ACCA F9 Financial Management - 2010 - Study text

Подождите немного. Документ загружается.

Paper F9

Financial management

Q&A



Answers to practice

questions

Contents

 Page

The financial management function and

environment



1 Equity ratios 478

2 Corporate governance 478

Working capital management

3 Cash operating cycle 479

4 Working capital 480

5 Inventory management 482

6 Trade receivables management 483

7 Discount and factor 484

8 Baumol and Miller-Orr 485

Capital investment appraisal

9 Appraisal 485

10 Investment appraisal methods 486

11 NPV 488

12 DCF and relevant costs 489

13 Annuities and perpetuities 489

14 Investment appraisal and tax 491

Paper F9: Financial management

476 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

15 More investment appraisal and tax 492

16 Investment appraisal and inflation 493

17 DCF exercises 494

18 DCF and tax 495

19 Risk in investment appraisal 496

20 Lease or buy 497

21 Asset replacement 499

22 Capital rationing 500

Business finance, cost of capital and

business valuations

23 Misteri Company 501

24 Valuation model 503

25 Rights 503

26 Rights issue 503

27 Convertible bonds 505

28 Warrants and convertibles 505

29 Gearing 506

30 Financial and operating gearing 507

31 Financing schemes 508

32 Free cash flow 509

33 Valuation 510

34 Valuation of bonds 510

35 Annuities and bond prices 511

36 Efficient markets 512

37 WACC 512

38 Optimal WACC 512

39 MM, gearing and company valuation 513

40 Geared beta 514

41 Diversify 515

42 Acquisition 515

Answers to practice questions

Risk management

43 Interest rate parity 517

44 Foreign exchange 517

45 Money market hedge 517

46 Dunborgen 518

47 FRA 518

48 Swap 519

49 Credit arbitrage 520

50 Currency futures 520

Paper F9: Financial management

478 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

1 Equity ratios

Earningspershare(EPS) $

Profitbeforeinterestandtax 600,000

Interest(10%×$250,000) 25,000

Profitbeforetax 575,000

Tax(30%) 172,500

Profitavailabletoequity(earnings) 402,500



Numberofequityshares 1,000,000

EPS $0.4025

This is a measure of the profit per equity share.

P/E ratio =

$3.20

$0.4025

= 7.95 times

Dividend yield =

$0.20

$3.20

×100% = 6.25%

Dividend cover =

$0.4025

$0.20

= 2.01 times

This shows that approximately 50% of the earnings for the year have been paid out

as dividends and the remainder reinvested in the company.

Interest yield on debentures =

$10

$90

×100% =11.1%

Gearing based on market values =

$250,000 ×

100

⎛

⎝

⎜

⎞

⎠

⎟

1,000,000 × $3.20

100%

Gearing based on market values =

$225,000

$32 million

×100% = 7.03%

Note:

Gearing could also be measured as market value of debt capital as a % of total

market capitalisation (equity + debt). It would then be

$225,000

$32, 225, 000

= 6.98%

2 Corporate governance

(a) The main aim of a code of corporate governance should be to ensure that the

directors or managers of a company should run the company in the interests

of its shareholders.

(b) The main issues in corporate governance, for both statutory and voluntary

codes, are likely to be:

Answers to practice questions

(i) the composition of the board of directors: achieving a balance of skills

and experience, preventing the board from being dominated by one

individual or a small group of individuals, the role of non-executive

directors (and in particular independent non-executive director)

(ii) the decision-making responsibilities of the board (and how much

decision-making responsibility should be delegated to management)

(iii) the process of nominating new directors for appointment to the board

(iv) the process of deciding the remuneration of directors, and trying to

ensure that remuneration systems reward directors for success and do

not reward them for failure

(v) the reliability of financial reporting, the independence of the external

auditors, and the role of the audit committee

(vi) communications between a company and its shareholders

(vii) risk management and internal control, and the review of internal control

and risk management systems

(viii) restricting the scope for insider trading or market abuse.

Corporate social responsibility and protection for whistle-blowers could also

be added to this list.

