ACCA F9 Financial Management - 2010 - Study text - Emile Woolf Publishing
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(2) If cash flows occur at a constant rate throughout the year:
Project A will pay back after 2 years + [(24,000/36,000) × 12 months]
= 2 years 8 months.
Project B will pay back after 1 year + [(20,000/24,000) × 12 months]
= 1 year 10 months.
(3) Both projects meet the policy requirement that investments must pay back
within three years. The preferred choice would be project B, which pays back
more quickly.
(4) However, an investment decision should not be made on the basis of payback
alone. Payback ignores the total expected returns from a project. In this
example, project A is expected to be more profitable over its full life.
In addition, payback method ignores the time value of money.
Chapter 8: Discounted cash flow
Exercise 1
To obtain an investment of $125,000 after 5 years, the investor would need to invest
now:
$125,000 ×
1
1.08
()
5
= $125,000 × 0.6806
= $85,075
Exercise 2
Costofcapital12% Costofcapital8%
Year
Cash
flow
Discount
factorat
12%
PV
Discount
factorat
8%
PV
$ $ $
0 (70,000+5,000) (75,000) 1.000 (75,000) 1.000 (75,000)
1 25,000 0.893 22,325 0.926 23,150
2 20,000 0.797 15,940 0.857 17,140
3 30,000 0.712 21,360 0.794 23,820
4 20,000 0.636 12,720 0.735 14,700
5 (3,000+7,000+ 5,000) 15,000 0.567 8,505 0.681 10,215
NPV +5,850 +14,025
Exercise 3
Annuityfactorat8%,years1–10 6.710
Annuityfactorat8%,years1–5 3.993
Thereforeannuityfactorat8%,years6–10 2.717
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Year Annualcash
flow
Discountfactorat
8%
Present
value
$ $
0 (70,000) 1.000 (70,000)
1–5 15,000 3.993 59,895
6–10 10,000 2.717 27,170
NPV +17,065
Exercise 4
The year 5 value of an annuity of $80,000 per year in perpetuity, at a discount factor
of 12%:
= $80,000/0.12 = $666,667.
Year Annualcash
flow
Discountfactorat
12%
Present
value
$ $
0 (800,000) 1.000 (800,000)
1–5 100,000 3.605 360,500
5 666,667 0.567 378,000
NPV (61,500)
At a cost of capital of 12%, the investment has a negative NPV and should not be
undertaken.
Chapter 9: DCF: taxation and inflation
Exercise 1
Workings
Tax allowances on the investment
Yearofclaim Taxsaving
(30%ofallowance)
Cashflow
year
$ $
Cost 120,000
0 Allowance(25%) (30,000) 9,000 1
90,000
1 Allowance(25%) (22,500) 6,750 2
67,500
2 Allowance(25%) (16,875) 5,063 3
50,625
3 Allowance(25%) (12,656) 3,797 4
37,969
4 Disposal (45,000)
Balancingcharge (7,031) (2,109) 5
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NPV calculation
Year 0 1 2 3 4 5
$ $ $ $ $ $
Capitalequipment (120,000) 45,000
Savingsbeforetax50,000 50,000 50,000 50,000
Taxonsavings(30%)(15,000) (15,000) (15,000) (15,000)
Casheffectofallowances 9,000 6,750 5,063 3,797 (2,109)
––––––––
–
–––––
–
–––––
–
–––––– ––––––– –––––––
Netcashflow (120,000) 59,000 41,750 40,063 83,797 (17,109)
DCFfactorat11% 1.000 0.901 0.812 0.731 0.659 0.593
PVofcashflow (120,000) 53,159 33,901 29,286 55,222 (10,146)
––––––––
–
–––––
–
–––––
–
–––––– ––––––– –––––––
NPV +41,422
––––––––
The NPV is + $41,422. This indicates that the project should be undertaken.
