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ACCA

Paper F9
Financial Management
Revision Mock Examination
June 2014
Question Paper
Time Allowed

15 minutes

Reading and planning

3 hours

Writing

ALL FOUR questions are compulsory and MUST be attempted.


Formulae Sheet, Present Value and Annuity Tables are at the
end of the paper.
Do NOT open this paper until instructed by the supervisor.
During reading and planning time only the question paper may
be annotated. You must NOT write in your answer booklet
until instructed by the supervisor.
.

Interactive World Wide Ltd, February 2014


All rights reserved. No part of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic,
mechanical, photocopying, recording or otherwise, without the prior written
permission of Interactive World Wide Ltd.
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This is a blank page.


Question 1 begins on page 4.

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ALL FOUR questions are compulsory and MUST be attempted


1. PEP Co is considering a project : whether or not to commercialise an innovative
muscle toning device (MTD) that will be used in the treatment of sporting
injuries. It is expected that the commercial life of MTD will be four years, after
which technological advances will bring more sophisticated devices to the
market and the sales of MTD will fall to virtually zero. $8,000,000 has been
spent in developing and testing the device over the past ye ar. Initial market
research has been conducted at a cost of $2,500,000 and is due to be paid
shortly.
Information on future returns from the investment has been forecast to be as
follows:
Year
Units demand
Selling Price in current
price terms ($/unit)
Variable cost in current
price terms ($/unit)
Fixed costs in current
price terms ($million/year)

20,000

70,000

125,000

20,000

2,000

2,200

1,600

1,500

900

1,000

1,020

1,020

10

10

10

10

Selling price inflation and fixed costs inflation are expected to be 5% per year
and variable cost inflation is expected to be 4% per year. Fixed costs represent
incremental fixed production overheads which are wholly attributable to the
project.
The production equipment for the new device would cost $120 million and an
additional initial investment of $20 million would be needed for working capital.
The equipment is expected to be sold at the end of four years for $10 million
when the production and sales cease. The average general level of inflation is
expected to be 3% per year and working capital would experience inflation of
this level.
Capital allowances (tax-allowable depreciation) on a 25% reducing balance
basis could be claimed on the cost of equipment. Profit tax of 30% per year will
be payable one year in arrears. A balancing allowance would be claimed in the
fourth year of operation.
PEP Co has a real cost of capital of 7.8%
Required:
(a) Calculate the net present value of the MTD project and comment on
whether this project is fina ncia lly acceptable to PEP Co.
(13 marks)
(b) Calculate the internal rate of return of the MTD project and
comment on whether this project is financially acceptable to PEP Co.
(4 marks)

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(c) Discuss the key issues to consider when identifying, evaluating,


authorising, monitoring a nd controlling capital investment projects.
(8 marks)
(25 marks)

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2. The most recent summarised financial statements of WLF are as follows:


Statement of financial position as at 30 September 2012
$000
Non-current assets
Freehold land and buildings
Fixtures and fittings
Motor vans

$000
490
44
68
_____
602

Current assets
Inventory
Trade Receivables

420
330
___

Total assets

750
_____
1,352
_____

Equity capital
Ordinary shares
Retained earnings

200
562
_____
762

Non-current liabilities
7% Loan notes
6% bank loan
Current liabilities
Trade payables
Proposed dividend
Total e quity and liabilities

180
105
___
245
60
___

285
_____

305
_____
1,352
_____

Income statement extract for the year ended 30 September 2012


$000
Profit after taxation
Proposed dividend
Retained profit for the year

216
60
_____
156
_____

The board of directors of WLF commissioned an independent valuer to establish


the current realisable value of the assets of the company as at 30 September
2012 and the figures provided were as follows: freehold premises $876,000;
fixtures and fittings $24,000; motor vans $52,000; and inventory $408. Trade
receivables were considered to have current realisable values that were in line
with their book values.
The average price earnings ratio for similar listed
businesses is nine times.
The dividends of the company have grown in recent years by an average rate of
3% per year. The ordinary shares of the company have a par value of $1 per
share and an ex div market value of $8.30 per share. WLF has a cost of equity
of 7%. The 7% loan notes are redeemable in six years time at their par value
of $100 per bond. The current ex interest market price of the bonds is $103.50.
Assume a corporation tax rate of 25%.

