INSTITUTE AND FACULTY OF ACTUARIES

EXAMINATION

5 April 2019 (pm)

Subject CB1 – Business Finance

Core Principles

Time allowed: Three hours and fifteen minutes

INSTRUCTIONS TO THE CANDIDATE

1. Enter all the candidate and examination details as requested on the front of your
answer booklet.

2. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.

3. Mark allocations are shown in brackets.

4. Attempt all questions. Answers to questions 1–10 should be indicated on the Multiple
Choice Answer Sheet included in your booklet. From question 11 onwards begin your
answer to each question on a new page.

5. Candidates should show calculations where this is appropriate.

Graph paper is NOT required for this paper.

AT THE END OF THE EXAMINATION

Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.

In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.

CB1 A2019 © Institute and Faculty of Actuaries

1 Which of the following statements best explains the role of the external auditor from
an agency perspective?

A The auditor enables the shareholders to rely on the financial statements

prepared by the directors.
B The auditor ensures that the company is well managed.
C The auditor provides the directors with independent advice on accounting and
financing matters.
D The shareholders can task the external auditor to examine particular areas of
concern.
[2]

2 Which of the following statements best describes the driver of the market price of a
quoted company?

A Expectations of future revenues.

B Expectations of future dividends.
C Historical trends of reported profits.
D Historical trends of dividend payments.
[2]

3 Martin has just been admitted to a long established business partnership. He has
bought 20% of the partnership equity, although he has not paid for this yet. He will
be entitled to 15% of the partnership profit. If the firm incurs any liability, what
proportion of that liability will be Martin’s legal responsibility?

A 0%
B 15%
C 20%
D 100%
[2]

4 When does a bondholder receive the nominal value of a bond?

A At the time of purchase.

B Annually.
C Whenever coupon payments are made.
D At maturity.
[2]

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5 Which of the following statements describes the agency problem?

A
Agents may feel that they cannot trust their principals.
B
Agents may have insufficient authority to manage their principals’ affairs.
C
Principals may feel that they cannot trust their agents.
D
Principals may not have the necessary expertise to manage their own
businesses.
[2]

6 Charlie is a 100% subsidiary of the Corpo Group. Corpo is a major quoted

corporation. Charlie has serious cash flow problems and is struggling to meet its
immediate liabilities. Which of the following statements is correct?

A Corpo has no reason to support Charlie.

B Corpo is forbidden from supporting Charlie unless there is a contractual
reason for doing so.
C Corpo is required by law to support Charlie and settle the liabilities.
D Corpo will make a commercial decision as to whether it will support Charlie.
[2]

7 A parent company’s only asset is an £8 million investment in a 60% subsidiary. The

subsidiary’s assets are valued at £25 million. What value will be attributed to group
assets in the consolidated financial statements?

A £8 million
B £15 million
C £25 million
D £33 million
[2]

8 A newly formed company was funded by an equity injection, in which the

shareholders purchased a total of 10,000 £1 fully-paid shares for £2.50 each. Which
of the following figures will appear in the company’s statement of financial position?

Share capital (£) Share premium (£)

A 10,000 15,000
B 10,000 25,000
C 25,000 0
D 25,000 15,000
[2]

CB1 A2019–3 PLEASE TURN OVER

9 Which of the following statements best describes the purpose of the depreciation
charge?

A The depreciation charge creates a reserve for the replacement of assets when
they reach the end of their useful lives.
B The depreciation charge ensures that asset values remain realistic.
C The depreciation charge ensures that businesses obtain tax relief on the
consumption of assets’ values.
D The depreciation charge reflects the consumption of an asset’s value during the
period that benefits from that consumption.
[2]

10 Which of the following statements is a valid interpretation of an unmodified external

auditor’s report?

