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Fundamentals Level โ Skills Module
Time allowed: 3 hours 15 minutes
This question paper is divided into three sections:
Section A โ ALL 15 questions are compulsory and MUST be attempted
Section B โ ALL 15 questions are compulsory and MUST be attempted
Section C โ BOTH questions are compulsory and MUST be attempted
Formulae Sheet, Present Value and Annuity Tables are on pages 13โ15.
Do NOT open this question paper until instructed by the supervisor.
Do NOT record any of your answers on the question paper.
This question paper must not be removed from the examination hall. Paper F
Financial Management
Friday 9 September 2016
The Association of
Chartered Certified
Accountants
Section A โ ALL 15 questions are compulsory and MUST be attempted
Please use the grid provided on page two of the Candidate Answer Booklet to record your answers to each multiple choice question. Do not write out the answers to the MCQs on the lined pages of the answer booklet.
Each question is worth 2 marks.
1 The owners of a private company wish to dispose of their entire investment in the company. The company has an issued share capital of $1m of $0ยท50 nominal value ordinary shares. The owners have made the following valuations of the companyโs assets and liabilities. Non-current assets (book value) $30m Current assets $18m Non-current liabilities $12m Current liabilities $10m The net realisable value of the non-current assets exceeds their book value by $4m. The current assets include $2m of accounts receivable which are thought to be irrecoverable.
What is the minimum price per share which the owners should accept for the company? A $ B $ C $ D $
2 Which of the following financial instruments will NOT be traded on a money market?
A Commercial paper B Convertible loan notes C Treasury bills D Certificates of deposit
3 Andrew Co is a large listed company financed by both equity and debt.
In which of the following areas of financial management will the impact of working capital management be smallest? A Liquidity management B Interest rate management C Management of relationship with the bank D Dividend policy
4 Which of the following are descriptions of basis risk?
(1) It is the difference between the spot exchange rate and currency futures exchange rate (2) It is the possibility that the movements in the currency futures price and spot price will be different (3) It is the difference between fixed and floating interest rates (4) It is one of the reasons for an imperfect currency futures hedge A 1 only B 1 and 3 C 2 and 4 only D 2, 3 and 4
10 Which of the following would you expect to be the responsibility of financial management?
A Producing annual accounts B Producing monthly management accounts C Advising on investment in non-current assets D Deciding pay rates for staff
11 Lane Co has in issue 3% convertible loan notes which are redeemable in five yearsโ time at their nominal value of $100 per loan note. Alternatively, each loan note can be converted in five yearsโ time into 25 Lane Co ordinary shares. The current share price of Lane Co is $3ยท60 per share and future share price growth is expected to be 5% per year. The before-tax cost of debt of these loan notes is 10% and corporation tax is 30%.
What is the current market value of a Lane Co convertible loan note? A $82ยท B $73ยท C $67ยท D $94ยท
12 Country X uses the dollar as its currency and country Y uses the dinar.
Country Xโs expected inflation rate is 5% per year, compared to 2% per year in country Y. Country Yโs nominal interest rate is 4% per year and the current spot exchange rate between the two countries is 1ยท5000 dinar per $1.
According to the four-way equivalence model, which of the following statements is/are true? (1) Country Xโs nominal interest rate should be 7ยท06% per year (2) The future (expected) spot rate after one year should be 1ยท4571 dinar per $ (3) Country Xโs real interest rate should be higher than that of country Y A 1 only B 1 and 2 only C 2 and 3 only D 1, 2 and 3
13 Which of the following government actions would lead to an increase in aggregate demand?
(1) Increasing taxation and keeping government expenditure the same (2) Decreasing taxation and increasing government expenditure (3) Decreasing money supply (4) Decreasing interest rates A 1 only B 1 and 3 C 2 and 4 only D 2, 3 and 4
14 Peach Coโs latest results are as follows:
$ Profit before interest and taxation 2, Profit before taxation 2, Profit after tax 1, In addition, extracts from its latest statement of financial position are as follows: $ Equity 10, Non-current liabilities 2,
What is Peach Coโs return on capital employed (ROCE)? A 14% B 18% C 20% D 25%
15 Drumlin Co has $5m of $0ยท50 nominal value ordinary shares in issue. It recently announced a 1 for 4 rights issue at $6 per share. Its share price on the announcement of the rights issue was $8 per share.
What is the theoretical value of a right per existing share? A $1ยท B $0ยท C $0ยท D $1ยท
(30 marks)
5 [P.T.O.
20 As regards the interest rate risk faced by Herd Co, which of the following statements is correct?
A In exchange for a premium, Herd Co could hedge its interest rate risk by buying interest rate options B Buying a floor will give Herd Co a hedge against interest rate increases C Herd Co can hedge its interest rate risk by buying interest rate futures now in order to sell them at a future date D Taking out a variable rate overdraft will allow Herd Co to hedge the interest rate risk through matching
7 [P.T.O.
