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June 2015 Edition
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PL
REVISION QUESTION BANK
ACCA
Paper F9 | FINANCIAL MANAGEMENT
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SA
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ACCA
PL PAPER F9
FINANCIAL MANAGEMENT
M
REVISION QUESTION BANK
SA
For Examinations to June 2015
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addressed to the Permissions Department, DeVry/Becker Educational Development Corp.
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Acknowledgement
Past ACCA examination questions are the copyright of the Association of Chartered Certified
Accountants and have been reproduced by kind permission.
(ii) 2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
REVISION QUESTION BANK FINANCIAL MANAGEMENT (F9)
CONTENTS
Question Page Answer Marks Date worked
MULTIPLE CHOICE QUESTIONS (Section A Questions)

1 The Financial Management Function 1 1001 22
2 The Financial Management Environment 3 1001 20
3 Investment Decisions 4 1002 12
4 Discounted Cash Flow Techniques 6 1003 20
5 Applications of Discounted Cash Flow Techniques 8 1004 10
6 Project Appraisal under Risk 10 1005 12
7 Equity Finance and Debt Finance 12 1007 34
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8 Cost of Capital 15 1008 22
9 Capital Asset Pricing Model 17 1010 16
10 Working Capital Management 19 1010 18
11 Inventory Management 21 1011 14
12 Cash Management 22 1012 12
13 Management of Accounts Receivable and Payable 23 1012 14
14 Risk Management 25 1013 30
1
2
15
Company objectives
PL
Business Valuation and Ratio Analysis
The financial management function

28
32
32
1014
1016
1018
30
Section B of the Examination will not include questions with less than 10 marks. Those included
below provide additional question practice on topics that could be examined within longer questions.
THE FINANCIAL MANAGEMENT FUNCTION

10
10
3 Financial management decisions (ACCA J10) 32 1018 10
4 Value for money (ACCA J03) 32 1019 6
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5 Non-For-Profit (ACCA D11) 32 1019 10
6 QSX Co (ACCA J10) 32 1020 10
7 Agency problem (ACCA D08) 33 1022 10
8 Listed company objectives (ACCA J13) 33 1022 6
9 Goal congruence (ACCA D13) 33 1023 6
THE FINANCIAL MANAGEMENT ENVIRONMENT

SA
10 Money markets 33 1024 6

11 Tagna (ACCA J03) 34 1024 10
12 Financial intermediaries (ACCA D09) 34 1025 5
INVESTMENT DECISIONS
13 Payback and ROCE (ACCA D04) 34 1025 10
14 Directors views (ACCA D10) 35 1026 10
DISCOUNTED CASH FLOW TECHNIQUES

15 OKM Co (ACCA J10) 35 1027 15
16 Limitations of NPV 36 1030 10
17 Ridag Co (ACCA J12) 36 1031 15
18 BQK Co (ACCA D12) 37 1034 15
19 HDW (ACCA J13) 38 1036 15
20 Darn Co (ACCA D13) 39 1038 15
2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. (iii)
FINANCIAL MANAGEMENT (F9) REVISION QUESTION BANK
APPLICATIONS OF DISCOUNTED CASH FLOW TECHNIQUES
21 Replacement cycles (ACCA J10) 39 1040 15

22 Basril Co (ACCA D03) 40 1042 15
23 Cavic Co (ACCA D06) 41 1044 15
24 ASOP Co (ACCA D09) 41 1045 15
25 Equivalent annual benefit (ACCA D09) 42 1047 10
26 Spot Co (ACCA D13) 42 1048 15
PROJECT APPRAISAL UNDER RISK
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27 Risk and uncertainty (ACCA D07) 42 1049 10
28 Warden Co (ACCA D11) 43 1049 15
29 Incorporating risk (ACCA J12) 43 1051 10
EQUITY FINANCE AND DEBT FINANCE
30
31
32
33
34
35
36
37
38
Islamic finance
PL
Short-term finance
SME finance (ACCA D01)
Nugfer Co (ACCA D10)
Bar Co (ACCA D11)
Dividend policy (ACCA D10)
Zigto Co (ACCA J12)
Bonds, placing and venture capital (ACCA J13)
Riba (ACCA D13)
43
43
44
44
45
46
46
46
47
1052
1054
1055
1056
1059
1060
1061
1063
1064
10
10
10
15
15
10
15
10
10
COST OF CAPITAL AND GEARING

M
39 KFP Co (ACCA J09) 47 1065 15
40 DD Co (ACCA D09) 48 1067 10
41 BKB Co (ACCA D12) 48 1068 15
42 AMH Co (ACCA J13) 49 1069 15
43 Capital structure and company value (ACCA D13) 49 1071 10
CAPITAL ASSET PRICING MODEL

SA
44 Project-specific discount rate (ACCA D08) 50 1071 10

45 CJ Co (ACCA D10) 50 1072 15
46 Business, financial and systematic risk (ACCA J12) 51 1074 10
47 CAPM and risk (ACCA J13) 51 1075 10
48 Card Co (ACCA D13) 51 1075 15
WORKING CAPITAL MANAGEMENT
49 Blin (ACCA J04) 52 1077 15

50 Bold Co (ACCA D11) 52 1079 10
51 AXP Co (ACCA D09) 53 1080 15
52 Working capital policy (ACCA J12) 54 1082 10
53 TGA Co (ACCA J13) 54 1083 15
54 Objectives, role and policy (ACCA D13) 55 1085 10
(iv) 2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
INVENTORY MANAGEMENT
55 EOQ and JIT 55 1086 15

56 FLG Co (ACCA J08) 56 1088 15
57 Product KN5 (ACCA D10) 56 1088 10
CASH MANAGEMENT
58 Baumol model (ACCA D05) 57 1089 10

59 HRG Co (ACCA J09) 57 1090 15
60 Wobnig (ACCA J12) 58 1093 15
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61 Cash and receivables management (ACCA D12) 59 1095 10
MANAGEMENT OF ACCOUNTS RECEIVABLE AND PAYABLE
62 PKA (ACCA D07) 59 1096 15

63 WQZ Co (ACCA D10) 60 1098 15
64
65
66
RISK MANAGEMENT
67
68
69
70
Bolder Co (ACCA D11)
KXP (ACCA D12)
Plot Co (ACCA D13)
GN Co (ACCA D09)
Gorwa Co (ACCA D08)
Boluje Co (ACCA D08)
Zigzag (ACCA J12)
PL 61
62
62
63
64
65
65
1099
1100
1102
1103
1104
1105
1106
15
10
15
10
10
10
10
71 Interest rate risk (ACCA D12) 66 1107 10
72 BNB Co (ACCA D12) 66 1108 10
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73 Types of currency risk (ACCA J13) 67 1109 10
BUSINESS VALUATION
74 NSX (ACCA J10) 67 1110 10

75 XB Co 68 1111 10
76 Closer (ACCA D11) 68 1111 10
77 Phobia Co (ACCA D07) 69 1113 6
SA
78 Efficient Markets Hypothesis (ACCA D07) 69 1113 10

79 NN Co (ACCA D10) 70 1114 15
80 Corhig Co (ACCA J12) 71 1115 15
81 WWW Co (ACCA D12) 72 1117 10
82 GXG Co (ACCA J13) 73 1118 15
ACCA SPECIMEN EXAMINATION PAPER
MCQ 74 1120 40
1 Cat Co 80 1121 10
2 GWW Co 80 1122 10
3 ZPS Co 81 1123 10
4 PV Co 82 1124 15
5 DD Co 83 1126 15
2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. (v)
Formula Sheet
Economic order quantity
2Co D
=
Ch
Miller Orr Model
Return point = Lower limit + (1/3 spread)
1
3 3
E
4 transaction cost variance of cash flows
Spread = 3
interest rate

The Capital Asset Pricing Model
a =

eV
PL
Vd
e
E(ri) = Rf + i(E(rm)Rf)
The asset beta formula
V
1 T

e +
The Growth Model

V
d V 1 T
d
e Vd 1 T

D O 1 g
M
PO =
re g
Gordons growth approximation
g = bre
The weighted average cost of capital

SA
Ve Vd
WACC = Ke + K d 1 T
Ve Vd Ve Vd
The Fisher formula
(1 + i) = (1 + r) (1 + h)
Purchasing power parity and interest rate parity
1 h c 1 i c
S1 = S0 F0 = S0
1 h b 1 i b
(vi) 2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
Present Value Table
Present value of 1 i.e. (1 + r)n

where r = discount rate
n = number of periods until payment
Discount rate (r)

Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
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2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826 2
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751 3
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683 4
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621 5
6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564 6
7
8
9
10
11
12
13
14
15
0.933
0.923
0.914
0.905
0.896
0.887
0.879
0.870
0.861
0.871
0.853
0.837
0.820
0.804
0.788
0.773
0.758
0.743
PL
0.813
0.789
0.766
0.744
0.722
0.701
0.681
0.661
0.642
0.760
0.731
0.703
0.676
0.650
0.625
0.601
0.577
0.555
0.711
0.677
0.645
0.614
0.585
0.557
0.530
0.505
0.481
0.665
0.627
0.592
0.558
0.527
0.497
0.469
0.442
0.417
0.623
0.582
0.544
0.508
0.475
0.444
0.415
0.388
0.362
0.583
0.540
0.500
0.463
0.429
0.397
0.368
0.340
0.315
0.547
0.502
0.460
0.422
0.388
0.356
0.326
0.299
0.275
0.513
0.467
0.424
0.386
0.350
0.319
0.290
0.263
0.239
7
8
9
10
11
12
13
14
15
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
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1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 2
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 3
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 4
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402 5
6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 6
SA
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279 7
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233 8
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194 9
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162 10
11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 11
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112 12
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093 13
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 14
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065 15
2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. (vii)
Annuity Table
1 (1 r ) n
Present value of an annuity of 1 i.e.
r
where r = discount rate
n = number of periods
Discount rate (r)
Periods
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
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1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909 1
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736 2
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487 3
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170 4
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791 5
6
7
8
9
10
11
12
13
14
5.795
6.728
7.652
8.566
9.471
10.37
11.26
12.13
13.00
5.601
6.472
7.325
8.162
8.983
9.787
10.58
11.35
12.11
PL
5.417
6.230
7.020
7.786
8.530
9.253
9.954
10.63
11.30
5.242
6.002
6.733
7.435
8.111
8.760
9.385
9.986
10.56
5.076
5.786
6.463
7.108
7.722
8.306
8.863
9.394
9.899
4.917
5.582
6.210
6.802
7.360
7.887
8.384
8.853
9.295
4.767
5.389
5.971
6.515
7.024
7.499
7.943
8.358
8.745
4.623
5.206
5.747
6.247
6.710
7.139
7.536
7.904
8.244
4.486
5.033
5.535
5.995
6.418
6.805
7.161
7.487
7.786
4.355
4.868
5.335
5.759
6.145
6.495
6.814
7.103
7.367
6
7
8
9
10
11
12
13
14
15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606 15
M
(n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 1
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528 2
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106 3
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589 4
SA
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991 5
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326 6
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605 7
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837 8
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031 9
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192 10
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.586 4.327 11
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439 12
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533 13
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611 14
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675 15
(viii) 2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
REVISION MULTIPLE CHOICE QUESTION BANK FINANCIAL MANAGEMENT (F9)
MULTIPLE CHOICE QUESTIONS
1 The Financial Management Function
1.1 Which of the following is one of the 3Es value for money concept?
A Earnings
B Equity
C Evaluation
D Effectiveness
1.2 Which of the following is most consistent with maximising shareholder wealth?
E
A Profit maximisation
B Market share growth
C Minimising the firms cost of capital
D Maximising earnings per share
1.3 Which of the following statements is correct?
1.4
A
B
C
D
A
B
PL
Profit maximisation results in shareholder wealth maximisation
Divorce of ownership and control can lead to agency costs
Maximising earnings per share results in shareholder wealth maximisation
Increasing market share will lead to increased shareholder wealth
Which of the following is the best indicator of shareholder wealth?
Profit before interest and tax

Sales revenues
C Market price of the share
M
D Price/earnings ratio
1.5 Which of the following is not a consequence or symptom of the agency problem?
A Managers diverting funds into their own pet projects

B Managers selecting quick payback projects
C Managers engaging in empire building
D Managers increasing the firms level of financial gearing
SA
1.6 Hathaway Co has just paid a dividend of 21 cents per share and its share price is $350 per
share. One year ago its share price was $360 per share.
Working to one decimal place, what is the total shareholder return over the period?
A 89%
B 86%
C 31%
D 09%
1.7 Which of the following actions is MOST likely to increase shareholder wealth?
A The average cost of capital is increased by a recent financing decision

B The firms cash operating cycle becomes longer
C The board of directors decides to invest in a project with a quick payback period
D The annual report declares full compliance with the corporate governance code
2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved. 1
FINANCIAL MANAGEMENT (F9) REVISION MULTIPLE CHOICE QUESTION BANK
1.8 Which of the following statements concerning not-for-profit organisations is correct?
A Not-for-profit organisations often have multiple stakeholders with conflicting

objectives
B The provision of value for money embodies economy, equality and effectiveness
C Not-for-profit organisations usually have one dominant stakeholder
D The key objective of not-for-profit organisations is to make profits
1.9 The following are extracts from the statement of profit or loss of IQ Co:
$000
E
Sales income 60,000
Cost of sales 50,000

Profit before interest and tax 10,000
Interest 4,000

Profit before tax
Tax
Profit after tax PL

80% of the cost of sales is variable costs.
What is the operational gearing of IQ Co?
A 20 times
6,000
4,500

1,500

B 25 times
C 05 times
M
D 30 times
1.10 Which of the following statements concerning financial management are correct?
(1) It is concerned with investment decisions, financing decisions and dividend decisions
(2) It may use information from management accounting
(3) It must hedge all of the firms currency risks
SA
A 1 and 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
1.11 Which ONE of the following statements concerning a company with low operating
gearing is true?
A A change in sales will have a relatively small impact on profits

B The company has a relatively low proportion of debt finance
C The company will have higher risk and increased potential return
D The company will have low interest cover
(22 marks)
2 2015DeVry/BeckerEducationalDevelopmentCorp.Allrightsreserved.
2 The Financial Management Environment
2.1 Which of the following is least likely to act as a financial intermediary?
A Insurance company
B Pension fund
C Credit rating agency
D Islamic bank
2.2 Which of the following lists of securities is ranked in order of increasing risk to the
investor?
A Ordinary share; Unsecured loan; Preference share
E
B Unsecured loan; Preference share; Ordinary share
C Preference share; Unsecured loan; Ordinary share
D Ordinary share; Preference share; Unsecured loan
2.3 Which of the following best describes commercial paper?
2.4
A
B
C
D
A
B
PL
Secured long-term loan notes issued by companies
Secured short-term loan notes issued by companies
Unsecured long-term loan notes issued by companies
Unsecured short-term loan notes issued by companies
Which of the following would be LEAST likely to be a function of a treasury

department?
Managing relationships with banks

Liquidity management including investment of surplus funds
C Currency management
M
D Investment appraisal
2.5 Which of the following is likely to have the LOWEST expected rate of return?
A Unsecured bank loan

B Preference shares
C Secured bonds
D Ordinary shares
SA
2.6 Which of the following statements are features of money market instruments?
(1) Interest-bearing instruments usually trade at less than face value

(2) The yield on commercial paper is usually higher than that on treasury bills
(3) Negotiable instruments can be sold before their maturity date
A 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
2.7 Governments have a number of economic targets as part of their fiscal policy.
Which of the following targets relate predominantly to fiscal policy?
(1) Increasing tax revenue

(2) Controlling the growth in the size of the money supply
(3) Reducing public expenditure
(4) Keeping interest rates low
A 1 only
B 1 and 3
C 2 and 4 only
D 2, 3 and 4
E
2.8 Freely fluctuating exchange rates perform which of the following functions?
A They tend to correct a trade surplus or deficit

B They make imports cheaper and exports more expensive
C They eliminate the opportunity for currency speculation
2.9
2.10
D
B
C
D
PL
They eliminate business exposure to currency risk
Supply side economic policy is designed for what purpose?
A To raise the level of demand in the economy

To increase the provision of state services
To improve the ability of the economy to produce goods and services
To reduce interest rates by increasing the money supply
Which ONE of the following government policies would NOT tend to raise national
income over time?
M
A Increased expenditure on infrastructure
B Tax cuts to encourage higher spending by consumers
C Supply side policies to increase labour flexibility
D Incentives to encourage personal saving
(20 marks)
3 Investment Decisions
SA
3.1 Harvey Co is evaluating a capital investment proposal with the following information:
Initial cost $500,000