A The auditor has checked all transactions and balances and found everything to
be in order.
B The auditor has material misgivings about the truth and fairness of the
financial statements.
C The auditor is of the opinion that there are no material breaches of the
applicable accounting reporting standards.
D The directors have properly discharged all of their duties with regard to the
financial statements.
[2]

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11 Discuss the proposition that businesses should take account of social responsibility
when conducting their operations. [5]

12 Describe whether preference shares should be treated as debt rather than equity when
evaluating a company’s gearing.  [5]

13 Explain the implications of credit risk for entities which are considering entering into
interest rate swaps.  [5]

14 Explain why top-down budgeting might be a more effective basis than

bottom-up for setting a consultancy firm’s annual budget for consultancy staff travel
and accommodation. [5]

15 The chief executive of a large actuarial consultancy has remarked that the head office
stationery cupboard is heavily stocked with basic office supplies such as pens, pencils,
paper clips and staples.

Discuss the implications of introducing a formal inventory management system to

reduce the value of the inventory held in the stationery cupboard.  [5]

16 Discuss the proposition that the cash flow statement is a more suitable basis for
understanding a business’ performance than the statement of profit or loss.[5]

17 Discuss the implications of the fact that an actuarial consultancy’s statement of

financial position will typically make no reference to the value of staff. [5]

18 The development and implementation of International Financial Reporting Standards

(IFRS) is sometimes a contentious and prolonged process.

Describe the implications of this. [5]

CB1 A2019–5 PLEASE TURN OVER

19 Jill is the chief executive of Gearworks, a small company which manufactures
components for the car industry. Gearworks is a member of a trade association. The
latest issue of the trade association’s journal contains an article that summarises the
averages of the accounting ratios of 20 companies which are members of the trade
association. The article includes the following table of accounting ratios:

Average
Return on capital employed, excluding debt 26%
Return on capital employed, including debt 22%
Gross profit margin % 25%
Current ratio 2.1:1
Inventory turnover 42 days
Receivables turnover 50 days

The latest draft financial statements for Gearworks are summarised below:

Gearworks
Statement of profit or loss for the year ended 31 March 2019

€000
Revenue 1,200
Cost of sales (840)
–––––
Gross profit 360
Administrative expenses (22)
Distribution costs (14)
–––––
Operating profit 324
Finance charges (54)
–––––
Profit for the year 270

–––––
–––––
Gearworks
Statement of financial position as at 31 March 2019

€000
Non-current assets 1,800
Current assets
Inventory 76
Trade receivables 150
Cash at bank 11
–––––
237
–––––
Total assets 2,037

–––––
–––––
Share capital 500
Retained earnings 862
–––––
1,362
Non-current liabilities
Loans 600
Current liabilities
Trade payables 75
–––––
Total equity and liabilities 2,037

–––––
–––––

CB1 A2019–6
 (i) Calculate each of the six ratios listed in the magazine article using Gearworks’
financial statements. You can assume that Revenue consists of credit sales. [6]

(ii) Comment on Gearworks’ performance in comparison to the industrial

averages.[9]

The draft financial statements provided above were prepared before the estimated tax
charge for the year had been calculated.

(iii) Explain how the inclusion of tax would have affected your understanding of
Gearworks’ performance. [5]
 [Total 20]

20 Central is a major quoted company which manufactures highly specialised equipment

for use in the mining industry. Central has very limited scope for expansion. It
dominates the markets for its equipment and there is no real scope to develop sales in
alternative markets. Central has been highly profitable and it has amassed significant
retained earnings and has a large cash balance.

Central’s board has sought advice about the most efficient use of that cash balance.
Three main options are under consideration:

• The first possibility is that the cash might be retained for the foreseeable future, so
that Central has the necessary funding in place if any new opportunities arise.

• Alternatively, the board could use the funds in order to diversify into a completely
different line of business. Central’s cash reserves are large enough to fund the
creation of a significant business in another industry, such as leisure.

• Finally, Central could implement a share buyback under which Central would buy
shares back using the surplus funds.

(i) Discuss the implications of Central retaining the surplus cash in order to take
advantage of any new opportunity which might arise. [6]

(ii) Discuss the potential advantages and disadvantages of Central using the
surplus funds in order to diversify. [7]

(iii) Discuss the suitability of a share buyback to Central’s circumstances. [7]

 [Total 20]

END OF PAPER

CB1 A2019–7