Professional Documents
Culture Documents
Paper F9
Financial Management
Revision Mock Examination
June 2014
Question Paper
Time Allowed
15 minutes
3 hours
Writing
www .s t u d yin t e ra ct i ve .o rg
20,000
70,000
125,000
20,000
2,000
2,200
1,600
1,500
900
1,000
1,020
1,020
10
10
10
10
Selling price inflation and fixed costs inflation are expected to be 5% per year
and variable cost inflation is expected to be 4% per year. Fixed costs represent
incremental fixed production overheads which are wholly attributable to the
project.
The production equipment for the new device would cost $120 million and an
additional initial investment of $20 million would be needed for working capital.
The equipment is expected to be sold at the end of four years for $10 million
when the production and sales cease. The average general level of inflation is
expected to be 3% per year and working capital would experience inflation of
this level.
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.
PEP Co has a real cost of capital of 7.8%
Required:
(a) Calculate the net present value of the MTD project and comment on
whether this project is fina ncia lly acceptable to PEP Co.
(13 marks)
(b) Calculate the internal rate of return of the MTD project and
comment on whether this project is financially acceptable to PEP Co.
(4 marks)
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$000
490
44
68
_____
602
Current assets
Inventory
Trade Receivables
420
330
___
Total assets
750
_____
1,352
_____
Equity capital
Ordinary shares
Retained earnings
200
562
_____
762
Non-current liabilities
7% Loan notes
6% bank loan
Current liabilities
Trade payables
Proposed dividend
Total e quity and liabilities
180
105
___
245
60
___
285
_____
305
_____
1,352
_____
216
60
_____
156
_____
Required:
(a) Calculate the possible values for an ordinary share in WLF Ltd using
each of the following:
(i) net assets (net book value) method;
(ii) net assets (liquidation) method;
(iii) dividend growth valuation method;
(iv) price earnings ratio method.
(8 marks)
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3. FAQ plc has recently appointed a new Finance Director who has concluded that
the business does not exert sufficient control over its working capital and is
considering making the following changes:
Inventory management
Within the first few weeks of taking up the new job, she found evidence of both
overstocking and under stocking of many items. She believes that the longer
term solution to these problems is to adopt a just-in-time approach for many
items.
However, in the short term she has started to implement stock
management models to help minimise costs. As a starting point, the company
has implemented the Economic Order Quantity model to the management of its
inventory. Although this has already proved beneficial, the business has now
received an offer from a supplier of one of its products. The supplier has
offered a discount of 2.5% on the cost of each of that product for order sizes of
200 or more and a discount of 4% for order sizes of 400 or more. Each product
costs $60 to purchase and the cost of holding one unit in stock is estimated at
$80 per year. The ordering cost is $50 and the annual sales demand is 8,000
units, which accrues evenly over the year.
Receivables management
The first proposal is to introduce a discount of 2% for payments within 30 days.
FAQ expects 80% of its customers to take the offer and pay on the 30th day.
The rest will continue to pay in 60 days on average. It also believes that this
will reduce its debt collection procedures costs to $40,000 a year.
The alternative proposal is to hire the services of a factor at the cost of 2% of
credit sales value. The factor expects to reduce the collection period of all the
credit sales to 20 days. The factor will also make an advance of 80% of the
trade receivables for which it will charge 10% interest per year. It is estimated
that the cost of debt collection procedures would fall to $5,000 per year as a
result.
Other relevant information
(i) It can be assumed that there are 360 days in a year.
(ii) Credit sales are $12,000,000 a year and have been stable over the past few
years.
(iii) Customers currently take an average of 60 days to pay .
(iv)The company spends $140,000 on debt collection procedures every year and
has negligible bad debts.
(v) FAQ has a large overdraft amounting to $3,000,000 and pays interest at a
rate of 15% per year on it.
Required:
(a) Identify the objectives of working capital management and discuss
the conflict that may arise between them.
(4 marks)
(b) Calculate the impact of introducing the early payment discount and
hiring the services of the factor, and recommend which proposal, if
any, FAQ should proceed with.
(10 marks)
(c) Discuss the arguments for and against the implementation of a justin-time approach to inventory management as a solution to the
problems of the business.
(5 marks)
(d) Calculate the appropriate order size for the product that will
minimise the total annual costs associated with the purchase of this
item.
