F 9

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www.accaapc.com f9 final live online revision

ACCA F9 Financial Management
June2014

Live Online 2 Days Revision Note

Tutor: Steve Harris

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Lesco Group Limited, April 2015
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise, without the prior written permission of Lesco Group Limited.

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Dear students:
Your ACCA F9 examiner would like to mix many topics into one
single question.

Our task in these 2days live revision is to cover the whole
syllabus by directly attempting as many past exam questions as
we can.

You may shout at the screen, OMG!! These 2 days would be the
tragedy of my life!! But don't worry I will make these questions
interesting because they are practical.
If you can do the following big questions YOU CAN BE A PRICE
WINNER because the following questions has covered every
aspects of the F9 exam you may see in the coming sitting and the
exam answer will be almost the same!

Print this out first before you attend our live revision.

Best of luck
Steve

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Plan

Topics:

Day1: investing + financing decision

Day2: working capital+business valuation+risk management

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Topic: investment appraisal

Tips:
Your examiner Tony will always examine this area in a very constant way.
So I decide to do these BIG3 questions in the live revision day1.
These BIG3 questions have mixed all of the possible areas that your examiner is going
to examine and if you can do these 3 questions well then no reasons to fail any
investment appraisal questions.

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Big investment questions 1
June2011 Q1 modified

BRT Co has developed a new confectionery line that can be sold for $500 per box and that
is expected to have continuing popularity for many years. The Finance Director has
proposed that investment in the new product should be evaluated over a four-year
time-horizon, even though sales would continue after the fourth year, on the grounds that
cash flows after four years are too uncertain to be included in the evaluation. The variable
and fixed costs (both in current price terms) will depend on sales volume, as follows.

Sales volume (boxes) less than 1 million 119 million 229 million 339 million
Variable cost ($ per box) 280 3.00 3.00 3.05
Total fixed costs ($) 1million 1.8million 2.8million 3.8million

Forecast sales volumes are as follows.
Year 1 2 3 4
Demand (boxes) 0.7million 1.6million 2.1million 3million

The production equipment for the new confectionery line would cost $2 million and an
additional initial investment of $750,000 would be needed for working capital. Capital
allowances (tax-allowable depreciation) on a 25% reducing balance basis could be claimed
on the cost of equipment. Profit tax of 30% per year will be payable one year in arrears. A
balancing allowance would be claimed in the fourth year of operation.

The average general level of inflation is expected to be 3% per year and selling price,
variable costs, fixed costs and working capital would all experience inflation of this level.
BRT Co uses a nominal after-tax cost of capital of 12% to appraise new investment
projects.

Required:
(a) Assuming that production only lasts for four years, calculate the net present
value of investing in the new product using a nominal terms approach and advise
on its financial acceptability (work to the nearest $1,000). (13 marks)

(b) Comment briefly on the proposal to use a four-year time horizon, and
calculate and discuss a value that could be placed on after-tax cash flows arising
after the fourth year of operation, using a perpetuity approach.

Assume, for this part of the question only, that before-tax cash flows and profit
tax are constant from year five onwards, and that capital allowances and working
capital can be ignored. (5 marks)

(c) Discuss THREE ways of incorporating risk into the investment appraisal
process. (7 marks)
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(d) Discuss how the net present value method of investment appraisal
contributes towards the objective of maximising the wealth of
shareholders(june2008 Q4). (5 marks)

(e) Discuss the problems faced when undertaking investment appraisal in the
following areas and comment on how these problems can be overcome:
(i) assets with replacement cycles of different lengths;
(ii) an investment project has several internal rates of return;
(iii) the business risk of an investment project is significantly different from
the business risk of current operations. (8 marks) (June2010 Q3)

(DEC2011 Q1)
Warden Co plans to buy a new machine. The cost of the machine, payable immediately, is
$800,000 and the machine has an expected life of five years. Additional investment in
working capital of $90,000 will be required at the start of the first year of operation. At the
end of five years, the machine will be sold for scrap, with the scrap value expected to be 5%
of the initial purchase cost of the machine. The machine will not be replaced and NPV of
project is $103,000 and internal rate of return calculated is 16%.

