AA3F9 UNIVERSITY OF BRIGHTON BRIGHTON BUSINESS SCHOOL ASSOCIATION OF CHARTERED CERTIFIED ACCOUNTANTS FUNDAMENTAL SKILLS MODULE PAPER F9 Financial Management May 2016 OUTLINE SOLUTIONS AND MARK SCHEME Instructions to Candidates Time allowed: READING AND PLANNING 15 MINUTES WRITING THREE HOURS Answer ALL FOUR questions. All questions carry equal marks. Show all workings. Non-programmable calculators are permitted. Present value/annuity tables provided. Formulae sheet provided.
Answer 1 a) Project 1 Year CFs 12% DF PV of CF 0-150,000.00 1 - NPV 16,358.39 150,000.00 1 42,500.00 0.892857143 37,946.43 PI 1.11 2 45,000.00 0.797193878 35,873.72 3 47,500.00 0.711780248 33,809.56 4 50,000.00 0.635518078 31,775.90 5 47,500.00 0.567426856 26,952.78 (3 marks) Project 2 Year CFs 12% DF PV of CF 0-225,000.00 1 - NPV 28,776.24 225,000.00 1 70,400.00 0.892857143 62,857.14 PI 1.13 2 70,400.00 0.797193878 56,122.45 3 70,400.00 0.711780248 50,109.33 4 70,400.00 0.635518078 44,740.47 5 70,400.00 0.567426856 39,946.85 (3 marks) Project 3 Year CFs 12% DF PV of CF 0-200,000.00 1 - NPV 38,881.56 200,000.00 1 62,160.00 0.892857143 55,500.00 PI 1.19 2 64,397.76 0.797193878 51,337.50 3 66,716.08 0.711780248 47,487.19 4 69,117.86 0.635518078 43,925.65 5 71,606.10 0.567426856 40,631.22 (4 marks) Divisible: project 1 Project 2 Project 3 Invested 400,000.00 0% 89% 100% Total NPV 64,492.42 (2 marks) Indivisible: 1+2 1+3 2+3 Invested 375,000.00 350,000.00 425,000.00 NPV 45,134.64 55,239.96 (3 marks) Page 2 of 10
b) Students are expected to define and explain hard and soft capital rationing, reasons for having restrictions in place, providing relevant examples of each using real-world examples where appropriate. (5 marks) c) Students are expected to define inflation and explain the need to account for it. The answer should refer to Fisher s equation and using the nominal discount rate for nominal cash flows and real rate for real cash flows. (5 marks) Marking will be flexible. (Total 25 marks) Page 3 of 10
Answer 2 a) DATA Book Val Price Cost Cost after CT Bank Loan 10% 36,000.00 7% Bond 9% 40,000.00 75.00 8.40% Pref. Shares (1) 7% 10,000.00 0.80 9% Ord. Shares (50p) 60,000.00 3.50 17% Reserves 100,000.00 17% CT 30% Market Val Weights Beta 1.5 BL 36,000.00 0.072874494 Risk Premium 8% Bond 30,000.00 0.060728745 3-m Yield 5% PS 8,000.00 0.016194332 par value 100 OS 420,000.00 0.850202429 Total 494,000.00 1 i) WACC (market) 15.62% Book Val Weights BL 36,000.00 0.146341463 Bond 40,000.00 0.162601626 PS 10,000.00 0.040650407 OS 60,000.00 0.243902439 Res 100,000.00 0.406504065 Total 246,000.00 1 ii) WACC (book) 13.81% (15 marks) b) Use of historic values when no MV available (i.e. bank loan), assumptions behind models used (i.e.capm), understating/overstating, rejecting good projects as the result of temporary changes in the market. (4 marks) Page 4 of 10
c) Problems: Difficulties with finding data, choosing relevant data, working with finances in foreign currencies, WACC is not constant, WACC may not be suitable for all projects (i.e. all-loan financed), unrealistic assumptions behind some modles. (6 marks) (Total 25 marks) Page 5 of 10
Answer 3 a) Discussion could include the following: The optimum inventory level is a trade-off between the cost of holding stock and the cost of not holding stock. The former include: - storage costs. - financing costs. - insurance costs. - obsolescence costs. Costs of holding too little stock include: - loss of customer goodwill. - production stoppages. - loss of flexibility. Each of the above could be developed. In addition, students could discuss forms of stock control. Marking will be flexible. (7 marks) b) i) EOQ = 2 x 200 x 400,000 0.40.1 = 20,000 units (2 marks) Page 6 of 10
