DO NOT OPEN THIS QUESTION PAPER UNTIL YOU ARE TOLD TO DO SO.

Financial Pillar

F3 Financial Strategy
Saturday 30 August 2014
Instructions to candidates

You are allowed 20 minutes reading time before the examination begins
during which you should read the question paper and, if you wish, highlight
and/or make notes on the question paper. However, you will not be allowed,
under any circumstances, to begin using your computer to produce your
answer or to use your calculator during the reading time.
You are strongly advised to carefully read ALL the question requirements
before attempting the question concerned (that is all parts and/or subquestions).
ALL answers must be submitted electronically, using the single Word and
Excel files provided. Answers written on the question paper and note paper
will not be submitted for marking.
You should show all workings as marks are available for the method you use.
The pre-seen case study material is included in this question paper on
pages 2 to 7. The unseen case study material, specific to this examination, is
provided on pages 8 and 9.
Answer the compulsory question in Section A on page 11. This page is
detachable for ease of reference.
Answer TWO of the three questions in Section B on pages 14 to 19.
Maths tables and formulae are provided on pages 21 to 25.
The list of verbs as published in the syllabus is given for reference on
page 27.
Your computer will contain two blank files a Word and an Excel file.
Please ensure that you check that the file names for these two documents
correspond with your candidate number.

F3 Financial Strategy

You are allowed three hours to answer this question paper.

TURN OVER

The Chartered Institute of Management Accountants 2014

Pre-seen case study

Introduction
P plc is based in the UK. It is one of the worlds leading distributors of plumbing, heating and
building materials employing over 35,000 people. It operates its own retail outlets, some of
which share a common trading name and are organised as separate business units. P plc
also sells directly to building and plumbing contractors and merchants through its external
direct sales units.
th

P plc was founded in the early 20 Century as a plumbing and buildings materials
manufacturing business and enjoyed very rapid growth in the 1970s and 1980s. In 1985, P
was listed on the UK stock exchange and at this time first ventured into the USA by acquiring
a building materials distribution company based in New Jersey. In 1990, P plc acquired a
building supplies business in the UK and, later in that decade, made acquisitions of other
European based plumbing and heating and building materials distribution companies. In the
st
early years of the 21 Century, P plc sold off all its manufacturing business units and
concentrated solely on being a distributor and retailer of plumbing, heating and building
materials.
Corporate values
P plc is proud of its history and traditions of distributing and retailing good quality products in
locations which are convenient to its customers. It has developed a series of core values
which are:
Trading fairly and honestly;
Being responsive to customer needs and market changes and not being satisfied with
standing still, but seeking to continuously improve;
Employing committed people and providing training opportunities to develop their skills;
Having respect for cultural diversity across all the companys stakeholders.
Business operations
P plcs head office is in the UK which also contains its centralised treasury. It has two
operating divisions which are:
Plumbing and heating

Products:
Baths, showers, toilets, sinks, heating systems, general plumbing
parts such as water taps, pipes and drainage systems.

Building materials

Products:
Concrete building blocks, bricks, tiles, flooring products, roofing
materials and wooden roof beams and other timber, as well as
upvc products, such as doors and window frames.

Each divisions operating arrangements are similar. Each division has two distribution
warehouses, one each in Europe and the USA. Each division uses these warehouses to fulfil
sales orders placed by its external direct sales units and retail outlets.
The external direct sales units sell to building contractors, plumbing contractors and
merchants who supply small building and plumbing companies with materials and parts.
P plcs retail outlets sell directly to the public and to the building and plumbing trades. Some
of these retail sales outlets were set up or acquired as chains of retail outlets each with a
common trading name and these have been retained as separate business units. The retail
outlets that have been acquired continue to operate under their own trading names so that P
plc can retain the benefit of the goodwill the retail outlets developed. Each has a specific line
of business, such as the sale of complete bathrooms and kitchens through chains of
showrooms.