Production and sales from the new machine are expected to be 100,000 units per year.
Each unit can be sold for $16 per unit and will incur variable costs of $11 per unit.
Incremental fixed costs arising from the operation of the machine will be $160,000 per
year.
Warden Co has an after-tax cost of capital of 11% which it uses as a discount rate in
investment appraisal. The company pays profit tax one year in arrears at an annual rate of
30% per year. Capital allowances and inflation should be ignored.

(f) (i) Explain briefly the meaning of the term sensitivity analysis in the context
of investment appraisal;
(1 mark)

(ii) Calculate the sensitivity of the investment in the new machine to a change
in selling price and to a change in discount rate, and comment on your
findings.
(6 marks)

(g) Discuss the nature and causes of the problem of capital rationing in the
context of investment appraisal, and explain how this problem can be
overcome in reaching the optimal investment decision for a company.
(7 marks)

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Big investment question2
DEC2009 Q1 modified
ASOP Co is considering an investment in new technology that will reduce operating costs
through increasing energy efficiency and decreasing pollution. The new technology will cost
$1 million and have a four-year life, at the end of which it will have a scrap value of
$100,000.
A licence fee of $104,000 is payable at the end of the first year. This licence fee will increase
by 4% per year in each subsequent year.

The new technology is expected to reduce operating costs by $580 per unit in current price
terms. This reduction in operating costs is before taking account of expected inflation of 5%
per year.

Forecast production volumes over the life of the new technology are expected to be as
follows:
Year 1 2 3 4
Production
(units per year)
60, 000 75, 000 95, 000 80, 000

If ASOP Co bought the new technology, it would finance the purchase through a four-year
loan paying interest at an annual before-tax rate of 86% per year.

Alternatively, ASOP Co could lease the new technology. The company would pay four
annual lease rentals of $380,000 per year, payable in advance at the start of each year. The
annual lease rentals include the cost of the licence fee.

If ASOP Co buys the new technology it can claim capital allowances on the investment on
a 25% reducing balance basis. The company pays taxation one year in arrears at an annual
rate of 30%. ASOP Co has an after-tax weighted average cost of capital of 11% per year.

(a) Based on financing cash flows only, calculate and determine whether ASOP Co
should lease or buy the new technology. (11 marks)

(b) Using a nominal terms approach, calculate the net present value of buying the
new technology and advise whether ASOP Co should undertake the proposed
investment. (6 marks)

(c) Discuss how an optimal investment schedule can be formulated when capital
is rationed and investment projects are either:
(i) divisible; or
(ii) non-divisible. (5 marks)

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One of the subsidiary of ASOP Co called AIMS plans to replace an existing machine and
must choose between two machines. Machine 1 has an initial cost of $200,000 and will have
a scrap value of $25,000 after four years. Machine 2 has an initial cost of $225,000 and will
have a scrap value of $50,000 after three years. Annual maintenance costs of the two
machines are as follows:

Year 1 2 3 4
Machine1($/year) 25,000 29,000 32,000 35,000
Machine 2 ($/year) 15,000 20,000 25,000

Where relevant, all information relating to the above cash flow has already been adjusted
to include expected future inflation.

Taxation and capital allowances must be ignored in relation to Machine 1 and Machine 2.

Other information
AIMS Co has a nominal before-tax weighted average cost of capital of 12% and a nominal
after-tax weighted average ost of capital of 7%.

(d)Calculate the equivalent annual costs of Machine 1 and Machine 2, and discuss
which machine should be purchased (6amrks) (June2012 Q1)

(e)Critically discuss the use of sensitivity analysis and probability analysis as
ways of including risk in the investment appraisal process, referring in your
answer to the relative effectiveness of each method. (7 marks) (June2012 Q1)

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Big investment question3
June2009 Q2

PV Co is evaluating an investment proposal to manufacture Product W33, which has
performed well in test marketing rials conducted recently by the companys research and
development division. The following information relating to his investment proposal has
now been prepared.

