ACCA Paper P4 Advanced Financial Management September 2015 to June 2016 Interim Assessment

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1 INTERIM ASSESSMENT SCRIPT SUBMISSION FORM Script marking is only availabl to Classroom, Liv Onlin and Distanc Larning studnts nrolld on appropriat Kaplan courss. Nam: Addrss: Kaplan Studnt Numbr:... Your mail addrss: Instructions ACCA Papr P4 Advancd Financial Managmnt Sptmbr 2015 to Jun 2016 Intrim Assssmnt Plas complt your prsonal dtails abov. All scripts should idally b submittd to your Kaplan cntr for marking via mail to hlp spd up th marking procss. Plas scan this form and your answr script in a singl PDF and mail it to your Kaplan cntr. Altrnativly you may post your script to us. If so, plas us th corrct Royal Mail tariff (larg lttr). Classroom studnts may submit scripts to thir local cntr in prson. You will b providd with th datd rcipt blow which you should rtain as proof of submission. Offic us Not: If you ar a sponsord studnt, your rsult will form part of th rport to your mployr. Cntr Dat rcivd Markr s initials Dat snt to markr Dat rcivd from markr Dat rturnd to studnt Studnt's ovrall mark Rcipt only issud if script submittd by classroom studnt in prson to Kaplan cntr: Nam:... Rcivd by:... Script:... Dat:...

Marking Rport Notic to Markrs 1 Whn commnting about th script prformanc, plas nsur on individual qustions and on ovrall assssmnt your commnts covr aras of xamination tchniqu including: Tim managmnt

2 Marking Rport Notic to Markrs 1 Whn commnting about th script prformanc, plas nsur on individual qustions and on ovrall assssmnt your commnts covr aras of xamination tchniqu including: Tim managmnt Points clarly and concisly mad Calculations cross-rfrncd to workings Handwriting Prsntation and layout Rlvanc of answrs to qustion All parts of th rquirmnt attmptd Covrag and dpth of answr Lngth of answrs quats to marks availabl 2 For ach qustion, plas provid suitabl constructiv commnts Us of English Accuracy of calculations Rad th qustion carfully Qustion Numbr Gnral Commnts Exam Tchniqu Commnts

3 ACCA INTERIM ASSESSMENT Advancd Financial Managmnt Sptmbr 2015 to Jun 2016 Tim allowd Rading tim: 15 minuts Writing tim: 3 hours Answr th qustion in sction A and TWO qustions in Sction B Papr P Mathmatical tabls start on pag 9. Do not opn this papr until instructd by th suprvisor This qustion papr must not b rmovd from th xamination hall Kaplan Publishing/Kaplan Financial

4 ACCA P4: ADVANCED FINANCIAL MANAGEMENT Kaplan Financial Limitd, 2015 All rights rsrvd. No part of this xamination may b rproducd or transmittd in any form or by any mans, lctronic or mchanical, including photocopying, rcording, or by any information storag and rtrival systm, without prior prmission from Kaplan Publishing. Th txt in this matrial and any othrs mad availabl by any Kaplan Group company dos not amount to advic on a particular mattr and should not b takn as such. No rlianc should b placd on th contnt as th basis for any invstmnt or othr dcision or in connction with any advic givn to third partis. Plas consult your appropriat profssional advisr as ncssary. Kaplan Publishing Limitd and all othr Kaplan group companis xprssly disclaim all liability to any prson in rspct of any losss or othr claims, whthr dirct, indirct, incidntal, consquntial or othrwis arising in rlation to th us of such matrials. 2 KAPLAN PUBLISHING