Financial Strategy

September 2014

The plumbing and heating division carries out its retail operations through established chains
of showrooms. These showrooms sell products to local tradesmen and also directly to the
public. The building materials divisions retail activities are carried out through small-scale
retail outlets which are usually located on industrial estates and those that have been
acquired retain their local building supply trading names.
Overall, P plc has well over 90,000 suppliers and sells to over 1.2 million customers across
the world. Each of the two divisions operates its own large logistics and distribution network.
They operate their own fleet of road transport vehicles to distribute products in Europe and
the USA and use rail, sea and air networks for distribution to their external direct sales units
and retail outlets in other parts of the world.
Board of Directors and Executive Board composition
The Board of Directors comprises a Non-executive Chair, a Chief Executive, the five directors
covering the functions of Finance, Logistics, Procurement, Marketing and Information
Systems, the Managing Directors of the two divisions, the Company Secretary and six nonexecutive directors.
In addition, P plc has an Executive Board comprising the Chief Executive, the five functional
executive directors, the Managing Directors of the two divisions and also the Chief Human
Resources Officer, who is not a main board member. The Executive Board reports to the
Board of Directors.
Divisional Management Structure
Each of the two divisions operates with a Divisional Executive Management Team (DEMT),
based in the UK. These comprise chief divisional officers for the functions of finance, human
resources, information systems, logistics, marketing and procurement. Each DEMT is led by
the relevant Divisional Managing Director. In the USA, there is also a Senior Executive Team
for each division which comprises chief officers covering the same functions as are
represented on the DEMT and chaired by the companys divisional Vice President (Plumbing
and Heating or Building Materials as appropriate) for US sales. The senior executive teams in
the USA report to their appropriate DEMT in the UK. An organisational structure chart is
presented at Appendix 1.
Financial structure
There are 500 million GBP 0.10 shares in issue. The ownership of the company is split in the
following proportions:
Financial institutions:
Individual investors:
Board members and employees:

90%
9.5%
0.5%

The share price has ranged between GBP 9 and GBP 6 over the last year. The dividend in
the last financial year was GBP 0.25 per share and represented an increase of 20% over the
previous year. The Chairman commented on this improved dividend stating that the Board
had strong confidence that the company would continue to grow.

September 2014

Financial Strategy

Chairmans statement on P plcs strategic objectives

P plcs Chairman has declared three strategic objectives for the company which all combine
with the aim of improving shareholder value. These three strategic objectives of P plc are:
1. To be the market leader in the regions of the world in which it operates;
2. To deleverage the company by disposing of business units or individual retail outlets
which do not contribute sufficiently to the aim of P plc becoming market leader or are
failing to meet minimum performance targets;
3. To continuously strive to improve its products and customer services.

The business acquisition strategy employed by P plc has led to high levels of goodwill. In
some cases, newly acquired businesses have underperformed and not met profit
expectations. Some impairment of goodwill has been necessary in respect of certain business
units. Those which have seriously underperformed have been disposed of. The net value of
goodwill, after impairment, is shown in the companys statement of financial position in
Appendix 2.
Comparative performance and assets employed by the divisions
The divisions measure performance at external direct sales unit and individual retail outlet
level. Where retail outlets are organised into business units under a common trading name,
then the performance of the retail units are consolidated enabling performance to be
measured at the business unit level. The performance of the divisions for the financial year
2013 and the assets they employed as at 31 December 2013 are as follows:
Performance:

Revenue
Operating profit

Plumbing and heating

GBP million
7,040
234

Building materials
GBP million
6,837
213

Plumbing and heating

GBP million

Building materials
GBP million

Assets employed:

Non-current assets:
Intangible assets
Property, plant and equipment
Trade and other receivables
Current assets:
Inventories
Trade and other receivables

781
597
65

967
729
70

930
1,075

854
1,052

Non-current assets employed by P plc at its head office were GBP 40 million at book value.
Source of products
P plc prides itself on operating an efficient supply chain and developing strong relationships
with a wide range of suppliers across the world which offer quality products. It grants
preferred supplier status to most of its suppliers and enters into long-term supply contracts.
All P plcs external direct sales units and retail outlets are supplied from its warehouses in
Europe or the USA. This means that some of its products which are sourced from Asia and
Africa are shipped to the companys warehouses in Europe and the USA. External direct
sales units and retail outlets in Asia and Africa then receive shipments from the companys
warehouses. This means that some products, which P plc sources from suppliers located in
Asia and Africa, cross the world, are stored in warehouses and then cross the world again to
be delivered to their destinations in Asia and Africa.

Financial Strategy

September 2014

Corporate Responsibility Aims

P plc aims to provide excellent customer service across its two divisions. This excellence in
customer service is underpinned by its:

provision of high levels of staff training and development, with strong concentration
on safety management;
adherence to the highest ethical standards both internally and with respect to supplier
relationships;
concern to cause the least environmental damage possible within its operations in
terms of emissions, waste management and recycling activities by employing
environmental performance management methods;
promotion of product integrity through selling only safe and reliable products which
are of the required standard of quality and partnering with key suppliers.

Strategic developments
P plc aims to increase its market share by making repeat sales through its external direct
sales units and retail outlets to existing customers and attracting new customers away from
competitors. It places customer service as its key critical success factor. The Board is
constantly seeking improvements in the companys logistics particularly in sourcing products
and their delivery to its external direct sales units and retail outlets wherever they are in the
world. It is actively considering acquiring logistic resources in parts of the world where it does
not own warehousing and distribution facilities at present and also pursuing the concept of
virtual warehousing by which its external direct sales units and retail outlets will still place their
orders with P plc but will obtain their supplies directly from the manufacturer. Other areas of
strategic development concern reviewing the life expectancy of its products so as to give
greater value for money to final customers and benchmarking its performance in different
countries in order to improve operating efficiency.

