Financial Management
Fundamentals Level – Paper F9
Study Text Edition
April 2007
AH07 – F9
For exams in December 2007 and June 2008
Dear Student,
A word from BPP
Welcome to your home study guide. This document will guide you through your BPP Learning Media Study Text and
other learning material .
By using this programme you will benefit from using the best possible materials, written by BPP Learning Media, with
clear exam-focussed guidance.
BPP Learning Media would like to take this opportunity to wish you all the best with your studies and exams.
Nicole Edgington
BPP Learning Media Sales and Marketing Director
Stephen Osborne
ACCA Home Study Materials Manager
STUDY TEXT EDITION: APRIL 2007
Financial Management
1 Introduction
This BPP Home Study Programme will guide you through the April 2007 edition of the BPP Study Text. If your Study
Text does not have that date on the cover, please contact BPP.
Before using this Study Programme, please familiarise yourself with the BPP Study Cycle on page 7. This is a tried and
tested way to study.
2 Using the Home Study Programme
This Home Study Programme is made up of 21 Study Periods, which have been graded as high or medium priority,
based upon guidance from ACCA and the examiners. Each Study Period consists of the following elements.
Exam Guidance
This gives you important information of how
your exam is likely to focus on the particular
area you are studying. It explains the emphasis
that the examiner has placed on the topics
covered in this Study Period on the basis of the
pilot paper and communication with BPP.
Introduction to the session
Here you are introduced to the subject and the
main issues that you should understand when
you have finished your study. You are also
directed to the relevant BPP Learn Online or
i-Learn module.
Guidance through the Study Text
This provides you with important instructions
on how to work through the BPP Study Text.
You must follow the guidance in this table for
time efficient study, as you will be told which
areas of each chapter must be worked through
in detail and which can be skimmed over. It
contains key points, summarising the most
vital areas of the Study Period.
1
STUDY TEXT EDITION: APRIL 2007
BPP i-Pass and Study Text Question Bank
Once you have studied the subject you are
ready to test your understanding and
application skills. Use i-Pass and Study Text
questions as directed. Re-visit any areas
where you are weak.
Quick Quiz
Use the Quick Quiz at the end of the chapter
to see if you have picked up the key technical
knowledge required.
Each Study Period should take about 2½ hours. There is an overview of all Study Periods, on page 10, which can
be used to set up a timetable.
This Study Programme will become a key document in your revision phase.
2
STUDY TEXT EDITION: APRIL 2007
Progress Tests
Some of the Study Periods are 'Progress Tests' which you can use to
assess the work you have done on a limited number of Study Periods.
You should mark the tests yourself using the solutions at the end of
this Study Programme.
Course Exams
(purchasers of Home study courses only)
Your BPP Learning Media material contains two Course Examinations.
These should be attempted at the points suggested within the Study
Programme (they cover all preceding Study Periods).
To gain the greatest benefit from the exams, you must set aside a period of two hours during which you will have no
interruptions.
By submitting these exams, you will increase your chances of passing the real exams by 30%.
3
STUDY TEXT EDITION: APRIL 2007
3 BPP's i-Pass CD Rom
Your Home Study Course may include BPP's i-Pass CD-Rom, which is designed to test knowledge and perfect exam
technique. It enables you to attempt tests, making it an ideal revision tool. If iPass is not included, ask your tuition
provider if you can upgrade your Home Study Course to include it.
i-Pass has two modes (or three for F1, F2 and F3).
The first one is 'Test as you learn'. This allows you to
test yourself on the areas that you are studying at the
time or a combination of different areas. Use the
sliders to choose the number of questions to do to fit
the time you have available.
The second mode provides exam practice by
creating an exam containing questions selected at
random from those within 'Test as you learn' for you
to answer or, if appropriate to your paper, exam
scenarios for you to attempt.
screen shot
Papers examined by Computer Based Exam (F1, F2
and F3) include a third mode, 'Final mock exam'.
The Final mock exam contains questions not included
within 'Test as you learn'. Attempt this to check
you're ready for the real thing.
Each mode gives you comprehensive feedback on the
questions and your performance.
4
STUDY TEXT EDITION: APRIL 2007
To help us answer BPP i-Pass queries you might have quickly and effectively, please follow the steps below. (This
procedure is necessary as question numbers change each time the CD is used.)
Step 1
With the question you wish to query on-screen, push the Print Scrn (Print Screen) button on your
keyboard (usually located to the right of the F12 key). This will copy the image of the question to your
computer's 'clipboard'.
Step 2
Start Microsoft Word. (You can do this while i-Pass is running – click on the start button, then select
Microsoft Word from the programs option.)
Step 3
Paste the image from the clipboard into a new Word document. Do this by selecting Edit, Paste – or by
using the Paste button on the Word toolbar.
Step 4
Step 5
Save the document with a meaningful name, eg iPass_PaperF4_query.doc.
E-mail the document, with details of your query, to learningmedia@bpp.com. If you make contact by
phone, the person dealing with your query will ask you to e-mail or post a copy of the document to them.
4 Learning to Learn Accountancy
Whether you are about to start your studies or continuing them, BPP's Learning to Learn Accountancy will help you
learn efficiently and effectively. It also provides essential guidance on dealing with your exam. If you would like to
obtain a copy e-mail learningmedia@bpp.com with your details.
5 Study Skills
Before you begin your studies, you may want to spend some time thinking about how to approach them. Consider the
following.
(a)
The study environment. Studying while working is very different from studying full time. Time management is crucial.
(b)
Types of subject. You need to think about the form the exam will take and the skills it will draw on. For example,
does it test knowledge, numerical skills, application of knowledge or application of theory?
(c)
What is your learning style? Your learning preferences should affect the way you approach this study material.
(d)
You need to think about how to work through the text, how to take notes and how to do examples.
(e)
How will you approach your revision?
(f)
You need a technique for dealing with common types of question.
(g)
You must approach the exam in a methodical manner.
5
STUDY TEXT EDITION: APRIL 2007
6 Getting ready to Study
To get off to the best possible start to your study, you should take time to read the following features in your BPP
Learning Media Study materials.
Approaching F9
You will find detailed guidance for approaching your exam on page 23 of your Study Text. This guidance describes
what the paper seeks to achieve, the skills you are expected to demonstrate and how you can improve your chances of
passing the paper.
Big Picture diagram
The three 'Big picture' diagrams found on pages 11, 27 and 47 in this Home Study Programme help you understand
and visualise the paper from a high level, giving you a clear perspective of the key topics and how they relate to each
other before you study the detail. Keep these pictures in the back of your mind when studying and refer back to them if
you get bogged down, they will help refocus your mind on what is really important.
