Professional Level – Financial Management - March 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 launching a new product onto the market.

Part 1.1 of the question covers NPV analysis.

Part 1.2 of the question requires a sensitivity calculation.
Part 1.3 of the question requires discussion of an ethical issue.
Part 1.4 of the question discusses the impact of increasing the life of the project.
Part 1.5 of the question discusses predictive and prescriptive analytics.

1.1

Option 1
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Wristband sales 2,500 3,000 3,025 2,475 1,650
Wristband costs (1,000) (1,272) (1,236) (1,072) (758)
Subscription fees 250 550 825 1,050 1,200
Fixed costs (+3%) (1,300) (1,339) (1,379) (1,421) (1,463)

Operating c/fs 450 939 1,235 1,032 629

Tax @ 25% (113) (235) (309) (258) (157)

IT equipment (2,500) 200

Capital allowances 113 92 76 62 51 181

Net cash flows (2,387) 429 780 988 825 853

PV of T1-T5 cash flows @ 11% £2,792k

Less: initial outlay in T0 (£2,387k)
NPV £405k

Wristband sales and costs

1 2 3 4 5
Wristbands sold 50,000 60,000 55,000 45,000 30,000

Selling price £50.00 £50.00 £55.00 £55.00 £55.00

Total sales £2,500k £3,000k £3,025k £2,475k £1,650k

Cost per band (+6% pa) £20.00 £21.20 £22.47 £23.82 £25.25
Total costs £1,000k £1,272k £1,236k £1,072k £758k

Subscription fees
1 2 3 4 5
App users 50,000 110,000 165,000 210,000 240,000

Fee per user £5.00 £5.00 £5.00 £5.00 £5.00

Total sales £250k £550k £825k £1,050k £1,200k

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 Professional Level – Financial Management - March 2022

Capital allowances
Cost/WDV 18% CA 25% Tax
£’000 £’000 £’000
Year 0 2,500 450 113
Year 1 2,050 369 92
Year 2 1,681 303 76
Year 3 1,378 248 62
Year 4 1,130 203 51
Year 5 927
Disposal -200 727 181

Option 2
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Wristband sales 2,625 1,625 1,250 1,000 625
Wristband costs (2,100) (1,378) (1,124) (953) (631)
Subscription fees 1,050 1,700 2,200 2,600 2,850
Fixed costs (+3%) (1,300) (1,339) (1,379) (1,421) (1,463)

Operating c/fs 275 608 947 1,226 1,381

Tax @ 25% (69) (152) (237) (307) (345)

IT equipment (2,500) 200

Capital allowances 113 92 76 62 51 181

Net cash flows (2,387) 298 532 772 970 1,417

PV of T1-T5 cash flows @ 11% £2,745k

Less: initial outlay in T0 (£2,387k)
NPV £358k

Wristband sales and costs

1 2 3 4 5
Wristbands sold 105,000 65,000 50,000 40,000 25,000

Selling price £25.00 £25.00 £25.00 £25.00 £25.00

Total sales £2,625k £1,625k £1,250k £1,000k £625k

Cost per band (+6% pa) £20.00 £21.20 £22.47 £23.82 £25.25
Total costs £2,100k £1,378k £1,124k £953k £631k

Subscription fees
1 2 3 4 5
App users 105,000 170,000 220,000 260,000 285,000

Fee per user £10.00 £10.00 £10.00 £10.00 £10.00

Total sales £1,050k £1,700k £2,200k £2,600k £2,850k

Conclusion
NPV Option 1 = £405k
NPV Option 2 = £358k

Oceania should invest. Both options give a positive NPV and would increase shareholder wealth.

They should choose pricing Option 1 because this has the highest NPV.

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 Professional Level – Financial Management - March 2022

Most candidates performed well on this requirement, with many of them scoring full marks or only making
minor mistakes. The most common mistakes related to the timing of the first capital allowance or
calculating the final balancing allowance. Some candidates also mixed up some of the figures between
Option 1 and Option 2. But overall, this was a well answered requirement.