September 2014

Financial Strategy

Appendix 1

P plc ORGANISATION STRUCTURE

Financial Strategy

P plc
Board of Directors

Executive Board

Building Materials Division

Divisional Executive Management Team

Plumbing and Heating Division

Divisional Executive Management Team
USA
Plumbing and Heating Division
Senior Executive Team

USA
Building Materials Division
Senior Executive Team

6
USA Warehouses

September 2014

External
Sales

Retail
Outlets

Europe Warehouses

External
Sales

Europe Warehouses

Retail
Outlets

External
Sales

Retail
Outlets

USA Warehouses

External
Sales

Retail
Outlets

Note: Some of the retail outlets were established, or were acquired as chains of retail outlets, operating as business units with a common trading name.
The remaining retail outlets are individual business units in their own right comprising a single outlet.
Financial Strategy

September 2014

Appendix 2
Extracts from P plcs statement of profit or loss and statement of financial position
Statement of profit or loss for the year ended 31 December 2013
GBP million
13,877
10,128
3,749
3,302
447
68
379
116
263

Revenue
Cost of sales
Gross profit
Operating costs
Operating profit
Net finance costs
Profit before tax
Tax
PROFIT FOR THE YEAR
Statement of financial position as at 31 December 2013

GBP million
ASSETS
Non-current assets
Intangible assets: goodwill (net)
Property, plant and equipment
Trade and other receivables
Total non-current assets
Current assets
Inventories
Trade and other receivables
Cash and cash equivalents
Total current assets
Total assets

1,748
1,366
135
3,249
1,784
2,127
418
4,329
7,578

EQUITY AND LIABILITIES

Equity
Share capital (GBP 0.10 shares)
Share premium
Retained earnings
Total equity

50
25
3,396
3,471

Non-current liabilities
Bank loans
Current liabilities
Trade and other payables
Bank loans and overdrafts
Total current liabilities
Total liabilities
Total equity and liabilities

1,000
2,905
202
3,107
4,107
7,578

End of Pre-seen Material

The unseen material begins on page 8

September 2014

Financial Strategy

SECTION A 50 MARKS
[You are advised to spend no longer than 90 minutes on this question.]

ANSWER THIS QUESTION. THE QUESTION REQUIREMENTS ARE ON PAGE

11, WHICH IS DETACHABLE FOR EASE OF REFERENCE

Question One
Unseen material
Today is 30 August 2014.
The Executive Board of P plc has identified Country C as a priority location for expansion of the
Plumbing and Heating Division. Country C uses currency C$.
Company B3, located in Country C, has been identified as a potential acquisition target. The
Plumbing and Heating Division already manages two business units in Country C, named B1 and B2,
and these have shown strong performance under P plcs ownership.
B3 is particularly attractive to P plc because it has its own warehouse and distribution and logistics
network, all of which could be used by B1 and B2 if the acquisition goes ahead. Currently, B1 and B2
send goods to customers from P plc warehouses located in the UK or USA. This involves
considerable cost and delay in delivery.
B3 is a private company and 100% of its shares are owned by the family that founded it. Many
shareholders are keen to realise their investment by selling the company to P plc.
Both companies are working towards an effective date for the sale of B3 to P plc of 1 January 2015.
Financial data for B3 for 2013
The statement of financial position of B3 as at 31 December 2013 showed the following balances:

Long term borrowings

Share capital (C$1 ordinary shares)
Reserves

C$ million
375
90
200
665

Additional information:

B3 reported an operating profit of C$ 75 million in the year ended 31 December 2013 and
declared a dividend of C$ 30 million on 20 December 2013 which was paid on
30 January 2014.
B3 pays 7% interest on long term borrowings.
The corporate income tax rate in Country C is 30%.

Forecast financial data for B3 for year 2015 onwards, following acquisition by P plc
Following consultation with the directors of B3, P plcs Finance Director has prepared the following
forecast data for B3 assuming it is acquired on 1 January 2015.
Forecast data for B3:

After tax free cash flow, ignoring synergistic benefits, of C$ 54.6 million in 2015, growing by
4% a year in perpetuity.
One-off synergistic cash flow benefit of C$ 8.0 million after tax in 2015.
After tax annual synergistic cash flow benefit, starting with C$ 5.0 million in 2016 and then
increasing by 4% a year in perpetuity.