3 Cash operating cycle

(a) Working capital cycle:



Year1 Year2Year3

 days days days

Rawmaterialsinventorycycle



(Rawmaterials/Purchases)×365days 76 76 91

MinusCreditfromsuppliers



(Tradepayables/Purchases)×365days (61) (55) (64)

 15 21 27

Productioncycle



(Work‐in‐progress/Costofsales)×365days 37 37 31

Finishedgoodsinventorycycle



(Finishedgoods/Costofsales)×365days 42 49 47

Credittocustomers



(Tradereceivables/Sales)×365days 73 88 91

Totallengthofworkingcapitalcycle 167 195196

(b) A long working capital cycle means that a large amount of capital will be tied

up in working capital.

Actions to reduce the length of the cycle

 Reduce raw materials inventory cycle – review the inventory levels and

quantities purchased.

Possible disadvantages of reducing inventory levels:

Paper F9: Financial management

480 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

− Risk of stock-outs and production hold-ups

−

Loss of bulk discounts.

 Delay payment to suppliers

Possible disadvantages of delaying payments

−

Loss of cash discounts

−

A bad business relationship with suppliers

−

Possible loss of reliable suppliers of supply

−

Suppliers might decide to charge higher prices.

 Speed up the production cycle

Possible disadvantages of making the production cycle shorter

−

Investment may be required in new technology and training

−

Higher rates of pay may be necessary

−

More efficient production should not be allowed to lead to a build-up of

finished goods inventories.

 Reduce inventories of finished goods

– Possible disadvantage of reducing finished goods inventories

−

Possible loss of profit due to stock-outs

 Reduce the period of credit allowed to customers

Possible disadvantage of reducing credit

−

Improved credit control will cost more

−

Cash discounts may be expensive to encourage prompt payment

−

Some loss of sales, because customers might buy from competitors offering

better credit terms.

4 Working capital

Overtrading (sometimes referred to as under-capitalisation) occurs when a business

entity attempts to expand its sales rapidly without adequate finance, especially

medium and long-term finance.

There are several symptoms of overtrading. These are:

(a) Very rapid growth in sales.

(b) An increase in inventory levels as a proportion of sales. This means slower

inventory turnover.

cash flow problems of the entity get worse, there might be an effort to collect

debts more quickly in order to improve the cash flow. If this happens, the

average credit period allowed to customers will fall.

(d) Payments to suppliers and other creditors are delayed. The total of trade

payables therefore increases significantly.

(e) Short-term bank borrowing increases. There is a rise in the bank overdraft.

Interest payments therefore increase.

Answers to practice questions

(f) The proportion of total assets financed by equity will decline.

(g) The current ratio and liquidity ratio get worse.

(h) There is a rapid increase in sales relative to the entity’s total assets.

(i) Profit margins fall, and new investment may be delayed.

There is some evidence of over-trading in the case of DON:

(a) Sales have increased by 61% during the year.

(b) Inventory levels have increased by 23%. However, this is much less than the

increase in sales turnover.

Trade receivables have increased by 58%, which is slightly less than the

growth in sales. The average credit period for customers has fallen from 73

days to 72 days.

(measured as payables/sales × 365 days) were paid in 57 days, but this

increased to 64 days in Year 6. However, the increase in the time taken to pay

is probably not excessive.

(d) Short-term borrowing (the bank overdraft) increased from $140,000 to

$250,000.

(e) Assets were financed by:



Year5 Year6

 % %

Equity 56 47

Tradepayables 22 31

Bankoverdraft 9 13

Medium‐termbankloan 13 10

The percentage of total assets financed by equity has fallen by a large amount.

(f)



Year5 Year6

Currentratio 1.48 1.15

Liquidityratio 0.77 0.66

Liquidity has worsened.

(g)



Year5 Year6

Sales/grossassets 1.18 1.46

Sales are being supported by a lower amount of assets per $1 of sales. This

might indicate overtrading, but it might also be the result of increased

efficiency.

Paper F9: Financial management

482 Go to www.emilewoolfpublishing.com for Q/As, Notes & Study Guides © EWP

(h)



Year5 Year6

Grossmargin 11.7% 8.96%

Profitbeforetax/sales 6.7% 5.5%

From the above data it is appears that DON is showing many of the symptoms

of overtrading.

Although DON is profitable, it is likely to experience cash flow problems if the

overtrading gets worse.