Life 10 years
Annual operating cash inflow $200,000
Scrap value $100,000
The investment will be depreciated using the straight-line method.
What is the payback period for this investment?
A 3.25 years
B 2.67 years
C 2.5 years
D 2 years
3.2 A project requires an initial outlay of $1,000. The forecast cash inflows are:
Year 1 $200
Year 2 $200
Year 3 $400
Year 4 $400
What is the investments payback period?
A 4.0 years
B 3.5 years
C 3.4 years
D 3.0 years
E
3.3 Which of the following statements about investment decision making methods is true?
A The discounted payback method takes into account cash flows for all periods
B The payback method ignores all cash flows after the end of the payback period
3.4
C
D
PL
The net present value rule is to accept investment opportunities when their rates of
return exceed the companys weighted avergae cost of capital
The internal rate of return rule is to accept the investment if the weighted average
cost of capital is greater than the internal rate of return
Which of the following statements is correct regarding investment decision making?
A Opportunity costs are not relevant

B The accounting rate of return considers the time value of money
M
C A strength of the payback method is that it is based on profitability
D Capital budgeting is based on predictions of an uncertain future
3.5 A company with an 8% cost of capital purchases a machine for $43,000. The forecast
operating cash flows generated by the machine are as follows:
Year 1 $10,000
Year 2 $15,000
SA
Year 3 $20,000
Year 4 $27,000
What is the discounted payback period in years?
A 3.10
B 3.25
C 2.90
D 3.14
3.6 Kuchman Kookies will invest $100,000 in new equipment. The firms discount rate is 8%
and the operating cash flows from the investment are expected to be as follows:
Year 1 $35,000
Year 2 $38,000
Year 3 $25,000
Year 4 $20,000
Year 5 $10,000
What is the investments payback period in years?
A 2.3
B 3.1
C 4.0
D 4.7
(12 marks)
4 Discounted Cash Flow Techniques
4.1 Gunning Industries is considering investment in a new machine. The following information is
provided:
E
The new machine will cost $190,000 and has a five year life with zero scrap value.
The investment in the new machine will also require an increase in working capital
of $35,000.
Tax-allowable depreciation is available on a straight-line basis.
B
C
D
$13,817
$15,200
$16,762
$20,725
PL
Gunning is subject to a 40% tax rate and has a 10% cost of capital.
What is the present value of the tax saving on the first years tax-allowable
depreciation?
A
M
4.2 Wendys Sandwich Shop acquires an asset for $100,000 that has no residual value and a 10-
year life. Wendys tax rate is 40%. Tax-allowable depreciation is available on a straight-line
basis.
What is Wendys annual tax saving from the asset?
A $10,000
B $6,000
SA
C $4,000
D $2,000
4.3 Which of the following events would decrease the internal rate of return of a potential
investment?
A Decreased tax-allowable depreciation available on the investment

B Decreased working capital requirements
C Decreased cost of capital
D Using reducing balance, instead of straight-line depreciation
4.4 Which of the following changes would result in the highest present value for a series of
cash flows?
A A $100 decrease in taxes each year for four years

B A $100 decrease in the cash outflow each year for three years
C A $100 increase in disposal value at the end of four years
D A $100 increase in cash inflow each year for three years
4.5 Which of the following is an advantage of the net present value method?
A It is measured in time, not dollars

B It uses accrual basis, not cash basis accounting for a project
C It uses the accounting rate of return
D It accounts for compounding of returns
4.6 ABC Co plans to buy a new machine. The cost of the machine is $100,000 and it has a five-
year life with no disposal value. The machine will be depreciated on a straight line basis
which matches the policy for tax-allowable depreciation. The machine will increase annual
operating cash flows by $50,000. ABCs profit tax rate is 35%.
What is the annual after-tax cash flow generated by the machine?
E
A $19,500
B $30,000
C $32,500
D $39,500
4.7
Net present value

PL
A company has identified two mutually-exclusive projects which have an equivalent effect on
the risk profile of the company:
Discounted payback period
Internal rate of return

Accounting rate of return
The companys cost of capital is 15%.

Project I
2.8 years
$17,200
18%
19%
Project II
3.2 years
$15,700
22%
21%
Assuming that the directors wish to maximise shareholder wealth and no shortage of
M
capital is expected, which project should the company choose?
A Project I because it has the shorter payback period

B Project I because it has the higher net present value
C Project II because it has the higher internal rate of return
D Project II because it has the higher accounting rate of return
4.8 A project has an initial cash outflow followed by several years of cash inflows.
SA
What would be the effects on the internal rate of return (IRR) of the project and its
discounted payback period (DPP) of a decrease in the companys cost of capital?
IRR DPP
A Decrease Decrease
B Decrease Increase
C No change Decrease
D No change Increase
4.9 A company has a money cost of capital of 21% per year. The general inflation rate is 9%
per year.
What is the real cost of capital?
A 9%
B 11%
C 12%
D 21%
4.10 The following data is relevant to the evaluation of a particular project:
Cost of capital in real terms 10% per year
E
General inflation rate 5% per year
Specific inflation rate of the projects annual cash inflow 6% per year
Specific inflation rate of the projects annual cash outflow 4% per year
Which of the following sets of adjustments will lead to the correct calculation of net
5
present value?
A
B
C
D
PL
Cash inflow
5% annual increase
6% annual increase
6% annual increase
Unadjusted
Cash outflow
5% annual increase
4% annual increase
4% annual increase
Unadjusted
Applications of Discounted Cash Flow Techniques

Discount rate
15.5%
15.0%
15.5%
10.0%
(20 marks)
M
5.1 Which of the following is a limitation of the profitability index?
A It uses accounting profits rather than cash flows

B It ignores the time value of money
C It is inconsistent with the goal of shareholder wealth maximisation
D It cannot deal with multi-period capital rationing
5.2 ABC Co is trying to decide between keeping an existing machine and replacing it with a new
SA
machine. The old machine was purchased just two years ago for $50,000 and had an expected
life of 10 years. It now costs $1,000 a month for maintenance and repairs due to a mechanical
problem. A new machine is being considered to replace it at a cost of $60,000. The new
machine is more efficient and it will only cost $200 a month for maintenance and repairs.
The new machine has an expected life of 10 years.
In deciding to replace the old machine, which of the following factors should ABC not
consider?
A Any estimated scrap value on the old machine

B The original cost of the old machine
C The estimated useful life of the new machine
D The lower maintenance cost on the new machine
5.3 A company is considering whether to buy or lease two assets:
Asset 1 has a 10-year economic life with a zero residual value. It can be purchased for
$80,000 payable immediately. Alternatively, it can be leased with 10 lease rentals of $12,000
per year payable annually in advance.
Asset 2 has a five-year economic life. It can be purchased for $81,000 payable immediately
and will have a residual value of $40,000 after five years. Alternatively, it can be leased with
five lease rentals of $14,000 per year payable annually in arrears.
The appropriate discount rate is 10% per year.
How should the company finance each asset?
E
Asset 1 Asset 2
A Lease Lease
B Lease Buy
C Buy Lease
D Buy Buy
5.4
PL
The cost of purchasing a machine is $100,000 payable immediately. Its disposal value is
expected to be $10,000 in five years time.
The same asset can be leased for a period of five years with rentals of $25,000 payable
annually in advance.
What is the net present value (to the nearest $10) to the lessor if it purchases the
machine then leases it to the user on the above terms if it applies an annual discount rate
of 10%?
M
A $990 positive
B $10,460 positive
C $1,960 negative
D $11,440 negative
5.5 A machine costing $150,000 has a useful life of eight years, after which time its estimated
resale value will be $25,000. Annual running costs will be $5,000 for the first three years of
use and then $8,000 for each of the next five years. All running costs are payable on the last
SA
day of the year to which they relate.
Using a discount rate of 20%, what is the equivalent annual cost of the machine (to the
nearest $100)?
A $46,600
B $43,900
C $43,300
D $21,100
(10 marks)
6 Project Appraisal under Risk
6.1 During a typical year, Deet Co experiences the following power cuts:
Number of power cuts Number of

per month months
0 3
1 2
2 4
3 3

12

E
Each power cut results in additional costs of $400. For $500 per month, Deet can lease a
generator to provide electricity during power cuts.
If Deet leases the generator what is the estimated annual savings/ (additional cost)?
6.2
A
B
C
D
($3,600)
($1,200)
$1,600
$1,900 PL
Excalibur Co has developed a model to predict sales levels for its beachwear based on long-
range weather forecasts. The probability of various temperatures and related sales units are as
follows:
Unit sales Temperature Probability