Total possible marks 17

Maximum full marks 17

1.2

Option 1
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Subscription fees 250 550 825 1,050 1,200
Tax @ 25% (63) (138) (206) (263) (300)
After tax 187 412 619 787 900

PV of T1-T5 cash flows @ 11% £2,008k

Sensitivity = £405k / £2,008k = 20.1%

Option 2
0 1 2 3 4 5
£’000 £’000 £’000 £’000 £’000 £’000
Subscription fees 1,050 1,700 2,200 2,600 2,850
Tax @ 25% (263) (425) (550) (650) (713)
After tax 787 1,275 1,650 1,950 2,137

PV of T1-T5 cash flows @ 11% £5,503k

Sensitivity = £358k / £5,503k = 6.5%

Comments
Option 1 is not very sensitive to changes in subscription fees but Option 2 is much more sensitive to any
change.

This makes Option 1 a more favourable choice than Option 2 (less risky).

Many candidates successfully completed the sensitivity calculations and made appropriate comments.
However, there was a notable number of candidates who didn’t know how to approach this requirement at
all. This was a surprise, as sensitivity analysis is examined frequently. It is possible that some candidates
may have tried to rote learn specific sensitivity analysis calculations based on changes in sales volume
and sales price, but subsequently had difficulty reapplying their knowledge to a different form of revenue.
Either way, many candidates may find the answer is much more straight forward than they initially thought.
Many candidates misinterpreted their results stating that the option with the highest % was the most
sensitive, rather than the least.

Total possible marks 6

Maximum full marks 6

1.3

Not telling employers that the subscription fees will automatically update would be dishonest and shows a
lack of integrity or transparency.

Taking money automatically from the employers without making them aware of the automatic renewal
could be fraud which would be illegal.

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 Professional Level – Financial Management - March 2022

The answers provided to this requirement, were generally very good. However, a small number of weaker
candidates failed to see the main issue relating to the transparency of the fee renewals and resorted to
suggesting any ethical term that they could think of in the hope of obtaining marks.

Total possible marks 3

Maximum full marks 3

1.4
Potential impact

The impact would be much greater for Option 2 which has a higher number of app users at 31 March 2027
and a higher subscription fee per user.

Option 1 may even lose money from this decision as the annual subscription fees are less than the
running cost of the data warehouse in each year.

The decision could make Option 2 a better choice than Option 1.

Factors to consider
• Impact on the fixed running costs.
• Number of app users who are a likely to remain (legally) subscribed.
• Number of additional years the app will be provided for.
• Technological obsolescence.
• Impact on the scrap value of the IT equipment.
• Impact on capital allowances.
• Impact on management time.

This requirement provided an opportunity for candidates to use their analytical skills to look back at the
two net present value calculations and consider what would happen if the subscription fees continued for
another few years. Candidates who did this successfully spotted that this would have a bigger impact on
Option 2 because the number of subscribers and subscription fee was higher than Option 1. Unfortunately,
there were many candidates who must not have looked back at their NPV calculations and struggled to
answer the first part of this requirement.

However almost all candidates provided sensible suggestions for other factors that the company should
consider before extending the app subscriptions.

Total possible marks 6

Maximum full marks 5

1.5
Predictive analytics

Predictive analytics uses historical and current data to create predictions about the future.

Predictive analytics could be used to forecast the impact of each alternative.

Prescriptive analytics

Prescriptive analytics combines statistical tools utilised in predictive analytics with Artificial Intelligence and
algorithms to calculate the optimum outcome from a variety of business decisions.

Predictive analytics could be used to identify the optimum pricing policy.

This requirement tested a topic that was added to the syllabus over 12 months ago. However, there were
a notable number of candidates who struggled to describe these two forms of analytics which suggested
that they may not have been familiar with this section of the learning materials.

Total possible marks 4

Maximum full marks 4

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 Professional Level – Financial Management - March 2022

Question 2

Total Marks: 35

General comments
The scenario of the question is a company that is calculating a cost of capital.

Part 2.1 of the question discusses dividend policy.

Part 2.2 of the question discusses the use of special dividends and share repurchases.
Part 2.3 of the question requires a calculation of dividend growth rates and a discussion of the most
appropriate rate to apply.
Part 2.4 of the question requires a WACC calculation using the dividend valuation model.
Part 2.5 of the question requires a WACC calculation using the CAPM.
Part 2.6 of the questions discusses the challenges of valuing a digital technology company.

