Financial

Management (FM)
Sept/Dec 2021
Examiner’s report
The examining team share their observations from the
marking process to highlight strengths and
weaknesses in candidates’ performance, and to offer
constructive advice for those sitting the exam in the
future.

Contents
General comments .............................................................. 2
Section A ............................................................................. 2
Example 1 ........................................................................ 3
Example 2 ........................................................................ 3
Example 3 ........................................................................ 4
Example 4 ........................................................................ 5
Conclusion ....................................................................... 5
Section B ............................................................................. 6
Question 1 ........................................................................ 6
Question 2 ........................................................................ 7
Question 3 ........................................................................ 7
Question 4 ........................................................................ 8
Question 5 ........................................................................ 8
Section C ........................................................................... 10
Hawker Co (Hawker)...................................................... 10
Requirement (a) – 10 marks ...................................... 11
Requirement (b) – 4 marks ........................................ 12
Requirement (c) – 6 marks ......................................... 13
Kandy Co ....................................................................... 15
Requirement (a)(i) – 6 marks ..................................... 16
Requirement (a)(ii) – 4 marks .................................... 17
Examiner’s
Requirementreport – FM
(a)(iii) – 2 September/December 2021 18
marks .................................... 1

Requirement (b) – 4 marks ........................................ 19

Requirement (c) – 4 marks ......................................... 19
General comments

This examiner’s report should be used in conjunction with the published

September/December 2021 sample exam which can be found on the ACCA Practice
Platform.

The Financial Management (FM) exam is offered as a computer-based exam (CBE).

The model of delivery for the CBE exam means that candidates do not all receive the
same set of questions. In this report, the examining team provide constructive
guidance on how to answer the questions whilst sharing their observations from the
marking process, highlighting the strengths and weaknesses of candidates who
attempted these questions. Future candidates can use this examiner’s report as part
of their exam preparation, attempting question practice on the ACCA Practice
Platform, reviewing the published answers alongside this report.

• Section A objective test questions – four specific questions that caused difficulty
in these exam sessions.
• Section B objective test case questions – one whole objective test case to
illustrate the types of questions candidates can expect to receive in this section
of the exam.
• Section C constructed response questions – guidance on what was done well
and where candidate performance could be improved from the published exam
questions.

Section A

The objective test questions in Section A ensure a broad coverage of the syllabus,
and so all areas of the syllabus need to be carefully studied, as all learning outcomes
can be tested in this part of the examination. Candidates preparing for the examination
are therefore advised to work through as many objective test questions as possible,
reviewing carefully to see how correct answers are derived in areas where they
experience difficulty.

The following questions are reviewed with the aim of giving future candidates an
indication of the types of questions asked which have caused difficulty and guidance
on dealing with such exam questions.

Example 1 is a question testing knowledge of return on capital employed.

Example 2 is numerical and tests knowledge of money market instruments.
Example 3 is a question testing working capital strategy.
Example 4 is numerical and tests the cost of equity.

Examiner’s report – FM September/December 2021 2

Example 1

In relation to the return on capital employed (ROCE) investment appraisal

method, which of the following statements is correct?

A ROCE leads to better investment decisions since it uses accounting profit rather
than estimated cash flows

B Investment projects with a ROCE greater than the weighted average cost of
capital should be accepted

C Investment projects with a ROCE less than the current ROCE of an

organisation should be rejected

D ROCE takes into account all years of operation of an investment project

The correct answer is D

ROCE does take into account all years of operation of an investment project.

Many candidates instead selected either option B or C, not recognising that investment
decisions should be made on the basis of discounted cash flows and that there is no
relationship between ROCE and the weighted average cost of capital which would
lead to good investment decisions.

Example 2

A large, listed company is to issue 90-day commercial paper with a nominal value of
$10m. Each paper will have a nominal value of $100,000.

The annual required rate of return is 4% assuming a 365-day year.

What will be the issue price of each paper?

A $99,023
B $96,154
C $99,014
D $96,000

The correct answer is A.

The issue price of each paper can be calculated by the nominal value divided by 1
plus the required rate of return, pro-rated for the 90-day issue period.