10,000 below 20 5%
M
30,000 20-24 25%
50,000 24-28 50%
40,000 28-32 15%
25,000 over 32 5%
What sales volume, in units, would Excalibur Co anticipate using the expected value
approach?
SA
A 31,000
B 40,250
C 50,000
D 155,000
6.3 A shopkeeper has determined the following probability distribution of weekly demand for one
of his most popular products.
Demand Probability
300 0.2
400 0.3
500 0.3
600 0.1
700 0.1
The shopkeeper must order each weeks sales in advance and any items left in inventory at the
end of the week are scrapped. The items cost the shopkeeper $2.50 and he sells them for $3
each.
What is the optimal quantity to be ordered each week?
A 300
B 400
C 450
D 500
6.4 A company has constructed a model for predicting profits. Net profit or loss depends on two
variables: gross profit and overheads. The following are independent probability
distributions of the two variables.
Gross profit Probability Overheads Probability

$ $
E
12,000 0.1 6,000 0.3
6,000 0.4 4,000 0.3
4,000 0.4 3,000 0.3
3,000 0.1 2,000 0.1
What is the probability that the company will make a positive net profit?
6.5
A
B
C
D
0.27
0.55
0.73
0.82
PL
Adrian is contemplating purchasing for $60,000 a machine which he will use to produce
10,000 disks per year for five years. These disks will be sold for $9 each and unit variable
costs are expected to be $5. Incremental fixed costs will be $14,000 per year for production
costs and $5,000 per year for selling and administration costs. Adrian has a discount rate of
10% per year.
M
By how many units must the estimate of production and sales volume fall for the project
to be regarded as not worthwhile?
A 575
B 1,293
C 1,623
D 2,463
SA
6.6 The following financial information relates to an investment project:

$000
Present value of sales revenue 50,025
Present value of variable costs 25,475

Present value of contribution 24,550
Present value of fixed costs 18,250

Present value of operating income 6,300
Initial investment 5,000
What is the sensitivity of the net present value of the investment project to a change in
fixed costs?
A 71%
B 53%
C 51%
D 26%
(12 marks)
7 Equity Finance and Debt Finance
7.1 What is a major advantage of issuing long-term debt?
E
A Increased financial flexibility
B The reduction in profit before tax
C Decreased financial risk
D The reduction of shareholders control over the company
7.2 When issuing new bonds what would be the primary reason for a debt covenant limiting
7.3
B
C
D
PL
the firms future level of debt?
A To cause the firms share price to rise

To lower the companys credit rating
To reduce issue costs
To reduce the coupon rate
Bander Co is determining how to finance some long-term projects. Bander has decided that it
prefers the flexibility of no fixed servicing cost, no fixed maturity date and an increase in the
credit rating of the company.
M
Which of the following would best meet Banders financing requirements?
A Irredeemable bonds
B Ordinary shares
C Long-term bank loans
D Preference shares
7.4 Which of the following statements is/are correct regarding corporate debt and equity
SA
securities?
(1) Both debt and equity holders have an ownership interest in the company.
(2) Both debt and equity securities have an obligation to pay income.
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
7.5 Which of the following types of bonds is most likely to maintain a constant market
value?
A Zero-coupon
B Floating-rate
C Irredeemable
D Convertible
7.6 A company currently has 1,000 ordinary shares in issue and no debt. It has the choice of
raising an additional $100,000 by issuing 9% long-term debt, or issuing 500 ordinary shares.
The company has a 40% tax rate.
What level of earnings before interest and taxes (EBIT) would result in the same
earnings per share (EPS) for the two financing options?
A $27,000
B $21,000
C $18,000
D $10,800
7.7 A company currently has 10 million $1 shares in issue with a market value of $3 per share.
E
The company wishes to raise new funds using a 1 for 4 rights issue. The resulting theoretical
ex-rights price per share has been calculated as $280.
How much new finance was raised?
A $2,500,000
7.8
B
C
D
$4,000,000
$5,000,000
$7,000,000
PL
Which of the following may be regarded as an advantage to existing shareholders of
listing the firm on a major stock market?
A
B
C
Reduced disclosure requirements
Larger dividends can be paid
Shares become more marketable
D Reduced risk of takeover
M
7.9 Which of the following defines dividend cover?
A Dividend per share divided by earnings per share.

B Earnings per share divided by dividend per share.
C Share price divided by dividend per share.
D Retained profit per share divided by dividend per share
SA
7.10 The Stock Exchange may provide a quotation for a companys existing shares without that
company making any new shares available to the market.
What is this method of obtaining a quotation called?
A An offer for sale

B An introduction
C A placing
D A scrip issue
7.11 Which of the following is prohibited under Islamic financing principles?
(1) The use of debt

(2) The financing of immoral activities
(3) The use of derivatives
A 2 only
B 1 and 3
C 1, 2 and 3
D 2 and 3
7.12 Which of the following statements concerning a rights issue are correct?
E
(1) The new shares are normally issued at a discount to the existing price
(2) There will be no change in shareholder wealth
(3) The main purpose of a rights issue is to raise finance
(4) The new shareas must be issued to the existing shareholders
A 1, 2 and 3 only
B 2, 3 and 4 only
7.13
C
D
A
B
C
D
PL
1, 3 and 4 only
1, 2 and 4 only
Which of the following statements concerning a bonus (scrip) issue is correct?
The new shares are issued at par value

Earnings per share would be expected to rise
The main purpose of a bonus issue is to raise finance
The bonus shares do not carry voting rights
7.14 Which of the following is the correct definition of a warrant?

M
A Security or collateral provided for debt
B Shares issued in lieu of a cash dividend
C Restritive covenants written into debt contracts
D Share options attached to a debt issue
7.15 Which of the following is an example of supply chain finance?

SA
A Finance raised to invest in supply chain infrastructure

B Taking loans from suppliers
C Selling a sales invoice to a customers bank for immedidate payment
D Issuing shares to a supplier
7.16 Which of the following is NOT true of peer-to-peer (P2P) lending?
A It can also be referred to as debt-based crowdfunding

B It involves individuals lending money to other individuals or to small businesses
C It requires a financial institution to act as an intermediary
D It is an example of microfinance
7.17 Which of the following statements concerning crowdfunding is correct?
A It involves either issuing shares or loans to large group of investors

B It is only available to unlisted companies
C Reward-based crowdfunding does not raise any cash for the business
D It is particularly appropriate for early stage seed finance
(34 marks)
8 Cost of Capital
8.1 Which of the following usually determines the optimal capital structure for an
organisation?
E
A Maximum degree of financial gearing
B Maximum degree of operating gearing
C Lowest weighted average cost of capital
D Capital structure used by competitors
8.2
8.3
C
D
PL
Which of the following rates is most commonly compared to a projects internal rate of
return to evaluate whether to make an investment?
A
B
Risk-free rate
Accounting Rate of Return
Weighted average cost of capital
Cost of equity
A company with a tax rate of 30% has the following capital structure:
Weight Instrument Pre-tax cost of capital

M
40% Bonds 6%
50% Ordinary shares 12%
10% Preference shares 8%
What is the companys weighted average cost of capital?
A 9.2%
B 7.7%
SA
C 8.2%
D 8.5%
8.4 A company has in issue 9% $20 nominal value preference shares. Their current market price
is $40 and the companys tax rate is 30%.
What is the companys cost of preference shares?
A 4.5%
B 3.15%
C 9.0%
D 6.3%
8.5 Which three elements are needed to estimate the cost of equity using the dividend
growth model?
A Current dividends per share, expected growth rate in earnings per share and current
market price per share
B Current earnings per share, expected growth rate in dividends per share and current
C Current earnings per share, expected growth rate in earnings per share and current
book value per share
D Current dividends per share, expected growth rate in dividends per share and current
E
8.6 A firm has a share price of $30, a forecast dividend per share after one year of $3 and
thereafter an expected growth rate of 10%.
What is the firms cost of equity?
8.7
A
B
C
D
21.1%
12.2%
11.0%
20.0% PL
A firm has a bank loan with a 10% interest rate. The firm also has in issue 8% preference
shares trading at par and has estimated that its cost of ordinary shares is 18%. The firm has a
30% tax rate.
What is the weighted average cost of capital if the firm uses a capital structure
comprising 50% debt and an even split between preference and ordinary shares?
M
A 11.50%
B 10.00%
C 9.40%
D 8.05%
8.8 A firms weighted average cost of capital is minimised when its debt to equity ratio is 4:1.
SA
Which of the following statements is most accurate?
A The value of the firm is maximised when it uses more equity than debt
B A higher ratio than 4:1 means debt holders will require a lower return
C A higher ratio than 4:1 means equity holders will require a higher return
D The value of the firm will be maximised if it is 75% debt financed
8.9 Recent statistics relating to the ordinary shares of Calc Co, a quoted company, are as follows:
Dividend (just paid) 5 cents

