acca f9 financial management qbr exam -...

ACCA F9 Financial Management

QBR Exam - Answers

|ACCA F9 QBR Exam - answers 2

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


15. C

16. B

17. B

18. C

19. B

20. A


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


(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

= 3.791 – 0.909

= 2.882

(iii) 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.


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.



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%


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.



(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.


(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.



(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


(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 financial management qbr exam -...

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