Issue price = $100,000 / (1 + (0.04 x 90/365)) = $99,023

Many candidates instead deducted the prorated rate of return from 1 and multiplied
this by the nominal value. $100,000 x (1 – (0.04 x 90/365)) = $99,014

Examiner’s report – FM September/December 2021 3

Example 3

Match the characteristic below with the appropriate working capital strategy.

The correct answers are:

Conservative investment strategy Relatively high level of current assets

Aggressive investment strategy Relatively low level of current assets
Aggressive financing strategy Relatively large amounts of short-term finance
Conservative financing strategy Relatively small amounts of short-term finance

A conservative investment policy involves carrying higher amounts of current assets,

a conservative financing policy involves using more long-term finance than short-term
finance.

Many candidates appear to be confused between working capital investment strategy

and financing strategy, or between aggressive and conservative approaches when
selecting their answers to this question.

Examiner’s report – FM September/December 2021 4

Example 4

A company has announced that it will pay an annual dividend equal to 55%
of earnings. Its earnings per share is $0.80 and it has ten million shares
in issue. The return on equity is 20% and the current cum div share price is $4.60.

What is the cost of equity?

A 19.4%
B 20.5%
C 28.0%
D 22.7%

The correct answer is B.

Dividend to be paid = $0.44 ($0.80 x 55%)

Current Earnings = $8m (10m x $0.80)

Retention ratio = 45% (100% - 55%)

Dividend growth rate = 9% (45% x 20%)

ke = [($0.44 x 1.09 / ($4.60-$0.44) + 0.09] = 20.5%

Many candidates did not adjust the cum dividend share price and instead used $4.60
or incorrectly used the given payout ratio as the retention ratio.

Conclusion

Candidates should read the question carefully and follow the instructions on how to
answer the question. For example if a question asks the candidate to select two correct
statements, then marks can only be awarded if two statements have been selected.
There is no partial marking, so an answer which only selects one statement will be
awarded no marks. A candidate who selects three statements will also receive no
marks.

In addition, when answering a number entry question, candidates must ensure they
are entering their answer in the correct format as stated in the requirement. If a number
is being requested in millions, there will be an ‘m’ after the number entry box. If a
candidate puts a full answer of say 13000000 in the box rather than 13, this will be
marked as incorrect.

If there is no format specified, answers may be given as an integer or to one or two

decimal places. The exam system is configured to allow any correct answer, under
these formats, to be awarded the available marks.

Examiner’s report – FM September/December 2021 5

Section B

Section B tests candidates’ knowledge on a number of topics in more detail than

section A, with three case questions containing five two-mark objective test questions.

Here is an example case question on the topic of business valuation.

Question 1

What is the market value of the preference shares of Dazvin Co?

A $7.50m
B $5.25m
C $3.75m
D $10.71m

The correct answer is A.

Preference dividend = 0.50 x 0.06 = $0.03 per share

Preference share value per share P0 = 0.03/0.08 = $0.375 per share

Examiner’s report – FM September/December 2021 6

Number of shares = 10/0.5 = 20m
Total market value = 20m x 0.375 = $7.50m

The most common error here was to take the nominal value of the preference shares
to be $1 and get an answer of $3.75m.

Question 2

Using the price/earnings ratio method, what is the value of Dazvin Co?

A $48.0m
B $68.4m
C $43.2m
D $40.8m

The correct answer is D.

Preference dividends = 10.0m x 0.06 = $0.6m

Earnings for equity after preference dividends = 4.0m – 0.6m = $3.4m
Price earnings ratio value = 3.4m x 12 = $40.8m

The most common error here was to not deduct the preference divided before taking
the earnings figure and instead using earnings of $4m and getting $48.0m.

Question 3

Based on a current ordinary share price of $2.00 per share, what is the market
value of the convertible debt of Dazvin Co?

A $19.0m
B $19.3m
C $21.0m
D $20.1m

The correct answer is C.

