Strategic Level Exams E3, P3, F3 – May 2010

Exam focus – May 2010 Strategic level exams and the new pre-seen case study

Doug Haste and Dave Halford analyse the pre-seen case study for the May 2010 Strategic
level exams from the viewpoint of each of the three papers (E3, F3 and P3)

It won’t have escaped your notice that CIMA have introduced a new pre-seen case study for
the May 2010 Strategic level exams which will form the basis for the 50 mark Section A
question in each of the three Strategic level papers (E3, F3 and P3).

This article explores the purpose of the pre-seen case material and analyses the May 2010
pre-seen from the perspective of each of the Strategic level papers, before concluding with
guidance on how to prepare for the Section A question and what to expect in the real exam.

The full text of the pre-seen case material can be found at

www.cimaglobal.com/strategicpreseen. You will need to read this before reading this article.

Purpose of the pre-seen case study material

It is very important that you understand that CIMA do not expect significant amounts of
your time to be tied up in researching the industry featured in the case study. This can
wait until the next stage of your exams – the T4 Part B Case Study exam.

If CIMA had expected detailed analysis before the exam, they would have made the case
study easier to research. In this case study, the industry concerned is only described in very
general terms as electronic components, and the company is based in a fictional country.
Also, you would have been given access to the pre-seen material much earlier than 6 weeks
before the exam, which deliberately restricts the amount of time you have to research the pre-
seen.

By introducing a case study element to your exam, CIMA are challenging you to demonstrate
that you can apply your technical knowledge to a practical scenario. Under the old syllabus
the practical scenario was only revealed on the day of the real exam. By giving you a pre-
seen case study, CIMA aim to ensure that no candidate is put at an advantage or
disadvantage by their level of familiarity with the industry involved in the practical
scenario. All candidates will now have time to ensure that they have a basic understanding
of the main issues involved in the case study, before walking into the exam.

Understanding the main issues from an F3 Financial Strategy Exam perspective

We are provided with some financial data for Aybe that will potentially be developed in the
unseen case material for the Section A question. This can be analysed as follows:

2009 2008 2007 2006 2005

Revenue (% growth) 3% 26% 10% 20%
Operating profit (% growth) 5% 11% 75% 54%
Operating profit margin 6.6% 6.5% 7.4% 4.6% 3.6%

Net profit margin (% revenue) 3.7% 3.5% 3.4% 2.1% 1.4%

Earnings growth 9% 31% 78% 79%
Average earnings growth p.a.
over 4 years 2005-2009 46%
th
(4 root of 0.128/0.028 -1)
Dividend payout (% earnings) 50% 50% 0 0 0
Dividend growth 10% n/a 0 0 0
P/E ratio (share price 0.64/eps) 5

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Strategic Level Exams E3, P3, F3 – May 2010

We are also told that Aybe’s bank has imposed an overdraft limit of C$10 million and two
covenants:
(i) that it’s interest cover must not fall below 5 and
(ii) it’s ratio of non-current liabilities to equity must not increase beyond 0·75:1.

Currently its performance in respect of these is not a concern:

Interest cover (operating profit / interest) 41/4 = 10.25

Non-current liabilities to (using book value of 40 /110 = 36%
equity equity)*
Overdraft C$4m
* the market value of equity could also be used and gives a similar result 40/(180x0.64) = 35%

The current financial objectives (dividend payout 50%, no new equity shares for 5 years) are
designed to ensure that funds are returned to shareholders after a number of years of zero
dividends.

What does this tell us about Aybe? We cannot say for sure until we see the real exam which
will give a more up to date picture, but a preliminary view would indicate the following:

• Aybe has achieved average earnings growth of 46% per annum;

• Earnings and revenue have slowed down in 2009 and there are concerns for 2010;
• Aybe has financial constraints due to its objectives (dividend and share issues) and
its overdraft limit and loan covenants;
• Dividends have only recently recommenced after a succession of years where
dividends have not been paid;
• Working capital ratios (not shown) indicate that receivables, payables and inventory
all look under control.

We are then told that Aybe’s strategic aims include achieving improved growth and
profitability (important to the institutional shareholders who own 55% of the company) and
expansion into overseas markets.

Potential issues for Aybe could therefore include:

• Acquisition of a business (domestic or more likely overseas);

• Investment appraisal of a project in Country C or overseas;
• The financing implications of the above investments;
• The risk implications of the above investments (political, economic, financial,
exchange rate);
• Post completion audit;
• Real options;
• Broader strategic implications of the investment decision;
• The impact of any of the above on key financial ratios;
• Valuation of the company to advise on a sell-off /demerger / MBO;
• Forecasting to advise on whether corporate objectives will be hit in 2010 and possible
control action required.

