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ACCA P4 Key Point Notes December 2010
ACCA P4 Key Point Notes December 2010
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ACCA
P4
Advanced Financial Management
Prepared By:
Sunil Bhandari
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Contents
Chapter Chapter Name
Number
Preliminaries
Chapter One Financial Objectives-Review of F9 Knowledge
Chapter Two Cost of Capital
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My Summary
• Strong Link To F9
• Core Topics will make up most of the paper
• Questions will be Scenario Based and Longer
• More Analytical Skills needed less Technical Difficulty
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Chapter One
Financial Objectives-
Review of F9 Knowledge
1 Primary Financial Objective
Compute Using:-
1.4 Check the question very carefully for the size of the
company is it:-
Listed
Private Company
2 Indicators
Market Share
Customer Satisfaction
Quality Measures
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Directors pay
Taking high risk business decisions
Non-payment of dividends
Using debt finance (against the wishes of the
S/H)
Company Law
Corporate Governance (eg UK Combined Code)
Share Options (ESOPS)
3.3.4 ESOPS
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Investment
Finance
Dividend
4.2 Investment
Company Liquidity
Future Profits and Asset values
Business Risk Profile i.e. effect upon
variability of the cash flows and profits.
4.3 Finance
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4.4 Dividends
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Efficiency - cost/pupil
- Number of pupils/teacher
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Chapter Two
Cost of Capital
1 Weighted Average Cost of Capital (WACC)
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We= Ve or (1-Wd)
Ve+Vd
W d = Vd or (1-We)
Ve+Vd
re=Ke=Cost Of Equity
rd(1-t)=Kd(1-t)=Cost of Debt
a)
Ke or re =Rf +βe(Rm-Rf)
b)
re=Do(1+g) +g
Po
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c)
Ke= DO(1+g) +g
PO
You need to find g
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g= 3√(0.32/0.24) -1
g=10%
g=bre
Example
g=0.70 x 0.12=0.084
Example
If Ke=11%
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Example
t= 30% βd=NIL
Find βa
βa = 4 x 1.95
4+1(1-0.30)
= 4 x 1.95
4.7
= 1.66
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Example
Tax =25%
= 1.38
1.38 = 68 x βe
68+32(1-0.25)
1.38= 68 x βe
92
βe =1.87
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Kd(1-t)=Interest % x (1-t)
Example
Kd(1-t)=11 x (1-0.30)=7.7%
Kd(1-t)=Ints x (1-t)
Po
Example
Time $
To Po (X) Take two guesses
T1-Tn Ints X(1-t) X like 10% and 1%
Tn Capital X and do an IRR
Repayment
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Example
Rating 1 yr 2 yr 3 yr 5 yr 7 yr 10 yr 30 yr
AAA 5 10 15 22 27 30 55
AA 15 25 30 37 44 50 65
A 40 50 57 65 71 75 90
Example
(1+r)-n = 1
(1+r)n
$7 + $7 + $7+$100
2
1.0525 1.0525 1.05253
= $104.97
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4 Use of WACC
i.e. NPV
IRR
MIRR
4.2 The nominal cost of capital has the symbol “i” at P4 and
can be found via:-
4.4 If the new project is a NON CORE Activity but the project
will have no significant effect upon the company’s
gearing ratio then the nominal cost of capital to use is
the RISK ADJUSTED WACC.
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Chapter Three
2 Approach
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Chapter Four
2 Practical Issues
Debt/Equity+Debt OR Debt/Equity
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a) Yield<Ke
b) Gearing causes Ke to rise
% Ke
Cost
Of
capital
WACC
Kd
0 X Gearing
Key Points:-
% Ke
Cost of
Capital
WACC
Kd
0 Gearing
Key points:-
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Vd=Vu+VDT
WACC=Keu{1-T x Vd}
(Ve+Vd)
Internally-generated funds
Debt
New issue of equity
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Debt
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Chapter Five
Dividend Policy
1 Introduction
2 Theories
2.1 Residual – If spare cash exists at the end of the year pay
dividend.
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3 Practical Considerations
Availability of cash
What dividends do S/H want (clientele effect)?
Signalling effect –payment of dividends indicates a
healthy company
Retaining cash is a key source of finance.
Dividend growth should be greater than inflation
Tax impact upon S/H
Effect the dividend will have on dividend
cover(EPS/DPS)
Number of investment opportunities will restrict
dividend payments.
Risk-paying now is safer than promising to pay next
year
Is the dividend within the company law regulations?
4.1.2 This will allow the S/H to sell extra shares for cash and
the gain will be subject to CGT.
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4.2.1 If the board has “one off” period of excess cash, they
could consider a share buy back.