Conversion value = 2.00 x 1.066 x 40 = $113.48/loan note

Conversion is higher than nominal value for redemption, so conversion is preferred.
Market value per loan note= (Interest x 6-year annuity factor) + Discounted conversion
value = (7.5 x 4.917) + (113.48 x 0.705) = $116.88

Total convertible debt value = 116.88/100 x 18m = $21.0m

A significant number of candidates selected option B, which they would have got by
taking the floor value of the loan note rather than the conversion value.

Examiner’s report – FM September/December 2021 7

Question 4

In relation to information requirements for valuing shares, which of the following

statements is correct?

A Only information on the market values of tangible assets should be used in

valuing shares
B Shares are likely to be mispriced where managers and investors have different
levels of information (information asymmetry)
C Details of key personnel are not relevant to the market capitalisation of a listed
company
D Since companies do not release information that undermines their competitive
advantage, most of the published information about a company is not relevant
to placing a value on its shares

The correct answer is B.

It is correct to state that shares are likely to be mispriced where information asymmetry
exists between managers and investors.

Some candidates selected option D, not realising that while it may be correct that
companies do not release information that undermines their competitive advantage
and so are not transparent, but there are still benefits from the availability of a wide
range of published information which can be used to

Question 5

In relation to behavioural finance, which of the following statements is/are

correct?

(1) When investors believe that recent share price increases will continue, this can lead to
irrational investment decisions by uninformed investors
(2) Informed investors can contribute to speculative stock market bubbles

A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2

The correct answer is C.

The first statement is correct, as the momentum effect can arise when investors
believe that recent share price increases will continue, leading to irrational investment
decisions by uninformed investors (noise trading) chasing the trend.

Examiner’s report – FM September/December 2021 8

The second statement is true, as informed investors can make speculative purchases
during a stock market bubble with the intention of selling when the price has increased
in the future, in the belief that they can realise their gain before the bubble bursts.

Examiner’s report – FM September/December 2021 9

Section C

In this section we will look in detail at TWO constructed response questions from
different syllabus areas. The full questions and solutions have been published and
are available on the ACCA Practice Platform.

Hawker Co (Hawker)

Hawker is from the Investment Appraisal area of the syllabus (syllabus area D),
specifically “Evaluate leasing and borrowing to buy using the before- and after-tax
costs of debt” for parts (a) and (b) (learning outcome D4a), and “Discuss the relative
merits of NPV and IRR” (learning outcome D1h) for part (c). Performance in this type
of question is mixed but well-prepared candidates can score very well in this type of
question.
The question is structured in a similar way to other investment appraisal questions –
10 marks are available for calculation of the respective present values of the financing
option together with a decision, with the other 10 marks available for discussion – as
is usually the case, the discussion marks require a good understanding of the financial
management concepts being tested, and how they may compliment the financial
elements in business decision making.
As with any longer question, read the requirements first to try and identify the syllabus
area you’re being asked about, and anything important you need to look out for in the
scenario. From the requirements (a) and (b), it is clear that we are looking at the
business decision of how to finance the replacement of an asset, in this case a delivery
vehicle. Part (c) is not related to the scenario, but for 6 marks a deep understanding
of the relative merits of NPV and IRR needs to be demonstrated.
Upon reading the scenario, it is clear that there is specific information in the scenario
relating to part (a). Part (b) follows on logically in requiring candidates to consider
reasons, other than after-tax cost advantages, why Hawker may choose to lease
rather than buy the new vehicle. This is the logical order in which to address the

Examiner’s report – FM September/December 2021 10

question. As always, make sure you leave enough time for part (c), as this is worth 6
marks.
This report will discuss the best way to tackle each requirement in turn, highlighting
common mistakes and demonstrating ways to pick up more marks.

