Institute of Certified Management Accountants of Sri Lanka

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1 Financial Strategy & Policy (FSP / SL 3 3) Managerial Level November 2015 Examination Suggested Answer Scheme Answer of Question No.1 Cash flow projection for the six months to 31 May 2016 is: Dec Jan Feb March April May Cash inflows Credit sales Cash sales Cash outflows Purchases Adm. Expenses Wages Selling exp 20 Fixtures 2 dividend net cash flow (53) (2) 30 (17) (47) (22) opening bal. (126) (179) (207) (177) (194) (241) closing bal. (179) (207) (177) (194) (241) (263) (b) The projected profit and loss account for the six months to 31 May 2016 is: sales Less cost of sales (balancing figure) Gross profit Wages Selling exp (excluding adv cam) Adm. Exp (inc.depreciation) (37) (12 Marks) The advertising campaign relates to the next financial period and will therefore be changed to the profit and loss account of that period. (0 Marks) 1

2 (c) (d) The following options or some combination of these might be feasible. New equity finance injected by the Dedigama family or others. Reduce stock levels. Delay purchase/payment of fixtures. Sell fixed assets. Increase proportion of cash sales Delay payment of trade creditors Each of the above options has advantages and disadvantages and these must be carefully assessed before a final decision is made. (12 Marks) Net Cost savings Net Cash flow Opening Balance Closing Balance Dec 15 (3) (126) (164) Jan 15 (13) (164) (177) Feb (177) (132) March 17 0 (132) (132) Apr 17 (30) (132) (162) May 17 (5) (162) (167) Total 96 (41) (126) (167) Profit/Loss Cost savings New profit Answer of Question No.2 Rs. (37) Mn Rs. 96 Mn Rs. 59 Mn (0 Marks) (Total Marks) Earnings 1,200,000 EPS Rs Dividends 600,000 DPS Rs Payout 50% Similar com s div.yield 7% and p/e ratio Then, price d/y basis (0.6/p)*0=7 60/7= Rs..57 Price-p/e basis p/1.2= = Rs Net assets 6.4/1 = Rs. 6. (14 Marks) (b) Interest paid semi-annually V=I(PVIFA r,n )+M(PVIFr,n) =(50x )+(Rs 1,000x0.311) = 5.3 Interest paid annually V=0(PVIFA r,n )+Rs.1,000(PVIFr,n) =(0x5.65)+(Rs 1,000x0.322) = =7 (06 Marks) 2

3 Answer of Question No.3 Cash outflows Rs. Rs. Cost of new equipment Add: shifting expenses Less: Tax benefits Less: sale proceeds of old equipment Incremental cash outflows 30,000 (,500) 300,000 19,500 (5,000) 314,500 Particulars Year 1 Year 2 Year 3 Year 4 Cash operating savings (i) Less: capital allowances Tax on ope activities 35% (ii) Total net cash flow (i) (ii) Discounting factor at 15% PV Total PV Cash outflow NPV 90,000 (73,750) 16,250 5,67 4, , ,000 55,312 94,6 33, , ,345 15,000 41,,516 37,91 112, , ,000 31,113 11,7 41,6, , ,5 (314,500) (17,095) Workings: Depreciation base on new equipment WDV of existing equipment 20,000 Add: cost of new equipment 300,000 Less: sale proceeds of existing equipment 5,000 Amount of equipment on which depreciation will be charged 315,000 Less: WDV of existing equipment 20,000 Incremental depreciation 295,000 Recommendation: The company should reject the proposal as the NPV is negative. (16 Marks) (b) i. When dividends are not paid 0=(p1+0)/1.1 ii. P1=1 price of the share, when dividend is declared: (D1+P1)/(1+ke), 0=(p1+6)/1.1, P1=4 3

4 Answer of Question No4 I. (% change in sales)xdol=% change in EBIT 20% x 2=% change in EBIT Therefore, 00x(1+.4)= m II. DOL at,000 units=,000/(,000-q BE )=2 Therefore, Q BE must equal 5,000 DOL at 12,000 units =12,000/(12,000-5,000)= 1.71 (b) I. policy Existing 2 3 Sales (millions) EBIT (millions) Total assets (millions) Total assets turnover Return on assets (before-tax) 37.5% 34,3% 32.6% Net profit margin (Before-tax) 12.0% 12.0% 12.0% The before-tax net profit margin is unchanged, as sales and earnings before interest and tax (EBIT) are the same regardless of the liquidity policy employed. II. Policy 2 3 Additional debt 300, ,000 Additional interest 45,000 90,000 The cost of financing additional current assets could be reduced by the amount that could be earned on any additional investment of cash in marketable securities. Also, more lenient credit terms may lead to increased sales and profits. A hidden cost is that part of the debt capacity of the firm is used up by virtue of financing increased levels of current assets with debt. Answer of Question No.5 (i) Details Kodage Wire and Mesh EPS Price earnings ratio Market price per share Offer to Mesh shareholders in Kotage stock (including the premium) = x1.20=rs. 12 per share Exchange ratio = 12/24=0.5 or half shares of Kotage stock for every share of Mesh stock. (ii) Number of shares issued = 00,000 x0.5 = 0,000shares (iii) Surviving company earnings (in thousands) 5,000 Common shares outstanding 2,0 Earnings per share There is an increase in earnings per share by virtue of acquiring a company with a lower price/earnings ratio. (iv) Market price per share: =

5 (b) K d = K i (1-t)(1-d)-d K i = interest/coupon rate T = corporate tax rate D = expected currency depreciation K d =(0.11)(1-0.35)(1-0.02)-0.02=5% This is consistent with Div. Growth pattern (D 0 (1 + g) / P) + g Or An alternative answer Kd = (0.11) (1-.35) (1-0.02) = 7% End of Answer 5

Institute of Certified Management Accountants of Sri Lanka. Strategic Level November 2015 Examination. Financial Strategy and Policy (FSP / SL 3-403)

Institute of Certified Management Accountants of Sri Lanka. Strategic Level November 2015 Examination. Financial Strategy and Policy (FSP / SL 3-403) Copyright Reserved Serial No Strategic Level November 2015 Examination Examination Date : 14 th November 2015 Number of Pages : 06 Examination Time: 1.30 p:m. 4.30 p:m. Number of Questions: 05 Instructions