Pilot Paper analysis
Page 34 of the Study Text provides you with a commentary on the Pilot Paper. It is important for you to read this to
understand the style of questions you will be faced with in the exam. Do not let these questions put you off studying –
by the end of the Course you will be able to tackle them!
6
STUDY TEXT EDITION: APRIL 2007
BPP Study Cycle
We recommend you follow this Study Cycle each time you study.
Step 5
Try the questions from the BPP i-Pass disk and any questions
recommended in the Home Study Programme.
Step 1
Read the Exam Guidance in the Home Study Programme and the
Introduction to the session.
Step 4
Test yourself out on the Quick Quiz at the end of the chapter, looking
back to the chapter detail for anything you are unsure on.
Step 2
Look at the chapter introduction in the Study Text and think what
you know about this area or what is likely to be in the chapter.
With Home Study Plus, Learn Online or if using the i-Learn disk,
use the BPP i-Learn module to get you started on the subject.
Tips for using Learn Online can be found at
www.bpp.com/acca/learnonline and selecting FAQs.
Step 3
Read the Guidance in the Home Study Programme and then read
the Study Text chapter, looking out for these points. Try any
examples as you go along.
7
STUDY TEXT EDITION: APRIL 2007
7 Revising
Familiarise yourself with BPP's Revision Cycle below.
For your revision phase, your Home Study Course includes the following.
(a)
The BPP Practice & Revision Kit, which contains exam standard questions and other useful practice questions.
The Kit also contains a Question Plan which highlights the key questions to attempt to maximise your chances
of exam success.
(b)
The Home Study Programme, where the Exam Guidance and Key Points will serve as a reminder of the work
you did in each Study Period.
(c)
The BPP Passcards, which give short summaries of the content of each chapter of the Study Text.
Revision should not start until you have completed your second course examination.
BPP Revision Cycle
Step 1
Look back to the Home Study
Programme as you start revising
each subject to remind you of
that subject.
Step 2
Step 4
Look at the appropriate
Passcard chapter to make
sure you are aware of the
full scope of the knowledge
needed.
For a change, test yourself
on i-Pass.
Step 3
You should spend most of your time on this
step. Do the suggested questions from the
Question Plan in the Revision Kit and make sure
you leave time to review your performance, both
the contents and the timing. Think what you
could do better next time and if you need to
brush up on any knowledge or techniques.
8
STUDY TEXT EDITION: APRIL 2007
8 BPP's Big Picture
The 'Big Picture' diagram provides you with an overview of the subject and builds up a framework containing the key
techniques and knowledge that you need to be confident of performing well in the exam.
You will find a 'Big Picture' at the start of the course followed by a written summary of the scope and contents of the
subject.
There are also 'Big Pictures' situated before the point at which you take Course Exams 1 and 2 to help consolidate what
you have learnt so far and to help you revise.
You will find the first 'Big Picture' on page 11, the second on page 27 and the third on page 47.
9
STUDY TEXT EDITION: APRIL 2007
Study Period Planner
Use this schedule and your exam timetable to plan the dates on which you will complete each Study Period. The letters
'H' and 'M' tell you whether the topic is high or medium priority.
Detailed guidance and prioritisation of each Study Period begins on page 13.
BIG PICTURE 1
Study
Period
Topic
Due Date
1
Financial management
and financial
objectives
M
2
Financial management
environment
M
3
Working capital
4
Study
Period
Topic
Due Date
11
Specific investment
decisions
H
12
Sources of finance
H
13
Gearing and capital
structure
H
H
14
Progress Test 2
H
Managing working
capital
H
15
Cost of capital
H
5
Working capital
finance
H
16
Capital structure
H
17
Business valuations
H
6
Progress Test 1
H
18
Market efficiency
M
7
Investment decisions
M
19
Foreign currency risk
H
8
Investment appraisal
using DCF methods
H
20
Interest rate risk
H
21
Progress Test 3
H
9
Allowing for inflation
and taxation
H
10
Project appraisal and
risk
M
BIG PICTURE 2
BIG PICTURE 3
COURSE EXAM 1 (if purchased)
COURSE EXAM 2 (if purchased)
A practice exam covering Study Periods 1-14.
A mock exam covering the whole syllabus.
REVISION PHASE
Your revision, using the questions and guidance in the BPP Learning Media Passcards and the BPP Learning Media
Practice & Revision Kit, will begin when Course Exam 2 is complete. This should, at the latest, be four weeks before the
final exam.
10
STUDY TEXT EDITION: APRIL 2007
Big Picture Diagram 1
Financial Management (F9)
Financial management function
Financial management environment
Working capital management
Investment appraisal
Business finance
Cost of capital
Business valuations
Risk management
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STUDY TEXT EDITION: APRIL 2007
Financial Management Summary
The aim of Paper F9, Financial Management, is to give you the skills that would be expected from a finance manager
responsible for the finance function of a business. The first part of the syllabus therefore starts by introducing the role
and purpose of financial management.
The three key financial management decisions are investment, financing and dividends and we start by looking at the
economic environment in which these decisions are made.
The second part of the syllabus looks at the investment decision in terms of working capital and the appraisal of new
projects and acquisitions. Financing decisions are looked at in the next part of the syllabus involving sources of finance,
including dividend policy and how much finance can be raised from within the business.
This is followed by the cost of capital and other factors influencing the choice of capital a business can raise. How to
value a business is covered in the next part of the syllabus and this links to the cost of capital.
Finally, we look at what risks a business may face and how these risks can be managed.
12
Study Period 1
Financial management and financial objectives
Medium Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
This study period provides an introduction to financial
management and is highly examinable as discussion parts of
questions or ratio calculations.
I-Pass Module 1 contains questions on these techniques but
you need to have covered more of the material in this area
before tackling these questions.
It is very important to recognise that different types of
organisations will have different objectives and always apply
your discussion to the specific organisation in the question.
Now attempt Question 1 from the Question Bank.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction and start to think about how
objectives of stakeholders impact on organisations you are
familiar with.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 1 looks at financial management and objectives
of different organisations.
Step 3 Guidance through the Study Text
Please read Chapter 1 after reading the guidance below.
•
Read through Sections 1 and 2 taking notes on any terminology and concepts that you are not familiar with. EPS in Section 2.3.3
is a very important ratio and you should make sure your really understand the concept and how to do the calculations.
•
Section 3 contains very important material on stakeholders so make detailed notes.
•
The ratios in Section 4 are again highly examinable and you need to memorise how to do them and be able to explain their
meaning.
•
Read through Sections 5 and 6 and make detailed notes.
This session is reflected in the Financial management function part of the 'Big Picture' diagram.