4.2.2 Considerations:-
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Chapter Six
Advanced Investment
Appraisal I
1 NET PRESENT VALUE OF FREE CASH FLOWS (FCF)
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Inflation
Taxation
Working Capital
Financial Maths
Exclude:-
1) Sunk Costs
2) Finance Charges
3) Dividends
4) Non-Cash flows
5) Non-incremental fixed overheads
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“Include”
a) Given in question
b) WACC or Risk Adjusted WACC Formula /Method
c) Fisher Formula
“Exclude”
(1+r)= (1+i)
(1+h)
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1.5 Taxation
$’000
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Here:-
Both “One Line” and “Two Line” will give the same yearly
FCF’S.
Finally,
eg
$’000 T0 T1 T2 T3
WC needed - 100 170 300
Relevant (100) (70) (130) 300
Cash Flows
A quick reminder
1
= 8.928
0.112
1 x DF3
r-g
1 X .712
0.12-0.02
= 7.12
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2 Layouts
Time
$’000 T0 T1 T2 T3 T4 T5
Revenue - X X X X
Materials - (X) (X) (X) (X)
Labour - (X) (X) (X) (X)
VOH - (X) (X) (X) (X)
Incremental - (X) (X) (X) (X)
FOH
Operating - X X X X
CF
Tax(w1) - - (X) (X) (X) (X)
Format B
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Chapter Seven
Advanced Investment
Appraisal II
1 IRR
1.2 Example
1.4 MIRR is a measure that gives an NPV of nil but will lead
to a project decision rule consistent with NPV.
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2 Computing MIRR
Time $’000
T0 (1000)
T1 400 Return phase
T2 600 of the project
T3 300
Cost of Capital=10%
Time $ 10% PV
T0 (1000) 1.0 (1000)
T1 400 0.909 363.6 *
T2 600 0.826 495.6
T3 300 0.751 225.3
84.5
* PV of Return Phase=$1084.50
Formula given
Alternative Method:
Time $’000
T1 400 X 1.102= 484
T2 600 X 1.10 = 660
T3 300 X 1.0 = 300
1444
T0 (1000)
T3 1444
MIRR = r
1444 - 1000=NIL
(1+r)3
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Foreign Currency T0 T1 T2 T3 T4
Revenue - X X X X
Costs - (X) (X) (X) (X)
T.A.D(not a C.F) - (X) (X) (X) (X)
Foreign Profit - X X X X
Foreign Tax - (X) (X) (X) (X)
Add:
TAD(above) - X X X X
CAPEX & Scrap (X) - - - X
W.C. (X) (X) (X) (X) X
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4.2 Method
APV
$m
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5 Capital Rationing
PI= NPV
Cash outlay in critical period
Example
ABC inc has $30m to spend today and has the following
projects available:-
a. 67/22=3.05
b. 25/17=1.47
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c. 65/40=1.63
d. 26/18=2.00
Multi-period-Divisible Projects
NPV x 100
PV Of Cash Flow
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Example
Revenue
Capex
6.2 Simulation
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Chapter Eight
Valuation of Options
+Value at Risk
1 Valuation of Options
1.1 An option gives the holder the right, but not the
obligation to buy or sell a share at a fixed price on a
specified future date.
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1.1 The above five factors have been built into the Black-
Scholes formula to find the value at time 0 of a
European call option. (c).
All three formulae are given in the tables but you must
know what the symbols stand for.
Symbols:
Pa=share price
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Example
1) e-rt
e-0.025 =0.975
d2 =0.43-0.25=0.18
N (d1) = 0.50+0.1664=0.6664
N (d2) = 0.50+0.0714=0.5714
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3) C
= $ 13.71
Example
= $6.34
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s= standard deviation
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Example
At 95%,what is VaR?
45% 50%
$50m
s=$4.85m
$ 50m-(1.65 X $4.85m) =$42m
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Chapter Nine
Risk Management
1 Introduction
2 Summary of P1
market
credit
liquidity
technological
legal
health and safety
reputation
business probity
derivatives
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Identify
Assess
Measure
Avoid
Accept
Hedge/Reduce Effect
Business Risk
Financial Risk (Chapter 4)
Foreign Currency Risk (Chapter 10)
Interest Rate Risk (Chapter 11)
4 Business Risk
Company profits
Returns to a shareholder
It is related to:
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5 Portfolio Theory(PT)
5.3 The correlation coefficient is a key value and its range is:
-1 0 +1
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Market Portfolio
Sp
Unsystematic
Risk
Systematic Risk
20
No of investments
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7 CAPM
Risk =βe
Return= RF + (Rm-RF)βe
OR
RF + (ERP)βe
Several Reasons:
Stabilise profits
Lead to move predictable cash flows
“Larger” or safer business
Conglomerate theory-some directors feel they can run
any type of business (Virgin, Tata)
Foreign acquisitions will reduce economic risk.
Risk of the investment failing a more of a problem for
the shareholder than the director
May be the only expansion option.