5 Inventory management

(a) Economic order quantity

(i) d = 40 × 250 = 10,000

= $64

= 25% × $2 = $0.50

EOQ =

2 × 64 ×10,000

0.50

=1,600 units

(ii)

Frequency of orders =

1,600

10,000

× 250 days = 40 days

(iii)

 $ $

Annualcostofordering200eachtime

Holdingcosts:200/2×$0.50 50

Orderingcosts:10,000/200×$64 3,200



–

––––

–

–

3,250

Annualcostofordering1,600eachtime

Holdingcosts:1,600/2×$0.50 400

Orderingcosts:10,000/1,600×$64 400



–

–––––––

800



––––––––

SavingbyorderinginEOQ‐sizebatches2,450



––––––––

(b)

Discounts

The EOQ is higher than the quantity required to obtain a 5% discount;

therefore we do not need to check the total cost of buying in order sizes of

1,000 (the lowest order size for a discount of 5%). Buying the EOQ quantity

should be cheaper.

Answers to practice questions

 $ $

Annualcostofordering1,600eachtime

Purchasecosts:10,000×95%×$2 19,000

Holdingcosts:1,600/2

×25%×95%×$2 380

Orderingcosts:10,000/1,600

×$64 400



–

–––––––

19,780



––––––––

Annualcostofordering5,000eachtime

Purchasecosts:10,000

×90%×$2 18,000

Holdingcosts:5,000/2

×25%×90%×$2 1,125

Orderingcosts:10,000/5,000

×$64 128



–

–––––––

19,253



––––––––

The higher discount is worthwhile. The order quantity should be 5,000 units.

6 Trade receivables management

Loss of sales based on Year 3 = 25% × $1,188,000 = $297,000

However, the cost of these sales will be avoided.

Gross profit percentage = (1,188,000 – 1,098,360)/1,188,000

= 0.755. Gross profit is 7.55% of sales. It is assumed that the loss from the reduction

in sales will be: 7.55% × $297,000 = $22,424

 $

Lossofprofitfromfallinsales (22,424)

Additionalcostofcreditcontrol (20,000)

 (42,424)

Reductioninbaddebts30,000

Reductioninprofit,beforesavingsininterest (12,424)

Working capital changes

Reductionininventories$

Rawmaterials (25%×180,000) 45,000

Workinprogress (25%×93,360) 23,340

Finishedgoods (25%×142,875) 35,719

104,059

Reductionintradepayables (25%×126,000)(31,500)

Reductionintradereceivables

Currenttradereceivables 297,000

Receivablesafterthechange=(60/365)

×75%×$1,188,000 146,466

150,534

Reductioninworkingcapital223,093

Paper F9: Financial management

Costoffinancingworkingcapital9%

Savingperyearininterestfromreduction$20,078

Neteffectonannualprofit $

Reductioninprofit,beforesavingsininterest(see

above)

(12,424)

Reductionininterestcost 20,078

Netincreaseinannualprofit 7,654

Reducing the credit period to 60 days will result in annual savings of $7,654.

To achieve these savings, there would have to be a fall in sales by 25%.

Senior management might decide that the size of the savings does not justify such a

large fall in annual sales, because of the longer-term consequences this might have

for the business.

7 Discount and factor

(a) Cost of offering the discount for early payment =

[1 + 2/ (100 – 2]

365/(90- 7)

- 1

= (1.02041)

4.39759

– 1

= 1.093 – 1 = 0.093 or 9.3%.

(b) Annual sales = = $100,000 × 12 months = $1,200,000.

Average trade receivables without the factor = $1,200,000 × 2 months/12

months = $200,000.

Average trade receivables with the factor = $1,200,000 × 1 month/12 months =

$100,000.

Annualcosts $ $

Withoutthefactor

Administration(12×$2,000) 24,000 

Baddebts(0.75%

×$1,200,000) 9,000 

Interestcostoffinance(9%

×$200,000) 18,000 

 51,000

Withthefactor

Fees(4%

×$1,200,000) 48,000 

Interestcostoffinance

Factorfinance(8%

×80%×$100,000) 6,400 

Overdraftfinance(9%

×20%×

$100,000)

1,800 

 56,200

Netextracostofthefactorperyear 5,200

ACCA F9 Financial Management - 2010 - Study text - Emile Woolf Publishing

Подождите немного. Документ загружается.