Requirement (a) – 10 marks

(a) Evaluate whether Hawker Co should use leasing or borrowing as a source of

finance for the new vehicle.
Hawker has decided to replace its delivery vehicle and is considering two financing
options, namely purchasing the asset using a bank loan (Option 1) or leasing the
vehicle for a period of four years (Options 2). Therefore, it’s not about whether to
replace the vehicle or not, that decision has already been made, rather it is about how
to finance the vehicle replacement.
Furthermore, the new design of delivery vehicle will save running costs of $2,000 per
year. These costs will be saved regardless of whichever financing option is chosen
and therefore the cost savings are not differential between the two options and can be
ignored in the financial analysis, as per the suggested solution. Some candidates
wasted time, but did not lose marks, by including the saved running costs under both
options.
It is possible to address this requirement by combining both financing options in one
cash flow forecast, but, for clarity of thought and to clearly distinguish between the two
options, the recommended approach is to consider each option separately, and then
compare the present value cost of each option.
Option 1, purchasing the vehicle using a bank loan has a specific after-tax cost of
borrowing of 4% per year, and this is the discount rate which is to be used. This
same rate is used for both buying and leasing, as this is a financing and not an
investment decision, and the rates reflect the risk level to the lender of providing
finance to the company. Many candidates incorrectly used the after-tax weighted
average cost of capital of 8% for one or both options
Some candidates erroneously included the loan interest payments (and in some cases
a loan repayment schedule) in their cash flow forecasts for borrowing to buy. It is an
error of principle to include the interest payments, or the tax relief arising on
them, in the NPV calculation. Interest cost, both under the bank loan and inherently
in the lease payments, is dealt with via the cost of capital.
Whilst there were many good answers to part (a), some candidates made errors which
should have been avoided. For example, the government CO2 emissions tax, payable
under Option 1, was paid by the lessor under Option 2 (leasing), and therefore was
not a cost to be included in Hawker’s cash flow forecast for Option 2.
Other errors included not treating tax as payable one year in arrears, which, under
Option 2, means commencing the tax benefits of leasing in year 2 since the lease

Examiner’s report – FM September/December 2021 11

payments are made at the start of each year, and, under Option 1, incorrectly placing
the residual value in year 5, when the value of $14,000 is clearly stated as being at
the end of the 4 year period.
A straightforward mark is available for making a justified decision about which option
to choose, but care must be taken to choose the option with the lowest negative figure,
since we are dealing with the present value cost of a replacement asset.
There are two recent published questions, Melanie Co (Sept/Dec 2018) and Dink Co
(Sept/Dec 2019), which also test this area of the syllabus.
Requirement (b) – 4 marks

(b) Discuss TWO reasons (other than possible after-tax cost advantages) why
Hawker Co may choose to lease rather than buy the new delivery vehicle.
As mentioned in the introduction to the commentary on this question, whilst the relative
costs of each financing option are of high importance, there are other issues to
consider before making a final decision as to whether to use leasing or borrowing as
a source of finance for acquiring an asset such as a new delivery vehicle.
The requirement here specifically asks for reasons ‘other than possible after-tax
cost advantages’. Unfortunately, some candidates seemed to ignore this and instead
discussed issues such as tax relief on lease payments, maintenance costs saved (as
they would be borne by the lessor) and the lessor paying the CO2 emissions tax. Such
reasons attracted no marks.
The suggested solution outlines the types of reasons which would have attracted
marks including the greater flexibility under leasing, such as where the asset type
undergoes rapid technological advances and therefore it is desirable to update the
asset more regularly than the asset’s useful life.
The issue of cash flow and the ability of a company to obtain a bank loan was also a
valid reason to opt for leasing and worthy of discussion in this part of the question.
What was not creditworthy in part (b) was a statement along the lines of:

Examiner’s report – FM September/December 2021 12

 “…leasing does not affect the gearing ratio as it is not considered as debt, whilst a
bank loan is considered as debt…”
Such a statement is incorrect in respect of leasing and displays out of date knowledge.
IFRS 16, eliminates nearly all so-called ‘off balance sheet’ financing. In accordance
with IFRS 16 a lessee should recognise assets and liabilities arising from a lease,
with only a few exceptions which do not apply in this scenario.
In summary, and for the purposes of the Financial Management examination, leasing
brings about a liability that affects the gearing ratio and borrowing to buy also brings
about a liability that affects the gearing ratio, therefore stating that leasing does not
affect the gearing ratio is an incorrect statement and attracted no marks in this
examination, and this will continue to be the case due to IFRS 16.
When asked to discuss two reasons for 4 marks, it should be clear that each reason
is worth 2 marks. For a reason to attract 2 marks, it should be discussed in sufficient
detail in that the reason should be developed and/or illustrated (best done by reference
to the scenario i.e., the circumstances of Hawker). For example, reference could be
made to the $14,000 residual value of the vehicle being a forecast cash flow four years
in the future, and therefore not a certain value. This risk is borne by Hawker under
Option 1 (purchasing) but is borne by the lessor under Option 2 (leasing).
Requirement (c) – 6 marks

(c) Discuss THREE advantages of using NPV rather than IRR in investment
appraisal.