Note: it is possible to calculate a cost of equity from the pre-seen data using the dividend
D1
growth formula Ke
= +g
P0

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Strategic Level Exams E3, P3, F3 – May 2010

Dividend growth from 2008-09 = 10.3% so the cost of equity = 21.3% ((0.064 × 1.103/0.64) +
0.103).

This could be used in a weighted average cost of capital calculation or in a business valuation
calculation. However, you should note that this cost of equity is unlikely to be an accurate
figure unless the dividend growth rate is maintainable, which looks unlikely given the fears for
profits in 2010.

Understanding the main issues from an E3 Enterprise Strategy Exam perspective

We are told that Aybe currently pursue a Rational Model approach to strategy, but that its
institutional investors are disappointed with its recent performance and that some members of
the Board are concerned about the slow growth of the company.

This may be caused in part by the functional structure of Aybe which was criticised in an
external consultant’s report which Aybe has chosen to ignore. Alternatively, perhaps the very
proactive approach towards business ethics is holding back the company in some way? Put
all this together with the company’s acknowledged weakness in e-commerce and proposed
move into manufacturing in Asia, and the following E3 syllabus areas spring to mind:

• Alternative approaches to strategy – emergent strategies

• Stakeholder management – how to manage different stakeholders affected by
strategic change
• Change management – how to manage and implement strategic change
• Strategic choices and evaluation – applying the Suitable, Acceptable and Feasible
framework
• Implementing ecommerce – assessing its strategic benefits
• Organisational structures – moving towards a divisional structure
• Ethical conflict – advising on the difference between ethics and CSR, and how ethics
impacts upon both the company and the accountant in business

From an E3 perspective, it’s always worth remembering that the examiner is more interested
in what you can do, not what you know. By this we mean you must be able to apply any
relevant theories to Aybe and its particular circumstance as outlined on the day of the real
exam. Any generic lists of the advantages and disadvantages of an e-commerce strategy,
without reference to Aybe’s business model specifically, will score well under half marks.
Equally, ensure that you understand and apply the CIMA verbs correctly. Discuss / explain /
evaluate etc, does not mean ‘produce a list of poorly explained observations unrelated to the
scenario at hand’.

Understanding the main issues from a P3 Performance Strategy Exam perspective

The pre-seen outlines a number of current and potential risk and control issues that may be
further explored in the unseen to follow. These include:

• Management accounting controls – the company has a history of large capital

overspends. It is likely that in the near future investments in overseas factories and
IT systems will occur and these must be managed within the constraints imposed by
Aybe’s bank (see F3 perspective above).
• Financial risk – the company buys and sells overseas and is therefore likely to have
some currency transaction and translation risks. Advice on a range of hedging
techniques, including derivatives, may be required, especially in light of the proposed
Asian factory development. Furthermore, with some clients not renewing contracts
and becoming more demanding, there is the possibility of severe financial pressure in
2010.
• Operational risks – Aybe has over ½ million customers in 20 countries and carries
over 100,000 inventory items, so the chances of something going wrong are
extremely high.

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Strategic Level Exams E3, P3, F3 – May 2010

• International risks – trading in 20 different countries exposes Aybe to a multitude of

credit, legal, cultural and political risks.
• Corporate governance – the company does not appear to have any corporate
governance concerns, given that it has a full compliment of NED’s and a functioning
audit committee. However, the executive directors are heavily invested in the
company and, rather strangely, the Chief Internal Auditor reports directly to the
Finance Director.
• Reputational risk – Aybe’s strong stance on business ethics means that it stands to
suffer some brand damage if any unethical practices come to light in the unseen.
• Technology risks – the current systems seem a little dated, and there is a significant
degree of risk associated with the design and implementation of any new IT system.

When dealing with any risks and controls in the unseen it is essential that you display a lot of
application. By this we mean explaining why something is a risk to Aybe (by illustrating
the potential consequences of inaction), and how a control will work (i.e. how it will control /
reduce / eliminate / transfer a risk).

What to expect on the day of the exam

We would strongly advise candidates to review the specimen examination papers to see
the extent to which knowledge and analysis of the pre-seen was important. These are
available at:
http://www.cimaglobal.com/Students/2010-professional-qualification/Strategic-level/E3-study-
resources/Sample-exam-papers/
http://www.cimaglobal.com/Students/2010-professional-qualification/Strategic-level/F3-study-
resources/Sample-exam-papers/
http://www.cimaglobal.com/Students/2010-professional-qualification/Strategic-level/P3-study-
resources/Sample-exam-papers/

You should see that in the specimen examination paper (for all strategic level papers) the
main challenge was in dealing with the new information supplied on the day of the exam.

Good luck in your final preparations. Remember that your preparation should focus on
preparing for the whole exam, and should not be dominated by over-researching the
pre-seen case study material.

Doug Haste and Dave Halford are education specialists working at BPP.