ACCA F9 Financial Management QBR Exam - Answers

ACCA F9 Financial Management QBR Exam - Answers

Section A 1. B 2. D 3. D 4. D 5. B 6. C 7. D 8. C 9. B 10. A 11. B 12. C 13. D 14. A ACCA F9 QBR Exam - answers 2

15. C 16. B 17. B 18. C 19. B 20. A ACCA F9 QBR Exam - answers 3

Section B - Question 1 (a) (i) Purchase 20X2 20X3 20X4 20X5 20X6 20X7 $ $ $ $ $ $ Purchase price (360,000) Rental (15,000) (15,000) (15,000) (15,000) Tax on rental 4,500 4,500 4,500 4,500 Tax allowable depreciation (W) 27,000 20,250 15,188 11,391 28,172 Disposal proceeds 20,000 Net cash flow (360,000) 12,000 9,750 4,688 20,891 32,672 Discount factor 1.000 0.909 0.826 0.751 0.683 0.621 Present value (360,000) 10,908 8,054 3,521 14,269 20,289 Net present value = $(302,959) Working Tax allowable depreciation Year of claim Depreciation Tax saved Year of tax payment/saving $ $ 20X2 90,000 27,000 20X3 20X3 67,500 20,250 20X4 20X4 50,625 15,188 20X5 20X5 37,969 11,391 20X6 20X6 93,906 28,172 20X7 Depreciation 20X2 360,000 25% = 90,000 20X3-5 75% of previous year 20X6 Balancing allowance = Purchase price Depreciation Sale proceeds = 360,000 90,000 67,500 50,625 37,969 20,000 = 93,906 ACCA F9 QBR Exam - answers 4

(ii) Finance lease Year Cash flow Discount Present value factor $ 10% $ 20X3-6 Rental and maintenance (135,000 + 15,000) (150,000) 3.170 (475,500) 20X4-7 Tax on payments 45,000 2.882* 129,690 Present value (345,810) 20X4-7 factor = Year 1-5 Factor Year 1 Factor (iii) = 3.791 0.909 = 2.882 Operating lease Year Cash flow Discount factor Present value $ 10% $ 20X2-5 Rental (140,000) 3.487 (488,180) 20X3-6 Tax on rental 42,000 3.170 133,140 Present value (355,040) Based on these calculations, purchase would appear to be the best option. ACCA F9 QBR Exam - answers 5

Section B Question 2 (a) Using the dividend growth model, the share price of NN Co will be the present value of its expected future dividends, i.e. (66 x 1 03)/(0 12 0 03) = 755 cents per share or $7 55 per share Number of ordinary shares = 50/0 5 = 100m shares Value of NN Co = 100m x 7 55 = $755m Net asset value of NN Co = total assets less total liabilities = 143 29 20 25 = $69m In calculating net asset value, preference share capital is included with long-term liabilities, as it is considered to be prior charge capital. (b) Market efficiency is usually taken to refer to the way in which ordinary share prices reflect information. Fama defined an efficient market as one in which share prices fully and fairly reflect all available information. A semi-strong form efficient market is one where share prices reflect all publicly available information, such as past share price movements, published company annual reports and analysts reports in the financial press. A strong form efficient market is one where share prices reflect all information, whether publicly available or not. Share prices would reflect, for example, takeover decisions made at private board meetings. ACCA F9 QBR Exam - answers 6

Section B Question 3 Calculation of cost of equity The cost of equity can be calculated using the capital asset pricing model Ke = 4 + (1 2 x 5) = 10% Calculation of cost of debt of convertible bonds Market value of bond = 100 x 21m/20m = $105 per bond Ordinary share price = 125m/25m = $5 00 per share Share price in five years time = 5 00 x 1 045 = $6 08 per share Conversion value = 6 08 x 19 = $115 52 It is assumed that conversion is likely to occur, as the conversion value is greater than the alternative $100 redemption value. After-tax interest payment = 0 07 x 100 x (1 0 3) = $4 90 per bond Using linear interpolation: Year Cash flow $ Discount at 7% PV ($) 0 Market price (105 00) 1 000 (105 00) 1 5 Interest 4 90 4 100 20 09 5 Conversion value 115 52 0 713 82 37 (2 54) Year Cash flow $ Discount at 6% PV ($) 0 Market price (105 00) 1 000 (105 00) 1 5 Interest 4 90 4 212 20 64 5 Conversion value 115 52 0 747 86 29 1 93 After-tax Kd = 6 + ((7 6) x 1 93)/(1 93 + 2 54)) = 6 + 0 43 = 6 43% Calculation of cost of preference shares Kp = 100 x (0 05 x 10m/6 25m) = 8% Alternatively, the preference dividend per share can be compared with the preference share price to find the cost of preference shares Calculation of weighted average after-tax cost of capital Total value of company = 125m + 6 25m + 21m = $152 25 million After-tax WACC = ((10% x 125m) + (8% x 6 25m) + (6 43% x 21m))/152 25m = 9 4% ACCA F9 QBR Exam - answers 7

It is assumed that the overdraft can be ignored in calculating the WACC, even though it persists from year to year and is a significant source of finance for BKB Co. ACCA F9 QBR Exam - answers 8