13
Study Period 2
Financial management environment
Medium Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
This study period aims to build your knowledge of the financial
environment and is unlikely to feature as a major part of an
exam question. This exam will not test economic theories, you
only need to be aware of what governments’ general economic
objectives are and how this can impact on a business.
I-Pass Module 1 contains questions on financial management.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introductions to Chapters 2 and 3 which
explain the focus of the material.
Please attempt the Quick Quiz at the end of the two Study Text
Chapters to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 1 covers the financial management topics in the
first three chapters of the Study Text.
Now attempt Questions 2 and 3 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapters 2 and 3 after reading the guidance below.
•
Read through Chapter 2 taking notes on areas which are unfamiliar to you. You need to think particularly about how each policy
described impacts on businesses.
•
Chapter 3 may contain terminology which is new to you so make sure you make detailed notes as this will provide essential
background knowledge.
This session is reflected in the Financial management part of the 'Big Picture' diagram.
14
Study Period 3
Working capital
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
The general objectives of working capital and the cash operating
cycle are the most important parts of this chapter and could be
expected to feature as a significant part of an exam question.
I-Pass Module 2 contains questions on these techniques but
you need to have covered more of the material in this area
before tackling these questions.
You may be familiar with some of the ratios from your earlier
studies and it is essential that you know how to do the
calculations and also explain their significance.
Now attempt Question 4 from the Question Bank.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 2 covers the working capital section of the
syllabus.
Step 3 Guidance through the Study Text
Please read Chapter 4 after reading the guidance below.
•
Read through Sections 1, 2 and 3 making notes on these important concepts. You will need to be able to describe the nature and
objectives of working capital.
•
Learn how to calculate the cash operating cycle and what it means from Section 4.
•
Work slowly through all of the ratios in Section 5. You will need to be able to calculate the ratios and explain the results of your
calculations for a specific business. You will need to be able to recognise the symptoms of over-capitalisation and over-trading.
This session is reflected in the Working capital management part of the 'Big Picture' diagram.
15
Study Period 4
Managing working capital
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
Questions on working capital management are likely to be a
mixture of calculations and discussion and you will need to be
able to do a wide range of different calculations.
I-Pass Module 2 contains questions on these techniques but
you need to have covered more of the material in this area
before tackling these questions.
Always make sure that your suggestions are practical and
suitable for the organisation in the question.
Now attempt Questions 5 and 6 from the Question Bank.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered and how to approach this area of the syllabus.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 2 covers the working capital section of the
syllabus.
Step 3 Guidance through the Study Text
Please read Chapter 5 after reading the guidance below.
•
Parts of Section 1 may be familiar to you from your earlier studies. Make sure you know what each part of the EOQ formula
stands for and that you are able to use it confidently. An EOQ question is very likely to involve a discount for a bulk order so
make sure you can do the calculation in Section 1.7. Take notes on JIT and its benefits.
•
You need to work through Section 2 slowly and carefully. You will need to be able to do calculations showing the effect of a
change in credit policy and also be able to explain how receivables should be managed. Make detailed notes on this section.
•
Section 3 is much briefer and again you need to be able to do the calculations and make enough notes so you could answer
discussion questions.
This session is reflected in the Working capital management part of the 'Big Picture' diagram.
16
Study Period 5
Working capital finance
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
This study period covers material which is again highly
examinable as calculations and/or discussion. Working capital
funding policy and the Miller-Orr model were tested for 13
marks in the Pilot Paper Question 3.
I-Pass Module 2 contains questions on ABC.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 2 covers the working capital section of the
syllabus.
Now attempt Pilot Paper Question 3 and Questions 7 and 8 from
the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 6 after reading the guidance below.
•
Read and make brief notes on Section 1.
•
Section 2 is very important. You will need to work through this slowly and carefully and practice being able to produce clear,
accurate cash forecasts. An exam question may also ask you how to deal with problems identified in a cash forecast so take notes
on Section 2.6.
•
Section 3 is a brief section on the treasury department, read and make notes so you would be able to explain its purpose.
•
Work through Section 4 carefully making sure you understand and can use the formulae that will be given to you in the exam.
•
Make brief notes on Section 5 so you have an understanding of the terminology.
•
Section 6 is important and highly examinable so make detailed notes.
This session is reflected in the Working capital management part of the 'Big Picture' diagram.
17
18
Study Period 6
Progress Test 1
High Priority
In order to reinforce what you have learnt so far, answer the following questions. Try to answer them without
referring to your Study Text or notes. The test should take you no longer than 30 minutes and covers Study Periods
1–5. Solutions are at the back of this Study Programme.
1
Which of the following is generally assumed to be the principal financial objective of a company?
A
B
C
D
2
Maximising profit retentions
Maximising operating profitability
Maximising the wealth of the ordinary shareholders
Maximising dividends
Examine the validity of the following statements.
Statement 1 All other things being equal, the higher the price earnings ratio (P/E ratio), the greater the growth
expected by financial markets.
Statement 2 All other things being equal, the higher the price earnings ratio (P/E ratio), the greater the risk
expected by financial markets.
A
B
C
D
3
Statement 1
Statement 2
True
True
False
False
True
False
True
False
The results of Price Gibbon Day Co for the year ended 31 March 20X2 were as follows.
Profit after tax for the financial year
Preference dividend
Ordinary dividend (paid and proposed)
Retained profits for the year
$
2,900,000
200,000
1,200,000
1,500,000
What is the dividend cover?
A
B
C
D
4
1.25 times
2.07 times
2.25 times
2.42 times
Which of the following is concerned with how well an activity is achieving its intended effects?
A
B
C
D
Earnings
Economy
Efficiency
Effectiveness
19
Study Period 6
Progress Test 1 (con't)
5
All of the following will normally lead to a fall in the level of economic activity in an economy except which one?
A
B
C
D
6
High Priority
A rise in cyclical unemployment
A fall in business investment
A decrease in government expenditure
A rise in interest rates
A firm's working capital comprises cash of $2,000, inventory, receivables and trade payables. The cost of sales
for the year is $28,800. Financial statistics include:
Gross profit margin
Inventory holding period
Trade payables payment period
Working capita; (current) ratio
40%
1 month
1.2 months
3:1
What is the receivables collection period?
A
B
C
D
7
A company has a positive level of working capital but has an overdraft. What will be the impact of the following
transactions on the current ratio?
Transaction 1
Cash is received from debtors and is then used to reduce the overdraft.
Transaction 2
A fixed asset is sold for cash and this is used to reduce the overdraft.
A
B
C
D
8
Statement 2
Increase
Increase
Decrease
Decrease
Increase
Decrease
Increase
Decrease
Falling sales
Increasing overdraft
Falling current ratio
Rising profit
Invoice discounting normally involves
A
B
C
D
20
Statement 1
Which of the following is not normally associated with overtrading?