5 INTERIM ASSESSMENT QUESTIONS SECTION A Answr this qustion 1 Rosy plc is a UK basd, intrnationally divrsifid company, oprating in th food manufacturing industry. It is currntly considring a nw capital projct in Australia, known as Projct XY. Nw projct dtails Projct XY would rquir immdiat capital xpnditur of A$ 15m, plus A$ 5m of working capital which would b rcovrd at th nd of th projct s four yar lif. It is stimatd that an annual rvnu of A$ 18m would b gnratd, with annual oprating costs of A$ 5m. Straight-lin dprciation ovr th lif of th projct is an allowabl xpns against company tax in Australia which is chargd at a rat of 50%, payabl at ach yarnd without dlay. Th projct s capital assts can b assumd to hav a zro scrap valu. Financing proposal Rosy plans to financ Projct XY with a 5m four-yar loan (nt of issu costs) from th Euro-strling markt, plus 5m of rtaind arnings. Issu costs on th Euro-strling dbt will b 2.5% and ar tax dductibl. Th crdit sprad applicabl to Rosy plc on th Eurostrling loan is 40 basis points abov th currnt UK risk fr rat. Howvr, thr has bn som disagrmnt about th proposd mthod of financ. Th Chairman has suggstd a rights issu of shars, whil th sals dirctor would lik th Board to considr th us of an Australian dollar loan. Othr information Th food manufacturing industry has an quity bta of 1.40 and an avrag dbt: quity garing ratio of 1:4. Dbt capital can b assumd to b virtually risk-fr. Th currnt rturn on UK govrnmnt stock is 5.6% and th quity risk prmium is 12%. Corporat tax in th UK is at 35% and can b assumd to b payabl at ach yar-nd without dlay. Bcaus of a doubl-taxation agrmnt, Rosy will not hav to pay any UK tax on Projct XY. Th company is xpctd to hav a substantial UK tax liability from othr oprations for th forsabl futur. Th currnt spot rat is A$ to 1 and th A$ is xpctd to dprciat against th at an annual rat of 10%. Rquird: (a) Estimat th adjustd prsnt valu (APV) of Projct XY. Rcommnd whthr th projct should b undrtakn. (14 marks) (b) (c) Explain th diffrnc btwn APV and NPV as mthods of invstmnt appraisal. Commnt upon th circumstancs undr which APV might b a bttr mthod of valuating a capital invstmnt than NPV. (6 marks) Discuss th advantags and disadvantags of th company s intndd financing plans for Projct XY. Brifly valuat th suggstd altrnativ ways of raising th rquird financ. (10 marks) KAPLAN PUBLISHING 3

6 ACCA P4: ADVANCED FINANCIAL MANAGEMENT (d) Rosy plc holds short trm invstmnts in th shars of four listd companis: Company A plc B plc C plc D plc Holding 100,000 shars, 50 pnc par valu 155,000 shars, 1 par valu 260,000 shars, 20 pnc par valu 430,000 shars, 10 pnc par valu Company Equity bta Markt pric (pnc) Latst dividnd yild (%) Expctd total rturn on invstmnt a yar (%) A plc B plc C plc D plc As statd in th scnario prsntd abov, th currnt rturn on UK govrnmnt stock is 5.6% and th quity risk prmium is 12%. Rquird: (i) (ii) Estimat th risk of Rosy plc s short trm invstmnt portfolio rlativ to th markt. (6 marks) Rcommnd, giving rasons, whthr th composition of Rosy plc s shorttrm invstmnt portfolio should b changd. Rlvant calculations must b shown. (14 marks) (Total: 50 marks) 4 KAPLAN PUBLISHING