Section B Question 4 (a) Evaluation of change in credit policy Current average collection period = 30 + 10 = 40 days Current accounts receivable = 6m x 40/ 365 = $657,534 Average collection period under new policy = (0.3 x 15) + (0.7 x 60) = 46.5 days New level of credit sales = $6.3 million Accounts receivable after policy change = 6.3 x 46.5/ 365 = $802,603 Increase in financing cost = (802,603 657,534) x 0.07 = $10,155 $ Increase in financing cost 10,155 Incremental costs = 6.3m x 0.005 = 31,500 Cost of discount = 6.3m x 0.015 x 0.3 = 28,350 Increase in costs 70,005 Contribution from increased sales = 6m x 0.05 x 0.6 = 180,000 Net benefit of policy change 109,995 The proposed policy change will increase the profitability of Ulnad Co (b) Determination of spread: Daily interest rate = 5.11/ 365 = 0.014% per day Variance of cash flows = 1,000 x 1,000 = $1,000,000 per day Transaction cost = $18 per transaction Spread = 3 x ((0.75 x transaction cost x variance)/interest rate) 1/3 = 3 x ((0.75 x 18 x 1,000,000)/ 0.00014)1/3 = 3 x 4,585.7 = $13,757 Lower limit (set by Renpec Co) = $7,500 Upper limit = 7,500 + 13,757 =$21,257 Return point = 7,500 + (13,757/ 3) = $12,086 The Miller-Orr model takes account of uncertainty in relation to receipts and payment. The cash balance of Renpec Co is allowed to vary between the lower and upper limits calculated by the model. If the lower limit is reached, an amount of cash equal to the difference between the return point and the lower limit is raised by selling short-term investments. If the upper limit is reached an amount of cash equal to the difference between the upper limit and the return point is used to buy short-term investments. The model therefore helps Renpec Co to decrease the risk of running out of cash, while avoiding the loss of profit caused by having unnecessarily high cash balances. ACCA F9 QBR Exam - answers 9

(c) There are four key areas of accounts receivable management: policy formulation, credit analysis, credit control and collection of amounts due. Policy formulation This is concerned with establishing the framework within which management of accounts receivable in an individual company takes place. The elements to be considered include establishing terms of trade, such as period of credit offered and early settlement discounts: deciding whether to charge interest on overdue accounts; determining procedures to be followed when granting credit to new customers; establishing procedures to be followed when accounts become overdue, and so on. Credit analysis Assessment of creditworthiness depends on the analysis of information relating to the new customer. This information is often generated by a third party and includes bank references, trade references and credit reference agency reports. The depth of credit analysis depends on the amount of credit being granted, as well as the possibility of repeat business. Credit control Once credit has been granted, it is important to review outstanding accounts on a regular basis so overdue accounts can be identified. This can be done, for example, by an aged receivables analysis. It is also important to ensure that administrative procedures are timely and robust, for example sending out invoices and statements of account, communicating with customers by telephone or e-mail, and maintaining account records. Collection of amounts due Ideally, all customers will settle within the agreed terms of trade. If this does not happen, a company needs to have in place agreed procedures for dealing with overdue accounts. These could cover logged telephone calls, personal visits, charging interest on outstanding amounts, refusing to grant further credit and, as a last resort, legal action. With any action, potential benefit should always exceed expected cost. ACCA F9 QBR Exam - answers 10

Section B Question 5 (a) Calculation of net present value Year 0 1 2 3 4 $ $ $ $ $ Sales revenue (W1) 728,000 1,146,390 1,687,500 842,400 Variable costs (W2) (441,000) (701,190) (1,041,750) (524,880) Contribution 287,000 445,200 645,750 317,520 Taxation @ 30% (86,100) (133,560) (193,725) (95,256 Initial investment (1,000,000) Working capital (W3) (50,960) (29,287) (37,878) 59,157 58,968 Tax benefit of tax depreciation (W4) 75,000 75,000 75,000 75,000 Net cash flows (1,050,960) 246,613 348,762 586,182 356,232 Discount at 12% 1 000 0 893 0 797 0 712 0 636 Present values (1,050,960) 220,225 277,963 417,362 226,564 NPV = $91,154 Workings (W1) Sales revenue Year 1 2 3 4 Selling price ($/unit) 20 80 21 63 22 50 23 40 Sales volume (units) 35,000 53,000 75,000 36,000 Sales revenue ($) 728,000 1,146,390 1,687,500 842,400 (W2) Variable costs Year 1 2 3 4 Variable cost ($/unit) 12 60 13 23 13 89 14 58 Sales volume (units) 35,000 53,000 75,000 36,000 Variable costs ($) 441,000 701,190 1,041,750 524,880 (W3) Working capital Year 0 1 2 3 4 $ $ $ $ $ Sales revenue 728,000 1,146,390 1,687,500 842,400 Working capital requirement @ 7% 50,960 80,247 118,125 58,968 Incremental working capital cash flow (50,960) (29,287) (37,878) 59,157 58,968 ACCA F9 QBR Exam - answers 11

(W4) Tax benefit of tax depreciation Depreciation = $1,000,000 / 4 = $250,000 per year Tax benefit = 30% x $250,000 = $75,000 (b) Calculation of internal rate of return Year 0 1 2 3 4 $ $ $ $ $ Net cash flows (1,050,960) 246,613 348,762 586,182 356,232 Discount at 20% 1 000 0 833 0 694 0 579 0 482 Present values (1,050,960) 205,429 242,041 339,399 171,704 NPV at 20% = ($92,387) NPV at 12% = $91,154 IRR = 12 + [(20 12) x 91,154/(91,154 + 92,387)] = 12 + 4 = 16% ACCA F9 QBR Exam - answers 12