(6 marks)
(25 marks)
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4. SGT plc is a large UK fashion retailer that opened stores in India and China
three years ago. Financing the overseas investments substantially increased
the debt finance and the financial risk of the company. In order to reduce the
gearing, the directors have decided to make a one-for-five rights issue at a
discount of 30% on the current market value to redeem some of the debt. The
most recent Income statement of the business is as follows:
Income statement for the year ended 31 October 2012
m
Sales
1,400.00
_______
155.00
55.00
_______
100.00
25.00
_______
75.00
14.00
_______
Retained profit
61.00
_______
520.00
550.00
_______
1,070.00
_______
The shares of the business are currently traded on the London Stock Exchange
at a P/E ratio of 16 times. An investor, owning 10,000 ordinary shares in the
business, has received information of the forthcoming rights issue but cannot
decide whether to take up the rights issue, sell the rights, or allow the rights
offer to lapse.
Other relevant information
(i) Sector average gearing (debt/equity)
100%
3.5 times
25%
Required:
(a) Calculate the theoretical ex-rights price of an ordinary share in SGT
plc.
(3 marks)
(b) Evaluate and comment on each of the options available to the
investor with 10,000 ordinary shares.
(6 marks)
(c) Calculate and comment on the effect of redeeming some of the debt
on:
(i) earnings per share
10
(7 marks)
(d) Assuming the price earnings ratio of SGT remains constant, evaluate
whether the proposal to pay some of the debt would increase the
wealth of SGT shareholde rs.
(3 marks)
(e) Discuss the factors
divide nd policy.
SGT
formulating it
(6 marks)
(25 marks)
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11
Formulae Sheet
2C0D
CH
Miller-Orr Model
Return point = Lower limit + (1/3 spread)
1
3
3
4 transaction cost variance of cash flows
Spread = 3
interest rate
Vd(1 T)
Ve
a =
e +
d
(V
V
(1
T))
(V
V
(1
T))
e d
e d
D0(1 g)
(K e g)
or P0 =
D0(1 g)
(re g)
Ve
Vd
WACC =
ke +
kd (1T)
V
V
e d
Ve Vd
The Fisher formula
(1 + i) = (1 + r)(1 + h)
Purchasing Power Parity and Interest Rate Parity
12
S1 = S 0
(1 hc )
(1 hb )
F 0 = S0
(1 ic )
(1 ib )
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= discount rate
= number of periods until payment
Discount rate (r)
Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
________________________________________________________________________________
1
2
3
4
5
0.990
0.980
0.971
0.961
0.951
0.980
0.961
0.942
0.924
0.906
0.971
0.943
0.915
0.888
0.863
0.962
0.925
0.889
0.855
0.822
0.952
0.907
0.864
0.823
0.784
0.943
0.890
0.840
0.792
0.747
0.935
0.873
0.816
0.763
0.713
0.926
0.857
0.794
0.735
0.681
0.917
0.842
0.772
0.708
0.650
0.909
0.826
0.751
0.683
0.621
1
2
3
4
5
6
7
8
9
10
0.942
0.933
0.923
0.914
0.905
0.888
0.871
0.853
0.837
0.820
0.837
0.813
0.789
0.766
0.744
0.790
0.760
0.731
0.703
0.676
0.746
0.711
0.677
0.645
0.614
0.705
0.665
0.627
0.592
0.558
0.666
0.623
0.582
0.544
0.508
0.630
0.583
0.540
0.500
0.463
0.596
0.547
0.502
0.460
0.422
0.564
0.513
0.467
0.424
0.386
6
7
8
9
10
11
0.896
0.804
0.722
0.650
0.585
0.527
0.475
0.429
0.388
0.350 11
12
0.887
0.788
0.701
0.625
0.557
0.497
0.444
0.397
0.356
0.319 12
13
0.879
0.773
0.681
0.601
0.530
0.469
0.415
0.368
0.326
0.290 13
14
0.870
0.758
0.661
0.577
0.505
0.442
0.388
0.340
0.299
0.263 14
15
0.861
0.743
0.642
0.555
0.481
0.417
0.362
0.315
0.275
0.239 15
________________________________________________________________________________
(n) 11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