2.1
Appropriateness of the dividend policy from 2016 to 2019

Reasons why Just Breathe’s dividend policy may be considered to be appropriate are as follows:

• Shareholders’ wealth will not be increased by paying dividends. Their wealth will be increased by
investing in projects with a positive NPV (M&M theory).

• During this period, Just Breathe were able to achieve significant growth, as a result of reinvesting
profits.

• Some shareholders may prefer to receive capital gains rather than dividends for tax purposes (tax
effect).

• If shareholders need cash now then they can raise this by selling some of their shares (DIY dividends)

• Using retained earnings before a rights issue or new issue of shares is consistent with the pecking
order theory.

Reasons why Just Breathe’s dividend policy may be considered to not be appropriate are as follows:

• Shareholders’ may prefer to receive money today rather than dividends or capital gains in the future
(traditional theory / bird in the hand theory).

• The shareholders may not want the company to make this investment but they are not being given a
choice (agency problem).

Reaction to the increase in dividend

• Shareholders are expecting 14.5% pa growth based on 2016-2019.

• Changing the dividend policy may have sent out a worrying or confusing signal to the market
(signalling)

• Some shareholders will have invested in the company based on the policy of paying low dividends and
reinvesting profits (clientele effect/tax).

• The share price may have fallen / fluctuated as a result of the uncertainty caused by the change in the
dividend policy.

Most candidates showed a reasonable level of knowledge of the different views on dividend policy.

However, often the answers provided to this requirement lacked structure and application.

Weaker candidates sporadically listed all of the different viewpoints without specifically relating them to the
scenario. Whilst stronger candidates started by discussing the pros and/or cons of paying a lower dividend
and then discussed the potential impact of the change in policy.

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 Professional Level – Financial Management - March 2022

Total possible marks 11

Maximum full marks 8

2.2
(a) Special dividend

A special dividend is a “one-off” dividend in addition to the ordinary dividend.

Special dividends can be used to pay extra dividends to shareholders without disrupting the normal
dividend pattern.

This would only be appropriate if the directors believed that the increase in dividend was temporary and
would eventually return to a lower dividend per share. Market circumstances suggest otherwise so not
appropriate.

(b) Share repurchase

A repurchase of shares may be achieved by buying shares in the stock market, inviting shareholders to
tender their shares or by arrangement with particular shareholders.

This is method would also only be appropriate if the directors wanted to release cash to shareholders on a
“one-off” basis. Market circumstances suggest otherwise so not appropriate.

This would reduce equity, which would have an impact on the dividends per share in future years (and
would increase gearing).

There appeared to be many students who were unfamiliar with the concept of a special dividend, despite
this topic being tested in many previous sittings. Many candidates are still confusing special dividends with
scrip dividends. Additionally, there were many candidates who also had difficulty describing a share
repurchase. As a result of these issues, many students struggled to provide meaningful answers to this
requirement.

Total possible marks 4

Maximum full marks 4

2.3

March 2016 to March 2022: g = (35.0 ÷ 5.0)(1/6) - 1 = 38.31%

March 2020 to March 2022: g = (35.0 ÷ 33.0) 1/2) - 1 = 2.99%

The dividend policy has changed in March 2020, which makes it less appropriate to consider the dividends
paid before then.

It seems unlikely that 38.3% growth would be sustainable in the future.

The problem with only considering the dividend from March 2020 is that it is difficult to predict future
growth based on three years.

However, overall it would be most appropriate to use the growth from March 2020 to March 2022.

Some candidates had difficulty calculating the growth rates, with the most common mistake being using
the wrong number of years. Curiously, some candidates would get one of the calculations correct but the
other one wrong. Generally, the discursive part of this requirement was answer well and most candidates
identified that it would be more appropriate to use the average growth rate from the 2020 to 2022.