A
B
C
D
9
1.26 months
1.06 months
0.98 months
0.66 months
Offering a cash discount for early settlement of invoices
Selling an invoice to a discount house at a profit
Selling an individual invoice for cash to a factoring organisation at a discount
Writing off an invoice, partly or in total, as a bad debt
Study Period 6
Progress Test 1 (con't)
10
High Priority
HMP Co has decided to adopt a moderate working capital policy. It has fluctuating current assets of $1m,
permanent current assets of $5m, and non-current assets of $9m. Which of the following mixes of finance is the
company most likely to choose?
A
B
C
D
Short-term financing of $1m; permanent financing of $14m
Short-term financing of $0.5m; permanent financing of $14.5m
Short-term financing of $2m; permanent financing of $13m
Short-term financing of $4m; permanent financing of $11m
You will find the answers to this test at the end of this Study Programme. If you answer more than 5 questions
correctly, your performance is satisfactory; if you answer more than 7 correctly, you are doing well. Once you have
reviewed how you have performed, go back over topics where you feel your understanding is poor.
21
Study Period 6
Progress Test 1 (con't)
22
High Priority
Study Period 7
Investment decisions
Medium Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
You need to be able to calculate payback and ROCE and also
able to discuss their drawbacks. A short question on ROCE
appeared in the Pilot Paper for 5 marks.
I-Pass Module 3 contains questions on these techniques but
you need to have covered more of the material in this area
before tackling these questions.
Now attempt Question 9 from the Question Bank.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 3 covers the investment appraisal section of the
syllabus.
Step 3 Guidance through the Study Text
Please read Chapter 7 after reading the guidance below.
•
Sections 1, 2 and 3 may be familiar to you from earlier studies so read through and take notes as necessary.
•
Work through Sections 4 and 5 slowly and carefully, learning the techniques and making good notes on the advantages and
disadvantages of each method.
This session is reflected in the Investment appraisal part of the 'Big Picture' diagram.
23
Study Period 8
Investment appraisal using DCF methods
High Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
It is essential that you are able to use NPV and IRR techniques,
both for this exam and also for papers you will study later.
I-Pass Module 3 contains questions on these techniques but
you need to have covered more of the material in this area
before tackling these questions.
Again, you need to be able to discuss the advantages and
limitations of the techniques. There are 7 marks available for
such a discussion in the Pilot Paper.
Now attempt Questions 10, 11 and 12 from the Question Bank.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 3 covers the investment appraisal section of the
syllabus.
Step 3 Guidance through the Study Text
Please read Chapter 8 after reading the guidance below.
•
This is a crucial chapter so take your time and work through it very carefully.
•
Section 1 introduces the discounted cash flow technique, make sure you are happy with the concept of discounting.
•
In Section 2, make sure you understand the timing of cash flows and how to use discount and annuity tables.
•
You will need to learn the IRR formula in Section 3 so make time to practise it in questions.
•
Sections 4 and 5 are highly examinable in discussion parts of questions so read through carefully and make detailed notes.
This session is reflected in the Investment appraisal part of the 'Big Picture' diagram.
24
Study Period 9
Allowing for inflation and taxation
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
NPV with inflation and tax was tested for 13 marks in the Pilot
Paper and is likely to feature regularly in future exams.
I-Pass Module 3 contains questions on investment appraisal.
Note that the examiner will invent tax rates, timing of tax
payments and tax depreciation rates so read the question very
carefully and follow the instructions.
Now attempt Pilot Paper Question 4 and Questions 13 and 14
from the Question Bank.
A neat layout will help you to make sense of the information in a
question and help the marker.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 3 covers the investment appraisal section of the
syllabus.
Step 3 Guidance through the Study Text
Please read Chapter 9 after reading the guidance below.
•
There are some difficult concepts and calculations in this chapter so work through it slowly and carefully.
•
Section 1 deals with inflation in investment appraisal and you will probably need to read this a few times in order to fully
understand it. Make sure you know the difference between nominal cash flows and real cash flows and how they should be dealt
with in an NPV calculation.
•
Section 2 will again need to be worked through a few times. Clear workings and use of the pro-forma layout in Section 3 will help
you to answer more complex exam standard NPV questions.
This session is reflected in the Investment appraisal part of the 'Big Picture' diagram.
25
Study Period 10
Project appraisal and risk
Medium Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
NPV will feature regularly in the exam and, given that all projects
offer highly uncertain returns, the material in this study period is
also likely to be regularly examined.
I-Pass Module 3 contains questions on investment appraisal
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 3 covers the investment appraisal section of the
syllabus.
Now attempt Question 15 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 10 after reading the guidance below.
•
You need to learn the difference between risk and uncertainty from Section 1. The rest of the chapter then looks at ways to deal
with uncertainty and risk.
•
Work through the example in Section 2.1. making sure you fully understand each element. You need to be aware of the
weaknesses of each of the techniques covered in this chapter.
•
You will have come across expected values in your earlier studies so much of Section 3 should be familiar. Read through the
examples, paying particular attention to the standard deviation as this will probably be new to you.
•
Section 4 covers a range of other risk adjustment techniques which you will need to be familiar with.
This session is reflected in the Investment appraisal part of the 'Big Picture' diagram.
26
Big Picture Diagram 2
Financial Management (F9)
Financial management function
• Financial management and financial
objectives [1]
Financial management environment
• The economic environment for business [2]
• Financial markets and institutions [3]
Working capital management
• Working capital [4]
• Managing working capital [5]
• Working capital finance [6]
Investment appraisal
• Investment decisions [7]
• Investment appraisal using DCF
methods [8]
• Allowing for inflation and taxation
[9]
• Project appraisal and risk [10]
Business finance
Cost of capital
Business valuations
Risk management
27
28
Study Period 11
Specific investment decisions
High Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
NPV will regularly feature in the exam and any of the techniques
in this study period could be tested as part of an NPV question.
Leasing is probably the most important area to focus on.
I-Pass Module 3 contains questions on investment appraisal
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 3 covers the investment appraisal section of the
syllabus.
Now attempt Questions 16, 17 and 18 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 11 after reading the guidance below.
•
There are some difficult calculations in this chapter so you will need to work through it slowly and carefully.
•
Read through Sections 1.1 to 1.6 and make notes. The rest of Section 1 takes you through the calculations involved in a lease or
buy problem. You may need to work through this several times to make sure you are completely happy with the steps involved.
•
Asset replacement decisions in Section 2 are quite straightforward. Work through the step by step example and learn the
equivalent annual cost formula.
•
Read through Sections 3.1 and 3.2 and make notes so you could answer a written question on capital rationing. Carefully work
through the calculations in the rest of Section 3.