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Chapter Ten
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2 Transaction Exposure
2.1 Change in the value of the spot rate over the short term
causing a cash gain or loss.
3 SPOT Rates
(Bid) (Offer)
$1.5000 - $1.5555 / £
Reciprocal and
cross over!!!!! £0.6429 - £0.6667 / $
(Bid) (Offer)
4 Internal Hedges
4.4 Netting
Class Illustration
Today 30 Sep
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5 External Hedges
“Fix the rate today that will apply on a set future date”
Technique: -
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Technique
Home Abroad
Today’s Spot
Today £ Answer FX
X ÷ 1 + ints foreign
1+ints home
Future Date
£ Answer FX
FX
Technique: -
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2. Setup – Today
Net FX Transaction
Futures Rate
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5.4 Options
Technique: -
2. Set up today
1. Cheapest premium or
2. Nearest to spot or
3. Best possible rate
• No. of contracts
Transaction ≈ Number
Strike Rate
• Summary
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Pros Cons
Forward Market
• Fixed Rate, certainty • Inflexible/contract
• Easy • Lose out on the upside
• Cheap • Must ensure FX receipts
• Tailored arrive
MMH
• Convert today • Complicated
• Cheap • May not apply for FX
• Tailored receipt
• Flexible
Futures
• Effectively fix rate • Complicated
• No cost • Small loss
• Small gain • Need cash for margin
• No tailoring
Options
• Best hedge – cover • Complicated
d/s risk only • No tailoring
• Flexibility • Expensive
• Lots of choice
7. SWAPS
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Solution
£m 0 1
Without swap
Buy 100m pesos @20 (5.0)
Sell 200m pesos @40 5.0
Interest on sterling loan (5 (0.5)
x 10%)
(5.0) 4.5
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£m 0 1
With forex swap
Buy 100m pesos @20 (5.0)
Swap 100m pesos back 5.0
@20
Sell 100m pesos @40 2.5
Interest on sterling loan (5 (0.5)
x 10%)
(5.0) 7.0
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Chapter Eleven
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5 years
Years to
Maturity
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No of years of maturity
3 Risk Management
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4.2 Futures
iii. Margins/deposits
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5 CEILING/CAPPED RATE
5.1 IRG
5.2 Options
6 SWAPS
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%
A (Fixed)+B (Float)
10+LIBOR+2 =LIBOR +12
A(Float)+B (Fixed)
LIBOR+1+13 =LIBOR+14
Difference 2%
LIBOR + 2
A B
12(w1)
10 LIBOR+2
(w1) B-(0.5 x 2) = 12
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Chapter Twelve
1.2.2 The Net Asset value equals the Ve and can be based
on:-
a) Book Values
b) Net Realisable Value(NRV)
c) Replacement cost
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OR
Po = Do(1+g)
(Ke-g)
1.3.4 Finding g
a) Past Growth model
eg:
Year DPS
2006 $0.45
2007 $0.49
2008 $0.52
2009 $0.54
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g= 3√ (0.54)-1
(0.45)
g=0.063
g=bre
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1.5.2 Establish:-
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1.5.4 Example
Ve= FCF0(1+g)
(re-g)
T1 $420m
T2 $490m
T3 $510m
Time
$m T1 T2 T3 T4-F.Ever
FCF 420 490 510 510(1.03)
1/1.0792 1/1.07922 1/1.07923 16.171*
PV 389 421 406 8,495
Ve=$9,711m
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* 1 X 1 = 16.171
3
(0.0792-0.03) (1.0792)
Approach:-
$ ‘000
Value Spread X
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r =Cost of Capital
4) Value of Equity is
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1 year 75
2 year 95
3 year 120
5 year 135
Required
Answer
For a 3 year zero coupon bond to have the same fair value,
the redemption premium would need to be:
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D1 = 1.73
D2 = 1.56
N (D1) = 0.95818
N (D2) = 0.94062
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a) Pre –Acquisition of A X
Pre –Acquisition of A X
A+B X
P.V of Synergies X
XX
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a) Cash
b) Shares
c) Loan Stock
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Cash offers
Advantages:
Disadvantages:
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Loan Stock
Advantages:
Disadvantages:
Share Exchange
Advantages:
Disadvantages:
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Competition Commission
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Chapter Thirteen
Company Performmance
Analysis
Ratios
1.1 Investor
P/E = Po
EPS
1.2 Gearing
1.3 Profitability
1.4 Liquidity
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Suggested layout:
$’000
Operating Profit xxx
Add: Depreciation xxx
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f. Example
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Required
g. Solution
= 10.75%
• NOPAT:-
£m
PAT 32
Add: Non – cash Expenses 15
47
Add: Post tax ints 3.25
(5m X 0.65)
£50.25
= £38.64m
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Chapter Fourteen
Corporate Reconstruction
and Reorganisation
1 Causes of Corporate Failure
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4 Financial Reconstructions
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