This requirement is not scenario-specific and tests learning outcome D1h “Discuss the
relative merits of NPV and IRR”, by asking candidates to discuss three advantages of
using NPV rather than IRR in investment appraisal.

Examiner’s report – FM September/December 2021 13

The previously mentioned Melanie Co from Sept/Dec 2018 also tested this learning
outcome.

Reinforcing the point made under requirement (b) above, when asked to discuss
three advantages for 6 marks, it should be clear that each advantage is worth 2 marks.
For an advantage to attract 2 marks, it should be discussed in sufficient detail in that
the advantage should be developed and/or illustrated. The suggested solution to this
question and other published questions gives an indication of the depth required for
an advantage to attract two marks.
For example, stating that the NPV of a proposed project is equal to the increase in
shareholder wealth offered by the project is a correct statement, but, for two marks,
should be supplemented by stating that this is an advantage over IRR because the
IRR does not measure the absolute increase in value arising from the proposed
project. IRR ignores the size of the project, instead IRR considers relative rates of
return.
The requirement asks for advantages of using NPV over IRR and therefore the two
methods must be compared when discussing each advantage. So, when discussing
mutually exclusive projects, one mark may be gained for stating that NPV should be
used in investment appraisal since the IRR may rank projects in a different order to
NPV, and this could lead to the incorrect investment decision if IRR is solely used. The
second mark could be gained if the candidate explains why this is the case, by correct
reference to the inbuilt reinvestment assumption of the IRR (see suggested solution),
thereby rewarding the candidates with the appropriate technical knowledge for an
examination in Financial Management at the Applied Skills level.
In summary, and this applies to all ‘Discuss’ type requirements such as parts (b) and
(c) in Hawker, making brief undeveloped points is likely to score few, if any, marks.
The discussion of a reason (b) or an advantage (c) requires further detail via a
developed explanation and/or illustration.
The key messages from this question are:
• Read the requirements carefully
• Look at the marks available for each requirement
• “Discuss” type questions require more than brief points
• Practice published questions!

Examiner’s report – FM September/December 2021 14

Kandy Co

The topic is from syllabus section C working capital management.

The scenario was a distributor, Kandy, which purchased goods from manufacturers
and then sold them to large retailers on credit. The question was primarily divided into
three parts: (a) 12 marks, (b) 4 marks, (c) 4 marks.
a)
i. The requirement was to calculate the financial effect of accepting bulk purchase
discounts.
ii. The requirement was to calculate the financial effect of offering an early
settlement discount.
iii. Comment on the two options in ai and aii.

b) Discuss the working capital objectives of liquidity and profitability and the conflict
between these objectives.
c) Explain the cash operating cycle and discuss its relationship with the level of
investment in working capital.

On the whole, candidates performed reasonably on the bulk purchase and early
settlement discount strategies and then went on to provide a conclusion based on their
workings. Kandy Co consisted of a reasonably long scenario that contained a lot of
information which could have made time management a challenge – it is essential not
to spend too long on one part and run out of time for the later ones. Remember the
rule of 1.8 minutes per mark. When attempting a question such as Kandy Co, it is good
to look at the requirements first and then go through the scenario to get an overall idea
of what the question is about. Emphasis is placed on the verbs in each requirement
and they will focus you on what type of answer is required.