This session is reflected in the Investment appraisal part of the 'Big Picture' diagram.
29
Study Period 12
Sources of finance
High Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
Sources of finance can be linked into questions on NPV,
working capital or cost of capital. The most important aspect is
to discuss sources that are appropriate for the specific
organisation in the question.
I-Pass Module 4 contains questions on sources of finance but
you need to have covered more of the material on business
finance before tackling these questions.
Now attempt Questions 19, 20 and 21 from the Question Bank.
Dividend policy is not likely to be a major question in the exam.
It is likely to be examined as a discussion question in
conjunction with ratio analysis, for example.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introductions which explain the areas that
will be covered.
Please attempt the Quick Quizzes at the end of the Study Text
Chapters to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 4 covers the business finance section of the
syllabus
Step 3 Guidance through the Study Text
Please read Chapters 12 and 13 after reading the guidance below.
•
Read and make notes on Section 1 so that you would be able to suggest suitable sources of short-term finance for an
organisation. This links to the working capital financing we covered earlier.
•
Read Section 2 and make detailed notes on reasons for using debt finance and the types of debt finance available. Work carefully
through the convertible loan note calculations.
•
Read and take notes on venture capital in Section 3.
•
Read Sections 4.1 to 4.7 making detailed notes. Carefully work through the calculations in the rest of the chapter, making sure
you are happy with the theoretical ex-rights price.
•
Chapter 13 is a brief chapter which you need to read through and take notes so that you could answer a discussion question on
the subject.
This session is reflected in the Business finance part of the 'Big Picture' diagram.
30
Study Period 13
Gearing and capital structure
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
Ratio analysis of the impact of debt finance is a key area of this
study period and was tested for 8 marks in the Pilot Paper.
I-Pass Module 4 contains questions on business finance.
Now attempt Question 22 from the Question Bank.
Capital structure can be examined with a number of other
syllabus areas.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 4 covers the business finance section of the
syllabus
Step 3 Guidance through the Study Text
Please read Chapter 14 after reading the guidance below.
•
You need to learn how to calculate the ratios in Section 1 and be able to explain their meaning. Practise using the ratios by
working through the examples and doing the questions.
•
Read through Section 2 as a reminder of the shareholder ratios you have previously covered and to understand how gearing will
affect them.
•
Section 3 concerns the specific financing needs and problems of small and medium sized entities. Make detailed notes so you
would be able to suggest suitable sources of finance for such an organisation.
This session is reflected in the Business finance part of the 'Big Picture' diagram.
31
32
Study Period 14
Progress Test 2
High Priority
In order to reinforce what you have learnt so far, answer the following questions. Try to answer them without
referring to your Study Text or notes. The test should take you no longer than 30 minutes and covers Study Periods
1–5. Solutions are at the back of this Study Programme.
1
Details of a new machine are:
Capital cost
Expected operating life
Expected scrap value at the end of 5 years
Annual depreciation
Expected annual cash inflows from operations
$120,000
5 years
$20,000
$20,000
$40,000
What is the payback period?
A
B
C
D
2
6.0 years
5.0 years
3.0 years
2.5 years
A project has a life of 3 years. In the first year, it is expected to generate sales of $200,000, increasing at the rate
of 10% per annum over the remaining two years. At the start of each year, working capital is required equal to
10% of the sales revenue for that year. All working capital will be released at the end of the project.
What is the net present value (to the nearest thousand pounds) of the working capital cash flows of the project,
discounting at a rate of 20% per annum?
A
B
C
D
3
Nil
($9,000)
($13,000)
($17,000)
Iceberg Co is about to embark on a project to develop frozen lettuces. It involves an initial outlay of $100,000
and cash inflows, at current prices, of $50,000, $60,000 and $40,000 at the end of years 1, 2 and 3 respectively.
Inflation is expected to be running at 10% pa during the life of the project, and the effective cost of capital is
10%.
What is the net present value of the project?
A
B
C
D
4
$50,000
$26,100
$25,050
$4,700
A company has 31 March as its accounting year end. On 1 April 20X6 a new machine costing $2,000,000 is
purchased. The company expects to sell the machine on 31 March 20X8 for $500,000.
The effective rate of tax on profits for the company is 35%. Tax depreciation is obtained at 25% on the reducing
balance basis and a balancing allowance is available on disposal of the asset. Tax cash flows occur 12 months
after the end of the accounting period in which the originating cash flows occurred. The company makes
sufficient profits to obtain relief for tax depreciation as soon as it arises.
33
Study Period 14
Progress Test 2 (con't)
High Priority
If the company's cost of capital is 10% per annum, what is the present value at 1 April 20X6 of the tax
depreciation (to the nearest thousand dollars?
A
B
C
D
5
$393,000
$407,000
$432,000
$448,000
A company is evaluating a new product proposal. The proposed product selling price is $180 per unit and the
variable costs are $60 per unit. The incremental cash fixed costs for the product will be $160,000 per annum.
The discounted cash flow calculation results in a positive NPV.
Year 0
Year 1–5
Year 5
Initial outlay
Annual cash flow
Working capital released
Net present value
Cash flow
$
(1,000,000)
320,000
50,000
Discount rate
factor
1.000
3.791
0.621
Present value
$
(1,000,000)
1,213,120
31,050
244,170
What percentage change in selling price would result in the project having a net present value of zero?
A
B
C
D
6
6.7 per cent
7.5 per cent
8.9 per cent
9.6 per cent
The following information relates to an asset which a company is considering leasing or buying:
Life of asset
Cost if purchased
Residual value
Lease details:
10 years
$28,000
$3,000
Ten annual repayments of $3,800 to begin at the start of the lease.
Ignoring taxation, what (to the nearest $100) is the net benefit in present value terms at 10% p.a. of leasing the
asset as opposed to purchasing it?
A
B
C
D
7
34
$5,000
$2,300
$3,500
$4,700
Which one of the following best describes the term 'coupon rate' as applied to loan notes?
A
The annual interest received on the face value of the units of the notes
B
The annual interest received divided by the current ex-interest market price of the notes
C
The total rate of return on loan notes, taking into account capital repayments as well as interest
repayments
D
The rate of stamp duty applicable to purchases of the notes
Study Period 14
Progress Test 2 (con't)
8
Bonds that are issued by a company at a large discount to their eventual redemption value, but on which no
interest is paid until redemption, are called:
A
B
C
D
9
High Priority
Deep discount bonds
Zero coupon bonds
Equity bonds
Floating rate bonds
Hairport de Lay Co is to make a rights issue of one share at $1.60 for every three existing shares. There is a
current dividend payment due of 4c per share, but the new shares will not qualify for this. The current price per
share just prior to the rights issue is $2.12 cum dividend.
What is the theoretical ex rights price per share?