Initial investment $2 million
Selling price (current price terms) $20 per unit
Expected selling price inflation 3% per year
Variable operating costs (current price terms) $8 per unit
Fixed operating costs (current price terms) $170,000 per year
Expected operating cost inflation 4% per year

The research and development division has prepared the following demand forecast as a
result of its test marketing rials. The forecast reflects expected technological change and its
effect on the anticipated life-cycle of Product W33.

Year 1 2 3 4
Demand(units) 60,000 70,000 120,000 45,000

It is expected that all units of Product W33 produced will be sold, in line with the companys
policy of keeping no nventory of finished goods. No terminal value or machinery scrap value
is expected at the end of four years, when roduction of Product W33 is planned to end. For
investment appraisal purposes, PV Co uses a nominal (money) iscount rate of 10% per year
and a target return on capital employed of 30% per year. Ignore taxation.

Required:
(a) Identify and explain the key stages in the capital investment decision-making
process, and the role of nvestment appraisal in this process. (7 marks)

(b) Calculate the following values for the investment proposal:
(i) net present value;
(ii) internal rate of return;
(iii) return on capital employed (accounting rate of return) based on average
investment; and
(iv) discounted payback period. (13 marks)

(c) Discuss your findings in each section of (b) above and advise whether the
investment proposal is financially acceptable. (5 marks)
(25 marks)

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Financing decision

Tips: again examiner will examine this topic in a very consistent way but also
very practical way.

Financing decision is much more difficult than investing decision so do make
sure you have practiced the following questions.

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1, June2011 Q2 modified
The finance director of AQR Co has heard that the market value of the company will
increase if the weighted average cost of capital of the company is decreased. The company,
which is listed on a stock exchange, has 100 million shares in issue and the current ex div
ordinary share price is $250 per share. AQR Co also has in issue bonds with a book value
of $60 million and their current ex interest market price is $104 per $100 bond. The current
after-tax cost of debt of AQR Co is 7% and the tax rate is 30%.

The recent dividends per share of the company are as follows.
Year 2006 2007 2008 2009 2010
Dividend per share (cents) 19.38 20.20 20.41 21.02 21.80

The finance director proposes to decrease the weighted average cost of capital of AQR Co,
and hence increase its market value, by issuing $40 million of bonds at their par value of
$100 per bond. These bonds would pay annual interest of 8% before tax and would be
redeemed at a 5% premium to par after 10 years.

Required:
(a) Calculate the market value after-tax weighted average cost of capital of AQR
Co in the following circumstances:
(i) before the new issue of bonds takes place;
(ii) after the new issue of bonds takes place.
Comment on your findings. (12 marks)

(b) Identify and discuss briefly the factors that influence the market value of
traded bonds. (5 marks)

(c) Discuss the directors view that issuing traded bonds will decrease the
weighted average cost of capital of AQR Co and thereby increase the market
value of the company. (8 marks)

(d) Discuss the circumstances under which the weighted average cost of capital
(WACC) can be used as a discount rate in investment appraisal. Briefly indicate
alternative approaches that could be adopted when using the WACC is not
appropriate. (7 marks) (DEC2011 Q3(d)

(e) Discuss the reasons why different bonds of the same company might have
different costs of debt. (6 marks) (DEC2009 Q2(b))

(f) Discuss whether a change in dividend policy will affect the share price of AQR
Co. (7 marks) (DEC2009 Q2(d))

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(g) Discuss whether the dividend growth model or the capital asset pricing model
offers the better estimate of the cost of equity of a company. (7 marks)
(June2008 Q1(c))

(H) Discuss the relationship between capital structure and weighted average
cost of capital, and comment on the suggestion that debt could be used to
finance a cash offer for AQR if the gearing ratio of AQR is relatively high.
(9 marks) (June2009 Q1(c))

(I) Discuss how the shareholders of Corhig Co can assess the extent to which
they face the following risks, explaining in each case the nature of the risk
being assessed:
(i) Business risk;
(ii) Financial risk;
(iii) Systematic risk. (9 marks) (June2012 Q4(d))

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2,Project specific discount rate and other cost of capital calculation

CJ Co is a profitable company which is financed by equity with a market value of $180
million and by debt with a market value of $45 million and it is considering to take project
B.