7 INTERIM ASSESSMENT QUESTIONS SECTION B ANSWER TWO QUESTIONS ONLY 2 (a) Discuss how a dcras in th valu of ach of th dtrminants of th option pric in th Black-Schols option-pricing modl for Europan options is likly to chang th pric of a call option. (8 marks) (b) Wllr Inc is considring th introduction of an xcutiv shar option schm. Th schm would b offrd to all middl managrs of th company. It would rplac th xisting schm of prformanc bonuss linkd to th post-tax arnings pr shar of th company. Such bonuss in th last yar avragd $1,500. If th option schm is introducd, nw options ar xpctd to b offrd to th managrs ach yar. It is proposd for th first yar that all middl managrs ar offrd options to purchas 2,000 shars at a pric of 200 cnts pr shar, aftr th options hav bn hld for on yar. Assum that th tax authoritis allow th xrcis of such options aftr thy hav bn hld for on yar. If th options ar not xrcisd at that tim thy will laps. Th company s shars hav a currnt markt pric of 280 cnts. Th short-trm riskfr intrst rat is 4% annum, and th company s shar pric has xprincd a standard dviation of 25% during th last yar. Rquird: (i) (ii) (iii) Discuss th rlativ mrits for th company of th xisting bonus schm and th proposd shar option schm. (4 marks) Evaluat whthr or not th proposd shar option schm is likly to b attractiv to middl managrs of Wllr Inc. (9 marks) Whn told of th schm on managr statd that h would rathr rciv put options than call options, as thy would b mor valuabl to him. (1) Discuss whthr or not Wllr Inc should agr to offr him put options. (2 marks) (2) Calculat whthr or not h is corrct in his statmnt that put options would b mor valuabl to him. (2 marks) (Total: 25 marks) KAPLAN PUBLISHING 5

8 ACCA P4: ADVANCED FINANCIAL MANAGEMENT 3 (a) Th financ tam of Flt plc is undrtaking a financial rviw of a potntial nw projct. Th nw projct is in th sam industry as Flt plc and th capital structur of th nlargd company will rmain unchangd. Th following dtails ar availabl: Th capital structur of Flt plc as at 1st January 20X8 is as follows: m Issud ordinary shars (25p shars) 250 Bank trm loan 300 8% irrdmabl dbntur 600 Th ordinary shars hav a currnt markt pric of 2 ach. Dividnds pr shar in th fiv prcding yars wr as follows: 20X3 6.9 pnc 20X4 7.2 pnc 20X5 8.8 pnc 20X6 9.6 pnc 20X pnc Th dividnd for 20X7 has just bn paid. Th bank is currntly charging 10% on th trm loan. Th dbntur stock has a markt pric of 75. Th company pays corporation tax at a rat of 30%. Rquird: (b) Calculat a suitabl discount rat for th nw projct. (10 marks) Flt plc has a subsidiary company Foxs plc. It currntly invsts in two projcts, on of which is in th lisur industry and th othr in publishing. Ths rprsnt 65% and 35% rspctivly of Foxs plc s total markt valu. Th firm is considring invsting additional funds into on of ths projcts, so th Financial Managr has prsntd th following analysis as a starting point to an invstmnt appraisal: Avrag bta quity Avrag garing of firms in th industry (D:E) Lisur industry Publishing industry Foxs plc 1.10???? :70 40:60 20:80 Unfortunatly, th Financial Managr s spradsht has bn corruptd so that th Publishing Industry bta quity is illgibl. H is now uncontactabl on holiday, so th firm s Chif Excutiv has askd for your hlp in rconstructing th spradsht. N.B. Corporat taxation is at th rat of 30%. Assum that dbt is risk fr, so th bta of dbt is zro. Rquird: From th information prsntd, rconstruct th Financial Managr s spradsht by calculating th avrag bta quity of th Publishing Industry. (10 marks) 6 KAPLAN PUBLISHING

9 INTERIM ASSESSMENT QUESTIONS (c) Th dirctors of Foxs plc hav dcidd to go ahad with a furthr invstmnt in th lisur industry. Thy hav prsntd you with th following furthr information: Th financial garing of th company is not xpctd to chang as a rsult of any xpansion. Th IRR of Foxs plc s aftr tax cash flows on rdmabl dbt is 6.0%. Th risk fr rat is 5% and th stimatd markt rturn is 10%. Rquird: Calculat a suitabl discount rat in ordr to apprais th additional invstmnt in th lisur industry. (5 marks) (Total: 25 marks) KAPLAN PUBLISHING 7