A
B
C
D
10
$1.95
$1.96
$1.99
$2.00
Suppose that, for a given level of activity, a firm's fixed costs rose and, at the same time, its ratio of debt to
equity fell. What would be the impact on the firm's financial risk and operating risk?
A
B
C
D
Financial risk would
Increase
Decrease
Increase
Decrease
Operating risk would
Increase
Increase
Decrease
Decrease
You will find the answers to this test at the end of this Study Programme. If you answer more than 5 questions
correctly, your performance is satisfactory; if you answer more than 7 correctly, you are doing well. Once you have
reviewed how you have performed, go back over topics where you feel your understanding is poor.
35
Study Period 14
Progress Test 2 (con't)
36
High Priority
Study Period 15
Cost of capital
High Priority
Examined: Pilot paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
Calculation of the weighted average cost of capital was tested
for 9 marks in the Pilot Paper and you can expect it to feature
regularly in the F9 exam. You may also be asked to discuss or
explain issues connected with its use.
I-Pass Module 5 contains questions on cost of capital but you
need to have covered Study Period 16 material before tackling
these questions.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 5 covers the cost of capital section of the
syllabus.
Now attempt Question 23 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 15 after reading the guidance below.
•
Read Section 1 and make sure you understand the relationship between risk, return and the cost of capital.
•
Work carefully through Section 2 making sure you are able to do these important calculations.
•
The other method of calculating the cost of equity is the capital asset pricing model which we will refer to again in a later study
period, so time spent here will be very useful. Work slowly and carefully through Section 3.
•
Section 4 takes you through how to calculate the cost of debt. There are a number of formulae for you to learn in this section as
well as learning the technique to calculate the cost of redeemable and convertible debt.
•
Section 5 brings together all of the individual costs of capital into one overall weighted average cost of capital. Again, work
through the examples slowly to ensure you fully understand this important technique.
This session is reflected in the Cost of capital part of the 'Big Picture' diagram.
37
Study Period 16
Capital structure
High Priority
Examined: Pilot paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
The theories covered in this study period could form the
discussion part of a question as in part (b) of Pilot Paper
Question 1. You may also be required to gear and ungear a
beta.
I-Pass Module 5 contains questions on cost of capital.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 5 covers the cost of capital section of the
syllabus.
Now attempt Question 1 from the Pilot Paper.
Step 3 Guidance through the Study Text
Please read Chapter 16 after reading the guidance below.
•
Read through Section 1 on capital structure theories and make notes. Think about the significance of the contrasting theories.
•
Section 2 may be hard to understand when you first read it. The main issue is that WACC is not always appropriate to use to
calculate a project’s NPV as it does not incorporate changes in risk. CAPM can be used to calculate a marginal cost of capital and
Section 2.7 shows you how to use the exam formula to do the necessary calculations. Work through the examples and questions
until you are happy with the process.
This session is reflected in the Cost of capital part of the 'Big Picture' diagram.
38
Study Period 17
Business valuations
High Priority
Examined: Pilot Paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
This is an important, highly examinable subject area and you
may need to produce a range of values for a company in the
exam, as well as discuss the advantages and disadvantages of
each method of valuation.
I-Pass Module 6 contains questions on business valuations.
Step 2 Introduction to the session
Step 4 Quick Quiz
This chapter covers the reasons why businesses are valued and
the main methods of valuation.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 6 covers the cost of capital section of the
syllabus.
Now attempt Questions 24 and 25 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 17 after reading the guidance below.
•
Quickly read through Section 1 and make notes on anything that is new to you.
•
The rest of the chapter goes through each valuation method. Asset valuation bases in Section 2 are very straightforward but make
sure you understand why each valuation base might be chosen.
•
In Section 3 you need to remember how to calculate EPS and P/E ratios. Practise doing the valuation using the question and
make notes on how and why this method is used.
•
Cash flow based valuations can use the dividend valuation model which you have studied before in the costs of capital part of the
syllabus, or a discounted cash flow basis. Work through the examples and questions slowly and carefully in Section 4 to make
sure you really understand these techniques.
•
Section 5 looks at how to value other securities and uses formulae you will have seen to calculate cost of capital. The formulae
are simply re-arranged so that a valuation (Po) can be calculated. Practice at these calculations will be needed.
This session is reflected in the Business valuation part of the 'Big Picture' diagram.
39
Study Period 18
Market efficiency
Medium Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
This study period may form a discussion part of a question,
combined for example with a business valuation.
I-Pass Module 6 contains questions on business valuations.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 6 covers the business valuations section of the
syllabus.
Now attempt Question 26 from the Question Bank.
Step 3 Guidance through the Study Text
Please read Chapter 18 after reading the guidance below.
•
Section 1 describes the efficient market hypothesis which is a popular discussion question in financial management exams. Read
and take notes. Make sure you fully understand the implications of the theory for businesses.
•
Section 2 covers practical considerations in the valuation of shares and businesses. Again, read it through and make notes so you
would be able to answer a discussion question.
This session is reflected in the Business valuation part of the 'Big Picture' diagram.
40
Study Period 19
Foreign currency risk
High Priority
Examined: Pilot paper
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
Foreign currency risk was examined in the Pilot Paper as a
mixture of explanations and calculations and this is the format
you can expect in the F9 exam. The Pilot Paper question gives a
good indication of the wide range of knowledge you will need in
this area.
I-Pass Module 7 contains questions on risk management but
you need to have covered Study Period 20 material before
tackling these questions.
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 7 covers the risk management section of the
syllabus.
Now attempt Question 27 from the Question Bank and Pilot
Paper Question 2.
Step 3 Guidance through the Study Text
Please read Chapter 19 after reading the guidance below.
•
Section 1 introduces the meaning of exchange rates so read it and take notes on any unfamiliar areas.
•
Section 2 contains essential information on the different types of exchange rate risk so make detailed notes.
•
Read Section 3 slowly and carefully and make detailed notes on the causes of exchange rate fluctuations and how to use the
formulae you will be given in the exam.
•
Section 4 explains the types of risk management methods that a company can use. Make detailed notes on Sections 4.1 to 4.6
and work slowly through the calculations in Sections 4.7 to 4.9. You will need to be able to do these calculations so do plenty of
practice.
•
You need to have an understanding of foreign currency derivatives in Section 5 but will not need to do any calculations. Read this
section and take notes but be aware that the calculations are there only to help your understanding.
This session is reflected in the Risk management part of the 'Big Picture' diagram.
41
Study Period 20
Interest rate risk
High Priority
Step 1 Exam Guidance
Step 5 BPP i-Pass and Study Text Question Bank
You will need to be familiar with the terminology in this study
period so that you can answer discussion questions.