Financial Strategy

September 2014

In any discounted cash flow analysis, cash flows should be assumed to arise at the end of the year to
which they relate.
On acquisition, B3 would be transferred to P plc free of debt because B3s lenders would only agree
to the sale on condition that their borrowings are repaid prior to the sale. After acquisition, new
borrowings would be arranged in addition to the equity investment by P plc and structured so that B3
would have approximately the same capital structure as P plc. That is, gearing (debt/debt+equity)
would be 25% based on market values. P plc would guarantee B3s new debt which can be assumed
to have the same risk profile as P plcs debt.
A proxy company has been identified which is also located in Country C and has a similar business
model to B3.
Proxy company data:

P/E ratio of 12.

Equity beta of 1.7 and debt beta of 0.4.
Gearing (debt/debt+equity) based on market values of 35%.

Country C has a risk free rate of 5% and a market premium of 4%.

Financial data for P plc
Latest data available for P plc shows:

P/E ratio of 14.

Equity beta of 1.5 and debt beta of 0.3.
Gearing (debt/debt+equity) based on market values of 25%.
P plc pays 6.2% interest on its long term borrowings.

The UK has a corporate income tax rate of 30% and uses currency GBP. The UK has the same risk
free rate and market premium as Country C.
The spot rate for C$ against GBP is, today, GBP/C$ 7.00 (that is, GBP 1 = C$ 7.00) and is not
expected to change in the foreseeable future.
Referral to the competition authorities
A competitor to B3 has raised objections about the takeover bid with Country Cs competition
authorities, claiming that the acquisition of B3 by P plc would result in P plc controlling approximately
70% of all plumbing product sales in Country C. Referral of the planned acquisition to the competition
authorities is a major set-back for P plc since it has already invested considerable time and resources
in preparing to bid for B3.

The requirement for question one is on page 11

TURN OVER
September 2014

Financial Strategy

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Financial Strategy

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September 2014

Required:
Assume you are the Finance Director of P plc. Prepare a report addressed to the Board of P plc in
which you:

(a)

Advise on:
The types of synergistic benefit that might arise from the acquisition of B3.
Possible reasons why both one-off and ongoing synergistic benefits might not be
achieved to the extent expected.
(12 marks)

(b)

(i)

Calculate a Weighted Average Cost of Capital (WACC) for use in valuing B3 based on
the proxy companys business and country risk and P plcs capital structure.
(7 marks)

(ii)

Calculate a range of values for the equity of B3 in C$ as at 1 January 2015 using the
following methods:

Asset basis.
P/E (including bootstrapping).
DCF (with and without synergistic benefits).
(11 marks)

(iii)

Advise on the validity of the valuation methods used in (b)(ii) when setting an
appropriate C$ initial offer price for the purchase of the equity of B3.
(11 marks)

(c)

Advise on the implications of the bid for B3 being referred to the Competition Authorities of
Country C.
(6 marks)

Additional marks for structure and presentation

(3 marks)
(Question One = 50 marks)

(Total for Section A = 50 marks)

End of Section A
Section B begins on page 14

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Financial Strategy

SECTION B 50 MARKS
[You are advised to spend no longer than 45 minutes on each question in this section.]

ANSWER TWO OF THE THREE QUESTIONS

Question Two
E is a company that develops computer software and is located in the eurozone. This is a fast
growing, high risk industry sector.
The company was recently listed on a major stock exchange. The EUR 1 ordinary shares are
currently quoted at EUR 3.50.
Extracts from Es recently published financial statements show the following:
EUR million
Bank borrowings
300
Share capital (EUR 1 ordinary shares)
100
Reserves
200

EUR million
Earnings for the year
50
Dividends paid in the year 30

Bank borrowings totalling EUR 200 million are due for repayment in 12 months time.
The following three alternative refinancing schemes are being considered, each with a principal of
EUR 200 million, to replace the EUR 200 million bank borrowings that are due for repayment in
12 months time:
Scheme 1. Bank borrowings
Arrange new bank borrowings for a 5 year term at an interest rate of 4.5% with interest paid annually.
Scheme 2. Public bond issue.
Issue a bond with a 5 year term and a 4% coupon paid annually.
Scheme 3. Convertible bond.
Issue a convertible bond with a 5 year term and a 3% coupon paid annually. The convertible bond
would include a conversion option of 22 ordinary EUR 1 shares per EUR 100 nominal bond at the end
of year 5. If the holder chooses not to take up the conversion option, no shares would be issued and
the principal would be repaid in full at the end of year 5.

Financial Strategy

14

September 2014

Required:
(a)

Calculate each of the following, assuming a share price at the end of year 5 of each of
EUR 4.00, EUR 5.00 and EUR 6.00:

Total interest cost for the whole 5 year term for each of refinancing schemes 1, 2 and 3.

The conversion premium in scheme 3, where conversion occurs.

The yield to maturity up to and including conversion for scheme 3.