Exercise 2
Cash flows with inflation
Year
Machine Revenue Costs
Netcash
flow
DCFfactor
at16% PV
$ $ $ $ $
0 (200,000) (200,000) 1.000 (200,000)
1214,000 (112,000) 102,000 0.862 87,924
2228,980 (125,440) 103,540 0.743 76,930
3306,261 (175,616) 130,645 0.641 83,743
4196,619 (118,014) 78,605 0.552 43,390
5 25,526 140,255 (88,117) 77,664 0.476 36,968
+128,955
Chapter 10: DCF: risk and uncertainty
Exercise 1
Discount
factorat
10%
Strongeconomy
Probability0.75
Weakeconomy
Probability0.25
YearCashflow PV Cashflow PV
$ $ $ $
0 1.000 (1,000,000) (1,000,000) (1,000,000) (1,000,000)
1 0.909 400,000 363,600 100,000 90,900
2 0.826 600,000 495,600 300,000 247,800
3 0.751 400,000 300,400 200,000 150,200
4 0.683 300,000 204,900 50,000 34,150
NPV 364,500 (476,950)
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Expected value of the NPV
= (0.75 × $364,500) + (0.25 × $(476,950))
= + $154,138.
Using the EV of NPV as the basis for making the investment decision, the project
should be undertaken.
However, there is a 25% risk that the NPV will be negative.
Chapter 11: Capital investment appraisal: further aspects
Exercise 1
(a) Replace every year
Year
Cash
flow
Discount
factorat
12%
PV
$ $
0 Purchasecost (30,000) 1.000 (30,000)
1 Runningcosts 4,000
1 Disposalvalue 15,000
1 Netcashflow,Year1 11,000 0.893 9,823
(20,177)
Annuityfactorat12%,Year10.893
Equivalentannualcost$(22,595)
(b) Replace every two years
Year
Cash
flow
Discount
factorat
12%
PV
$ $
0 Purchasecost (30,000) 1.000 (30,000)
1 Runningcosts (4,000) 0.893 (3,572)
2 Runningcosts (5,000)
2 Disposalvalue 10,000
2 Netcashflow,Year2 5,000 0.797 3,985
(29,587)
Annuityfactorat12%,Years1–2 1.690
Equivalentannualcost$(17,507)
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(c) Replace every three years
Year
Cash
flow
Discount
factorat
12%
PV
$ $
0 Purchasecost (30,000) 1.000 (30,000)
1 Runningcosts (4,000) 0.893 (3,572)
2 Runningcosts (5,000) 0.797 (3,985)
3 Runningcosts (6,500)
3 Disposalvalue 6,000
3 Netcashflow,Year3 (500) 0.712 (356)
(37,913)
Annuityfactorat12%,Years1–3 2.402
Equivalentannualcost $(15,784)
(d)
Replace every four years
Year
Cash
flow
Discount
factorat
12%
PV
$ $
0 Purchasecost (30,000) 1.000 (30,000)
1 Runningcosts (4,000) 0.893 (3,572)
2 Runningcosts (5,000) 0.797 (3,985)
3 Runningcosts (6,500) 0.712 (4,628)
4 Runningcosts (8,000)
4 Disposalvalue 1,000
4 Netcashflow,Year4 (7,000) 0.636 (4,452)
(46,637)
Annuityfactorat12%,Years1–4 3.037
Equivalentannualcost$(15,356)
Recommendation
The machine should be replaced every four years, because this replacement policy
gives the lowest equivalent annual cost.
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Chapter 14: Capital structure
Exercise 1
$ $ %increase
Sales 800,000 1,000,000 +25%
Variablecosts 200,000 250,000
Fixedcosts 400,000 400,000
Totalcosts 600,000 650,000
Profitbeforeinterestand
tax
200,000 350,000 +75%
Interest($1,200,000x10%) 120,000 120,000
Profitbeforetax 80,000 230,000
Taxat40% 32,000 92,000
Earnings 48,000 138,000 +187.5%
Numberofshares 800,000 800,000
EPS $0.06 $0.1725 +187.5%
(a) Operational gearing
=
75%
25%
= 3.0
(b) Financial gearing
=
187.5%
75%
= 2.5
(c) Combined gearing
=
187.5%
25%
= 7.5
(d) Operational gearing x Financial gearing = Combined gearing
3.0 × 2.5 = 7.5
An increase of 1% in sales will result in an increase in EPS of 7.5%, because of
the effects of operational and financial gearing.