I-Pass Module 7 contains questions on risk management .
Step 2 Introduction to the session
Step 4 Quick Quiz
Read the Study Text introduction which explains the areas that
will be covered.
Please attempt the Quick Quiz at the end of the Study Text
Chapter to reinforce your understanding. You will find it
beneficial to do so after a break, to see what has 'stuck' and
what hasn't.
I-Learn Module 7 covers the risk management section of the
syllabus.
Now attempt Question 28 from the Question Bank
Step 3 Guidance through the Study Text
Please read Chapter 20 after reading the guidance below.
•
Section 1 is a brief reminder of the pattern of interest rates that was covered in Study Period 2. You may want to go back over
this before tackling the rest of this chapter.
•
Read through Section 2 and take notes on the types of interest rate risk.
•
Take notes on Section 3, paying particular attention to the yield curve as this may be an important area for the exam.
•
You need to have a good knowledge of how interest rate risks can be managed so make good notes on Sections 4 and 5 and
think about how the methods described could be used in different types of organisations.
This session is reflected in the Risk management part of the 'Big Picture' diagram.
42
Study Period 21
Progress Test 3
High Priority
In order to reinforce what you have learnt so far, answer the following questions. Try to answer them without
referring to your Study Text or notes. The test should take you no longer than 30 minutes and covers Study Periods
1–5. Solutions are at the back of this Study Programme.
1
Sultan Pepper Co issued its 12% irredeemable loan notes at 102. The current market price is 95. The company
is paying tax on profits at a rate of 40%.
The current cost of capital to the company of these loan notes is:
A
B
C
D
2
7.1%
7.2%
7.6%
12.6%
The following data relates to the ordinary shares of Lye Cheese.
Current market price, 31 December 20X1
Market price one year ago, 31 December 20X0
Earnings per share, 20X1
Dividend per share, 20X1
Expected growth rate in dividends and earnings
Average market return
Risk-free rate of return
Basic rate of income tax
Beta factor of Lye Cheese plc's equity
250c
227c
57.73c
35c
10% per annum
20%
13%
30%
1.5
The estimated cost of Lye Cheese's equity, using the dividend growth model and market price, is
A
B
C
D
24.0%
25.4%
30.0%
32.0%
Data for questions 3 and 4
The directors of Mace are considering the acquisition of Dickson, a much smaller company that is capable of making
annual profits after tax of $200,000. The current balance sheet of Dickson is as follows.
Non-current assets (net book value)
Inventory and work in progress
Receivables (less provision of 1% for doubtful debts)
Bank balances
Bank overdraft
Trade payables
$
800,000
504,000
396,000
20,000
920,000
50,000
490,000
$
(540,000)
1,180,000
Share capital and reserves
1,180,000
43
Study Period 21
Progress Test 3 (con't)
High Priority
The estimated values of Dickson's assets are as follows.
Replacement
cost
$
850,000
540,000
Non-current assets
Inventories and WIP
Net realisable
value
$
600,000
580,000
It is generally agreed that 2% of total receivables will be uncollectable.
The cost of capital of Mace is 15%.
3
What is the net realisable value of Dickson?
A
B
C
D
4
On the basis of this data, what is the minimum price that the owners of Dickson should accept for their shares?
A
B
C
D
5
$1,048,080
$1,032,000
$1,052,000
$1,582,000
Net realisable value
$1,176,000
$1,262,000
$1,333,000
Kahn Flowers Co's equity has a beta factor of 0.9. The company is financed by a mixture of equity, preference
shares and irredeemable long term debt capital, as follows.
Ordinary shares
7% Preferred shares of £1 each
12% Debt capital
40 million shares, market value $2 per share
20 million shares, market value 50c per share
$20 million nominal, market value $80
If the market rate of return is 18%, the risk-free rate of return is 12% and the rate of tax 35%, what is the
company's weighted average cost of capital?
A
B
C
D
6
15.6%
15.7%
15.9%
16.7%
Gould Fisher Pond has a beta factor of 1.20 and a equity: debt ratio of 4:1. The rate of corporate tax is 35%, and
the impact of personal taxes can be ignored.
What would be the beta factor of the company if it changed to being an all-equity company?
A
B
C
D
44
1.03
1.06
1.10
1.48
Study Period 21
Progress Test 3 (con't)
7
An investor who bases all his investment decisions solely on an analysis of past share price movements is
acting as if he believed that the capital market is:
A
B
C
D
8
Statement 1:
The existence of projects with positive expected net present value contradicts the idea that the
stock market is strong-form efficient.
Statement 2:
The existence of information content in dividends contradicts the idea that the stock market is
strong-form efficient.
Statement 1
True
True
False
False
Statement 2
True
False
True
False
The current inflation rate in the US is running at 6% and 5% in the UK. The exchange rate between the two
countries is 1.7800 $/£. If exchange rates adjust to keep purchasing power unchanged in each country, the
exchange rate in one year's time will be
A
B
C
D
10
Strongly efficient
Semi-strongly efficient
Weakly efficient
Not efficient at any level
What is the validity of the following statements?
A
B
C
D
9
High Priority
1.6952
1.7632
1.7970
1.8690
Examine the validity of the following statements with respect to the yield curve showing the term structure of
interest rates.
(1)
When interest rates are expected to fall consistently, short-term interest rates are likely to be higher than
long-term interest rates.
(2)
When interest rates are expected to fall consistently, a yield curve would normally be downward sloping.
A
B
C
D
Statement 1
True
True
False
False
Statement 2
False
True
False
True
You will find the answers to this test at the end of this Study Programme. If you answer more than 5 questions
correctly, your performance is satisfactory; if you answer more than 7 correctly, you are doing well. Once you have
reviewed how you have performed, go back over topics where you feel your understanding is poor.
45
Study Period 21
Progress Test 3 (con't)
46
High Priority
Big Picture Diagram 3
Financial Management (F9)
Financial management function
• Financial management and financial
objectives [1]
Financial management environment
• The economic environment for business [2]
• Financial markets and institutions [3]
Working capital management
• Working capital [4]
• Managing working capital [5]
• Working capital finance [6]
Investment appraisal
• Investment decisions [7]
• Investment appraisal using DCF
methods [8]
• Allowing for inflation and taxation
[9]
• Project appraisal and risk [10]
• Specific investment decisions [11]
Business finance
• Sources of finance [12]
• Dividend policy [13]
• Gearing and capital structure [14]
Cost of capital
• Cost of capital [15]
• Capital structure [16]
Business valuations
• Business valuations [21]
• Market efficiency [22]
Risk management
• Foreign currency risk [19]
• Interest rate risk [20]
47
48
Solutions
Progress Test 1
1
C
The wealth of the shareholders comes from dividends received and from the market value of the shares.