Ignore taxation.
(11 marks)

(b)

Evaluate the potential impact on Es shareholders of choosing refinancing scheme 3 rather

than scheme 1 or 2. Your answer should include reference to your results in part (a).
(5 marks)

(c)

Advise the directors of E of factors that should be taken into account when choosing between
the refinancing schemes under consideration in addition to those considered in part (b).
(9 marks)
(Total for Question Two = 25 marks)

A REPORT FORMAT IS NOT REQUIRED FOR THIS QUESTION

TURN OVER

September 2014

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Financial Strategy

Question Three
G is a listed multinational group. The parent company is located in the USA. G manufactures
spectacles and contact lenses. Designs and technical specifications are constantly changing and
G needs to invest heavily in research and development in order to remain competitive.
G has 31 December as its financial year end. Financial data for the last 3 years is given below:
2011

2012

2013

USD million

USD million

USD million

Dividend

120

160

170

Profit/(loss) after tax

300

300

(100)

Depreciation included in profit/(loss)

100

100

120

On-going capital expenditure

160

700

300

USD 2,000 million

USD 1,820 million

USD 2,090 million

USD 4.00

USD 3.50

USD 3.00

Year to 31 December:

Data as at 31 December:
Long term borrowings
Share price
Additional information:
On 1 January 2011, G had 600 million USD 1 shares in issue.
On 1 January 2012, there was a 1 for 3 rights issue at an issue price of USD 3.20 per share.
There were no other changes to share capital in the 3 year period shown above.
Assume that depreciation is the only non-cash item included in profit/(loss) after tax above.
Over two-thirds of the shares are held by large financial institutions such as pension funds, insurance
companies and investment vehicles. The remaining shares are held by directors of the company and
private individuals.

Financial Strategy

16

September 2014

Required:
(a)

(i)

Analyse Gs dividend policy in the years 2011, 2012 and 2013 based on the data
provided. Support your answer with calculations of:

Dividend cover based on profit/(loss) after tax.

Dividend per share.

Free cash flow generated in the year (before dividend payments).

Up to 5 marks are available for calculations
(7 marks)

(ii)

(b)

Advise G on the benefits and drawbacks of the current dividend policy AND possible
alternative policies.
(9 marks)

Discuss the interrelationship between financing decisions and, investment and dividend
decisions. Illustrate your answer with reference to G.
(9 marks)
(Total for Question Three = 25 marks)

A REPORT FORMAT IS NOT REQUIRED FOR THIS QUESTION

TURN OVER

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Financial Strategy

Question Four
Company MV owns a number of motor vehicle retail showrooms in its home country, Country H. It
has grown rapidly in recent years, largely by acquiring land and building new showrooms.
The directors of MV are currently considering a number of possible sites for development to achieve
further expansion. One or more of these sites may be developed up to a maximum overall capital
budget of H$ 100 million. One of the sites being considered is located in a neighbouring country,
Country J. If selected, this would be the first showroom to be opened in a foreign country.
Four possible sites have been identified, each of which would support a certain size of showroom. It
would not be possible to change the plans so that only part of a site is developed.
Each possible site has been allocated a project name as shown below. Single period capital rationing
is to be applied when selecting projects.
Project data is given below:
Project

Initial
investment

Forecast
after tax net
cash inflow
each year for
a 10 year
period

Risk
adjustment
(to be added
to the H$
WACC)

Project net
present
value
(NPV)

Undiscounted
payback
period

Profitability
index

Project A
Project B
Project C

H$ million
50
100
75

H$ million
12
20
15

%
2.5
2.0
1.5

H$ million
33.9
49.1
39.7

Years
4.2
5.0
5.0

0.678
0.491
0.529

Project D

J$ million
80

J$ million
20

%
2.5

To be
calculated

To be
calculated

To be
calculated

Note that projects A, B and C are located in MVs home country, Country H and project D is located in
neighbouring Country J.
Additional data:

Based on its target gearing, MV has an after tax Weighted Average Cost of Capital (WACC)
of 9.5%.
The risk free rate is 2% in Country H and 4% in Country J.
The spot rate is currently H$/J$ 2.2900 (that is, H$ 1 = J$ 2.2900).
Each project has a 10 year term.
The residual value of each project at the end of its 10 year term should be assumed to be
equal to the value of the initial investment.

A separate decision has yet to be made about how best to finance the selected project or projects.