Average annual growth rate of dividends 10%
Dividend cover 2.4
Price/earnings ratio 8
What is Calc Cos cost of equity?
A 13.8%
B 15.2%
C 15.7%
D 23.8%
E
8.10 A firm has achieved an average growth in dividends over the last five years of 10.5% per
year. It is now widely believed that the long-run average annual dividend growth rate will be
9.16% per year. The firms current dividend yield is 4.8%.
What is the firms cost of equity?
8.11
A
B
C
D
13.96%
14.40%
15.30%
15.80%
PL
Which of the following statements concerning capital structure theory is correct?
A In the traditional view, there is a linear relationship between the cost of equity and
financial risk
B Modigliani and Miller said that, in the absence of tax, the cost of equity would
M
remain constant
C Pecking order theory does not suggest an optimal debt to equity ratio
D Modigliani and Miller said that, in the presence of tax, the weighted average cost of
capital would remain constant
(22 marks)
SA
9 Capital Asset Pricing Model
9.1 Colt Co has an equity beta factor of 1.15 and an asset beta factor of 0.85. The risk-free rate of
return is 8.5% and the market return is estimated at 12.4%. The corporate tax rate is 25%.
What is Colts cost of equity geared?
A 11.82%
B 12.99%
C 9.74%
D 14.26%
9.2 The risk-free rate of return is 3% and the market premium is 6.5%. A firms equity beta is
1.15 and asset beta 0.85.
What will the firms cost of equity be if it redeems all outstanding debt?
A 7.0%
B 10.5%
C 8.5%
D 6.0%
9.3 A firms equity beta is 1.10 and its asset beta is 0.85. The market premium is 4.50% and the
risk-free rate 3%
E
What is the firms cost of equity geared?
A 7.95%
B 4.65%
C 6.83%
D 4.28%
9.4
9.5
A
B
C
D
PL
What type of risk cannot be eliminated through diversification?
Business risk
Unsystematic risk
Financial risk
Systematic risk
The risk-free rate of return is 6% and the required return on a security with a beta factor of 12
is 156%.
M
What is the required annual rate of return on the market portfolio?
A 1152%
B 1300%
C 1400%
D 1752%
SA
9.6 The beta of company Xs shares is 16, the risk free rate is 5% and the required return on
company Xs shares is 162%. Company Y is quoted in the same stock market, but its shares
have a beta of 14.
What is the required rate of return on company Ys shares?
A 120%
B 130%
C 132%
D 148%
9.7 Which of the following measures business risk?
A Equity beta
B Debt beta
C Volatility of net income
D Asset beta
9.8 Which of the following are assumptions of the capital asset pricing model?
(1) Linear relationship between risk and required return

(2) Constant dividend growth rate
(3) Perfect capital markets
A 2 only
B 1 and 3
C 1, 2 and 3
D 2 and 3
(16 marks)
10 Working Capital Management
E
10.1 Which of the following would increase the net working capital of a firm?
A Cash collection of accounts receivable

B Refinancing of accounts payable with a two-year bank loan
C Payment to suppliers
10.2
D
decreased by $50,000.
PL
Payment of a dividend
During the year, Mason Cos current assets increased by $120,000 and current liabilities
What was the effect on net working capital?
A
B
Increased by $70,000
Decreased by $170,000
C Increased by $170,000
D Decreased by $70,000
M
10.3 Which of the following indicates that a company is becoming more conservative in its
working capital funding policy?
A Increase in the ratio of current liabilities to non-current liabilities

B Decrease in the operating cycle
C Decrease in the current ratio
SA
D Increase in the ratio of long-term finance to current liabilities
10.4 Which of the following may indicate overtrading?
A Significant new issues of long-term finance

B Rising profits but falling margins
C Rising receivables turnover
D Falling revenues
10.5 Which working capital financing policy exposes the firm to the greatest risk of being
unable to meet its obligations as they fall due?
A Financing fluctuating current assets with long-term debt

B Financing permanent current assets with long-term debt
C Financing permanent current assets with short-term debt
D Financing fluctuating current assets with short-term debt
10.6 A company has a current ratio of 23 and a quick ratio of 08. It increases its overdraft in
order to buy more inventory as a cash purchase.
What will happen to the companys ratios as a result of this transaction?
Current ratio Quick ratio

A Increase Increase
B Increase Decrease
C Decrease Increase
D Decrease Decrease
10.7 Which of the following is LEAST likely to characterise overtrading?
E
A Increased short-term borrowing
B Increased cash balances
C Increased revenue
D Reduced working capital
10.8
PL
The following information has been calculated for AAA Co:
Trade receivables collection period

Raw material holding period
Length of the production cycle
Credit taken from suppliers
Finished goods holding period
What is the length of the working capital cycle?

25 days
24 days
30 days
56 days
34 days
A 3 days
M
B 27 days
C 57 days
D 169 days
10.9 Which of the following statements concerning working capital management are correct?
(1) The twin objectives of working capital management are profitability and liquidity
(2) An aggressive approach to working capital financing can increase profitability
SA
(3) Poor working capital management is a signal of overtrading
A 1 and 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
(18 marks)
11 Inventory Management
11.1 Which of the following would affect the optimal level of inventory?
(1) Holding cost per unit of inventory

(2) Current level of inventory
(3) Cost of placing an order for inventory
(4) Demand
A 1, 2 and 3 only
B 2, 3 and 4 only
C 1, 3 and 4 only
D 1, 2 and 4 only
E
11.2 In inventory management, which of the following will tend to increase the level of safety
stock?
A Holding cost increases

B Cost of running out of inventory decreases
11.3
C
D
A
B
C
D
PL
Variability of lead-time increases
Reliability of demand forecasting increases
Which of the following assumptions is associated with the economic order quantity
model?
The holding cost per unit will vary with quantity ordered
The cost of placing an order will vary with quantity ordered
Holding costs depend on the average level of inventory
The purchase cost per unit will vary based on quantity discounts
M
11.4 To measure inventory management performance, a company monitors its inventory turnover
ratio. Selected data from the companys accounting records show the following:
Current year Prior year

Annual sales 2,525,000 2,125,000
Gross profit 40% 35%
Opening finished goods inventory for the current year was 15% of the prior years annual
SA
sales volume at cost and closing finished goods inventory was 22% of the current-years
annual sales volume at cost.
What was the companys inventory turnover for the current year?
A 4.55 times
B 5.61 times
C 6.51 times
D 6.81 times
11.5 Which of the following statements about the economic order quantity (EOQ) and the re-
order level (ROL) are true?
A The EQO determines the ROL

B The ROL determines the EOQ
C Both are influnced by demand
D Both are influnced by lead time
11.6 Which of the following is LEAST relevant to the economic order quantity model for
inventory?
A Safety stock
B Annual demand
C Holding costs
D Order costs
11.7 Which of the following is/are usually seen as benefits of the just-in-time approach to
inventory management?
(1) Reduced risk of stock outs

(2) Reduced holding holds
E
(3) Reduced dependence on suppliers
A 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
12
12.1
Cash Management
PL
The CFO of Lang Co wants to earn a higher return on the companys cash holdings.
Which of the following comparable maturity investments will earn Lang the highest
expected return?
A Certficates of deposit
(14 marks)
B Treasury bills
M
C Commercial paper
D Bank deposits
12.2 Which of the following securities has the least amount of default risk?
A Corporate bonds
B Treasury bills
C Commercial paper
SA
D Bills of exchange
12.3 Which of the following best describes the risk associated with the ability to sell a short-
term investment quickly without significant impact on the price?
A Interest rate risk

B Purchasing power risk
C Financial risk
D Liquidity risk
12.4 Which of the following statements about the Miller-Orr cash management model is/are
true?
(1) The greater the variability in cash flows, the greater is the spread between the upper
and lower cash balance limits.
(2) When short-term investments are liquidated the firms cash balance should return to
the lower limit.
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
E
12.5 A company uses the Baumol cash management model. Cash disbursements are constant at
$20,000 each month. Short-term investments yield 5% a year, while cash held in the
companys bank account earns zero interest. Switching costs (that is, for each purchase or
sale of short-term investments) are $30 for each transaction.
12.6
B
C
D
$500
$1,700
$4,900
$17,000
PL
What is the optimal amount (to the nearest $100) to be transferred in each transaction?
Which is the following is an assumption of the Baumol model but not of the Miller-Orr
model?
A Constant usage of cash