Project B
This project is a diversification into a new business area that will cost $4 million. A company
that already operates in the new business area, GZ Co, has an equity beta of 15. GZ Co is
financed 75% by equity with a market value of $90 million and 25% by debt with a market
value of $30 million.

Risk-free rate of return: 4%
Equity risk premium: 6%

(c) Calculate a project-specific cost of equity for Project B and explain the stages
of your calculation.
(6 marks)(DEC2010 Q1 C)

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3,JUNE2009 Q4(ratio+business finance)

JJG Co is planning to raise $15 million of new finance for a major expansion of existing
business and is considering a rights issue, a placing or an issue of bonds. The corporate
objectives of JJG Co, as stated in its Annual Report, are to maximise the wealth of its
shareholders and to achieve continuous growth in earnings per share. Recent financial
information on JJG Co is as follows:
2008 2007 2006 2005
Turnover ($m) 28.0 24.0 19.1 16.8
Profit before interest and tax ($m) 9.8 8.5 7.5 6.8
Earnings ($m) 5.5 4.7 4.1 3.6
Dividends ($m) 2.2 1.9 1.6 1.6
Ordinary shares ($m) 5.5 5.5 5.5 4.5
Reserves ($m) 13.7 10.4 7.6 5.1
8% Bonds, redeemable 2015 ($m) 20 20 20 20
Share price ($) 8.64 5.74 3.35 2.67

The par value of the shares of JJG Co is $100 per share. The general level of inflation has
averaged 4% per year in the period under consideration. The bonds of JJG Co are currently
trading at their par value of $100. The following values for the business sector of JJG Co are
available:

Average return on capital employed 25%
Average return on shareholders funds 20%
Average interest coverage ratio 20 times
Average debt/equity ratio (market value basis) 50%
Return predicted by the capital asset pricing model 14%

Required:
(a) Evaluate the financial performance of JJG Co, and analyse and discuss the
extent to which the company has achieved its stated corporate objectives of:
(i) maximising the wealth of its shareholders;
(ii) achieving continuous growth in earnings per share.
Note: up to 7 marks are available for financial analysis.
(12 marks)

(b) If the new finance is raised via a rights issue at $750 per share and the major
expansion of business has not yet begun, calculate and comment on the effect of
the rights issue on:
(i) the share price of JJG Co;
(ii) the earnings per share of the company; and
(iii) the debt/equity ratio. (6 marks)

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(c) Analyse and discuss the relative merits of a rights issue, a placing and an
issue of bonds as ways of raising the finance for the expansion. (7 marks)
(25 marks)

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4,DEC2010 Q2(business finance question)
The following financial position statement as at 30 November 2010 refers to Nugfer Co, a
stock exchange-listed company, which wishes to raise $200m in cash in order to acquire a
competitor.
$m $m $m
Assets
Non-current assets 300
Current assets 211
Total assets 511

Equity and liabilities
Share capital 100
Retained earnings 121
Total equity 221

Non-current liabilities
Long term borrowings 100
Current liabilities
Trade payables 30
Short term borrowings 160

Total current liabilities 190
Total liabilities 290
Total equity and liabilities 511

The recent performance of Nugfer Co in profitability terms is as follows:

Year ending 30 November 2007 2008 2009 2010
$m $m $m $m
Revenue 122.6 127.3 156.6 189.3
Operating profit 41.7 43.3 50.1 56.7
Finance charges(interest) 6.0 6.2 12.5 18.8
Profit before tax 35.7 37.1 37.6 37.9
Profit after tax 25.0 26.0 26.3 26.5

Notes:
1. The long-term borrowings are 6% bonds that are repayable in 2012
2. The short-term borrowings consist of an overdraft at an annual interest rate of 8%
3. The current assets do not include any cash deposits
4. Nugfer Co has not paid any dividends in the last four years
5. The number of ordinary shares issued by the company has not changed in recent years
6. The target company has no debt finance and its forecast profit before interest and tax for
2011 is $28 million

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Required:
(a) Evaluate suitable methods of raising the $200 million required by Nugfer Co,
supporting your evaluation with both analysis and critical discussion. (15 marks)

(b) Briefly explain the factors that will influence the rate of interest charged on a
new issue of bonds. (4 marks)

(c) Identify and describe the three forms of efficiency that may be found in a
capital market.
(6 marks) (25 marks)

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5, JUNE2008 Q2 (covered in video)

THP Co is planning to buy CRX Co, a company in the same business sector, and is
considering paying cash for the shares of the company. The cash would be raised by THP Co
through a 1 for 3 rights issue at a 20% discount to its current share price.

The purchase price of the 1 million issued shares of CRX Co would be equal to the rights
issue funds raised, less issue costs of $320,000. Earnings per share of CRX Co at the time
of acquisition would be 448c per share. As a result of acquiring CRX Co, THP Co expects to
gain annual after-tax savings of $96,000.

THP Co maintains a payout ratio of 50% and earnings per share are currently 64c per share.
Dividend growth of 5% per year is expected for the foreseeable future and the company has
a cost of equity of 12% per year.

Information from THP Cos statement of financial position:

Equity and liabilities $000
Shares($1par value) 3,000
Reserves 4,300
7,300
8% loan notes 5,000
Current liabilities 2,200
Total equity and liabilities 14,500

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Required:
(a) Calculate the current ex dividend share price of THP Co and the current
market capitalisation of THP Co using the dividend growth model. (4 marks)

(b) Assuming the rights issue takes place and ignoring the proposed use of the
funds raised, calculate:
(i) the rights issue price per share;
(ii) the cash raised;
(iii) the theoretical ex rights price per share; and
(iv) the market capitalisation of THP Co. (5 marks)

(c) Using the price/earnings ratio method, calculate the share price and market
capitalisation of CRX Co before the acquisition. (3 marks)

(d) Assuming a semi-strong form efficient capital market, calculate and comment
on the post acquisition market capitalisation of THP Co in the following
circumstances:
(i) THP Co does not announce the expected annual after-tax savings; and
(ii) the expected after-tax savings are made public. (5 marks)

(e) Discuss the factors that THP Co should consider, in its circumstances, in
choosing between equity finance and debt finance as a source of finance from
which to make a cash offer for CRX Co. (8 marks)
(25 marks)

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Working capital management

Pilot paper Q3 modified
Ulnad Co has annual sales revenue of $6 million and all sales are on 30 days credit,
although customers on average take ten days more than this to pay. Contribution
represents 60% of sales and the company currently has no bad debts.

Accounts receivable are financed by an overdraft at an annual interest rate of 7%.
Ulnad Co plans to offer an early settlement discount of 1.5% for payment within 15 days
and to extend the maximum credit offered to 60 days. The company expects that these
changes will increase annual credit sales by 5%, while also leading to additional
incremental costs equal to 0.5% of turnover. The discount is expected to be taken by 30%
of customers, with the remaining customers taking an average of 60 days to pay.

Required:
(a) Evaluate whether the proposed changes in credit policy will increase the
profitability of Ulnad Co. (6 marks)

(b) Renpec Co, a subsidiary of Ulnad Co, has set a minimum cash account balance of
$7,500. The average cost to the company of making deposits or selling investments is
$18 per transaction and the standard deviation of its cash flows was $1,000 per day
during the last year. The average interest rate on investments is 5.11%.

