Fundamentals Level – Skills Module

Financial Management
Mock Exam – Answers

Time allowed: 3 hours 15 minutes

This question paper is divided into three sections:

Section A – ALL 15 questions are compulsory and MUST be attempted
Section B – ALL 15 questions are compulsory and MUST be attempted
Section C – BOTH questions are compulsory and MUST be attempted

Formulae Sheet, Present Value and Annuity Tables

are on pages 14–16.

Do NOT open this question paper until instructed by the supervisor.

Do NOT record any of your answers on the question paper.
This question paper must not be removed from the examination hall.

The Association of Chartered Certified Accountants

1
Answers

2
Fundamentals Level – Skills Module, Paper F9
Financial Management November 2017

Section A

1 C

2 D ,3B

4 D

Dividend growth rate = 100 x ((33·6/32) – 1) = 5%

MV = 33·6/(0·13 – 0·05) = $4·20

5 D

6 A
Monetary value of return = $3·10 x 1·197 = $3·71
Current share price = $3·71 – $0·21 = $3·50

7 B

8 C

9 B

1 0 A

1 1 C

1 2 C
Total cash flow Joint probability EV of cash flow
($) ($)
36,000 0·1125 4,050
14,000 0·0375 525
32,000 0·4500 14,400
10,000 0·1500 1,500
16,000 0·1875 3,000
(6,000) 0·0625 (375)
23,100
Less initial investment (12,000)
–––––––
EV of the NPV 11,100

1 3 C

14 B
MV = (7 x 5·033) + (105 x 0·547) = $92·67

15 A
3
16 D
The secured loan notes are safer than the bank loan, which is secured on a floating charge. The redeemable preference shares
are above debt in the creditor hierarchy. Ordinary shares are higher in the creditor hierarchy than preference shares.

17 C
Future share price after seven years = 10·90 x 1·067 = $16·39 per share
Conversion value of each loan note = 16·39 x 8 = $131·12 per loan note

18 B
Market value of each loan note = (8 x 5·033) + (126·15 x 0·547) = 40·26 + 69·00 = $109·26

19 C
An equity beta of greater than 1 indicates that the investment is more risky than the market as a whole.

20 B
It is correct that the price/earnings ratio is more suited to valuing the shares of listed companies, and it is also true that it is
difficult to find a suitable price earnings ratio for the valuation.

21 A
Interest payment = 5,000,000 pesos
Six-month forward rate for buying pesos = 12·805 pesos per $
Dollar cost of peso interest using forward market = 5,000,000/12·805 = $390,472

22 B
Exchange rates reflecting the different cost of living between two countries is stated by the theory of purchasing power parity.
The theory holds in the long term rather than the short term.
The forward rate is found by multiplying the spot rate by the ratio of the inflation rates of the two countries.

23 C
Dollars will be borrowed now for six months at 4·5 x 6/12 = 2·25%
Pesos will be deposited now for six months at 7·5 x 6/12 = 3·75%

24 C
Currency futures and swaps could both be used. As payment must be made on the date set by the bank, leading or lagging are
not appropriate. Matching is also inappropriate as there are no peso income streams.

25 A
The correct procedure is to: Borrow euro now, convert the euro into dollars and place the dollars on deposit for three months, use
the customer receipt to pay back the euro loan.

4
26 A
Deregulation to increase competition should mean managers act to reduce costs in order to be competitive. The need to reduce
costs may mean that quality of products declines.

27 A
Since taxation and capital allowances are to be ignored, and where relevant all information relating to project 2 has already been
adjusted to include future inflation, the correct discount rate to use here is the nominal before-tax weighted average cost of
capital of 12%.

0 1 2 3 4
Maintenance costs (25,000) (29,000) (32,000) (35,000)
Investment and scrap (200,000) 25,000
–––––––– ––––––– ––––––– ––––––– –––––––
Net cash flow (200,000) (25,000) (29,000) (32,000) 10,000
Discount at 12% 1·000 0·893 0·797 0·712 0·636
–––––––– ––––––– ––––––– ––––––– –––––––
Present values (200,000) (22,325) (23,113) (22,784) (6,360)

Present value of cash flows ($274,582)

Cumulative present value factor 3·037
Equivalent annual cost = 274,582/3·037 = $90,412

28 D
Both statements are false. The machine with the lowest equivalent annual cost should be purchased not the present value of
future cash flows alone.
The lives of the two machines are different and the equivalent annual cost method allows this to be taken into consideration.