B Holding cash incurrs an opportunity cost
M
C Fixed commission for switching between cash and cash equivalents
D Variability of cash flows
(12 marks)
13 Management of Accounts Receivable and Payable
13.1 A supplier offers a 3% discount for payment within 10 days or full payment within 45 days.
SA
Assuming a 360-day year what is the annualised cost of not taking the discount?
A 37.11%
B 36.00%
C 24.74%
D 31.81%
13.2 A company has daily sales of $150,000. A debt factor has guaranteed to reduce the
companys receivables collection time by four days for a monthly fee of $2,500. Cash
surpluses can be invested in money market deposits yielding 4% per annum.
What is the additional annual income/(loss) from using the cash management service?
A $6,000
B $(6,000)
C $12,000
D $(12,000)
13.3 Amicable Wireless Co offers customers credit terms of 2% discount for payment within 10
days or full payment within 25 days. 60% of Amicables customers take the 2% discount and
pay on day 10. The remainder of Amicables customers pay on day 30.
What is Amicables receivables days?
A 16
B 12
C 18
D 20
13.4 The CFO of a company is concerned about the companys accounts receivable turnover ratio.
The company currently offers customers terms of 3% discount for settlement within 10 days
E
or full payment within 30 days.
Which of the following strategies would most likely improve the companys accounts
receivable turnover ratio?
A Using invoice discouting
13.5
B
C
D
PL
Changing customer terms to a 1% discount for settelement within 10 days
Entering into a factoring agreement with a finance company
Changing customer terms to a 3% discount for settlment within 20 days
Scrimpy Co buys materials from Frugal Enterprises. Frugal offers discount terms of 2%
discount for payment within 10 days or full payment within 30 days.
Assuming a 360-day year, what is the annual percentage cost associated with Scrimpys
failure to take advantage of the discount offered by Frugal?
M
A 2.0%
B 33.3%
C 36.0%
D 36.7%
13.6 Which of the following statements about debt factoring and invoice discounting is
correct?
SA
A Factoring is with recourse whereas discounting is without recourse

B Invoice discounting is usually performed on the entire receivables ledger
C Both are relatively cheap sources of finance
D Only factoring involves outsourcing the administration of the receivables ledger.
13.7 The management of XYZ Co has annual credit sales of $20 million and accounts receivable
of $4 million. Working capital is financed by an overdraft at 12% interest per year. Assume
365 days in a year.
What is the annual finance cost saving if the management reduces the collection period
by 60 days?
A $85,479
B $394,521
C $78,904
D $68,384
(14 marks)
14 Risk Management
14.1 Hedgehog International is a UK-based firm which must pay $500,000 to its foreign supplier
in 90 days. The current spot rate is $1.60 per 1. Hedgehog purchases an option to buy the
dollar in 90 days at $1.64 per 1, paying a premium of $0.07 per $1. The spot rate after 90
days is $1.58 per 1.
What will Hedgehog do on the payables settlement date?
A Hedgehog will exercise the option

B Hedgehog will not exercise the option
C Hedgehog will be indifferent as to whether it exercises the option or not
D Hedgehog will allow the option to lapse
E
14.2 Hedgehog International is a UK-based firm which will receive $500,000 to its overseas
customer in 90 days. The current spot rate is $1.60 per 1. Hedgehog purchases an option to
sell the dollar in 90 days at $1.61 per 1, paying a premium of $0.03 per $1. The spot rate
after 90 days is $1.58 per 1.
14.3
B
C
D
PL
What will Hedgehog do after 90 days?
A Hedgehog will exercise its option

Hedgehog will lapse the option
Hedgehog will be indifferent as to whether it exercises the option or not
Hedgehog will receive a refund of the premium
A US importer expects to pay a European supplier 500,000 in three months.
Which of the following hedges could be appropriate for the US importer?

M
A Buying call options on the euro
B Buying put options on the euro
C Selling put options on the euro
D Selling call options on the euro
14.4 Platinum Co is US-based and has a receivable due in 30 days for 30,000 euros. The treasurer
is concerned that the value of the euro relative to the dollar will drop before the payment is
received.
SA
What should Platinum do to reduce this risk?
A Deposit 30,000 euros today

B Enter into an interest rate swap contract for 30 days
C Enter into a forward contract to sell 30,000 euros in 30 days
D Platinum cannot effectively reduce this risk
14.5 In evaluating the impact of relative inflation rates on the demand for a foreign currency,
which of the following is true?
A Inflation is irrelevant to currency demand.

B As inflation associated with a foreign economy increases in relation to a domestic
economy, demand for the foreign currency falls.
C As inflation associated with a foreign economy increases in relation to a domestic
economy, demand for the foreign currency increases.
D As inflation associated with a foreign economy decreases in relation to a domestic
economy, demand for the foreign currency falls.
E
14.6 A company has several long-term floating rate bonds outstanding and is considering hedging
interest rate risk.
Which of the following derivative instruments is recommended for this purpose?
A Money market hedge
14.7
B
C
D
PL
Forward currency contract
Fixed rate bank loans
Interest rate swap
Which of the following statements about the term structure of interest rates is/are true?
(1)
(2)
An inverted yield curve is where long-term interest rates are higher than short-
term interest rates.
A rising yield curve is caused when investors prefer to buy for long-dated bonds
A 1 only
M
B 2 only
C Both 1 and 2
D Neither 1 nor 2
14.8 In relation to hedging currency risk, which of the following statements is correct?
SA
A The flexible nature of currency futures means that they can always be matched with
a specific currency exposure
B Currency options carry an obligation to the holder to exercise the option at maturity
C Forward contracts require the payment of a premium
D A money market hedge should give approximately the same result as a forward
contract
14.9 The home currency of GB Co is sterling () and it trades with a company in a foreign country
whose home currency is the rupee. The following information is available:
Home country Foreign country
Spot rate 8000 rupees per
Interest rate 2% per year 9% per year
Inflation rate 1% per year 5% per year
What is the two-year forward exchange rate?
A 9136 rupees per

B 8646 rupees per
C 7005 rupees per
E
D 7696 rupees per
14.10 What is the impact of an appreciation in the value of a countrys currency?
(1) Exports will be given a stimulus

(2) The rate of domestic inflation will rise
14.11
A
B
C
D
1 only
2 only
Both 1 and 2 PL
Neither 1 nor 2
There is a risk that the value of our export earnings will fall over the next few years due to an
appreciating domestic currency.
To which risk does the above statement refer?
A Translation risk
M
B Economic risk
C Transaction risk
D Financial risk
14.12 In relation to the term structure of interest rates what is a normal yield curve?
A Upward sloping
SA
B Downward sloping
C U-shaped
D Horizontal
14.13 Burger Queen Co conducts business in a number of different countries and is trying to
evaluate its economic exposure to long-term exchange rate trends.
Which of the following statements is correct?
A Burger Queen will suffer an economic loss if it has to make payments in a foreign
currency and its domestic currency appreciates
B Burger Queen will enjoy an economic gain if it has to make payments in a foreign
currency and the foreign currency appreciates
C Burger Queen will suffer an economic loss if it has net receipts of a foreign
currency and its domestic currency depreciates
D Burger Queen will suffer an economic loss if it has net receipts of a foreign
currency and the foreign currency depreciates
14.14 Universal Exports Co limits its operations to exporting overseas.
Which ONE of the following statements concerning Universals exposures to exchange

rate risk is correct?
A Universal is subject to transaction, economic and translation exposure

B Universal is subject to transaction and economic exposure
C Universal is only subject to transaction exposure
D Universal is not subject to exchange rate risk as currency fluctuations would balance
out over time
E
14.15 What is the effect on a UK-based company when a foreign competitors currency
becomes weaker compared to sterling?
A The foreign company will have an advantage in the UK market

B The foreign company will be disadvantaged in the UK market
C No effect
15
15.1
D
PL
It is advantageous for the UK company when sterling strengthens
Business Valuation and Ratio Analysis
Assuming an increase in price levels over time, which of the following asset valuations
will produce the highest return on assets?
A
B
Net book value
Gross book value
(30 marks)
C Replacement cost
D Depreciated replacement cost
M
15.2 Kent Co had sales growth of 10% over the past year. EBIT grew by 15% and earnings
per share (EPS) grew by 25% over the same period.
Which of the following statements regarding Kent Cos gearing is correct?
A Total gearing is equal to 0.9