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Required:
(a) Calculate the possible values for an ordinary share in WLF Ltd using
each of the following:
(i) net assets (net book value) method;
(ii) net assets (liquidation) method;
(iii) dividend growth valuation method;
(iv) price earnings ratio method.

(8 marks)

(b) Calculate the we ighted average a fter-tax cost of capital of WLF.


(9 marks)
(c) Explain the term efficient in the context of stock markets and
describe the different levels of stock market efficiency that may
exist.
(8 marks)
(25 marks)

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3. FAQ plc has recently appointed a new Finance Director who has concluded that
the business does not exert sufficient control over its working capital and is
considering making the following changes:
Inventory management
Within the first few weeks of taking up the new job, she found evidence of both
overstocking and under stocking of many items. She believes that the longer
term solution to these problems is to adopt a just-in-time approach for many
items.
However, in the short term she has started to implement stock
management models to help minimise costs. As a starting point, the company
has implemented the Economic Order Quantity model to the management of its
inventory. Although this has already proved beneficial, the business has now
received an offer from a supplier of one of its products. The supplier has
offered a discount of 2.5% on the cost of each of that product for order sizes of
200 or more and a discount of 4% for order sizes of 400 or more. Each product
costs $60 to purchase and the cost of holding one unit in stock is estimated at
$80 per year. The ordering cost is $50 and the annual sales demand is 8,000
units, which accrues evenly over the year.
Receivables management
The first proposal is to introduce a discount of 2% for payments within 30 days.
FAQ expects 80% of its customers to take the offer and pay on the 30th day.
The rest will continue to pay in 60 days on average. It also believes that this
will reduce its debt collection procedures costs to $40,000 a year.
The alternative proposal is to hire the services of a factor at the cost of 2% of
credit sales value. The factor expects to reduce the collection period of all the
credit sales to 20 days. The factor will also make an advance of 80% of the
trade receivables for which it will charge 10% interest per year. It is estimated
that the cost of debt collection procedures would fall to $5,000 per year as a
result.
Other relevant information
(i) It can be assumed that there are 360 days in a year.
(ii) Credit sales are $12,000,000 a year and have been stable over the past few
years.
(iii) Customers currently take an average of 60 days to pay .
(iv)The company spends $140,000 on debt collection procedures every year and
has negligible bad debts.
(v) FAQ has a large overdraft amounting to $3,000,000 and pays interest at a
rate of 15% per year on it.
Required:
(a) Identify the objectives of working capital management and discuss
the conflict that may arise between them.
(4 marks)
(b) Calculate the impact of introducing the early payment discount and
hiring the services of the factor, and recommend which proposal, if
any, FAQ should proceed with.
(10 marks)
(c) Discuss the arguments for and against the implementation of a justin-time approach to inventory management as a solution to the
problems of the business.
(5 marks)

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(d) Calculate the appropriate order size for the product that will
minimise the total annual costs associated with the purchase of this
item.
(6 marks)
(25 marks)

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4. SGT plc is a large UK fashion retailer that opened stores in India and China
three years ago. Financing the overseas investments substantially increased
the debt finance and the financial risk of the company. In order to reduce the
gearing, the directors have decided to make a one-for-five rights issue at a
discount of 30% on the current market value to redeem some of the debt. The
most recent Income statement of the business is as follows:
Income statement for the year ended 31 October 2012
m
Sales

1,400.00
_______
155.00
55.00
_______

Net profit before interest and taxation


Interest payable
Net profit before taxation
Corporation tax
Net profit after taxation
Ordinary dividends payable

100.00
25.00
_______
75.00
14.00
_______

Retained profit

61.00
_______

The capital and reserves of the business as at 31 October 2012 are as


follows:
m
60.00
140.00
320.00
_______

Ordinary shares (025 par value)


Revaluation reserve
Retained profit

520.00
550.00
_______
1,070.00
_______

10% loan notes (31/10/2020)

The shares of the business are currently traded on the London Stock Exchange
at a P/E ratio of 16 times. An investor, owning 10,000 ordinary shares in the
business, has received information of the forthcoming rights issue but cannot
decide whether to take up the rights issue, sell the rights, or allow the rights
offer to lapse.
Other relevant information
(i) Sector average gearing (debt/equity)

100%

(ii) Sector average interest cover

3.5 times

(iii) Tax rate

25%

Required:
(a) Calculate the theoretical ex-rights price of an ordinary share in SGT
plc.
(3 marks)
(b) Evaluate and comment on each of the options available to the
investor with 10,000 ordinary shares.
(6 marks)
(c) Calculate and comment on the effect of redeeming some of the debt
on:
(i) earnings per share

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(ii) interest cover and


(iii) gearing (debt-equity ratio) of SGT.