Total possible marks 6

Maximum full marks 5

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 Professional Level – Financial Management - March 2022

2.4
Cost of equity

Ke = (35.0p x 1.0299 / 560.0p) + 0.0299 = 9.43%

MVe = £120m ÷£0.50 = 240 million x £5.60 = £1,344m

3% redeemable debentures

Using the rate function the inputs are:

Number of payments 5
Annual coupon £3.00
Ex-interest market value -£94.00
Redemption £100.00
Annual YTM using the rate function 4.36%

Less: tax @ 25% = 4.36% x (1 – 0.25) = 3.27%

MVd = £400m x £94 / £100 = £376m

WACC calculation

Cost % Market value (£m) Cost (£)

Ordinary shares 9.43 1,344 126.7
3% debentures 3.27 376 12.3
1,720 139.0

WACC = 139 / 1720 = 8.1%

This was a well answered requirement overall. However, there were still some careless mistakes which
usually related to calculating the market value of the ordinary shares or an inability to calculate the cost of
equity formula correctly, even with all the correct figures.

Total possible marks 6

Maximum full marks 6

2.5

NutriFit plc should be used to find an appropriate asset beta as this is the only company which has an app
covering both nutrition and fitness.

NutriFit’s asset beta:

βa = 1.65 ÷ (1 + ((50 x 0.75)/75)) = 1.10

Re-gear with Just Breathe’s gearing:

βe = 1.10 x (1 + ((376 x 0.75)/1344)) = 1.33

Calculate ke using the CAPM:

Ke = 2 + 1.33 (8 - 2) = 10.0%

WACC calculation

Cost % Market value (£m) Cost (£)

Ordinary shares 10.00 1,344 134.4
3% debentures 3.27 376 12.3
1,720 146.7

WACC = 146.7 / 1720 = 8.5%

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 Professional Level – Financial Management - March 2022

The cost of equity will have to reflect the systematic business risk of the diversification and the
(systematic) financial risk of Just Breathe.

The calculation shows that the systematic business risk of the diversification is higher than sportswear
manufacturing as the cost of equity (or WACC) is higher than Just Breathe’s current cost of equity (or
WACC).

Many candidates made this requirement much more difficult that it needed to be by choosing to calculate
an average equity beta from the beta of the three companies that had been provided, along with average
values of debt and equity. If those candidates had taken careful notice of the information provided, they
should have spotted that this was unnecessary because the description of the activities carried out by
NutriFit perfectly matched the activities of the target company.

Total possible marks 8

Maximum full marks 8

2.6

It is difficult use an asset based valuation because most of Biddle’s assets are digital assets which are
difficult to value.

They cannot apply an earnings (or dividends) based valuation as this is a newly formed company with no
previous earnings (or dividends).

It will be difficult to predict future earnings because Biddle have an inexperienced management team.

Additionally, the future performance of technology companies can be difficult to predict as they are likely to
have:

• Unpredictable market acceptance of the products

• Unknown competition.

Without previous experience, it would be difficult to value the potential synergies that could be achieved by
the two companies working together.

Most candidates correctly identified the challenges of using an asset-based valuation on a company like
this. However, many answers only considered this form of valuation and did not consider any other
valuation methods such earnings based approaches.

Total possible marks 5

Maximum full marks 4

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 Professional Level – Financial Management - March 2022

Question 3

Total Marks: 30

General comments

The scenario of the question is a company that receives money from overseas investors.

Part 3.1(a) of the question requires computations using various forex hedging instruments.
Part 3.1(b) of the question discusses the use of the hedging instruments used in the first part of the
question.

Part 3.2(a) of the question requires computations using various Bitcoin hedging instruments.
Part 3.2(b) of the question discusses the difference between the calculations from the third part of the
question.

Part 3.3 of the question requires a computation to demonstrate how traded options can be used to protect
the company against a fall in the value of a portfolio of investments.

3.1(a)
Forward contract

Forward rate: HK$ 10.70 + HK$0.04 = HK$ 10.74

Sterling receipt: HK$ 15,000,000 ÷ HK$ 10.74/£ = £1,396,648

Money market hedge

Borrow HK$: HK$ 15,000,0000 ÷ (1 + (0.024 x 6/12)) = HK$ 14,822,134

Sell HK$ at spot rate: HK$14,882,134 ÷ HK$ 10.70/£ = £1,385,246

Deposit in £ to give a total receipt: £1,385,246 x (1 + (0.016 x 6/12) = £1,396,328

OTC currency option

Use put options to sell HK$ with an exercise price of HK$ 10.75

The premium will be HK$ 15,000,000 x £0.002/HK$ = £30,000

The premium with interest = £30,000 x (1 + (0.016 x 6/12)) = £30,240

If the spot is HK$ 11.22 on 30 September they would exercise the option.

