Study notes 47

CIMA corporate centre 26 Chapter Street,London SW1P 4NP T: +44 (0)20 8849 2251E: cima.contact@ cimaglobal.comwww.cimaglobal.comCIMA Australia 5 Hunter Street, Sydney, NSW 2000T: +61 (0)2 9376 9902E: sydney@cimaglobal.comCIMA Bangladesh Suite 309, RM Center, (3rd Floor), 101 Gulshan Avenue, Dhaka-1212T: +8802 881 5724E: zareef.matin@ cimaglobal.comCIMA Botswana Plot 50374 , Block 3, 1st Floor, Southern Wing, Fairgrounds Financial Centre, GaboroneT: +267 395 2362E: gaborone@cimaglobal.comCIMA China: head officeUnit 1508A, 15th Floor, Azia Center, 1233 Lujiazui Ring Road, Pudong, Shanghai 200120T: +86 (0)21 6160 1558E: infochina@cimaglobal.comCIMA China: BeijingC 201, 2/F Landmark Tower 2, 8 North Dongsanhuan Road,Beijing 100004

T: +86 (0)10 6590 0751 E: beijing@cimaglobal.comCIMA China: ChongqingRoom 1202, Metropolitan Plaza, 68 Zou Rong Road, Yuzhong District, Chongqing 400010T: +86 (0)23 6371 3538 E: infochina@cimaglobal.comCIMA China: Shenzhen16/F, CITIC City Plaza,Shennan Road Central, Shenzhen 518031T: +86 (0)755 3330 5151 E: shenzhen@cimaglobal.comCIMA Ghana3rd Floor, Ayele Building,IPS/Attraco Road,Madina, AccraT: +233 (0)30 250 3407E: accra@cimaglobal.comCIMA Hong KongSuite 2005, 20th Floor, Tower One, Times Square, 1 Matheson Street, Causeway Bay, Hong KongT: +852 (0)2511 2003E: hongkong@cimaglobal.comCIMA India Unit 1-A-1, 3rd Floor, Vibgyor Towers, C-62, G Block, Bandra Kurla Complex, Bandra (East), Mumbai 400051T: +91 22 4237 0100E: india@cimaglobal.com

CIMA Ireland5th Floor, Block E, Iveagh Court, Harcourt Road, Dublin 2T: +353 (0)1 643 0400E: cima.ireland@ cimaglobal.comCIMA Malaysia: head office CIMA Malaysia, Lots 1.03b & 1.05, Level 1, KPMG Tower, 8 First Avenue, Bandar Utama, 47800 Petaling Jaya, Selangor Darul EhsanT: +60 (0)3 77 230230E: kualalumpur@ cimaglobal.comCIMA Malaysia: SarawakSublot 315, 1st Floor, 21 Jalan Bukit Mata, 93100 Kuching, Sarawak T: +6082 233136E: doreen.tan@cimaglobal.com CIMA Malaysia: PenangSuite 12-04A, 12th Floor, Menara Boustead Penang,39 Jalan Sultan Ahmad Shah, 10050 PenangT: +60 (0)4 226 7488E: penang@cimaglobal.comCIMA Middle EastOffice E01, 1st Floor, Block 3,PO Box 502221, Dubai Knowledge Village, Al Sofouh Road, Dubai, United Arab EmiratesT: +9714 434 7370E: middleeast@cimaglobal.com

CIMA NigeriaLandmark Virtual Office, 5th Floor, Mulliner Towers, 39 Alfred Rewane Road, Ikoyi, LagosT: +234 1 463 8353 (ext 518)E: lagos@cimaglobal.comCIMA Pakistan 201, 2nd Floor, Business Arcade, Plot 27-A, Block 6, PECHS, Shahra-e-faisal, KarachiT: +92 21 3432 2387E: pakistan@cimaglobal.comCIMA Pakistan: Islamabad1st Floor, Rehman Chambers,Fazal-e-Haq Road, Blue Area, IslamabadT: + 92 51 260 5701-6CIMA Pakistan: LahoreFlat 1, 2, 1st Floor, Front Block 3, Awami Complex at 1-4, Usman Block, New Garden Town, LahoreT: +92 42 3594 0311-16CIMA PolandWarsaw Financial Centre , Floor 11, ul Emilii Plater 53,00-113 Warsaw T: +48 22 528 6651E: poland@cimaglobal.comCIMA RussiaOffice 4009, 4th floor,Zemlyanoj Val 9, Moscow 105064 T: +7495 967 9328E: russia@cimaglobal.com

CIMA Singapore3 Phillip Street, Commerce Point, Level 19, Singapore 048693T: +65 68248252E: singapore@cimaglobal.comCIMA South Africa 1st Floor, 198 Oxford Road, Illovo 2196T: +27 11 788 8723 E: johannesburg@ cimaglobal.comCIMA Sri Lanka356 Elvitigala, Mawatha,Colombo 05T: +94 (0)11 250 3880E: colombo@cimaglobal.comCIMA Sri Lanka: Kandy229 Peradeniya Road, KandyT: +94 (0)81 222 7883E: kandy@cimaglobal.comCIMA UK 26 Chapter Street, London SW1P 4NP T: +44 (0)20 8849 2251E: cima.contact@ cimaglobal.comCIMA Zambia6053 Sibweni Road,Northmead, LusakaT: +260 1 290219E: lusaka@cimaglobal.comCIMA Zimbabwe6th Floor Michael House, 62 Nelson Mandela Ave, HarareT: +263 4 708600E: harare@cimaglobal.com

Global contact details

If you try to think like a CFO in your Financial Strategy studies, you will greatly improve their effectiveness and your chances of success in the exam. Try to observe senior financial managers at work whenever you have the chance. Ask yourself what they’re trying to do and why they

take certain decisions. If it’s not possible to see at first hand how they operate, then read the financial press and keep asking yourself why, why, why?

