Grand TEST 1 June 23 SAUD TARIQ

CFAP 4 Business Finance Decisions

ST Academy
Certified Finance and Accounting Professional Stage Examination
February 12, 2023
1 Hour 30 Minutes – 52 marks
Additional reading time – 10 minutes

CFAP 4 - Business Finance Decisions (Grand Test 1)

Question 1A)

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(Total 16 Marks)

IMPORTANT NOTE:
Please take Depreciation from 31-12-X9 (i.e. from Year 0 instead of Year 1. It means
depreciation needs to be taken from Year 0 and onwards)

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Question 1B)

(Total 11 Marks)

Question 2)

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a)

b)

c)

IMPORTANT NOTE:
Please take Depreciation from 31-12-X9 (i.e. from Year 0 instead of Year 1. It means
depreciation needs to be taken from Year 0 and onwards)

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CFAP 4 Business Finance Decisions
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CFAP 4 – BFD (Solution Grand Test 1)
Question 1:

Marks

(0.5)

(0.5)

(0.5)

(0.5)

20Y3 WDA _244,146 @ 17% = 41,505 (0.5)

1,112,219
Proceeds 1,000,000
Disposal Loss 112,219 @ 17% = 19,077 (0.5)

Year 0 1 2 3 4
Project 3 Cashflows (3,000,000) (1,500,000) 3,750,000 3,750,000 3,750,000
Tax Saving from Dep & Loss 91,800 75,276 61,276 50,616 60,582
Revised Net Cashflows (2,908,200) (1,424,724) 3,811,726 3,800,616 3,810,582
Discount Factor @ 10% 1 0.909 0.826 0.751 0.683
PV -2,908,200 -1,295,074 3,148,486 2,854,263 2,602,628
NPV £4,402,103
(1 Mark for NPV Calculation)

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CFAP 4 Business Finance Decisions
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Part Q1b)
Scenario 1:

With no capital rationing, all projects yielding a positive NPV should be accepted.Therefore,

accept 100% of Projects 1, 3 and 4. (1 Mark)

Scenario 2:
With capital rationing of £4.5 million at T0 and divisible projects, the NPV per £invested
needs to be calculated for each project:
Project 1: 2,676,600/2,400,000 = £1.12 (0.5 Mark for PI)… (Rank 2) … (0.5 Mark for Rank)
Project 2: (461,700)/2,250,000 = Negative (0.5 Mark for showing negative)

Project 3: 4,402,103/3,000,000 = £1.47 (0.5 Mark for PI) (Rank 1)… (0.5 Mark for Rank)

Project 4: 2,016,250/2,630,000 = £0.77 (0.5 Mark for PI) (Rank 3) …

Project 5: (45,250)/3,750,000 = Negative
So with £4.5 million to invest, accept 100% of Project 3 (£3m) and 62.5% of Project 1 (£1.5m) …

(1 Mark for Decision).

Scenario 3:
Under this scenario, Project 2 will never be accepted as it yields a negative NPV andconsumes
funds in the year of capital rationing. (1 Mark)
However, Project 4 will always be accepted as it yields a positive NPV and generates funds in
the year of capital rationing. (1 Mark)
Of the remaining projects:
Project 1: 2,676,600/750,000 = £3.57 (Rank 1)… (0.5 Mark for PI & Rank)

Project 3: 4,402,103/1,500,000 = £2.93 (Rank 2) … (0.5 Mark for PI & Rank)

Project 5: Negative NPV
However, although Project 5 has a negative NPV of £45,250 it does release £1,050,000 at T1. The
question that needs to be asked, therefore, is whether the negative NPV is outweighed by the
return on these released funds if Project 5 is undertaken.
Without Project 5, capital available = £300,000 + £750,000 (from Project 4) which means
Horton can accept 100% of Projects 1 and 4, and 20% of Project 3 to yield anoverall NPV of
£5,573,271 (£2,676,600 + £2,016,250 + (0.2 * £4,402,103)).
If Project 5 is undertaken, capital available = £300,000 + £750,000 (from Project 4) +
£1,050,000 (from Project 5) which means Horton can accept 100% of Projects 1, 4, 5and 90%
of Project 3 (£1.35m) to yield an overall NPV of £8,609,493. So this latter solution maximises
shareholder wealth. (2 Marks)

