Financial

Management (FM)
March/July 2020
Detailed
commentary
The aim of this commentary is to provide constructive
guidance for future candidates and their tutors by
giving insight into what markers are looking for and
identifying issues encountered by candidates who sat
these questions.

Contents
General comments ............................................................... 2
Pumice Co ........................................................................... 2
LaForge Co .......................................................................... 3

Examiner’s report – FM March/July 2020 1

General comments

This detailed commentary should be used in conjunction with the published

March/July 2020 sample exam which can be found on the ACCA website.

Pumice Co

(a)(i) The requirement here was for candidates to prepare a forecast statement of
financial position (SFP) resulting from an expansion of business. Many answers
gained good marks here.

The question contained the current SFP which candidates could use as a template
for their answer, and most did so. The question gave forecast working capital ratios
and other information that allowed candidates to calculate forecast credit sales, cost
of sales, inventory, trade receivables, trade payables, reserves, non-current assets
and non-current liabilities. Forecast cash and overdraft balances were provided.
Some candidates incorrectly used current SFP values in their forecast SFP, such as
inventory or trade receivables. A number of candidates were not aware that forecast
profit after tax would increase forecast reserves, while some candidates classed an
issue of loan notes as an increase in equity. Occasionally, ignoring the information
provided in the question, candidates used 365 days when 360 days was specified.

(a)(ii) This requirement was for candidates to calculate the effect of the expansion of
business on three working capital ratios listed by the finance director. Answers here
tended to gain lower marks than in the first part of this question.

Calculating the effect of the expansion of business meant that before and after
values of the identified ratios were required. Some candidates wasted valuable exam
time by calculating working capital ratios not listed by the finance director, such as
inventory turnover period and trade receivables collection period, for which no credit
could be given. Most candidates made a good attempt at calculating the trade
payables payment period and the current ratio, although some candidates only gave
values for before, or only for after, when both values were required. The ratio that
tended to cause candidates difficulty was the revenue/net working capital ratio, even
though net working capital was defined in the question. Although provided with this
definition, some candidates calculated net working capital incorrectly. Although
asked for revenue/net working capital, some candidates calculated net working
capital/revenue, occasionally as a percentage. Where a definition is provided in an
exam question, candidates must use it.

A point that must be strongly emphasised is that the verb used in the requirement
here was ‘calculate’. Some candidates discussed their calculated ratios, often at
length, and markers could give no credit to these discussions as the requirement,
clearly stated, was ‘calculate’. To gain marks, candidates must meet the question
requirement.

(b)(i) The requirement here was for a discussion of ways in which implementing the
proposed changes in working capital represented changes in working capital
investment policy. Many answers struggled to gain good marks.

Examiner’s report – FM March/July 2020 2

One reason for the lower marks here was that many candidates struggled to
differentiate between working capital investment policy (about the level of investment
in current assets) and working capital funding policy (about how working capital is
funded), to the extent that some candidates discussed working capital funding policy
here, instead of working capital investment policy. Candidates must learn to
differentiate between these two policy areas, even though the terms aggressive,
conservative and moderate are used in both. In working capital investment policy,
‘aggressive’ refers to a lower level of investment in current assets than a comparable
company, while in working capital funding policy, ‘aggressive’ means preferring
short-term funding when financing fluctuating current assets and permanent current
assets.

Many candidates did not recognise that working capital ratios such as revenue/net
working capital could offer insight into working capital investment policy.

(b)(ii) The requirement here was for a discussion of ways in which implementing the
proposed changes in working capital represented changes in working capital funding
policy. Answers here tended to gain higher marks that in part (b)(i), perhaps because
candidates were on more familiar ground. However, discussions of working capital
funding policy tended to be more technical than required, given that the requirement
was to consider the proposed changes in working capital attendant on the proposed
expansion of business. A number of candidates correctly recognised that issuing
loan notes to finance the expansion meant increased reliance on long-term finance,
while reducing the overdraft and the trade payables payment period represented
decreased reliance on short-term finance; these changes represented movement to
a more conservative funding policy.

LaForge Co

(a)(i) Candidates were required here to calculate the theoretical ex-rights price per
share. Many candidates gained good marks here, the only persistent error being
errors with the form of the rights issue. Some candidates used a 1 for 1 weighting,
which is heavily at odds with the amount of finance required, since a 1 for 1 issue
would raise 70m x $1.82 = $127.4m, five times the $25.48m required.

(a)(ii) The requirement here was for candidates to calculate the value of a right per
existing share and many candidates gained good marks here too. There are several
ways to arrive at a figure of $0.13 per existing share and all were given credit. Some
candidates offered a value of $0.65 but this was the value per new share, rather than
the value per existing share.

(b)(i) Candidates were required to calculate the forecast earnings per share (EPS)
and the resulting share price if finance is raised by a rights issue. Some candidates
struggled to gain good marks here.

Many candidates experienced difficulty calculating the forecast profit after tax (PAT).
A common approach was to use the after-tax value of the increased profit from
operations as the forecast PAT, but this approach overstated the forecast PAT by
ignoring existing finance costs, which were $16.56m/0.8 = $20.7m - $25.50m =
$4.8m. The suggested answer avoids calculating this figure by amending the existing
PAT (which is given in the question) for the after-tax effect of the increased profit
from operations. A further problem here was that some answers did not use the

Examiner’s report – FM March/July 2020 3

increased number of shares following the rights issue when calculating the EPS.
Most candidates’ calculations showed an understanding of the price/earnings ratio
(PER) valuation method, where a share price can be calculated by multiplying EPS
by PER.

(b)(ii) Candidates were required here to calculate the forecast EPS and the resulting
share price if finance is raised by an issue of loan notes. Some candidates found it
difficult to gain good marks here.

While many candidates calculated the finance cost of the proposed issue of loan
notes, existing finance costs were again often ignored. Many answers then gained
subsequent marks under the own figure rule, which awards marks for correct method
even when an earlier error has made the figures incorrect.

(c) Candidates were asked here to discuss the ways in which a company can issue
new equity shares. Candidates tended to struggle to gain marks here.

Better answers discussed rights issue, placing, public offer and initial public offer as
ways of issuing new equity shares, which are the methods of raising equity finance
given in the Financial Management Syllabus and Study Guide. Many answers were
very brief for the marks on offer, with some adopting a bullet-point approach which
did not satisfy the question requirement for discussion.

(d) This part of the question required candidates to discuss and recommend whether
finance should be raised by reducing the annual dividend. Surprisingly, many
candidates struggled to gain good marks here.

One problem was the approach adopted by some candidates of discussing, often at
length, the views of Miller and Modigliani on dividend policy. Given the listed status
of the company in question, such a discussion would only be of marginal interest to
the dividend reduction decision. A dividend relevance approach was needed, and
better answers discussed the signalling effect, the needs of dividend clienteles, and
shareholders’ liquidity preference, as in the suggested answer. Few candidates
recognised that cutting a dividend of $0.08 x 70m = $5.6m would generate only part
of the finance required by the company, although it would reduce the amount of
external finance needed to be raised. As in the previous part-question, many
answers were very brief for the marks on offer, and often employed a bullet-point
approach which did not meet the requirement for discussion. Surprisingly, even
though it was part of the requirement, few candidates made a recommendation on
whether the dividend should be cut.

Examiner’s report – FM March/July 2020 4