Sterling payment will be HK$ 15,000,000 ÷ HK$ 10.75 /£ = £1,395,349

Total receipt will be £1,395,349- £30,240 = £1,365,109

Generally this requirement was very well answered. However, a small number of candidates still made
mistakes on the OTC option such as choosing a call option instead of a put. Other candidates made more
careless mistakes such as correctly identifying that this company should use a put option but then
calculating the premium for a call option.

Total possible marks 8

Maximum full marks 8

3.1(b)
Expected cost
Forward contract = £1,396,648
Money market hedge = £1,396,328

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 Professional Level – Financial Management - March 2022

OTC option = £1,365,109

Without hedging = £1,336,898

Forward contract is the higher receipt.

MMH is only marginally lower.
The receipt from the OTC option is significantly lower. This is due to the premium.

Forward contract
Tailored specifically for Peregrine
However, there is no secondary market

Money market hedge

More difficult to set up than a forward contract
Might use up credit lines

OTC currency option

Allows Peregrine to exploit upside risk potential
There is no secondary market

Conclusion
The forward contract would be recommended if the intention is to maximise the receipt.

However, the OTC currency option may be preferred if the directors wish to retain the upside risk potential.

This requirement was answered very well by the majority of candidates. However, considering the number
of marks available for this requirement, some weaker responses contained a relatively small range of
comments.

Total possible marks 8

Maximum full marks 10

3.2(a)
Forward contract

Peregrine will receive 26 bitcoin x £40,780 = £1,060,280

Bitcoin futures

Peregrine will sell May futures at £40,820

Number of contracts = 26 Bitcoin ÷5 Bitcoin per contract = 5.2 = 5 contracts

At 31 May 2022:
Sell 26 Bitcoin @ £36,480 = £948,480
Gain on futures (£40,820 - £36,500) x 5 contracts x 5 Bitcoin = £108,000
Net receipt = £948,480 + £108,000 = £1,056,480

This was the second time that crypto-currency hedging had been tested in this paper and it was pleasing
to see that many candidates were familiar with Bitcoin forward contracts. The calculating relating to Bitcoin
futures proved to be a bit trickier with errors often occurring when calculating the gain on the futures.

Total possible marks 5

Maximum full marks 5

3.2 (b)

One reason why there is a difference between the net sterling receipts is because the two contracts were
offered at different rates (£40,780 vs £40,820).

Based on these rates the net receipt from the futures contracts should have been higher. But instead, the
forward contract provides the highest net receipt.

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 Professional Level – Financial Management - March 2022

This is because five futures contracts did not cover the full transaction and Peregrine could not recover the
fall in value of the unhedged Bitcoin.

Most answers correctly identified that the rounding of the contacts would be one factor that would cause a
difference in the two calculations. However, many failed to spot what should have been a more obvious
difference which was that the futures and forward contracts were being offered at different rates. Answers
tended to focus on basis risk instead, which would have been more appropriate if the final transaction had
taken place before the 31 May.

Total possible marks 3

Maximum full marks 2

3.3

Peregrine should use June put options at a price of 7150.

The number of contracts = £2,781,350 ÷ (7,150 x £10) = 38.9 = 39 contracts

The premium will cost = 39 contracts x 60 pts x £10 = £23,400

FTSE index rises

Peregrine should let the options lapse
Net receipt = £2,878,600 - £23,400 = £2,855,200

FTSE index falls

Peregrine should exercise the options
Gain on options (7150 - 6800) x 39 contracts x £10 = £136,500
Net receipt = £2,645,200 + £136,500 - £23,400 = £2,758,300

There were a lot of very good answers provided for this requirement, with many candidates obtaining full
marks. Common mistakes included choosing July contracts instead of June or forgetting to adjust for the
£10 per point contract size when calculating the number of contracts or the gain on the options.

Total possible marks 7

Maximum full marks 7

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