Chapter 16: Cost of capital
Exercise 1
Value of the convertible bond if it is expected to convert the bonds into shares
Year
Amount
Discount
factorat6%
Present
value
$ $
1 Interest 4.00 0.943 3.77
2 Interest 4.00 0.890 3.56
2 Sharevalue(25×$4.25) 106.25 0.890 94.56
101.89
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Value of the convertible bond if not converted into shares
Year
Amount
Discount
factorat6%
Present
value
$ $
1 Interest 4 0.943 3.77
2 Interest 4 0.890 3.56
3 Interest 4 0.840 3.36
4 Interestandcapitalredemption 104 0.792 82.37
93.06
The value of the convertible bond will be 101.78, in the expectation that the bonds
will be converted into shares when the opportunity arises.
Exercise 2
Marketvalue Cost Marketvaluexcost
$m $m
Equit
y
80 10% 8.0
Debt 20 5% 1.0
100 9.0
WACC = (9/100) × 100% = 9%.
Ignoring corporate taxation, Modigliani and Miller argued that the WACC at all
levels of gearing is the same (9%), and the market value of the company is also the
same, $100 million.
If debt in increased to $40 million and equity is replaced by the increase in debt
capital, the total market value will remain at $100 million. The market value of
equity = Total value – Value of debt = $100 million – $40 million = $60 million.
New cost of equity = 9% + 40/60 [9% - 5%]
= 9% + 2.67%
= 11.67%.
Chapter 19: Foreign exchange risk
Exercise 1
(a) The French company will be given the more unfavourable rate for selling
Australian dollars, 1.5240.
It will receive 7,000/1.5240 = €4,593.18.
(b) The Australian company needs to buy euros and will be given the more
unfavourable rate, which is 1.5240. The cost will be Aus$18,288 (12,000 ×
1.5240).
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Exercise 2
The company will be given the more unfavourable rate, 11.2470 + discount 0.0340 =
11.2810.
Cost of Mexican pesos = 10,000,000/11.2810 = US$886,446.24.
Exercise 3
US$1 = SwFR 1.2166
£1 = US1.8610
Therefore £1 = (1.2166 × 1.8610) = SwFr 2.2641.
Chapter 20: Interest rate risk
Exercise 1
It needs a 2v5 FRA.
It needs to borrow, therefore the FRA bank will quote the higher rate, 3.67%.
If three-month LIBOR is 4.5% on the fixing date for the FRA, the FRA bank will pay
the equivalent of (4.5% - 3.67%) = 0.83%.
%
Three‐monthborrowingrate(4.5%+50basis
points)
5.00
Less:settlementreceivedinFRAagreement (0.83)
Effectiveborrowingrate 4.17
This is the same as the FRA rate of 3.67% + the basis points borrowing margin
= 3.67% + 0.50% = 4.17%.
Exercise 2
Since the company wants to swap to net floating rate payments, it will receive the
fixed rate in the swap. The bank will quote the lower of the two rates (the less
favourable to its customer).
%
Costofbonds (5.00)
Swap
Receive 4.22
Pay (LIBOR)
Neteffectiveinterestcost (LIBOR+0.78)
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Paper F9
Financial management
Q&A
Practice questions
Contents
Page
The financial management function and
environment
1 Equity ratios 446
2 Corporate governance 446
Working capital management
3 Cash operating cycle 446
4 Working capital 447
5 Inventory management 448
6 Trade receivables management 449
7 Discount and factor 449
8 Baumol and Miller-Orr 450
Investment appraisal
9 Appraisal 450
10 Investment appraisal methods 451
11 NPV 452
12 DCF and relevant costs 452
13 Annuities and perpetuities 453
14 Investment appraisal and tax 453
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15 More investment appraisal and tax 454
16 Investment appraisal and inflation 455
17 DCF exercises 455
18 DCF and tax 456
19 Risk in investment appraisal 457
20 Lease or buy 457
21 Asset replacement 458
22 Capital rationing 459
Business finance, cost of capital and
business valuations
23 Misteri Company 459
24 Valuation model 460
25 Rights 460
26 Rights issue 461
27 Convertible bonds 461
28 Warrants and convertibles 462
29 Gearing 463
30 Financial and operating gearing 464
31 Financing schemes 464
32 Free cash flow 466
33 Valuation 466
34 Valuation of bonds 466
35 Annuities and bond prices 467
36 Efficient markets 467
37 WACC 468
38 Optimal WACC 468
39 MM, gearing and company valuation 469
40 Geared beta 469
41 Diversify 469
42 Acquisition 469