ii) Saving re quantity discounts (2 x 0.02 x 400,000) = 16,000 Present inventory costs: Ordering (400,000/20,000) x 200 4,000 Carrying (20,000/2) x 0.4 4,000 8,000 Revised costs re orders of 50,000: Ordering (400,000/50,000) x 200 1,600 Carrying (50,000/2) x 0.4 10,000 11,600 Difference (Increase) 3,600 Increase in profit (16,000 3,600) = 12,400, therefore it would be beneficial. (4 marks) Page 7 of 10
c) Current investment in receivables 5m x 0.40 x 1 / 12 = 166,667 5m x 0.58 x 2 / 12 = 483,333 650,000 Cost of investment 650,000 x 15 97,500 Bad debts 5m x 0.02 100,000 Current Total Contribution 5m x.2 1,000,000 Revised re cash discount 5m x 1.06 x.50 x 10 / 365 = 72,603 5m x 1.06 x.10 x 1 / 12 = 44,167 5m x 1.06 x.38 x 2 / 12 = 335,667 452,437 Cost of investment 452,437 x.15 67,866 Bad debts 5m x 1.06 x 0.02 106,000 Revised Total Contribution 5m x 1.06 x.2 1,060,000 Cost of cash discount 5m x 1.06 x.5 x 0.02 53,000 Summary: Savings in cost of debtors (97,500 67,866) 29,634 Increased contribution (1,060,000 1,000,000) 60,000 Increase in bad debts (106,000 100,000) (6,000) Cost of cash discount (53,000) Net saving 30,634 Therefore, Stanley should introduce the proposed cash discount policy. (12 marks) (Total 25 marks) Page 8 of 10
Answer 4 a) and b) Invoice 500,000.00 Term (months) 3 (5 and 15 marks) Borrow (3m) Deposit (3m) UK 4.00% 3.50% Spot 1.12359 IT 4.75% 3.60% Forward 1.176 Option Strike price 1.1546 Scenario 1 1.2 Option Premium 10,000.00 Scenario 2 1.05 Do nothing Can be cheapest, total uncertainty, the up/downside is unlimited Actual (market) Scenario 1 416,666.67 Scenario 2 476,190.48 Forward Entering a binding contract to sell EUR and buy GBP in 3-month time at the price agreed now (forward rate) Provides certainty, protects from downside but may result in "paper losses" Actual (forward) Possible (market) Gain/Loss Scenario 1 425,170.07 416,666.67 8,503.40 paper gain Scenario 2 425,170.07 476,190.48 51,020.41 paper loss Money Market As there is an asset in EUR, need to create a matching liability by borrowing in EUR. The amount borrowed plus accrued interest should equal to 500,000 EUR in 3-month time In 3-month time, the invoice payment in EUR will be used to offset the loan in EUR Protects from FOREX risk as no exchange is taking place at the future date, can be expensive due to associated transaction costs, subject to other risks (i.e. interest rate) Amount to borrow now Convert to GBP at spot Deposit in the UK for 3-m 477,326.97 424,823.08 439,691.89 Possible (market) Gain/Loss Scenario 1 416,666.67 23,025.23 paper gain Scenario 2 476,190.48 36,498.58 paper loss Page 9 of 10
Option Gives a right but not a liability to exchange at strike price in 3-month time. Need to pay premium now. Each contract is for 15, 644.83; Therefore 32 contracts are required for hedging with a total premium of 10,000. Premium in GBP at spot Premium cost in 3-m time 8,900.04 Need to borrow 9,256.05 Opportunity cost 9,211.55 Strike price Market price Gain/Loss Scenario 1 433,050.41 416,666.67 16,383.74 exercise option Scenario 2 433,050.41 476,190.48 43,140.07 allow option to lapse Cost of strategy Borrowed premium Opportunity Cost Scenario 1 423,794.36 423,838.86 Scenario 2 466,934.43 466,978.93 c) Internal stratefies include leading/lagging, matching, netting, invoicing in dometic currency. (5 marks) (Total 25 marks) Page 10 of 10