29 B
EV of year 3 cash flow = (23,000 x 0·2) + (24,000 x 0·35) + (30,000 x 0·45) = 26,500
PV discounted at 12% = 26,500 x 0·712 = 18,868

30 C
The statement about uncertainty increasing with project life is true.

5
Question 31 – Part A

a) NPV

YEARS £000

Desc 0 1 2 3 4 5 6
I.I. (1060) 115
Saving – CA 87 66 49 37 28 45
Penalty (150)
Maintenance (43) (43) (43) (43) (43)
Disposal Charge 3200 3520 3872 4259 4685
Savings Of Cost 280 308 339 373 410
Processing Cost (2960) (3256) (3582) (3940) (4334)
Tax on Cash Flow (157)* (175) (193) (214) (237)
N.C.F. (1210) 564 438 460 493 647 (192)
D.F. X1 0.893 0.797 0.712 0.636 0.567 0.507
(1210) 504 349 328 343 367 (97)

*0.33 x 477 NPV + 634,000 = Accept

Workings : CA

Description Bal T. Rate Saving

Yr Realised
O. Cost 1.06
Yr 0 – CA @25% (0.265) x 33 % 0.087 1
Bal 0.795
Yr 1 - CA (0.199) x 33 % 0.066 2
Bal 0.596
Yr 2 - CA (0.149) x 33 % 0.049 3
Bal 0.447
Yr 3 – CA (0.112) 33 % 0.037 4
Bal 0.335
Yr 4 – CA (0.084) 33 % 0.028 5
Bal 0.251
Yr 5 – Disposal 115000 Loss 136,000 0.045 6

Tonnes Of Tyres

Year 1 80,000
Year 2 88,000
Year 3 96,800
Year 4 106,480
Year 5 117,128

6
Question 1 Part B

Step 1 - Possibly cycles 2 or 3 years

Step 2 - NPC
2 Year Cycle

Description 0 1 2 3
I.I. (24,500)
Mtce (550) (968)
Cost 17,199
Resale - - -
NCF (24,500) (550) 16,231
D.F X1 0.87 0.756
(24,500) (478) 12,273
NPC 12,705

1.626
12705 = EAC x PV1F A 15% 2 yrs

12705 = EAC
1.626

EAC = 7813

3 year Cycle

Description 0 1 2 3
I.I. (24,500)
Mtce (550) (968) (1997)
Resale - - - 12,965
NCF (24,500) (550) (968) 10,968
D.F. X1 0.87 0.756 0.657
PV (24,500) (478) (732) 7205

NPC = 18505

18505 = EAC x PV1FA 15% 3 yr

18505 = EAC
2.283
= $8,106

Therefore Recommend : Replace every 2 years.

7
32. (a) Effect on profitability of implementing the proposal

Benefits: £ £
Increased contribution (W1) 200,000
Decrease in bad debts (W2) 6,300 206,300
––––––––
Costs
Increase in current Class 1 discount (W3) 12,167
Discount from transferring Class 2 debtors (W4) 11,498
Discount from new Class 1 debtors (W5) 3,750
Increase in bad debts, new Class 2 debtors (W6) 2,055
Increase in financing cost from new debtors (W7) 4,932 34,402
–––––––– ––––––––
Net benefit of implementing the proposal 171,898
––––––––

The proposed change appears to be financially acceptable and so may be recommended. Uncertainty with respect to
some of the assumptions underlying the financial evaluation would be unlikely to change the favourable
recommendation.

Workings
Contribution/sales ratio = 100 x (5,242 – 3,145)/5,242 = 40%
Bad debts ratio for Class 2 debtors = 100 x (12,600/252,000) = 5%
Increase in Class 1 debtors from new business = 250,000 x 30/365 = £20,548
Increase in Class 2 debtors from new business = 250,000 x 60/365 = £41,096