Examiner’s report – FM September/December 2021 15

Requirement (a)(i) – 6 marks

(a)(i) Calculate the financial effect on Kandy Co of accepting the bulk purchase
discount.
Two separate calculations are required: the current and revised situations for the
bulk purchase discount. The information in the question provides the re-order levels,
and therefore, there is no justification for using economic order quantity, and
candidates using this method would not have gained any credit for it. A good and
well laid out answer should show the labels and the relevant workings for both
current and revised conditions. Some candidates use cell references in their
workings, which may be faster but care should be taken to ensure the correct
references are used.
Two complexities need to be dealt with in this question: First, we have to deal with
buffer due to the uncertainty in demand. Second, holding cost per unit is based on
9% of the purchase price, which will also affect the bulk purchase discount values.
The following section demonstrating the answer has been done in a spreadsheet to
show the layout, the ease of labelling, and all the detailed workings that will score
you maximum marks.

We can now repeat the above using the bulk purchase discount information, using the
function copy and paste from the current situation. However, watch out for any cell
references which have been copied as they may now be referring to an incorrect cell.

Examiner’s report – FM September/December 2021 16

Requirement (a)(ii) – 4 marks

(a)(ii) Calculate the financial effect on Kandy Co of offering the early settlement
discount.
We need to consider two issues here: First, early settlement calculation will suggest
that the trade receivables amount be reduced. Secondly, there will be a cost to
Kandy Co for the amount of discount made available. The following section lays out
the steps to find the net effect of providing an early settlement discount to customers.
Please note that this is an alternative format the answer published on the ACCA
website, and both methods are acceptable. This is best described using the following
steps:
Step 1: Calculate the current trade receivables.
Step 2: Calculate the revised trade receivable using the new policy.
Step 3: Calculate the reduction in trade receivables.
Step 4: Savings: calculate the finance cost saved due to decreased trade
receivables.
Step 5: Costs: calculate the discount cost.
Step 6: Find the net effect using steps 4 and 5.

Examiner’s report – FM September/December 2021 17

Please note that both (a)(i) and (a)(ii) require practice and familiarity with the
approaches. A key point to make here is that the annual credit sales are not
expected to change and remain at $45million with or without early settlement
discounts.
Candidates are advised to practise using the spreadsheet tool to answer questions
before attempting the financial management exam.
Requirement (a)(iii) – 2 marks

(a)(iii) Using your results from (i) and (iii) above, comment on the financial
acceptability to Kandy Co of each option.
It is important to be able to explain and discuss an understanding of what the
calculations show. For two marks candidates cannot just say accept or reject but
must justify the bulk purchase and early settlement discount based on their
calculations. For example, ‘the early settlement discount option has a net cost so it
should be rejected.’

Examiner’s report – FM September/December 2021 18

Requirement (b) – 4 marks

(b) Discuss the working capital objectives of liquidity and profitability and the
conflict between these objectives.
It is important to show an understanding of the two objectives, liquidity and
profitability, and explain both using financial management terms. The requirement is
to “discuss”. Therefore, candidates should refrain from using bullet point or list type
answers.
Candidates should show that they understand the working capital objectives. It would
be helpful to start by briefly explaining liquidity and profitability. This should be
followed by suggesting the reason for holding high levels of current assets and
specifically cash as satisfying the liquidity objective but not the profitability. In
contrast, one could also discuss maintaining low levels of current assets but with
high levels of cash invested in long-term non-current assets that will support the
profitability objective but not liquidity.
Candidates could use the scenario provided in exhibiting the conflict between the
two objectives.
Most candidates managed to comment on the trade-off between profitability and
liquidity. However, the discussion on the differences was more limited, with some
candidates commenting on poor returns of liquid assets.
Requirement (c) – 4 marks

(c) Explain the cash operating cycle and discuss its relationship with the level
of investment in working capital.

Most candidates did not have issues with explaining the operating cash cycle and
demonstrated how this worked in terms of the formula and working capital ratios. As
this was a discussion, it is not sufficient to merely write the equation for the cash
operating cycle. One approach in answering this question is to discuss the
relationship between liquidity and cash generation, discuss the longer cash operating
cycle and the level of resources tied up in working capital. In contrast, this suggests
that a shorter cycle is better. However, external factors such as the nature of the
business sector, industry norms, and supplier relationships may limit the duration of
the cash operating cycle.

Examiner’s report – FM September/December 2021 19