Determine the spread, the upper limit and the return point for the cash account of
Renpec Co using the Miller- Orr model and explain the relevance of these values
for the cash management of the company. (6 marks)

(c) Identify and explain the key areas of accounts receivable management. (6
marks)

(d) Discuss the key factors to be considered when formulating a working capital
funding policy. (7 marks)

(e) Discuss how risks arising from granting credit to foreign customers can be
managed and reduced. (8 marks) (June2009 Q3)

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One of the subsidiary of Ulnad is called KXP Co and In order to encourage customers to pay
on time, KXP Co proposes introducing an early settlement discount of 1% for payment
within 30 days, while increasing its normal credit period to 45 days. It is expected that, on
average, 50% of customers will take the discount and pay within 30 days, 30% of
customers will pay after 45 days, and 20% of customers will not change their current
paying behaviour.

Other information:
KXP Co is an e-business which trades solely over the internet. In the last year the company
had sales of $15 million. All sales were on 30 days credit to commercial customers.

Extracts from the companys most recent statement of financial position relating to working
capital are as follows:
$000
Trade receivables 2,466

KXP Co has an overdraft facility charging interest of 6% per year.

(f) Calculate the net benefit or cost of the proposed changes in trade receivables
policy and comment on your findings. (6 marks) (DEC2012 Q2)

(g) Identify and discuss the factors to be considered in determining the optimum
level of cash to be held by a company. (5 marks) (DEC2012 Q2)

(H) Discuss the key factors which determine the level of investment in current
assets.
(6 marks)
(June2008 Q3)
(I) Discuss the ways in which factoring and invoice discounting can assist in the
management of accounts receivable.
(6 marks)
(June2008 Q3)

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A factor has offered to manage the trade receivables of Bold Co in a servicing and
factor-financing agreement. The factor expects to reduce the average trade receivables
period of Bold Co from its current level to 35 days; to reduce bad debts from 09% of
turnover to 06% of turnover; and to save Bold Co $40,000 per year in administration
costs.

The factor would also make an advance to Bold Co of 80% of the revised book value of trade
receivables. The interest rate on the advance would be 2% higher than the 7% that Bold Co
currently pays on its overdraft. The factor would charge a fee of 075% of turnover on a
with-recourse basis, or a fee of 125% of turnover on a non-recourse basis.

Assume that there are 365 working days in each year and that all sales and supplies are on
credit. Current trade receivable balance is $3.5m and sales revenue is $21.3m.

(J) Calculate the value of the factors offer:
(i) on a with-recourse basis;
(ii) on a non-recourse basis. (7 marks) (DEC2011 Q2)

(k) Explain the meaning of the term cash operating cycle and discuss the
relationship between the cash operating cycle and the level of investment in
working capital. Your answer should include a discussion of relevant
working capital policy and the nature of business operations.
(7 marks)
(DEC2011 Q2)

(l) Identify the objectives of working capital management and discuss the
conflict that may arise between them.
DEC2007 Q4 (3 marks)

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Accounts payable management
PKA Co has used a foreign supplier for the first time and must pay $250,000 to the supplier in six
months time. The financial manager is concerned that the cost of these supplies may rise in euro
terms and has decided to hedge the currency risk of this account payable. The following information
has been provided by the companys bank:

Spot rate ($ per ): 1998 0002

Six months forward rate ($ per ): 1979 0004

Money market rates available to PKA Co:

Borrowing Deposit
One year euro interest rates: 61% 54%
One year dollar interest rates: 40% 35%
(m) Evaluate whether a money market hedge or a forward market hedge should
be used to hedge the foreign account payable.
DEC2007 Q4 (8 marks)

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Another subsidiary of Ulnad is called WQZ Co and it is considering making the following
changes in the area of working capital management:

Inventory management

It has been suggested that the order size for Product KN5 should be determined using the
economic order quantity model (EOQ).