Financial Strategy

18

September 2014

Required:
(a)

Calculate the following in respect of project D:

(b)

An appropriate J$ based discount rate to use in calculating the Net Present Value
(NPV) of project Ds J$ cash flows.
The project NPV stated in terms of H$.
Undiscounted payback period.
Profitability index.
(8 marks)

Advise the directors of MV on:

(i)

The project or combination of projects which is expected to maximise shareholder wealth

based on a single period capital rationing model.
(2 marks)

(ii)

Other financial and strategic factors that should be taken into account when deciding
which project or projects to select.
(10 marks)

(c)

Discuss TWO key issues that MV should consider when deciding how best to finance a foreign
investment such as project D.
(5 marks)
(Total for Question Four = 25 marks)

A REPORT FORMAT IS NOT REQUIRED FOR THIS QUESTION

(Total for Section B = 50 marks)

End of Question Paper

Maths tables and formulae are on pages 21 to 25

September 2014

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Financial Strategy

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September 2014

MATHS TABLES AND FORMULAE

Present value table

-n

Present value of 1.00 unit of currency, that is (1 + r) where r = interest rate; n = number of periods until payment
or receipt.

Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

1%
0.990
0.980
0.971
0.961
0.951
0.942
0.933
0.923
0.914
0.905
0.896
0.887
0.879
0.870
0.861
0.853
0.844
0.836
0.828
0.820

2%
0.980
0.961
0.942
0.924
0.906
0.888
0.871
0.853
0.837
0.820
0.804
0.788
0.773
0.758
0.743
0.728
0.714
0.700
0.686
0.673

3%
0.971
0.943
0.915
0.888
0.863
0.837
0.813
0.789
0.766
0.744
0.722
0.701
0.681
0.661
0.642
0.623
0.605
0.587
0.570
0.554

4%
0.962
0.925
0.889
0.855
0.822
0.790
0.760
0.731
0.703
0.676
0.650
0.625
0.601
0.577
0.555
0.534
0.513
0.494
0.475
0.456

Interest rates (r)

5%
6%
0.952
0.943
0.907
0.890
0.864
0.840
0.823
0.792
0.784
0.747
0.746
0.705
0.711
0.665
0.677
0.627
0.645
0.592
0.614
0.558
0.585
0.527
0.557
0.497
0.530
0.469
0.505
0.442
0.481
0.417
0.458
0.394
0.436
0.371
0.416
0.350
0.396
0.331
0.377
0.312

7%
0.935
0.873
0.816
0.763
0.713
0.666
0.623
0.582
0.544
0.508
0.475
0.444
0.415
0.388
0.362
0.339
0.317
0.296
0.277
0.258

8%
0.926
0.857
0.794
0.735
0.681
0.630
0.583
0.540
0.500
0.463
0.429
0.397
0.368
0.340
0.315
0.292
0.270
0.250
0.232
0.215

9%
0.917
0.842
0.772
0.708
0.650
0.596
0.547
0.502
0.460
0.422
0.388
0.356
0.326
0.299
0.275
0.252
0.231
0.212
0.194
0.178

10%
0.909
0.826
0.751
0.683
0.621
0.564
0.513
0.467
0.424
0.386
0.350
0.319
0.290
0.263
0.239
0.218
0.198
0.180
0.164
0.149

Periods
(n)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

11%
0.901
0.812
0.731
0.659
0.593
0.535
0.482
0.434
0.391
0.352
0.317
0.286
0.258
0.232
0.209
0.188
0.170
0.153
0.138
0.124

12%
0.893
0.797
0.712
0.636
0.567
0.507
0.452
0.404
0.361
0.322
0.287
0.257
0.229
0.205
0.183
0.163
0.146
0.130
0.116
0.104

13%
0.885
0.783
0.693
0.613
0.543
0.480
0.425
0.376
0.333
0.295
0.261
0.231
0.204
0.181
0.160
0.141
0.125
0.111
0.098
0.087

14%
0.877
0.769
0.675
0.592
0.519
0.456
0.400
0.351
0.308
0.270
0.237
0.208
0.182
0.160
0.140
0.123
0.108
0.095
0.083
0.073

Interest rates (r)

15%
16%
0.870
0.862
0.756
0.743
0.658
0.641
0.572
0.552
0.497
0.476
0.432
0.410
0.376
0.354
0.327
0.305
0.284
0.263
0.247
0.227
0.215
0.195
0.187
0.168
0.163
0.145
0.141
0.125
0.123
0.108
0.107
0.093
0.093
0.080
0.081
0.069
0.070
0.060
0.061
0.051

17%
0.855
0.731
0.624
0.534
0.456
0.390
0.333
0.285
0.243
0.208
0.178
0.152
0.130
0.111
0.095
0.081
0.069
0.059
0.051
0.043

18%
0.847
0.718
0.609
0.516
0.437
0.370
0.314
0.266
0.225
0.191
0.162
0.137
0.116
0.099
0.084
0.071
0.060
0.051
0.043
0.037

19%
0.840
0.706
0.593
0.499
0.419
0.352
0.296
0.249
0.209
0.176
0.148
0.124
0.104
0.088
0.079
0.062
0.052
0.044
0.037
0.031

20%
0.833
0.694
0.579
0.482
0.402
0.335
0.279
0.233
0.194
0.162
0.135
0.112
0.093
0.078
0.065
0.054
0.045
0.038
0.031
0.026

