FINANCIAL MANAGEMENT

Transcription

1 FINANCIAL MANAGEMENT PROFESSIONAL 2 EXAMINATION - APRIL 2010 NOTES: Section A - Answer all three questions. Section B - Answer two questions only. (If you provide answers to more questions than required in Section B, you must draw a clearly distinguishable line through the answer not to be marked. Otherwise, only the first two questions to hand will be marked.) FINANCIAL MANAGEMENT TABLES ARE PROVIDED TIME ALLOWED: 3 hours, plus 10 minutes to read the paper. INSTRUCTIONS: During the reading time you may write notes on the examination paper but you may not commence writing in your answer book. Marks for each question are shown. The pass mark required is 50% in total over the whole paper. Start your answer to each question on a new page. You are reminded that candidates are expected to pay particular attention to their communication skills and care must be taken regarding the format and literacy of the solutions. The marking system will take into account the content of the candidates' answers and the extent to which answers are supported with relevant legislation, case law or examples where appropriate. List on the cover of each answer booklet, in the space provided, the number of each question(s) attempted. The Institute of Certified Public Accountants in Ireland, 17 Harcourt Street, Dublin 2.

2 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL MANAGEMENT PROFESSIONAL 2 EXAMINATION - APRIL 2010 Time Allowed: 3 hours, plus 10 minutes to read the paper. Section A - Answer all three questions. Section B - Answer two questions only. SECTION A - ATTEMPT ALL THREE QUESTIONS 1. Your client, John Mc Daid, provides back packers with cheap overnight accommodation in Dublin City and Cork City. John has been considering growing the business, but is of the view that the Dublin market is saturated. A friend recently asked John if he is interested in buying a hostel located in County Cork. John is excited at this proposal and has researched the opportunity, which he has summarised as follows: The hostel has twelve family rooms, twenty twin rooms and thirty single rooms. Each family room is expected to be occupied by three guests, whilst twin rooms will always be occupied by two guests. John estimates that he will be able to charge 100 per family room per night, 70 per twin room per night and 50 per single room per night. It is anticipated that these room rates will remain at the above level for two years and that they will increase by 10% per annum thereafter. The hostel will be open for 300 nights per year. John expects the following occupancy rates to be achieved over the next three years: % Occupancy Rates Year/Room Type Family Twin Single Year Year Year The present staffing level of the hostel is as follows: Staffing Levels Details Number of Staff Annual Salary Security Staff 4 25,000 Housekeeping Staff 2 21,000 Cleaning Staff 3 19,000 Reception Staff 4 36,000 Maintenance Staff 1 41,000 Management Staff 1 42,000 John is of the opinion that security staff and reception staff numbers could be reduced by 50%. Each member of staff made redundant would be paid a full year s wages payable immediately. Employees will receive a pay increase of 4% effective from year 2 followed by a further 10% uplift each year thereafter. The annual running costs are as follows: Rates of 40,000 in year one, expected to increase by 15% per annum thereafter. Light & Heat A fixed annual charge of 10,000. The annual charge is expected to decrease by 1,000 per annum commencing in year 2. Page 1

3 Gas A variable cost of 5 per night per room occupied. This cost is expected to increase by 5% per year commencing in year 3. Laundry will cost 2 per night per guest. This charge is not expected to increase for the next three years. Depreciation of 20,000 will be charged on sundry items of equipment. John has yet to meet the vendors of the hostel to agree an acceptable price. John s cost of capital is 10%. John has made it abundantly clear to you that he will only invest in a hostel which delivers a discounted payback of three years or less. REQUIRED: Prepare a briefing note for John Mc Daid that: a) Determines the maximum amount payable for the Cork Hostel if it must achieve a discounted payback after three years (ignore taxation). (15 Marks) b) Consider five qualitative factors that John should consider before deciding whether or not to purchase the County Cork Hostel. (10 Marks) [Total: 25 Marks] 2. M Limited produces one product The AXX1. The sales price in December 2009 was 200 per unit, with forecast increases of 5 in each month throughout the year ended Twenty percent of sales are for cash. Debtors pay within one month of sale, with 10% of all credit sales expected to be uncollectable. The sales projections for the AXX1 product are as follows: April ,000 units May ,000 units June ,000 units July ,000 units August ,000 units September ,000 units October ,000 units Opening stock on 1st July 2010 is expected to total 400 units of AXX1. It is company policy to produce enough of both finished products to meet 10% of the following month s estimated sales demand. The raw materials used to produce the AXX1 presently cost 30 per litre. Each AXXl unit requires three litres of materials. M Limited purchases enough raw material stock to meet 80% of the following month s production requirements. The opening stock on 1st July 2010 is expected to be 8,000 litres of raw material. Creditors terms allow M Limited to pay for raw materials two months after their date of purchase. M Limited employs sixteen factory operatives paid 24,000 each per annum (spread evenly throughout the year). Wages are paid in the month to which they relate. M Limited has agreed that operative wages will be uplifted by 5% effective from September M Limited s head office staff cost 24,000 per month in total, uplifted by 4% in August Factory rental is payable in four equal instalments, payable three month s in advance on the quarter days 1st February, May, July and October each year. The rental for the year ended December 2010 has been fixed at 2,400,000. Light & Heat bills are expected to represent 5% of gross turnover and are paid two months in arrears. M Limited plans to dispose of a forklift vehicle for 1,000 in July A replacement forklift vehicle will be purchased in July 2010 for 98,000 with a 5% discount for immediate payment which M Limited plans to avail of. M Limited s forecast Statement of Financial Position as at 30th June 2010 is as follows: Page 2