The following scenario relates to questions 21 to 25.
Ring Co has in issue ordinary shares with a nominal value of $0ยท25 per share. These shares are traded on an efficient capital market. It is now 20X6 and the company has just paid a dividend of $0ยท450 per share. Recent dividends of the company are as follows:
Year 20X6 20X5 20X4 20X3 20X Dividend per share $0ยท450 $0ยท428 $0ยท408 $0ยท389 $0ยท
Ring Co also has in issue loan notes which are redeemable in seven yearsโ time at their nominal value of $100 per loan note and which pay interest of 6% per year.
The finance director of Ring Co wishes to determine the value of the company.
Ring Co has a cost of equity of 10% per year and a before-tax cost of debt of 4% per year. The company pays corporation tax of 25% per year.
21 Using the dividend growth model, what is the market value of each ordinary share?
A $8ยท B $9ยท C $9ยท D $7ยท
22 What is the market value of each loan note?
A $109ยท B $112ยท C $116ยท D $118ยท
23 The finance director of Ring Co has been advised to calculate the net asset value (NAV) of the company.
Which of the following formulae calculates correctly the NAV of Ring Co? A Total assets less current liabilities B Non-current assets plus net current assets C Non-current assets plus current assets less total liabilities D Non-current assets less net current assets less non-current liabilities
24 Which of the following statements about valuation methods is true?
A The earnings yield method multiplies earnings by the earnings yield B The equity market value is number of shares multiplied by share price, plus the market value of debt C The dividend valuation model makes the unreasonable assumption that average dividend growth is constant D The price/earnings ratio method divides earnings by the price/earnings ratio
25 Which of the following statements about capital market efficiency is/are correct?
(1) Insider information cannot be used to make abnormal gains in a strong form efficient capital market (2) In a weak form efficient capital market, Ring Coโs share price reacts to new information the day after it is announced (3) Ring Coโs share price reacts quickly and accurately to newly-released information in a semi-strong form efficient capital market A 1 and 2 only B 1 and 3 only C 3 only D 1, 2 and 3
8
30 Which of the following statements about Fence Co directorsโ remuneration package is/are correct?
(1) Directorsโ remuneration should be determined by senior executive directors (2) Introducing a share option scheme would help bring directorsโ objectives in line with shareholdersโ objectives (3) Linking financial rewards to a target return on capital employed will encourage short-term profitability and discourage capital investment A 2 only B 1 and 3 only C 2 and 3 only D 1, 2 and 3
(30 marks)
Section C โ BOTH questions are compulsory and MUST be attempted
Please write your answers to all parts of these questions on the lined pages within the Candidate Answer Booklet.
31 Nesud Co has credit sales of $45 million per year and on average settles accounts with trade payables after 60 days. One of its suppliers has offered the company an early settlement discount of 0ยท5% for payment within 30 days. Administration costs will be increased by $500 per year if the early settlement discount is taken. Nesud Co buys components worth $1ยท5 million per year from this supplier. From a different supplier, Nesud Co purchases $2ยท4 million per year of Component K at a price of $5 per component. Consumption of Component K can be assumed to be at a constant rate throughout the year. The company orders components at the start of each month in order to meet demand and the cost of placing each order is $248ยท44. The holding cost for Component K is $1ยท06 per unit per year. The finance director of Nesud Co is concerned that approximately 1% of credit sales turn into irrecoverable debts. In addition, she has been advised that customers of the company take an average of 65 days to settle their accounts, even though Nesud Co requires settlement within 40 days. Nesud Co finances working capital from an overdraft costing 4% per year. Assume there are 360 days in a year.
Required: (a) Evaluate whether Nesud Co should accept the early settlement discount offered by its supplier. (4 marks)
(b) Evaluate whether Nesud Co should adopt an economic order quantity approach to ordering Component K. (6 marks)
(c) Critically discuss how Nesud Co could improve the management of its trade receivables. (10 marks)
(20 marks)
11 [P.T.O.
13 [P.T.O.