(W1) Contribution from increased business = 500,000 x 40% = £200,000

(W2) Decrease in bad debts for transferring current Class 2 debtors = 12,600 x 0·5 = £6,300
(Note that other assumptions regarding bad debts are possible here)
(W3) Current sales of Class 1 debtors = 200,000 x (365/30) = £2,433,333
Rise in discount cost for current Class 1 debtors = 2,433,333 x 0·005 = £12,167
(W4) Current sales of Class 2 debtors = 252,000 x (365/60) = £1,533,000
Discount cost of transferring Class 2 debtors = 1,533,000 x 0·5 x 0·015 = £11,498
(W5) Discount cost for new Class 1 debtors = 250,000 x 0·015 = £3,750
(W6) Bad debts arising from new Class 2 debtors = 41,096 x 0·05 = £2,055
(Note that other assumptions regarding bad debts are possible here)
(W7) Increase in financing cost from new debtors = (20,548 + 41,096) x 0·08 = £4,932
(Note that it could be assumed that transferring debtors pay after 30 days rather than 60
days)

Examiner’s Note: because of the various assumptions that could be made regarding bad debts and payment period, other
approaches to a solution are also acceptable.

(b) Current cash operating cycle

Stock days = (603/3,145) x 365 = 70 days
Creditor days = (574·5/3,145) x 365 = 67 days
Average debtor days = (744·5/5,242) x 365 = 52 days
Cash operating cycle = 70 + 52 – 67 = 55 days

After implementation of the proposal, it is reasonable to assume that stock days and creditor days remain unchanged.
Total debtors have increased by £61,644 to £806,144 and turnover has increased to £5·742m. Average debtor days are
now 365 x (806/5,742) = 51 days. The cash operating cycle has marginally decreased by one day to 54 days (70 + 51 –
67).

(c) Current sterling value of overseas debtors = £182,500

Current dollar value of overseas debtors = 182,500 x 1·7348 = $316,601
A forward market hedge (i.e. a forward exchange contract) will lock the sterling value of the debtors at the three-month
forward rate.
8
Hedged sterling value of overseas debtors in three months = 316,601/1·7367 = £182,300
This is less than the current sterling value of the overseas debtors because sterling is expected to appreciate against the
dollar.

(d) The key elements of a debtor management system may be described as establishing a credit policy, credit
assessment, credit control and collection of amounts due.

Establishing credit policy

The credit policy provides the overall framework within which the debtor management system of PNP plc operates and
will cover key issues such as the procedures to be followed when granting credit, the usual credit period offered, the
maximum credit period that may be granted, any discounts for early settlement, whether interest is charged on overdue
balances, and actions to be taken with accounts that have not been settled in the agreed credit period. These terms of
trade will depend to a considerable extent on the terms offered by competitors to PNP plc, but they will also depend on
the ability of the company to finance its debtors (financing costs), the need to meet the costs of administering the
system (administrative costs) and the risk of bad debts.

Credit assessment
In order to minimise the risk of bad debts, PNP plc should assess potential customers as to their creditworthiness before
offering them credit. The depth of the credit check depends on the amount of business being considered, the size of the
client and the potential for repeat business. The credit assessment requires information about the customer, whether
from a third party as in a trade reference, a bank reference or a credit report, or from PNP itself through, for example, its
analysis of a client’s published accounts. The benefits of granting credit must always be greater than the cost involved.
There is no point, therefore, in PNP plc paying for a detailed credit report from a credit reference agency for a small
credit sale.

Credit control
Once PNP plc has granted credit to a customer, it should monitor the account at regular intervals to make sure that the
agreed terms are being followed. An aged debtor analysis is useful in this respect since it helps the company focus on
those clients who are the most cause for concern. Customers should be reminded of their debts by prompt despatch of
invoices and regular statements of account. Customers in arrears should not be allowed to take further goods on credit.

Collection of amounts due

The customers of PNP plc should ideally settle their accounts within the agreed credit period. There is no indication as
to what this might be, but the company clearly feels that a segmental analysis of its clients is possible given their
payment histories, their potential for bad debts and their geographical origin. Clear guidelines are needed over the
action to take when customers are late in settling their accounts or become bad debts, for example indicating at what
stage legal action should be initiated.

Overseas debtors
PNP plc will need to consider the ways in which overseas debtors differ from domestic debtors. For example, overseas
debtors tend to take longer to pay and so will need financing for longer. Overseas debtors will also give rise to exchange
rate risk, which will probably need to be managed. The credit risk associated with overseas customers can be reduced in
several ways, however, for example by using advances against collection, requiring payment through bills of exchange,
arranging documentary letters of credit or using export factoring.