4 M Limited Forecast Statement of Financial Position as at 30th June s Non-Current Assets at NBV Land 3,000 Other Assets 120 Total Non-Current Assets 3,120 Current Assets Inventories 120 Prepayments - Rental 0 Trade Receivables (fully collectible) 465 Cash & Cash Equivalents 10 Total Current Assets 595 Total Assets 3,715 Equity & Liabilities Equity Attributable to Equity Holders Share Capital (@ 3 each) 600 Other Reserves 2,121 2,721 Non-Current Liabilities Long term borrowings 0 Current Liabilities Trade payables - May Trade payables - June Overhead Creditors 114 Accruals 10 Total Current Liabilities 994 Total Liabilities 3,715 REQUIRED: a) Prepare a monthly cash budget for M Limited for the four month s ended October (17 Marks) b) Comment on the cash budget and advise management on four steps it might take to improve its liquidity position. (8 Marks) [Total: 25 Marks] 3. Write a brief note on the meaning and significance of any five of the following terms: Internal Rate of Return. Earnings Yield. National Assets Management Agency. Fundamental Theory of Share Value. Capital Rationing. Market Capitalisation. Beta Factor. [TOTAL: 20 Marks] Page 3

5 SECTION B ANSWER TWO QUESTIONS ONLY 4. Discuss five reasons, citing real life examples where possible, why management buy outs tend to be more successful than third party acquisitions. [Total: 15 Marks] 5. Explain the key responsibility of Treasury Management Departments and provide five reasons why many companies decide to centralise treasury management functions for global operations. [Total: 15 Marks] 6. Horse Limited is a private company that manufactures medical instruments. The company is planning to embark on a significant expansion strategy. Prior to embarking on the new strategy, Horse Limited s Managing Director is anxious to carry out a detailed independent review of the company s financial performance, position and management. Extracts from the company s most recent audited accounts read as follows: Horse Limited Extracts from the Statement of Comprehensive Income For Year Ended 31st March s 000s Revenue 1,782 1,411 Opening Inventories Purchases 1, Closing Inventories Cost of Sales Gross Profit 1, Selling & Distribution Expenses Administration Expenses Operating Profit Finance Costs Profit before Taxation Income Tax Expense Profit for the period Page 4

6 Horse Limited Extracts from the Statement of Changes in Equity - Year Ended 31st March s 000s Opening Balance Profit for the period Dividend Paid Closing Balance Horse Limited Extracts from the Statement of Financial Position as at 31st March 2010 Non-Current Assets s 000s Property, Plant and Equipment 1, Long Term Investments Total Non-Current Assets 1,530 1,209 Current Assets Inventories Trade Receivables Cash & Cash Equivalents Total Current Assets Total Assets 2,457 1,948 Equity & Liabilities Equity Attributable to Equity Holders Share Capital (@ 2 each) Retained Earnings ,444 1,194 Non-Current Liabilities Long term borrowings - Debentures Current Liabilities Trade payables Short Term Borrowings Current portion of long term borrowings Total Current Liabilities Total Liabilities 2,457 1,948 Note: Horse Limited had the following balances as at 31st March 2008 Inventories 79,000 Trade Receivables 129,000 Trade payables 25,000 REQUIRED: Prepare a report for the Managing Director, assessing the working capital management, liquidity and profitability of Horse Limited for the most recent financial year. [Total: 15 Marks] END OF PAPER Page 5