(7 marks)

(d) Assuming the price earnings ratio of SGT remains constant, evaluate
whether the proposal to pay some of the debt would increase the
wealth of SGT shareholde rs.
(3 marks)
(e) Discuss the factors
divide nd policy.

SGT

should consider before

formulating it
(6 marks)
(25 marks)

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11

Formulae Sheet

Economic Order Quantity


=

2C0D
CH

Miller-Orr Model
Return point = Lower limit + (1/3 spread)
1

3
3
4 transaction cost variance of cash flows
Spread = 3

interest rate

The Capital Asset Pricing Model


E(ri ) = Rf + i (E (rm) Rf)
The Asset Beta Formula

Vd(1 T)

Ve
a =
e +
d
(V

V
(1

T))
(V

V
(1

T))
e d

e d

The Growth Model


P0 =

D0(1 g)
(K e g)

or P0 =

D0(1 g)
(re g)

Gordons Growth Approximation


g = bre
The weighted average cost of capital

Ve
Vd
WACC =
ke +
kd (1T)
V

V
e d
Ve Vd
The Fisher formula
(1 + i) = (1 + r)(1 + h)
Purchasing Power Parity and Interest Rate Parity

12

S1 = S 0

(1 hc )
(1 hb )

F 0 = S0

(1 ic )
(1 ib )

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Present Value Table


Present value of 1 ie (1 + r) - n
Where r
n

= discount rate
= number of periods until payment
Discount rate (r)

Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
________________________________________________________________________________
1
2
3
4
5

0.990
0.980
0.971
0.961
0.951

0.980
0.961
0.942
0.924
0.906

0.971
0.943
0.915
0.888
0.863

0.962
0.925
0.889
0.855
0.822

0.952
0.907
0.864
0.823
0.784

0.943
0.890
0.840
0.792
0.747

0.935
0.873
0.816
0.763
0.713

0.926
0.857
0.794
0.735
0.681

0.917
0.842
0.772
0.708
0.650

0.909
0.826
0.751
0.683
0.621

1
2
3
4
5

6
7
8
9
10

0.942
0.933
0.923
0.914
0.905

0.888
0.871
0.853
0.837
0.820

0.837
0.813
0.789
0.766
0.744

0.790
0.760
0.731
0.703
0.676

0.746
0.711
0.677
0.645
0.614

0.705
0.665
0.627
0.592
0.558

0.666
0.623
0.582
0.544
0.508

0.630
0.583
0.540
0.500
0.463

0.596
0.547
0.502
0.460
0.422

0.564
0.513
0.467
0.424
0.386

6
7
8
9
10

11
0.896
0.804
0.722
0.650
0.585
0.527
0.475
0.429
0.388
0.350 11
12
0.887
0.788
0.701
0.625
0.557
0.497
0.444
0.397
0.356
0.319 12
13
0.879
0.773
0.681
0.601
0.530
0.469
0.415
0.368
0.326
0.290 13
14
0.870
0.758
0.661
0.577
0.505
0.442
0.388
0.340
0.299
0.263 14
15
0.861
0.743
0.642
0.555
0.481
0.417
0.362
0.315
0.275
0.239 15
________________________________________________________________________________
(n) 11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
________________________________________________________________________________
1
2
3
4
5