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Scenario 4:
With indivisible projects, the potential portfolios of investments possible with capital of
£5.25 million are as follows: Project 1 or Project 3 or Project 4 or Projects 1 and 4.The NPVs
generated by these four possibilities are:

Possibility NPV
1 Project 1: 2,676,600
2 Project 3: 4,402,103
3 Project 4: 2,016,250
4 Projects 1 and 4: 4,692,850

Therefore, the projects that should be undertaken are Projects 1 and 4

(2 Marks)…. 0.5 Mark for each correct possibility… Direct 2 Marks if mentioned Project 1 & 4.

General Comments (NOT PART OF SOLUTION):

Note: 99.9% of candidates attempting this question proceeded on the basis set out above,
which takes account of the revised NPV for Project 3 calculated in part 3.1(a) – £4,402,103 –
but which retains the original Project 3 cash outlays as (£3m) in T0 and (£1.5m) in T1, thereby
reflecting the practical reality that Horton would have to spend these sums before receiving
the benefit of the capital allowances calculated in part 3.1(a).
However, it should be noted that full credit was given to any candidate who used the revised
Project 3 cash outlays of £2,908,200in T0 and £1,424,724 in T1. Taking this approach would
have the following impact on the calculations:
In Scenario 1, no impact.
In Scenario 2, Project 3 would now yield an NPV per £ invested of £1.51 (still Rank 1) and 66.3%
of Project 1 could now be undertaken (up from 62.5%).
In Scenario 3, Project 3 would now yield an NPV per £ invested of £3.09 (still Rank 2); without
Project 5, 21.1% of Project 3 could now be undertaken (up from 20%); and this would now
yield an overall NPV of £5,621,694; with Project 5, 94.8% of Project 3 could now be undertaken
and this would now yield an overall NPV of £8,820,794

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Solution Q1B

(a) Calculation of NPVs of each potential replacement cycle: 1-year cycle:

(11,000) + {7,000 * 0.909} + {(6,600) * 0.909} = £(10,636) (1 Mark)
2- year cycle:
(11,000) + {4,200 * 0.826} + {(6,600) * 0.909} + {(7,600) * 0.826} = £(19,808) (1 Mark)
3- year cycle:
(11,000) + {1,800 * 0.751} + {(6,600) * 0.909} + {(7,600) * 0.826} + {(9,200) * 0.751}
= £(28,834) (1 Mark)
The annual equivalent costs are:
1-year cycle: (10,636)/0.909 = £(11,701) (0.5 Mark)
2-year cycle: (19,808)/1.736 = £(11,410) (0.5 Mark)
3-year cycle: (28,834)/2.487 = £(11,594) (0.5 Mark)
Therefore the advice to the managing director should be to replace the new company cars after two
years. (0.5 Mark for conclusion)

(b) Weaknesses of the method (1.5 Mark per valid point):

• The analysis in part 3.1(a) ignores price changes of all descriptions. A change in the price of a
new car, for example, could easily alter the conclusion. The same would be true for all of the
input factors. (1.5 Marks)
• The approach taken assumes that replacement will take place with an identical car. The car may
be replaced with an improved model. Horton may conclude that it no longer has a need for such
a car. In practice it seems unlikely that cars are replaced with identical models on a continuing
basis. (1.5 Marks)
• The timing of the cash outflows on new cars could be an issue in practice, ie, making payments
every fourth year may cause less of a cash flow problem than every third year. (1.5 Marks)
• The effects of taxation have been ignored in this analysis. (1.5 Marks)

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CFAP 4 Business Finance Decisions
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Question 2)
Marks Allocation Q2a)

Marks Allocation Q2b)

Marks Allocation Q2c)

Solution Q2a)

(4)

(1)
(1)
(1)

(1)

(1)
(2)
(3)

(0.5)
(0.5)

(1)

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CFAP 4 Business Finance Decisions
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Q2b) (Marks Allocation mentioned on previous page)

Question 2c) (Marks Allocation mentioned on previous page)

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