Let’s try this approach by using parts of the first question from May 2012’s F3 paper, which can be downloaded from bit.ly/F3studyresources.

Question 1(a)(ii) – “evaluate B’s financial per-formance” – gives us the scope to discuss many issues, but since only nine marks are available,

there is clearly a need to cover only the most significant ones. The question’s guidance advises us to focus, but not necessarily restrict, our approach. The first clue in the text is the phrase “for each of the years 2007 to 2011 inclusive”. The point here is that shareholders, and hence directors, tend to be concerned about growth trends. Where is the line on the graph going and can it be extrapolated? Candidates who calculated B’s average earnings growth for the five years using an arithmetic average or compound growth based on only a single start and end point would have been given some credit, but a more detailed analysis is required for higher marks to be awarded. This will separate the fall in earnings and share price in 2007-08 out from the gradual recovery since 2008.

The big picture in the pre-seen and unseen scenarios is that B’s fortunes had been affected by the financial crisis of 2007-08, when its share price dropped by 29 per cent, reflecting falls across stock markets around the world. This systemic shock was followed by a recession, although so-called defensive stocks such as supermarkets did not fare quite as badly as those in many other sectors. Starting from the lower base in 2008, B has hit

Paper F3Financial strategy

By the examiner for F3 and Ian Herbert FCMA, CGMA Senior lecturer in accounting and financial management at the University of Loughborough

With its tedious calculations and arcane concepts, F3 is the most challenging paper of the curriculum for many students. The most successful candidates tend to approach it from a CFO’s point of view

‘Try to observe senior financial managers at work whenever you have the chance’

48

Paper F3Financial strategy

Study notes

its target of seven per cent EPS growth annually apart from in 2009, when it still managed five per cent. Its fortunes now look solid, based on steady growth since 2008, and the shareholders are likely to be pleased. While the share price has not yet reached its pre-2008 mark, its growth is back on track at a time when many other firms’ share prices have failed to rebound as quickly. The P/E ratio has also been relatively stable since 2008, indicating investors’ continued confidence in B’s prospects.

Higher-scoring answers will give this more holistic view, whereas weaker answers will include comments such as “the share price is lower now than five years ago” or ignore the 2007 figures, wrongly treating them as unimportant outliers.

Question 1(a)(iii) asks us to “explain the possible rationale behind B’s dividend pay-out history”. A simplistic response would be to say that the directors had thrown money at shareholders to pump up the share price, being aware of the signalling effect of dividends and the clientele effect. Candidates who recognised these influences would have gained credit, but more sophisticated analysts would have seen beyond the immediate dividend and would quickly lose confidence in B if it clearly couldn’t afford such pay-outs. The fact that the share price has been resilient since 2008 shows that B was earning enough cash to support the pay-outs. Indeed, one view might be that, as the economy contracted, the opportunities for growth were reduced and a cash-generative firm such as B took the chance to return cash to investors instead of accumulating it in the statement of financial position. The company remains cash-rich and can expand into new markets.

In question 1(b)(i) – “calculate the expected financial benefit to B of the rebranding exercise…” – a key difference between an average answer and a good one is the ability to determine what’s significant and what isn’t. For example, the tax calculations require “carry-forward sums”, which might be handled better as a sub-working to be brought back into the table. The evaluation uses an A$ discount rate, so the correct approach is to calculate NPV in A$ and convert to € at the spot rate. There is therefore no point in converting the currency for every year.

Some candidates failed to multiply the NPV for one store rebranding by the 15 stores. In the heat

of the exam this can be missed, but a credibility check along the lines of “what is the significance of this investment to the top management team?” would have led them to challenge that figure.

Question (b)(ii) – “evaluate the potential risks and opportunities…” – again requires big-picture thinking. While it’s easy to get lost in the detail of a DCF calculation, the whole investment was not significantly risky, given the amount of cash available. So it isn’t appropriate to focus solely on financing issues. The key strategic significance of acquiring and rebranding the Alpha stores is the potential for using this project as a springboard for growth. The main value of the project is the real option it offers B to proceed with further development. The company is clearly a mature business, probably in a developed country, that has limited opportunities to support con tinued growth. The chance to invest in emerging markets is likely to be of great interest to B, providing greater diversification across different markets and the potential for huge growth.

Rebranding the Alpha stores represents a relatively low-risk way to evaluate the potential for growth and diversification and to learn from first-hand operating experience. The greatest risk to B from the project is not a financial loss, but a mishap that damages B’s reputation in the country to the extent that it limits its growth prospects there. For background reading, see the press reports on Tesco’s overseas expansion, particularly the relatively small-scale development of its Fresh & Easy concept brand in the US and some of the setbacks it faced. There are many other examples of retail growth and contraction around the world.

Lastly, three marks are available for “structure and presentation”. Candidates often assume that this simply entails being neat and using a report format. Although that’s expected, the marks awarded under this criterion are also for the intelligent use of subheadings to structure the report and guide the reader – as though you were preparing a report for a busy chief executive who has a pile of other proposals competing with yours for attention. And remember to show DCF and cash flow calculations in a clear tabular form so that they’re easy to read and mark (it’s often best to show the years along the top and list the cash flows down the left-hand side).

‘The greatest risk from the project is not a financial loss but a mishap that damages B’s reputation in the country to the extent that it limits its growth prospects there’

Further reading CIMA Official Study Text – Financial Strategy (2012-13 edition), CIMA Publishing, 2012.