2
B
Statement 1 is true as the higher the level of the ratio, the greater the future earnings expected by the
market.
Statement 2 is false as an increase in risk will revise expectations of future earnings, and hence price,
downwards.
3
C
Total profit after tax
Preference dividend
Profits available for distribution to ordinary shareholders
$'000
2,900
200
2,700
Actual dividend to ordinary shareholders
1,200
Dividend cover (2,700 ÷ 1,200) = 2.25 times
4
D
Effectiveness.
5
A
A rise in cyclical unemployment is a consequence of a fall in the level of economic activity rather than its
cause
6
B
Cost of sales 28,800
∴Sales =
28,800
– 48,000 pa
0.6
Monthly sales $4,000
Working capital
Inventory (1 month × 4,000 × 0.6)
Cash
Payables
Current ratio = 3 =
2,400
2,000
2,880
2,400 + 2,000 + receivables
2,880
∴receivables = 4,240
Receivables collection period =
7
A
4,240
= 1.06 months
4,000
For transaction 1 say Current assets = 20,000, Current liabilities (including Overdraft) = 10,000 and
Current ratio is 2. If receivables pay $4,000, both current assets and liabilities reduce by $5,000 and
current ratio is 15,000 ÷ 5,000 = 3.
For transaction 2 current liabilities reduce and therefore the current ratio will rise.
8
A
Falling sales.
9
C
Selling an individual invoice for cash to a factoring house at a discount.
10
A
Short-term finance is matched to fluctuating current assets. B is a conservative policy, while C and D re
aggressive policies.
49
Solutions
Progress Test 2
1
C
Flows
(120,000)
40,000
40,000
40,000
40,000
60,000
0
1
2
3
4
5
2
B
Time
0
1
2
3
3
∴3 years
C
Discount
factor
Flow
$
(20,000)
(2,000)
(2,200)
24,200
Present value
$
(20,000)
(1,666)
(1,527)
14,012
(9,181)
1.000
0.833
0.694
0.579
Effective rate = real rate
∴DCF calculation
Time
0
1
2
3
4
B
Flow
$
(100,000)
50,000
60,000
40,000
DF
Present value
$
(100,000)
45,450
49,560
30,040
25,050
1.000
0.909
0.826
0.751
Tax flows 12 months after the end of the accounting period means first tax saving from tax depreciation
in time 2 (claimed time 1).
Time 1 claim
Time 2 claim for BA
2,000,000
500,000
1,500,000
1,000,000
500,000
Flow
175,000
Tax
t2
350,000
t3
∴Present value = (175,000 × 0.826) + (350,000 × 0.751) = 407,400
50
Solutions
Progress Test 2 (con't)
5
C
$
320,000
160,000
480,000
Annual cash flow
Add fixed costs
Annual contribution
∴Annual sales volume = $480,000/$120 = 4,000 units
Permissible fall in present value of revenue =
PV of revenue (4,000 × $180 × 3.791)
Percentage change in selling price = $244,170/$2,729,520
6
A
$244,170
÷ $2,729,520
= 8.9%
Incremental cash flows.
Lease – purchase
Time
0
0–>9
10
$
DF @ 10%
(28,000)
3,800
3,000
1
5.759
0.386
PV
$
(28,000)
21,884
1,158
(4,958)
= $5,000 benefit
7
A
A is true.
B would give the yield if the debt was irredeemable.
C is the overall redemption yield.
D is definitely wrong!
8
B
'Coupon' is the interest paid. Hence, 'zero coupon' is no interest.
9
B
Theoretical ex rights price =
10
B
Financial risk is the risk that operating profits might be insufficient to cover interest costs of debt capital
and leave a responsible return for equity shareholders. Financial risk therefore increases as gearing rises,
and (as in this case) decreases when gearing falls.
1
[(3 × 2.08) + 1.60] = $1.96.
(3 × 1)
Operating risk is the risk that contribution (sales minus variable costs of sales) will be insufficient to
cover fixed costs and earn a profit unless a sufficient volume of out put and sales is achieved. Higher
fixed costs cause operating risk to increase.
51
Solutions
Progress Test 3
1
C
Cost =
2
B
r=
=
12 × (100 – 40)%
= 7.6% (after tax)
95
d 0 (1 + g)
MVexdiv
+g
35 (1.10)
+ 0.10 = 0.254 or 25.4%
250
Notice that the growth rate in dividend should result in a comparable growth in the share price over time.
Thus, the share price one year ago (227c) has risen by about 10% to 250c, which is consistent with the
growth in dividends.
3
C
$
600,000
580,000
392,000
20,000
(540,000)
1,052,000
Non-current assets
Inventory and WIP
Receivables, 98% of $396,000 × (100 ÷ 99)
Bank balances
Bank overdraft and trade payables
4
A
On the basis of the data, the minimum price acceptable to Dickson's shareholders is the opportunity cost
of not realising the assets piecemeal – its net realisable value.
The price that Mace might be willing to pay is up to $200,000 ÷ 15% = $1,333,333, but this is not the
question. The value to Dickson's shareholder's of an annual earnings stream of $200,000 cannot be
evaluated unless we can estimate their opportunity cost of capital (or 'marginal rate of preference')
which we do not know, but which is likely to exceed 15% because of Dickson's private company status.
5
C
Cost of equity (using the capital asset pricing model) = 12% + 0.9 (18 – 12)% = 17.4%.
Cost of preference shares = ($1 ÷ £0.50) × 7% = 14%.
Cost of loan stock after tax = 65% of
Item
Market value
Equity
Preference shares
Loan stock
80,000
10,000
16,000
106,000
WACC =
6
A
$12
= 9.75%.
($80)
βu =
Cost
0.1740
0.1400
0.0975
$'000
13,920
1,400
1,560
16,880
16,880
× 100% = 15.9% approximately
106,000
1.20
1.20
=
[1 + 0.25 (1 – 0.35)] 1.1625
= 1.032258, say 1.03
52
Solutions
Progress Test 3 (con't)
7
D
If the market is weak form efficient then investors can't beat the market. Question assumes that investors
are trying to beat the market, therefore, investors must believe that the market is not efficient at all.
8
C
(i)
Strong form efficiency implies that all sales/purchases of shares are zero NPV transactions.
However other 'projects' can have positive NPVs.
(ii)
9
C
If market is strong form efficient, then the share price reflects all information and therefore the
dividend is irrelevant as a signal.
The current inflation rate in the US is running at 6% and 5% in the UK. The exchange rate between the
two countries 1.78 $/£.
Exchange rate in one year's time = 1.78 ×
10
B
1.06
= 1.7970
1.05
Both statements are true.
53
Solutions
Progress Test 1 (con't)
54