Financial Management

Friday 6 June 2014

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 6, 7 and 8.
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

ALL FOUR questions are compulsory and MUST be attempted

1

The Board of OAP Co has decided to limit investment funds to $10 million for the next year and is preparing its capital
budget. The company is considering five projects, as follows:
Project
Project
Project
Project
Project

A
B
C
D
E

Initial investment
$2,500,000
$2,200,000
$2,600,000
$1,900,000
$5,000,000

Net present value

$1,000,000
$1,550,000
$1,350,000
$1,500,000
To be calculated

All five projects have a project life of four years. Projects A, B, C and D are divisible, and Projects B and D are mutually
exclusive. All net present values are in nominal, after-tax terms.
Project E
This is a strategically important project which the Board of OAP Co have decided must be undertaken in order for the
company to remain competitive, regardless of its financial acceptability. Information relating to the future cash flows
of this project is as follows:
Year
Sales volume (units)
Selling price ($/unit)
Variable cost ($/unit)
Fixed costs ($000)

1
12,000
450
260
750

2
13,000
475
280
750

3
10,000
500
295
750

4
10,000
570
320
750

These forecasts are before taking account of selling price inflation of 50% per year, variable cost inflation of 60%
per year and fixed cost inflation of 35% per year. The fixed costs are incremental fixed costs which are associated
with Project E. At the end of four years, machinery from the project will be sold for scrap with a value of $400,000.
Tax allowable depreciation on the initial investment cost of Project E is available on a 25% reducing balance basis
and OAP Co pays corporation tax of 28% per year, one year in arrears. A balancing charge or allowance is available
at the end of the fourth year of operation.
OAP Co has a nominal after-tax cost of capital of 13% per year.
Required:
(a) Calculate the nominal after-tax net present value of Project E and comment on the financial acceptability of
this project.
(14 marks)
(b) Calculate the maximum net present value which can be obtained from investing the fund of $10 million,
assuming here that the nominal after-tax NPV of Project E is zero.
(5 marks)
(c) Discuss the reasons why the Board of OAP Co may have decided to limit investment funds for the next year.
(6 marks)
(25 marks)

The current assets and current liabilities of CSZ Co at the end of March 2014 are as follows:
Inventory
Trade receivables
Trade payables
Overdraft

$000
5,700
6,575

2,137
4,682

Net current assets

$000
12,275
6,819

5,456

For the year to end of March 2014, CSZ Co had domestic and foreign sales of $40 million, all on credit, while cost
of sales was $26 million. Trade payables related to both domestic and foreign suppliers.
For the year to end of March 2015, CSZ Co has forecast that credit sales will remain at $40 million while cost of
sales will fall to 60% of sales. The company expects current assets to consist of inventory and trade receivables, and
current liabilities to consist of trade payables and the companys overdraft.
CSZ Co also plans to achieve the following target working capital ratio values for the year to the end of March 2015:
Inventory days:
Trade receivables days:
Trade payables days:
Current ratio:

60 days
75 days
55 days
14 times

Required:
(a) Calculate the working capital cycle (cash collection cycle) of CSZ Co at the end of March 2014 and discuss
whether a working capital cycle should be positive or negative.
(6 marks)
(b) Calculate the target quick ratio (acid test ratio) and the target ratio of sales to net working capital of CSZ Co
at the end of March 2015.
(5 marks)
(c) Analyse and compare the current asset and current liability positions for March 2014 and March 2015, and
discuss how the working capital financing policy of CSZ Co would have changed.
(8 marks)
(d) Briefly discuss THREE internal methods which could be used by CSZ Co to manage foreign currency
transaction risk arising from its continuing business activities.
(6 marks)
(25 marks)

[P.T.O.

The equity beta of Fence Co is 09 and the company has issued 10 million ordinary shares. The market value of each
ordinary share is $750. The company is also financed by 7% bonds with a nominal value of $100 per bond, which
will be redeemed in seven years time at nominal value. The bonds have a total nominal value of $14 million. Interest
on the bonds has just been paid and the current market value of each bond is $10714.
Fence Co plans to invest in a project which is different to its existing business operations and has identified a company
in the same business area as the project, Hex Co. The equity beta of Hex Co is 12 and the company has an equity
market value of $54 million. The market value of the debt of Hex Co is $12 million.
The risk-free rate of return is 4% per year and the average return on the stock market is 11% per year. Both companies
pay corporation tax at a rate of 20% per year.
Required:
(a) Calculate the current weighted average cost of capital of Fence Co.

(7 marks)

(b) Calculate a cost of equity which could be used in appraising the new project.

(4 marks)

(c) Explain the difference between systematic and unsystematic risk in relation to portfolio theory and the capital
asset pricing model.
(6 marks)
(d) Discuss the differences between weak form, semi-strong form and strong form capital market efficiency, and
discuss the significance of the efficient market hypothesis (EMH) for the financial manager.
(8 marks)
(25 marks)

The following financial information relates to MFZ Co, a listed company:

Year
Profit before interest and tax ($m)
Profit after tax ($m)
Dividends ($m)
Equity market value ($m)

2014
183
128
51
564

2013
177
124
51
552

2012
171
120
48
540

MFZ Co has 12 million ordinary shares in issue and has not issued any new shares in the period under review. The
company is financed entirely by equity, and is considering investing $92 million of new finance in order to expand
existing business operations. This new finance could be either long-term debt finance or new equity via a rights issue.
The rights issue price would be at a 20% discount to the current share price. Issue costs of $200,000 would have
to be met from the cash raised, whether the new finance was equity or debt.
The annual report of MFZ Co states that the company has three financial objectives:
Objective 1: To achieve growth in profit before interest and tax of 4% per year
Objective 2: To achieve growth in earnings per share of 35% per year
Objective 3: To achieve total shareholder return of 5% per year
MFZ Co has a cost of equity of 12% per year.
Required:
(a) Analyse and discuss the extent to which MFZ Co has achieved each of its stated objectives.

(7 marks)

(b) Calculate the total equity market value of MFZ Co for 2014 using the dividend growth model and briefly
discuss why the dividend growth model value may differ from the current equity market value. (5 marks)
(c) Calculate the theoretical ex rights price per share for the proposed rights issue.

(5 marks)

(d) Discuss the sources and characteristics of long-term debt finance which may be available to MFZ Co.
(8 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 = R f + i E rm Rf

The asset beta formula

Vd 1 T
Ve

a =
e +
d

V
+
V
1

T
V
+
V
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
k +
k 1 T
WACC =
e
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
5

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
5

6
7
8
9
10

0942
0933
0923
0914
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

0350
0319
0290
0263
0239

11
12
13
14
15

(n)

11%

12%

13%

14%

15%

16%

17%

18%

19%

20%

1
2
3
4
5

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
5

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
11255
12134
13004
13865

9787
10575
11348
12106
12849

9253
9954
10635
11296
11938

8760
9385
9986
10563
11118

8306
8863
9394
9899
10380

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