period, obtaining capital and managing cash are a major problem.
Once a business is fairly well established and starts growing (i.e. the situation
described for Jessy plc) the key problem becomes managing the growth and
particularly obtaining finance for it. If growth is rapid, retained profits may not be
sufficient and to prevent the company from overtrading, new equity capital may
be required.
Small businesses will find the raising of new equity far more difficult than do larger
companies since the latter are generally perceived as less risky.
Managing the growth may require the recruitment of more specialised personnel,
which the existing managers may be reluctant to do (having seen the business
through the early years).
Some companies stay small for the following reasons:
If the owners also manage the business, it may be that their personal goals are
satisfied with the firm remaining small.
Owners are unable or unwilling to delegate responsibilities.
Nature of business if a specialist market, it may be that demand will only support
a small business.
Lack of management skills for growth.
Shortage of funds.


Accountancy Tuition Centre (International Holdings) Ltd 2008 7
Marking Scheme
Marks Marks
1 REXEL PLC
(a) Tax savings on WDA - TJ 2
Tax savings on WDA - CSM 2
Project TJ:
Outlay & proceeds 1
WDA b/f
Incremental revenues 1
Incremental operating costs 1
Tax on revenue items 1
Project CSM as for TJ 4
NPVs and conclusion 2 16

(b) 1 mark per reasonable idea 4 max

(c) 1 mark per reasonable idea 5 max

25

2 JESSY PLC
(a) (i) Receivables with advertising 3
Receivables without advertising 3

__

6
(ii) Extra contribution 1
Bad Debts 1
Finance cost 2
Conclusion 1

__

5
(b) 2 marks per method 6
(c) 1 mark per well made comment 4
1 mark per reason 4

__

8

__

25

__