WQZ Co forecasts that demand for Product KN5 will be 160,000 units in the coming year
and it has traditionally ordered 10% of annual demand per order. The ordering cost is
expected to be $400 per order while the holding cost is expected to be $512 per unit per
year. A buffer inventory of 5,000 units of Product KN5 will be maintained, whether orders
are made by the traditional method or using the economic ordering quantity model.

(n) Calculate the cost of the current ordering policy and the change in the costs of
inventory management that will arise if the economic order quantity is used
to determine the optimum order size for Product KN5.
(6 marks)DEC2010 Q3

(o) Briefly describe the benefits of a just-in-time (JIT) procurement policy.
(5 marks) DEC2010 Q3

(p) Critically discuss the similarities and differences between working capital policies in the
following areas:
(i) Working capital investment;
(ii) Working capital financing. (9 marks) (june2012 Q2)

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June2012 Q2 (overtrading)

Income statement extracts
2011 2010
Revenue 14,525 10,375
Cost of sales 10,458 6,640
PBIT 4,067 3,735
Interest 355 292
Profit before tax 3,712 3,443
Taxation 1,485 1,278
Distributable profit 2,227 2,165

Statement of financial position extracts
2011 2010
$000 $000 $000 $000
Non-current assets 15,284 14,602
Current assets
Inventory 2,149 1,092
Receivables 3,200 1,734
5,349 2,826
20,633 17,428
Current liabilities
Payables 2,865 1,637
Overdraft 1,500 250
4,365 1,887
Equity
Shares 8,000 8,000
Reserves 4,268 3,541
12,268 11,541
Long term liabilities
7%Bonds 4,000 4,000
Total equity &liabilities 20,633 17,428

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Average ratios for the last two years for companies with similar business operations to
Wobnig Co are as follows:
Current ratio 17 times
Quick ratio 11 times
Inventory days 55 days
Trade receivables days 60 days
Trade payables days 85 days
Sales revenue/net working capital 10 times
(a)Using suitable working capital ratios and analysis of the financial information
provided, evaluate whether Wobnig Co can be described as overtrading
(undercapitalised). (12 marks)

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June2009 Q3 Cash budget

Statement of financial position at the current date (extracts)

$000 $000 $000
Non-current assets 48,965
Current assets
Inventory 8,160
Receivable 8,775
16,935
Current liabilities
Overdraft 3,800
Payable 10,200
14,000
Net current assets 2,935
Total assets-current liabilities 51,900

Cash flow forecasts from the current date are as follows:

Month1 Month2 Month3
Cash operating receipts ($000) 4,220 4,350 3,808
Cash operating payments ($000) 3,950 4,100 3,750
Six-monthly interest on traded bonds ($000) 200
Capital investment ($000) 2,000

The finance director has completed a review of accounts receivable management and has
proposed staff training and operating procedure improvements, which he believes will
reduce accounts receivable days to the average sector value of 53 days. This reduction
would take six months to achieve from the current date, with an equal reduction in each
month. He has also proposed changes to inventory management methods, which he hopes
will reduce inventory days by two days per month each month over a three-month period
from the current date. He does not expect any change
in the current level of accounts payable.

HGR Co has an overdraft limit of $4,000,000. Overdraft interest is payable at an annual
rate of 617% per year, with payments being made each month based on the opening
balance at the start of that month. Credit sales for the year to the current date were
$49,275,000 and cost of sales was $37,230,000. These levels of credit sales and cost of
sales are expected to be maintained in the coming year. Assume that there are 365 working
days in each year.

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Required:
(a) Discuss the working capital financing strategy of HGR Co. (7 marks)
(b) For HGR Co, calculate:
(i) the bank balance in three months time if no action is taken; and
(ii) the bank balance in three months time if the finance directors proposals
are implemented.