September 2014

21

Financial Strategy

Cumulative present value of 1.00 unit of currency per annum

Receivable or Payable at the end of each year for n years

Periods
(n)
1
2
3
4
5

1(1+ r ) n
r

1%
0.990
1.970
2.941
3.902
4.853

2%
0.980
1.942
2.884
3.808
4.713

3%
0.971
1.913
2.829
3.717
4.580

4%
0.962
1.886
2.775
3.630
4.452

Interest rates (r)

5%
6%
0.952
0.943
1.859
1.833
2.723
2.673
3.546
3.465
4.329
4.212

7%
0.935
1.808
2.624
3.387
4.100

8%
0.926
1.783
2.577
3.312
3.993

9%
0.917
1.759
2.531
3.240
3.890

10%
0.909
1.736
2.487
3.170
3.791

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

11
12
13
14
15

10.368
11.255
12.134
13.004
13.865

9.787
10.575
11.348
12.106
12.849

9.253
9.954
10.635
11.296
11.938

8.760
9.385
9.986
10.563
11.118

8.306
8.863
9.394
9.899
10.380

7.887
8.384
8.853
9.295
9.712

7.499
7.943
8.358
8.745
9.108

7.139
7.536
7.904
8.244
8.559

6.805
7.161
7.487
7.786
8.061

6.495
6.814
7.103
7.367
7.606

16
17
18
19
20

14.718
15.562
16.398
17.226
18.046

13.578
14.292
14.992
15.679
16.351

12.561
13.166
13.754
14.324
14.878

11.652
12.166
12.659
13.134
13.590

10.838
11.274
11.690
12.085
12.462

10.106
10.477
10.828
11.158
11.470

9.447
9.763
10.059
10.336
10.594

8.851
9.122
9.372
9.604
9.818

8.313
8.544
8.756
8.950
9.129

7.824
8.022
8.201
8.365
8.514

11%
0.901
1.713
2.444
3.102
3.696

12%
0.893
1.690
2.402
3.037
3.605

13%
0.885
1.668
2.361
2.974
3.517

14%
0.877
1.647
2.322
2.914
3.433

Interest rates (r)

15%
16%
0.870
0.862
1.626
1.605
2.283
2.246
2.855
2.798
3.352
3.274

17%
0.855
1.585
2.210
2.743
3.199

18%
0.847
1.566
2.174
2.690
3.127

19%
0.840
1.547
2.140
2.639
3.058

20%
0.833
1.528
2.106
2.589
2.991

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

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

16
17
18
19
20

7.379
7.549
7.702
7.839
7.963

6.974
7.120
7.250
7.366
7.469

6.604
6.729
6.840
6.938
7.025

6.265
6.373
6.467
6.550
6.623

5.954
6.047
6.128
6.198
6.259

5.668
5.749
5.818
5.877
5.929

5.405
5.475
5.534
5.584
5.628

5.162
5.222
5.273
5.316
5.353

4.938
4.990
5.033
5.070
5.101

4.730
4.775
4.812
4.843
4.870

Periods
(n)
1
2
3
4
5

Financial Strategy

22

September 2014

FORMULAE
Valuation models

(i)

Irredeemable preference shares, paying a constant annual dividend, d, in perpetuity, where

P0 is the ex-div value:
d

P0 =

k pref

(ii)

Ordinary (equity) shares, paying a constant annual dividend, d, in perpetuity, where P0 is

the ex-div value:
d

P0 =

ke

(iii)

Ordinary (equity) shares, paying an annual dividend, d, growing in perpetuity at a constant

rate, g, where P0 is the ex-div value:
d1

P0 =

or

d 0 [1 + g ]

P0 =

g
ke g
Irredeemable bonds, paying annual after-tax interest, i [1 t], in perpetuity, where P0 is the
ex-interest value:
ke

(iv)

P0 =

i [1 t ]
k d net

(v)

P0 =

or, without tax:

kd

Total value of the geared entity, Vg (based on MM):

Vg = Vu + TB

(vi)

Future value of S, of a sum X, invested for n periods, compounded at r% interest:

n

S = X[1 + r]
(vii)

Present value of 100 payable or receivable in n years, discounted at r% per annum:

PV =

(viii)

[1 + r ]

Present value of an annuity of 100 per annum, receivable or payable for n years,
commencing in one year, discounted at r% per annum:
PV =

(ix)

1
1
1

n
r
[1 + r ]

Present value of 100 per annum, payable or receivable in perpetuity, commencing in one
year, discounted at r% per annum:
PV =

1
r

(x)

Present value of 100 per annum, receivable or payable, commencing in one year, growing
in perpetuity at a constant rate of g% per annum, discounted at r% per annum:
PV =