Formulae Sheet
Economic order quantity
MillerโOrr Model
The Capital Asset Pricing Model
The asset beta formula
The Growth Model
Gordonโs growth approximation
The weighted average cost of capital
The Fisher formula
Purchasing power parity and interest rate parity
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Present Value Table Present value of 1 i.e. (1 + r )โ n Where r = discount rate n = number of periods until payment Discount rate (r) Periods
- 1 0ยท990 0ยท980 0ยท971 0ยท962 0ยท952 0ยท943 0ยท935 0ยท926 0ยท917 0ยท909 (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
- 2 0ยท980 0ยท961 0ยท943 0ยท925 0ยท907 0ยท890 0ยท873 0ยท857 0ยท842 0ยท826
- 3 0ยท971 0ยท942 0ยท915 0ยท889 0ยท864 0ยท840 0ยท816 0ยท794 0ยท772 0ยท751
- 4 0ยท961 0ยท924 0ยท888 0ยท855 0ยท823 0ยท792 0ยท763 0ยท735 0ยท708 0ยท683
- 5 0ยท951 0ยท906 0ยท863 0ยท822 0ยท784 0ยท747 0ยท713 0ยท681 0ยท650 0ยท621
- 6 0ยท942 0ยท888 0ยท837 0ยท790 0ยท746 0ยท705 0ยท666 0ยท630 0ยท596 0ยท564
- 7 0ยท933 0ยท871 0ยท813 0ยท760 0ยท711 0ยท665 0ยท623 0ยท583 0ยท547 0ยท513
- 8 0ยท923 0ยท853 0ยท789 0ยท731 0ยท677 0ยท627 0ยท582 0ยท540 0ยท502 0ยท467
- 9 0ยท914 0ยท837 0ยท766 0ยท703 0ยท645 0ยท592 0ยท544 0ยท500 0ยท460 0ยท424
- 10 0ยท905 0ยท820 0ยท744 0ยท676 0ยท614 0ยท558 0ยท508 0ยท463 0ยท422 0ยท386
- 11 0ยท896 0ยท804 0ยท722 0ยท650 0ยท585 0ยท527 0ยท475 0ยท429 0ยท388 0ยท350
- 12 0ยท887 0ยท788 0ยท701 0ยท625 0ยท557 0ยท497 0ยท444 0ยท397 0ยท356 0ยท319
- 13 0ยท879 0ยท773 0ยท681 0ยท601 0ยท530 0ยท469 0ยท415 0ยท368 0ยท326 0ยท290
- 14 0ยท870 0ยท758 0ยท661 0ยท577 0ยท505 0ยท442 0ยท388 0ยท340 0ยท299 0ยท263
- 15 0ยท861 0ยท743 0ยท642 0ยท555 0ยท481 0ยท417 0ยท362 0ยท315 0ยท275 0ยท239
- 1 0ยท901 0ยท893 0ยท885 0ยท877 0ยท870 0ยท862 0ยท855 0ยท847 0ยท840 0ยท833 (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
- 2 0ยท812 0ยท797 0ยท783 0ยท769 0ยท756 0ยท743 0ยท731 0ยท718 0ยท706 0ยท694
- 3 0ยท731 0ยท712 0ยท693 0ยท675 0ยท658 0ยท641 0ยท624 0ยท609 0ยท593 0ยท579
- 4 0ยท659 0ยท636 0ยท613 0ยท592 0ยท572 0ยท552 0ยท534 0ยท516 0ยท499 0ยท482
- 5 0ยท593 0ยท567 0ยท543 0ยท519 0ยท497 0ยท476 0ยท456 0ยท437 0ยท419 0ยท402
- 6 0ยท535 0ยท507 0ยท480 0ยท456 0ยท432 0ยท410 0ยท390 0ยท370 0ยท352 0ยท335
- 7 0ยท482 0ยท452 0ยท425 0ยท400 0ยท376 0ยท354 0ยท333 0ยท314 0ยท296 0ยท279
- 8 0ยท434 0ยท404 0ยท376 0ยท351 0ยท327 0ยท305 0ยท285 0ยท266 0ยท249 0ยท233
- 9 0ยท391 0ยท361 0ยท333 0ยท308 0ยท284 0ยท263 0ยท243 0ยท225 0ยท209 0ยท194
- 10 0ยท352 0ยท322 0ยท295 0ยท270 0ยท247 0ยท227 0ยท208 0ยท191 0ยท176 0ยท162
- 11 0ยท317 0ยท287 0ยท261 0ยท237 0ยท215 0ยท195 0ยท178 0ยท162 0ยท148 0ยท135
- 12 0ยท286 0ยท257 0ยท231 0ยท208 0ยท187 0ยท168 0ยท152 0ยท137 0ยท124 0ยท112
- 13 0ยท258 0ยท229 0ยท204 0ยท182 0ยท163 0ยท145 0ยท130 0ยท116 0ยท104 0ยท093
- 14 0ยท232 0ยท205 0ยท181 0ยท160 0ยท141 0ยท125 0ยท111 0ยท099 0ยท088 0ยท078
- 15 0ยท209 0ยท183 0ยท160 0ยท140 0ยท123 0ยท108 0ยท095 0ยท084 0ยท074 0ยท065