________________________________________________________________________________
1
2
3
4
5
0.901
0.812
0.731
0.659
0.593
0.893
0.797
0.712
0.636
0.567
0.885
0.783
0.693
0.613
0.543
0.877
0.769
0.675
0.592
0.519
0.870
0.756
0.658
0.572
0.497
0.862
0.743
0.641
0.552
0.476
0.855
0.731
0.624
0.534
0.456
0.847
0.718
0.609
0.516
0.437
0.840
0.706
0.593
0.499
0.419
0.833
0.694
0.579
0.482
0.402
1
2
3
4
5
6
7
8
9
10
0.535
0.482
0.434
0.391
0.352
0.507
0.452
0.404
0.361
0.322
0.480
0.425
0.376
0.333
0.295
0.456
0.400
0.351
0.308
0.270
0.432
0.376
0.327
0.284
0.247
0.410
0.354
0.305
0.263
0.227
0.390
0.333
0.285
0.243
0.208
0.370
0.314
0.266
0.225
0.191
0.352
0.296
0.249
0.209
0.176
0.335
0.279
0.233
0.194
0.162
6
7
8
9
10
11
12
13
14
15
0.317
0.286
0.258
0.232
0.209
0.287
0.257
0.229
0.205
0.183
0.261
0.231
0.204
0.181
0.160
0.237
0.208
0.182
0.160
0.140
0.215
0.187
0.163
0.141
0.123
0.195
0.168
0.145
0.125
0.108
0.178
0.152
0.130
0.111
0.095
0.162
0.137
0.116
0.099
0.084
0.148
0.124
0.104
0.088
0.074
0.135
0.112
0.093
0.078
0.065
11
12
13
14
15
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13
Annuity Table
Present value of an annuity of 1 ie
Where
1 - (1 + r)-n
r
r = discount rate
n = number of periods
Discount rate (r)
Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
________________________________________________________________________________
1
2
3
4
5
0.990
1.970
2.941
3.902
4.853
0.980
1.942
2.884
3.808
4.713
0.971
1.913
2.829
3.717
4.580
0.962
1.886
2.775
3.630
4.452
0.952
1.859
2.723
3.546
4.329
0.943
1.833
2.673
3.465
4.212
0.935
1.808
2.624
3.387
4.100
0.926
1.783
2.577
3.312
3.993
0.917
1.759
2.531
3.240
3.890
0.909
1.736
2.487
3.170
3.791
1
2
3
4
5
6
7
8
9
10
5.795
6.728
7.652
8.566
9.471
5.601
6.472
7.325
8.162
8.983
5.417
6.230
7.020
7.786
8.530
5.242
6.002
6.733
7.435
8.111
5.076
5.786
6.463
7.108
7.722
4.917
5.582
6.210
6.802
7.360
4.767
5.389
5.971
6.515
7.024
4.623
5.206
5.747
6.247
6.710
4.486
5.033
5.535
5.995
6.418
4.355
4.868
5.335
5.759
6.145
6
7
8
9
10
11 10.37
9.787
9.253
8.760
8.306
7.887
7.499
7.139
6.805
6.495 11
12 11.26
10.58
9.954
9.385
8.863
8.384
7.943
7.536
7.161
6.814 12
13 12.13
11.35
10.63
9.986
9.394
8.853
8.358
7.904
7.487
7.103 13
14 13.00
12.11
11.30
10.56
9.899
9.295
8.745
8.244
7.786
7.367 14
15 13.87
12.85
11.94
11.12
10.38
9.712
9.108
8.559
8.061
7.606 15
________________________________________________________________________________
(n) 11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
_________________________________________________________________ _______________
1
2
3
4
5
0.901
1.713
2.444
3.102
3.696
0.893
1.690
2.402
3.037
3.605
0.885
1.668
2.361
2.974
3.517
0.877
1.647
2.322
2.914
3.433
0.870
1.626
2.283
2.855
3.352
0.862
1.605
2.246
2.798
3.274
0.855
1.585
2.210
2.743
3.199
0.847
1.566
2.174
2.690
3.127
0.840
1.547
2.140
2.639
3.058
0.833
1.528
2.106
2.589
2.991
1
2
3
4
5
6
7
8
9
10
4.231
4.712
5.146
5.537
5.889
4.111
4.564
4.968
5.328
5.650
3.998
4.423
4.799
5.132
5.426
3.889
4.288
4.639
4.946
5.216
3.784
4.160
4.487
4.772
5.019
3.685
4.039
4.344
4.607
4.833
3.589
3.922
4.207
4.451
4.659
3.498
3.812
4.078
4.303
4.494
3.410
3.706
3.954
4.163
4.339
3.326
3.605
3.837
4.031
4.192
6
7
8
9
10
11
12
13
14
15
6.207
6.492
6.750
6.982
7.191
5.938
6.194
6.424
6.628
6.811
5.687
5.918
6.122
6.302
6.462
5.453
5.660
5.842
6.002
6.142
5.234
5.421
5.583
5.724
5.847
5.029
5.197
5.342
5.468
5.575
4.836
4.988
5.118
5.229
5.324
4.656
4.793
4.910
5.008
5.092
4.486
4.611
4.715
4.802
4.876
4.327
4.439
4.533
4.611
4.675
11
12
13
14
15
14
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