SA
B Total gearing is equal to 2.1

C Financial gearing is equal to 0.6
D Operating gearing is equal to 1.5
15.3 Jack Co owns a $1,000 face value bond purchased at par with an annual coupon of 5%.
What would happen to the market value of the bond if market interest rates later
decreased to 4% and why?
A Increase because the bond pays a higher coupon than the current market rate
B Stay the same since the bond pays a fixed coupon
C Stay the same since the firms credit rating has not changed
D Decrease since market interest rates have declined
15.4 Fernwell wants to buy shares of Gurst Co in two years. Fernwell uses the dividend valuation
model with an assumed dividend growth rate of 5%.
If Fernwells discount rate is 10% and Gursts current year dividend is $20, what is the
approximate price Fernwell will pay?
A $400
B $420
C $441
D $463
15.5 Harken Cos price earnings ratio is 10, its earnings in the current year is $5 per share but the
earnings forecast for the next year is $8 per share.
E
What is the current share price of Harken Co?
A $0.50
B $0.80
C $50
15.6
15.7
D
B
C
D
$80
PL
Whichof the following is a basic premise of behavioural corporate finance?
A Cost behaviour determines valuation

Behavioural characteristics of financial managers can distort judgment
Corporate behaviour will impact financial decisions
Corporate finance is inherently quantitative and objective
A financial manager believes that his actions will cause earnings to increase and the firms
share price to rise in direct proportion to earnings.
M
What does the managers behaviour illustrate?
A Overconfidence
B Excessive optimism
C Illusion of control
D Confirmation bias
SA
15.8 A loan note has a fixed annual coupon of 7% and it will be repaid at its face value of $100 in
one years time. Similar loan notes have a gross redemption yield (i.e. yield to maturity) of
8%.
What is the current market value of the loan note?
A $9907
B $10000
C $10093
D $10607
15.9 Which of the following statements about the efficient market hypothesis is/are true?
(1) In a strongly efficient market, the price/earnings ratios of all companies would be
the same.
(2) In a semi-strong efficient market, the share price for a particular company should
not change when its financial statements are made public.
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
E
15.10 A firm maintains a 30% pay-out ratio. Future projects are expected to generate an annual
post-tax return on investment of 15% and a pre-tax return of 20%.
What is the firms expected annual rate of growth?
A 45%
15.11
B
C
D
60%
105%
140%
PL
Warren analyses publically available information about firms and uses this to try and predict
their share price movements.
To what extent does Warren believe capital markets to be efficient?
A Not efficient at all

B Weak form efficient
M
C Semi-strong form efficient
D Strong form efficient
15.12 Korma Co has paid the following dividends per share in recent years:
Year 2014 2013 2012 2011

Dividend (cents per share) 350 338 328 311
SA
The dividend for 2014 has just been paid and Korma Co has a cost of equity of 12%.
What is the market price of Korma Co shares to the nearest cent?
A $401
B $466
C $407
D $455
15.13 Donald Co has 8% convertible loan notes in issue which are redeemable in five years time at
their nominal value of $100 per loan note. Alternatively, each loan note could be converted
after five years into 60 equity shares with a nominal value of $1 each.
The equity shares of Donald Co are currently trading at $125 per share and this share price is
expected to grow by 4% per year. The yield to maturity (gross redemption yield) of the loan
notes is 10%
What is the current market value of each loan note to the nearest dollar?
A $91
B $92
C $100
E
D $103
15.14 Stern Bear is using the dividend valuation model with a constant growth rate to estimate the
value of an ordinary share.
Which of the following assumptions is Stern Bear making?
15.15
A
B
C
D
A
B
PL
The cost of equity will grow at a constant rate
Earnings will grow at a constant rate
The share price will grow at the same rate as the dividend
The share price will grow at the same amount as the dividend
What does a low price/earnings (P/E) ratio indicate to investors?
Earnings have limited growth potential

Earnings are expected to rise quickly
C There are prolems with the companys management
M
D The company is overvalued
(30 marks)
SA
Question 1 COMPANY OBJECTIVES
Justify and criticise the usual assumption made in financial management literature that the
objective of a company is to maximise the wealth of the shareholders. (Do not consider how this
wealth is to be measured).
Outline other goals that companies claim to follow, and explain why these might be adopted in
preference to the maximisation of shareholder wealth.
(10 marks)
Question 2 THE FINANCIAL MANAGEMENT FUNCTION
(a) Discuss the main decisions within the scope of financial management. (5 marks)
E
(b) Explain how management accounting information may assist the financial manager.
(5 marks)
(10 marks)
appropriate.
Question 4 VALUE FOR MONEY

PL
Question 3 FINANCIAL MANAGEMENT DECISIONS
Discuss the relationship between investment decisions, dividend decisions and financing decisions
in the context of financial management, illustrating your discussion with examples where
(10 marks)
Explain and compare the public sector objective of value for money and the private sector
objective of maximisation of shareholder wealth.
M
(6 marks)
Question 5 NON-FOR-PROFIT
Compare and contrast the financial objectives of a stock exchange listed company and the
financial objectives of a not-for-profit organisation such as a large charity.
(10 marks)
SA
Question 6 QSX CO
A shareholder of QSX Co is concerned about the recent performance of the company and has collected
the following financial information.
Year to 31 May 2015 2014 2013

Revenue $68m $68m $66m
Earnings per share 589c 642c 617c
Dividend per share 400c 385c 370c
Closing ex-dividend share price $648 $835 $740
Return on equity predicted by CAPM 8% 12%
The current cost of equity of QSX Co is 10% per year.
Assume that dividends are paid at the end of each year.
Required:
Calculate the dividend yield, capital gain and total shareholder return for 2014 and 2015, and
briefly discuss your findings with respect to:
(i) the returns predicted by the capital asset pricing model (CAPM);
(ii) the other financial information provided.
(10 marks)
Question 7 AGENCY PROBLEM
At a recent board meeting of Dartig Co, a non-executive director suggested that the companys
remuneration committee should consider scrapping the companys current share option scheme, since
E
executive directors could be rewarded by the scheme even when they did not perform well. A second
non-executive director disagreed, saying the problem was that even when directors acted in ways which
decreased the agency problem, they might not be rewarded by the share option scheme if the stock
market were in decline.
Required:
Question 8 LISTED COMPANY OBJECTIVES

PL
Explain the nature of the agency problem and discuss the use of share option schemes and
performance-related pay as methods of reducing the agency problem in a stock-market listed
company such as Dartig Co.
(10 marks)
Identify TWO financial objectives of a listed company and discuss how each of these financial
objectives may be supported by investment in new projects.
M
(6 marks)
Question 9 GOAL CONGRUENCE
Explain ways in which the directors of a listed company can be encouraged to achieve the
objective of maximisation of shareholder wealth.
(6 marks)
SA
Question 10 MONEY MARKETS
Explain the role of the money markets and give four examples of money market instruments.
(6 marks)
Question 11 TAGNA
Tagna is a medium-sized company that manufactures luxury goods for several well-known chain stores.
In real terms, the company has experienced only a small growth in revenue in recent years, but it has
managed to maintain a constant, if low, level of reported profits by careful control of costs. It has paid
a constant nominal (money terms) dividend for several years and its managing director has publicly
stated that the primary objective of the company is to increase the wealth of shareholders. Tagna is
financed as follows:
$m
Overdraft 10
10 year fixed interest bank loan 20
Share capital and reserves 45
E