7 SUGGESTED SOLUTIONS SOLUTION 1 THE INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS IN IRELAND FINANCIAL MANAGEMENT Briefing Note To: John Mc Daid From: Management Consultant Date: 8th May 2010 Subject: Proposed Purchase of Cork County Hostel PROFESSIONAL 2 EXAMINATION - APRIL 2010 Financial Review The maximum payable for the hostel in order to achieve a discounted payback over three years is 742,589. This was calculated as follows: County Cork Hostel Proposal Details Note Year 0 Year 1 Year 2 Year 3 Redundancy Payment -122,000 Income 1,2,3 741, , ,600 Rates -40,000-46,000-52,900 Wages Costs 4-304, , ,776 Light & Heat -10,000-9,000-8,000 Gas 5-57,300-60,750-73,080 Laundry 6-37,560-38,700-46,320 Total Annual Cashflow -122, , , ,524 Discount Factor Present Value -122, , , ,002 Net Present Value 742,589 Note 1 Details Family Twin Single Total Capacity Occupancy Annual Nights Total Nights 2,160 3,000 6,300 11,460 Guests per Room Total Guests 6,480 6,000 6,300 18,780 Charge Per Night Total Income 216, , , ,000 Note 2 Details Family Twin Single Total Capacity Occupancy Annual Nights Total Nights Guests per Room Total Guests Charge Per Night Total Income Page 7

8 Note 3 Details Family Twin Single Total Capacity Occupancy Annual Nights Total Nights 2,520 4,200 7,200 13,920 Guests per Room Total Guests 7,560 8,400 7,200 23,160 Charge Per Night Total Income 277, , , ,600 Note 4 Details Number Cost Total Security Housekeeping Cleaning Reception Maintenance Management Total Year Total Year Total Year Note 5 Details Year 1 Year 2 Year 3 Total Rooms Gas cost per room Total Gas Cost Note 6 Details Year 1 Year 2 Year 3 Total Guests Laundry cost per guest Total Gas Guest Qualitative Factors Impact of redundancy on service levels. Impact of redundancy on staff morale. Will his organisation be overstretched? Will it impact adversely on Cork City occupancy rates? Will customer goodwill continue? Page 8

9 SOLUTION 2 M Limited - Cash Budget Details Note Jul-10 Aug-10 Sep-10 Oct-10 Receipts Sales 1 653, ,800 1,379,800 1,634,800 Sale of Forklift 1,000 Payments Trade Creditors 2 & 3-395, , , ,000 Operative wages -32,000-32,000-33,600-33,600 Administration Wages -24,000-24,960-24,960-24,960 Rental -600, ,000 Light & Heat 4-56,250-57,500-47,000-72,000 Forklift Purchase -93,100 NET IN CASH MOVEMENT -547, , , ,240 OPENING CASH BALANCE 10, , , ,030 CLOSING CASH BALANCE -537, , , ,270 Note 1 - Sales receipts Details Note Jul-10 Aug-10 Sep-10 Oct-10 Jun ,000 Jul , ,800 Aug ,000 1,036,800 Sep ,000 1,234,800 Oct ,000 Total Receipts 653, ,800 1,379,800 1,634,800 Note 2 - Production Schedule Details Note Jul-10 Aug-10 Sep-10 Opening Stock Closing Stock Sales ,000 7,000 Planned Production 4,200 6,100 7,100 Note 3 - Raw Material Requirements Details Note Jul-10 Aug-10 Sep-10 Opening Stock -8,000-14,640 Closing Stock 14,640 17,040 Required for Production 12,600 18,300 21,300 Litres to Purchase 19,240 20,700 Cost at 30 per litre 577, ,000 Note 4 - Light & Heat Costs Details Note May-10 Jun-10 Jul-10 Aug-10 Sales 1,125,000 1,150, ,000 1,440,000 Light & Heat Cost 5, ,500 47,000 72,000 Findings The investment in the forklift and prepayment of rental has placed a strain on the company s cash resources during the four months ended October Recommendations In order to ease the cash pressure on the business during this period of plant renewal and product market entry the following practical steps could be followed: improve credit control to speed up receipt of monies due from debtors and to reduce bad debts request a longer settlement period from raw materials creditors. Lease the forklift rather than buy it negotiate later payment of the rent adjust inventory policies to reduce stock holding Page 9