10 ACCA P4: ADVANCED FINANCIAL MANAGEMENT 4 Th following data rlats to a larg company oprating in th lctronics industry. 20X3 20X4 20X5 20X6 20X7 Aftr tax arnings ($ million) Dividnd pr shar (cnts) Numbr of ordinary shars (million) Avrag shar pric (cnts) ,012 Nt capital invstmnt ($ million) Annual incras in inflation (%) A major institutional sharholdr has criticisd th lvl of dividnd paymnt of th company suggsting that it should b substantially incrasd. Rquird: (a) (b) (c) Brifly discuss th factors that ar likly to influnc th company's dividnd policy. (7 marks) Discuss whthr or not th institutional sharholdr's criticism is likly to b valid. (8 marks) Hiom Co has xprincd a priod of abov avrag growth for its industry, but is now growing at a normal rat of about 10% pr annum. Th company s dirctors ar rviwing th currnt dividnd policy. On dirctor has suggstd that, as th company no longr nds as much intrnally gnratd funds to financ nw invstmnt, a highr proportion of arnings should b paid out as dividnds in ordr to bnfit th company s sharholdrs. Anothr dirctor has rad that two minnt conomists, Millr and Modigliani, hav statd that th pattrn of dividnd payouts is irrlvant, and thrfor sharholdrs will xprinc no gain from a highr lvl of dividnds. Rquird: Discuss whthr or not an incras in dividnds is likly to bnfit th sharholdrs of Hiom Co. (10 marks) (Total: 25 marks) 8 KAPLAN PUBLISHING

11 MATHEMATICAL TABLES Formula and tabls Modigliani and Millr Proposition 2 (with tax) k = k i + (1 T)(k i k d ) INTERIM ASSESSMENT QUESTIONS V V Th Capital Asst Pricing Modl E(r i ) = R f + β i (E(r m ) R f ) Th asst bta formula d β a = V β (V + V (1 T)) d + Vd (1 T) βd V + V (1 T)) d Th Growth Modl Do(1 + g) Po = (r g) Gordon s growth approximation g = br Th wightd avrag cost of capital WACC = V V + V d k + Vd V + V Th Fishr formula (1+i) = (1+r)(1+h) d k d (1 T) Purchasing powr parity and intrst rat parity s 1 = s o (1 + hc) f (1 + h ) b 0 = s o (1 + ic) (1 + i ) Modifid intrnal rat of rturn b MIRR = PVR PV I 1 n ( 1 + r ) 1 Th Black-Schols option pricing modl c = P a N(d 1 ) P N(d 2 ) rt Whr: ln(pa /P )+(r + 0.5s )t d1 = s t 2 d = d1 2 s t Th Put Call Parity rlationship p = c P a + P rt KAPLAN PUBLISHING 9

12 ACCA P4: ADVANCED FINANCIAL MANAGEMENT Prsnt valu of 1, i.. (1 + r) n Whr r = discount rat n = numbr of priods until paymnt Prsnt valu tabl Discount rat (r) Priods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Discount rat (r) Priods (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% KAPLAN PUBLISHING

13 INTERIM ASSESSMENT QUESTIONS Annuity Tabl Prsnt valu of an annuity of 1, i.. Whr r = discount rat n = numbr of priods 1 (1 + r) r n Discount rat (r) Priods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% Discount rat (r) Priods (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% KAPLAN PUBLISHING 11

14 ACCA P4: ADVANCED FINANCIAL MANAGEMENT Standard Normal Distribution Tabl This tabl can b usd to calculat N(d i ), th cumulativ normal distribution functions ndd for th Black-Schols modl of option pricing. If d 1 > 0, add 0.5 to th rlvant numbr abov. If d 1 < 0, subtract th rlvant numbr abov from KAPLAN PUBLISHING

Holding period yield the distinction between interest rates and

Holding period yield the distinction between interest rates and LECTURE 3 Hamza Ali Malik Econ 315: Mony and anking Wintr 005 Holding priod yild th distinction btwn intrst rats and rturns. Th pric of most forms of dbt fluctuats ovr tim whil th yild to maturity can