Comment on the forecast cash flow position of HGR Co and recommend a suitable
course of action.
(10 marks)

30
Business valuation and risk management
DEC2012 Q4
GWW Co is a listed company which is seen as a potential target for acquisition by financial
analysts. The value of the company has therefore been a matter of public debate in recent
weeks and the following financial information is available:

Year 2009 2010 2011 2012
Profit after tax($m) 8.5 8.9 9.7 10.1
Total dividends($m) 5.0 5.2 5.6 6.0

Statement of financial position information for 2012

$000 $000 $000
Non-current assets 91.0
Current assets
Inventory 3.8
Receivable 4.5 8.3
99.3
Equity finance
Share capital 20.0
Reserves 47.2 67.2

8% bonds 25
Current liabilities 7.1
Total liabilities 99.3

The shares of GWW Co have a nominal (par) value of 50c per share and a market value of
$400 per share. The cost of equity of the company is 9% per year. The business sector of
GWW Co has an average price/earnings ratio of 17 times. The 8% bonds are redeemable at
nominal (par) value of $100 per bond in seven years time and the before-tax cost of debt
of GWW Co is 6% per year.

The expected net realisable values of the non-current assets and the inventory are $860m
and $42m, respectively.

In the event of liquidation, only 80% of the trade receivables are expected to be collectible.

31
Required:
(a) Calculate the value of GWW Co using the following methods:

(i) market capitalisation (equity market value);
(ii) net asset value (liquidation basis);
(iii) price/earnings ratio method using the business sector average
price/earnings ratio;
(iv) dividend growth model using:
(1) the average historic dividend growth rate;
(2) Gordons growth model (the bre model).

The total marks will be split equally between each part. (10 marks)

(b) Discuss the relative merits of the valuation methods in part (a) above in
determining a purchase price for GWW Co. (8 marks)

(c) Calculate the following values for GWW Co:
(i) the before-tax market value of the bonds of GWW Co;
(ii) debt/equity ratio (book value basis);
(iii) debt/equity ratio (market value basis).
Discuss the usefulness of the debt/equity ratio in assessing the financial risk of
GWW Co.
The total marks will be split equally between each part. (7 marks)
(25 marks)

32
June2012 Q3 modified

Zigto Co is a medium-sized company whose ordinary shares are all owned by the members
of one family. It has recently begun exporting to a European country and expects to receive
500,000 in six months time. The prospect of increased exports to the European country
means that Zigto Co needs to expand its existing business operations in order to be able to
meet future orders. All of the family members are in favour of the planned expansion, but
none are in a position to provide additional finance. The company is therefore seeking to
raise external finance of approximately $1 million. At the same time, the company plans to
take action to hedge the exchange rate risk arising from its
European exports.

Zigto Co could put cash on deposit in the European country at an annual interest rate of 3%
per year, and borrow at 5% per year. The company could put cash on deposit in its home
country at an annual interest rate of 4% per year, and borrow at 6% per year. Inflation in
the European country is 3% per year, while inflation in the home country of Zigto Co is 45%
per year.

The following exchange rates are currently available to Zigto Co:

Current spot exchange rate 2000 euro per $
Six-month forward exchange rate 1990 euro per $
One-year forward exchange rate 1981 euro per $

(a) Explain the nature of a mudaraba contract and discuss briefly how this form of
Islamic finance could be used to finance the planned business expansion. (5
marks)

(b) Calculate whether a forward exchange contract or a money market hedge
would be financially preferred by Zigto Co to hedge its future euro receipt. (5
marks)

(c) Calculate the one-year expected (future) spot rate predicted by purchasing
power parity theory and explain briefly the relationship between the expected
(future) spot rate and the current forward exchange rate.
(3 marks)

(d) Describe other methods, including derivatives, that Boluje Co could use to
hedge against exchange rate risk.
(8 marks)DEC2008 Q4

(e)Discuss the factors to be considered in formulating the dividend policy of a
stock-exchange listed company.
(10marks) DEC2010 Q4

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