0.901
0.812
0.731
0.659
0.593

0.893
0.797
0.712
0.636
0.567

0.885
0.783
0.693
0.613
0.543

0.877
0.769
0.675
0.592
0.519

0.870
0.756
0.658
0.572
0.497

0.862
0.743
0.641
0.552
0.476

0.855
0.731
0.624
0.534
0.456

0.847
0.718
0.609
0.516
0.437

0.840
0.706
0.593
0.499
0.419

0.833
0.694
0.579
0.482
0.402

1
2
3
4
5

6
7
8
9
10

0.535
0.482
0.434
0.391
0.352

0.507
0.452
0.404
0.361
0.322

0.480
0.425
0.376
0.333
0.295

0.456
0.400
0.351
0.308
0.270

0.432
0.376
0.327
0.284
0.247

0.410
0.354
0.305
0.263
0.227

0.390
0.333
0.285
0.243
0.208

0.370
0.314
0.266
0.225
0.191

0.352
0.296
0.249
0.209
0.176

0.335
0.279
0.233
0.194
0.162

6
7
8
9
10

11
12
13
14
15

0.317
0.286
0.258
0.232
0.209

0.287
0.257
0.229
0.205
0.183

0.261
0.231
0.204
0.181
0.160

0.237
0.208
0.182
0.160
0.140

0.215
0.187
0.163
0.141
0.123

0.195
0.168
0.145
0.125
0.108

0.178
0.152
0.130
0.111
0.095

0.162
0.137
0.116
0.099
0.084

0.148
0.124
0.104
0.088
0.074

0.135
0.112
0.093
0.078
0.065

11
12
13
14
15

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13

Annuity Table
Present value of an annuity of 1 ie

Where

1 - (1 + r)-n
r

r = discount rate
n = number of periods
Discount rate (r)

Periods
(n)
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
________________________________________________________________________________
1
2
3
4
5

0.990
1.970
2.941
3.902
4.853

0.980
1.942
2.884
3.808
4.713

0.971
1.913
2.829
3.717
4.580

0.962
1.886
2.775
3.630
4.452

0.952
1.859
2.723
3.546
4.329

0.943
1.833
2.673
3.465
4.212

0.935
1.808
2.624
3.387
4.100

0.926
1.783
2.577
3.312
3.993

0.917
1.759
2.531
3.240
3.890

0.909
1.736
2.487
3.170
3.791

1
2
3
4
5

6
7
8
9
10

5.795
6.728
7.652
8.566
9.471

5.601
6.472
7.325
8.162
8.983

5.417
6.230
7.020
7.786
8.530

5.242
6.002
6.733
7.435
8.111

5.076
5.786
6.463
7.108
7.722

4.917
5.582
6.210
6.802
7.360

4.767
5.389
5.971
6.515
7.024

4.623
5.206
5.747
6.247
6.710

4.486
5.033
5.535
5.995
6.418

4.355
4.868
5.335
5.759
6.145

6
7
8
9
10

11 10.37
9.787
9.253
8.760
8.306
7.887
7.499
7.139
6.805
6.495 11
12 11.26
10.58
9.954
9.385
8.863
8.384
7.943
7.536
7.161
6.814 12
13 12.13
11.35
10.63
9.986
9.394
8.853
8.358
7.904
7.487
7.103 13
14 13.00
12.11
11.30
10.56
9.899
9.295
8.745
8.244
7.786
7.367 14
15 13.87
12.85
11.94
11.12
10.38
9.712
9.108
8.559
8.061
7.606 15
________________________________________________________________________________
(n) 11%
12%
13%
14%
15%
16%
17%
18%
19%
20%
_________________________________________________________________ _______________
1
2
3
4
5

0.901
1.713
2.444
3.102
3.696

0.893
1.690
2.402
3.037
3.605

0.885
1.668
2.361
2.974
3.517

0.877
1.647
2.322
2.914
3.433

0.870
1.626
2.283
2.855
3.352

0.862
1.605
2.246
2.798
3.274

0.855
1.585
2.210
2.743
3.199

0.847
1.566
2.174
2.690
3.127

0.840
1.547
2.140
2.639
3.058

0.833
1.528
2.106
2.589
2.991

1
2
3
4
5

6
7
8
9
10

4.231
4.712
5.146
5.537
5.889

4.111
4.564
4.968
5.328
5.650

3.998
4.423
4.799
5.132
5.426

3.889
4.288
4.639
4.946
5.216

3.784
4.160
4.487
4.772
5.019

3.685
4.039
4.344
4.607
4.833

3.589
3.922
4.207
4.451
4.659

3.498
3.812
4.078
4.303
4.494

3.410
3.706
3.954
4.163
4.339

3.326
3.605
3.837
4.031
4.192

6
7
8
9
10

11
12
13
14
15

6.207
6.492
6.750
6.982
7.191

5.938
6.194
6.424
6.628
6.811

5.687
5.918
6.122
6.302
6.462

5.453
5.660
5.842
6.002
6.142

5.234
5.421
5.583
5.724
5.847

5.029
5.197
5.342
5.468
5.575

4.836
4.988
5.118
5.229
5.324

4.656
4.793
4.910
5.008
5.092

4.486
4.611
4.715
4.802
4.876

4.327
4.439
4.533
4.611
4.675

11
12
13
14
15

14

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