September 2014

23

1
r g

Financial Strategy

Cost of capital
(i)

Cost of irredeemable preference shares, paying an annual dividend, d, in perpetuity, and

having a current ex-div price P0:
d

kpref =

P0

(ii)

Cost of irredeemable bonds, paying annual net interest, i [1 t], and having a current exinterest price P0:
i [1 t ]

kd net =

P0

(iii)

Cost of ordinary (equity) shares, paying an annual dividend, d, in perpetuity, and having a
current ex-div price P0:
d

ke =

P0

(iv)

Cost of ordinary (equity) shares, having a current ex-div price, P0, having just paid a
dividend, d0, with the dividend growing in perpetuity by a constant g% per annum:
ke =

d1

+g

or

ke =

d 0 [1 + g ]

P0

(v)

+g

P0

Cost of ordinary (equity) shares, using the CAPM:

ke = Rf + [Rm Rf]

(vi)

Cost of ordinary (equity) share capital in a geared entity :

VD [1 t ]
VE

keg = keu + [keu kd]

(vii)

Weighted average cost of capital, k0 or WACC

WACC = ke

(viii)

VE
VD

+ k d [1 t ]

VE + VD
VE + VD

Adjusted cost of capital (MM formula):

Kadj = keu [1 tL]

(ix)

VD [1 t ]
VE
V + V [1 t ] + d

VE + VD [1 t ]
D

Regear :
g = u + [u d]

(xi)

r* = r[1 T*L]

Ungear :
u = g

(x)

or

VD [1 t ]
VE

Adjusted discount rate to use in international capital budgeting (International Fisher effect)
1 + annual discount rate B$
1 + annual discount rate A$

Future spot rate A$/B$ in 12 months' time

Spot rate A$/B$

where A$/B$ is the number of B$ to each A$

Financial Strategy

24

September 2014

Other formulae

(i) Expectations theory:

Future spot rate A$/B$ = Spot rate A$/B$ x

1 + nominal countryB interest rate

1 + nominal countryA interest rate

where:
A$/B$ is the number of B$ to each A$, and
A$ is the currency of country A and B$ is the currency of country B
(ii) Purchasing power parity (law of one price):
Future spot rate A$B$ = Spot rate A$/B$ x

1 + countryB inflation rate

1 + countryA inflation rate

(iii) Link between nominal (money) and real interest rates:

[1 + nominal (money) rate] = [1 + real interest rate][1 + inflation rate]
(iv) Equivalent annual cost:
Equivalent annual cost =

PV of costs over n years

n year annuity factor

(v) Theoretical ex-rights price:

TERP =

1
N +1

[(N x cum rights price) + issue price]

(vi) Value of a right:

Theoretica l ex rights price issue price
N

where N = number of rights required to buy one share.

September 2014

25

Financial Strategy

This page is blank

Financial Strategy

26

September 2014

LIST OF VERBS USED IN THE QUESTION REQUIREMENTS

A list of the learning objectives and verbs that appear in the syllabus and in the question requirements for
each question in this paper.

It is important that you answer the question according to the definition of the verb.
LEARNING OBJECTIVE
Level 1 - KNOWLEDGE
What you are expected to know.

Level 2 - COMPREHENSION
What you are expected to understand.

VERBS USED

DEFINITION

List
State
Define

Make a list of
Express, fully or clearly, the details/facts of
Give the exact meaning of

Describe
Distinguish
Explain

Communicate the key features

Highlight the differences between
Make clear or intelligible/State the meaning or
purpose of
Recognise, establish or select after
consideration
Use an example to describe or explain

Identify
Illustrate

something
Level 3 - APPLICATION
How you are expected to apply your knowledge.

Apply
Calculate/compute
Demonstrate
Prepare
Reconcile
Solve
Tabulate

Level 4 - ANALYSIS
How are you expected to analyse the detail of
what you have learned.

Level 5 - EVALUATION
How are you expected to use your learning to
evaluate, make decisions or recommendations.

September 2014

Analyse
Categorise
Compare and contrast

Put to practical use

Ascertain or reckon mathematically
Prove with certainty or to exhibit by
practical means
Make or get ready for use
Make or prove consistent/compatible
Find an answer to
Arrange in a table

Construct
Discuss
Interpret
Prioritise
Produce

Examine in detail the structure of

Place into a defined class or division
Show the similarities and/or differences
between
Build up or compile
Examine in detail by argument
Translate into intelligible or familiar terms
Place in order of priority or sequence for action
Create or bring into existence

Advise
Evaluate
Recommend

Counsel, inform or notify

Appraise or assess the value of
Advise on a course of action

27

Financial Strategy

Financial Pillar

Strategic Level Paper

F3 Financial Strategy

September 2014

Saturday

Financial Strategy

28

September 2014