10 SOLUTION 3 Internal Rate of Return This is the discount rate at which an investment proposal delivers a zero/break even net present value (NPV). It is derived using trial and error inn selecting discount rates and mathematical interpolation. It is used in investment appraisal by comparing the IRR to a hurdle/target discount rate to determine whether or not a proposal investment is acceptable or not. Earnings Yield This is a ratio used by investors which considers the return on an equity share relative to its market value. It is a percentage measure calculated as follows: EPS / Market Value Per Share * 100 Investors would prefer a higher earnings yield at all times. The earnings yield enables an investor to compare consistently the return from different forms of investment e.g. property, equities, bonds etc. Earnings Yield is often used as an income based model for company valuation. NAMA This is a governmental agency created in the last twelve months to purchase toxic debt from the main registered Irish banks, and to provide the banks with much needed capital in order to free up lending to small and medium size Irish enterprises. Ownership of the land assets to be purchased will be achieved at a discount to book value. The extent of the discount is of significant debate and is a contentious issue in Irish society, given the general disquiet over the lending practices of banks over the last decade. The agency is still subject to legislative agreement. Fundamental Theory of Share Value Fundamental theory of share values states that the market price of a share is the present value of the discounted cash flows i.e. dividends receivable from that share. The dividend growth model enables an investor to determine the current market price of a share. The fundamental theory of share value is often criticised as dividends do not grow smoothly in practice and because the model fails to consider capital gains tax. It can be directly contrasted with Modigliani and Miller s dividend irrelevance theory which suggests that dividend policy is irrelevant to share values. Capital Rationing Capital rationing refers to the situation whereby an organisation cannot avail of the necessary investment funds to invest in all proposed investments which deliver a positive Net Present Value (NPV). The limit on capital available may be imposed internally (soft) for reasons such as: excessive cost and financial risks associated with debt capital dilution of control associated with equity capital a temporarily depressed share price or externally (hard) for reasons such as: high financial risk/gearing high business risk profile of investment opportunities In a situation of capital rationing management must be selective in choosing the investment proposal to be accepted in order to illicit maximum financial benefit from the limited funds available. Market Capitalisation Market Capitalisation refers to the total market value of a company. It is calculated by multiplying the market price of shares by the number of shares in issue. Market Capitalisation indicates the size of a company. Beta Factor A Beta Factor is a measure of risk. It measures the systematic risk of an investment relative to the market risk. Beta factors are used by the Capital Asset Pricing Model to predict the required rate of return for an investment/the cost of equity for an organisation. Page 10

11 SOLUTION 4 MBOs Reasons for success (compared to 3rd party acquisition): Higher levels of motivation. Given the financial an time commitment that members of the MBO team will have invested in the acquisition. Knowledge of business e.g. Lifestyle Sports. As the management team will have many years of experience working in the industry and for the organisation. Ability to concentrate on core competence. The management team will not be distracted by the running of the remainder of the organisation. Quicker decision making. As the management hierarchy is likely to involver fewer layers and administrative bureaucracy. Savings in overheads, such as the running of the head office and all of its necessary functions. Strong customer and supplier relationships that will have been built up over the management team s time working in the industry Retention of key personnel if the management team can persuade them to play a part in the future of the business. SOLUTION 5 Treasury Management involves The corporate handling of all financial matters, the generation of external and internal funds, the management of currencies and cash flows and financial risks Areas of Responsibility: Funding Management Ensuring that the appropriate sources of funds are available to the organisation when required. Currency Risk Management Hedging strategies against foreign currency transaction and translation risk. Corporate Finance Advising on acquisitions and mergers and the provision of finance therefore. Taxation Managing taxation liabilities proactively Interest Rate Risk Management Reducing exposure to basis risk. Reasons Why Centrally Managed Economies of Scale reducing transaction costs based on the volume of transactions being managed. Expertise The ability to employ experts in each area, which would not be possible if managed on a decentralised basis. Divisions can concentrate on the core business of improving the turnover and profits thereor Allows for more effective risk management as a company wide overview of transactions and exposure may be taken. Page 11

12 SOLUTION 6 Report To: Managing Director, Horse Limited From: A.N Other, Financial Consultant Date: 1st May 2010 Subject: Financial Review of Horse Limited as at 31st March 2010 Horse Limited Ratios Liquidity Cash Reserves Current Ratio Quick Ratio Working Capital Stock Days Debtors Days Creditor Days Profitability GP % 59.03% 37.07% NP % 32.15% 12.19% Turnover Growth 26.29% n/a Overview The company has grown sales 26% in 2010, a considerable achievement. However, in doing so it has stretched its liquidity to dangerous levels. Liquidity Horse Limited s liquidity position has deteriorated during Both the current and acid test ratios have reduced to below textbook recommended averages of 2:1 and 1:1 respectively. The main reason for this deterioration is that long term loans have been repaid/redeemed without replacement and the increased investment in non-current assets and working capital. Horse Limited is overtrading. Working Capital The increased investment was required in working capital to support the rapid growth the company achieved. As a result the operating cash cycle increased by 24 days to 76 days in It is taking the company 90 days to pay creditors compared to 30 one year ago. This will ultimately damage Horse Limited s credit rating. Profitability Both the GP and NP margins have improved significantly during This probably represents the achievement of economies of scale given the 26% increase in revenues during Page 12