75

The financial press has reported that it expects the Central Bank to make a substantial increase in
interest rate in the near future in response to rapidly increasing consumer demand and a sharp rise in
PL
inflation. The financial press has also reported that the rapid increase in consumer demand has been
associated with an increase in consumer credit to record levels.
Required:
On the assumption that the Central Bank makes a substantial interest rate increase, discuss the
possible consequences for Tagna in the following areas:
(i)
(ii)
sales;
operating costs; and
(iii) earnings (profit after tax).
M
(10 marks)
Question 12 FINANCIAL INTERMEDIARIES
Discuss the role of financial intermediaries in providing short-term finance for use by business
organisations.
(5 marks)
SA
Question 13 PAYBACK AND ROCE
Backpay Co is considering investing $50,000 in a new machine. The machine will have scrap value of
$10,000 at the end its five year life. It is expected that 20,000 units will be sold each year at a selling
price of $300 per unit. Variable production costs are expected to be $165 per unit, while incremental
fixed costs, mainly the wages of a maintenance engineer, are expected to be $10,000 per year. The
directors expect investment projects to recover their initial investment within two years and achieve a
return on capital employed (accounting rate of return) of 25% based on average investment.
Required:
(a) Calculate and comment on the projects payback period. (5 marks)
(b) Calculate and comment on the projects return on capital employed based on average
investment. (5 marks)
(10 marks)
Question 14 DIRECTORS VIEWS
The directors of a company require that all investment projects should be evaluated using either
payback period or return on capital employed (accounting rate of return). The target payback period of
the company is two years and the target return on capital employed is 20%, which is the firms current
return on capital employed. A project is accepted if it satisfies either of these investment criteria.
In addition the directors also require all investment projects to be evaluated using net present value
calculated over a four-year planning period, ignoring inflation, any scrap value or working capital
recovery, with a balancing allowance being claimed at the end of the fourth year of operation.
Required:
E
Critically discuss the directors views on investment appraisal.
(10 marks)
Question 15 OKM CO
The following draft appraisal of a proposed investment project has been prepared for the finance
operations of OKM Co.
Year
Contribution
Fixed costs
Depreciation
1,330
1
(530)
(438)
PL
director of OKM Co by a trainee accountant. The project is consistent with the current business
Annual sales (units) 250,000
$000
2
400,000
$000
2,128
(562)
(438)
2,660
3
500,000
$000
(596)
(437)
$000
4
250,000
1,330
(631)
(437)
$000
5
Interest payments (200) (200) (200) (200)

M

Taxable profit 162 928 1,427 62
Taxation (49) (278) (428) (19)

Profit after tax 162 879 1,149 (366) (19)
Scrap value 250

After-tax cash flows 162 879 1,149 (116) (19)
SA
Discount at 10% 0909 0826 0751 0683 0621

Present values 147 726 863 (79) (12)

Net present value = 1,645,000 2,000,000 = ($355,000) so reject the project.
The following information was included with the draft investment appraisal:
1. The initial investment is $2 million, payable at the start of the first year
2. Selling price: $12/unit (current price terms), selling price inflation is 5% per year
3. Variable cost: $7/unit (current price terms), variable cost inflation is 4% per year
4. Fixed overhead costs: $500,000/year (current price terms), fixed cost inflation is 6% per year
5. $200,000/year of the fixed costs are development costs that have already been incurred and
are being recovered by an annual charge to the project
6. Investment financing is by a $2 million loan at a fixed interest rate of 10% per year
7. OKM Co can claim 25% tax-allowable depreciation on a reducing balance basis on this
investment and pays taxation one year in arrears at a rate of 30% per year
8. The scrap value of machinery at the end of the four-year project is $250,000
9. The real weighted average cost of capital of OKM Co is 7% per year
10. The general rate of inflation is expected to be 47% per year
E
Required:
(a) Identify and comment on any errors in the investment appraisal prepared by the trainee
accountant. (5 marks)
(b)
Question 16 LIMITATIONS OF NPV

PL
Prepare a revised calculation of the net present value of the proposed investment project
and comment on the projects acceptability. (10 marks)
Identify the limitations of Net Present Value techniques when applied generally to investment
appraisal.
(10 marks)
(15 marks)
Question 17 RIDAG CO
M
Ridag Co is evaluating two investment projects, as follows.
Project 1
This is an investment in new machinery to produce a recently-developed product. The cost of the
machinery, which is payable immediately, is $15 million, and the scrap value of the machinery at the
SA
end of four years is expected to be $100,000. Tax-allowable depreciation can be claimed on this
investment on a 25% reducing balance basis. Information on future returns from the investment has
been forecast to be as follows:
Year 1 2 3 4
Sales volume (units/year) 50,000 95,000 140,000 75,000
Selling price ($/unit) 2500 2400 2300 2300
Variable cost ($/unit) 1000 1100 1200 1250
Fixed costs ($/year) 105,000 115,000 125,000 125,000
This information must be adjusted to allow for selling price inflation of 4% per year and variable cost
inflation of 25% per year. Fixed costs, which are wholly attributable to the project, have already been
adjusted for inflation. Ridag Co pays profit tax of 30% per year one year in arrears.
Project 2
Ridag Co plans to replace an existing machine and must choose between two machines. Machine 1 has
an initial cost of $200,000 and will have a scrap value of $25,000 after four years. Machine 2 has an
initial cost of $225,000 and will have a scrap value of $50,000 after three years. Annual maintenance
costs of the two machines are as follows:
Year 1 2 3 4
Machine 1 ($/year) 25,000 29,000 32,000 35,000
Machine 2 ($/year) 15,000 20,000 25,000
Where relevant, all information relating to Project 2 has already been adjusted to include expected
future inflation. Taxation and tax-allowable depreciation must be ignored in relation to Machine 1 and
E
Machine 2.
Other information
Ridag Co has a nominal before-tax weighted average cost of capital of 12% and a nominal after-tax
weighted average cost of capital of 7%.
Required:
(a)
(b)
PL
Calculate the net present value of Project 1 and comment on whether this project is
financially acceptable to Ridag Co.
machine should be purchased.

(10 marks)
Calculate the equivalent annual costs of Machine 1 and Machine 2, and discuss which
(5 marks)
(15 marks)
M
Question 18 BQK CO
BQK Co, a house-building company, plans to build 100 houses on a development site over the next four
years. The purchase cost of the development site is $4,000,000, payable at the start of the first year of
construction. Two types of house will be built, with annual sales of each house expected to be as
follows:
Year 1 2 3 4
SA
Number of small houses sold: 15 20 15 5

Number of large houses sold: 7 8 15 15
Houses are built in the year of sale. Financial information relating to each type of house is as follows:
Small house Large house

Selling price: $200,000 $350,000
Variable cost of construction: $100,000 $200,000
Selling prices and variable cost of construction are in current price terms, before allowing for selling
price inflation of 3% per year and variable cost of construction inflation of 45% per year.
Fixed infrastructure costs of $1,500,000 per year in current price terms would be incurred. These
would not relate to any specific house, but would be for the provision of new roads, gardens, drainage
and utilities. Infrastructure cost inflation is expected to be 2% per year.
BQK Co pays profit tax one year in arrears at an annual rate of 30%. The company can claim tax-
allowable depreciation on the purchase cost of the development site on a straight-line basis over the
four years of construction.
BQK Co has a real after-tax cost of capital of 9% per year and a nominal after-tax cost of capital of
12% per year.
New investments are required by the company to have a before-tax return on capital employed
(accounting rate of return) on an average investment basis of 20% per year.
Required:
(a) Calculate the net present value of the proposed investment and comment on its financial
E
acceptability. Work to the nearest $1,000. (11 marks)
(b) Calculate the before-tax return on capital employed (accounting rate of return) of the
proposed investment on an average investment basis and discuss briefly its financial
acceptability. (4 marks)
Question 19 HDW CO
PL
HDW Co is a listed company which plans to meet increased demand for its products by buying new
machinery costing $5 million. The machinery would last for four years, at the end of which it would be
replaced. The scrap value of the machinery is expected to be 5% of the initial cost. Tax-allowable
depreciation would be available on the cost of the machinery on a 25% reducing balance basis, with a
balancing allowance or charge claimed in the final year of operation.
(15 marks)
This investment will increase production capacity by 9,000 units per year and all of these units are
M
expected to be sold as they are produced. Relevant financial information in current price terms is as
follows:
Forecast inflation
Selling price $650 per unit 40% per year
Variable cost $250 per unit 55% per year
Incremental fixed costs $250,000 per year 50% per year
SA
In addition to the initial cost of the new machinery, initial investment in working capital of $500,000
will be required. Investment in working capital will be subject to the general rate of inflation, which is
expected to be 47% per year.
HDW Co pays tax on profits at the rate of 20% per year, one year in arrears. The company has a
nominal (money terms) after-tax cost of capital of 12% per year.
Required:
(a) Calculate the net present value of the planned purchase of the new machinery using a
nominal (money terms) approach and comment on its financial acceptability. (11 marks)
(b) Discuss the difference between a nominal (money terms) approach and a real terms
approach to calculating net present value. (4 marks)
(15 marks)
Question 20 DARN CO
Darn Co has undertaken market research at a cost of $200,000 in order to forecast the future cash flows
of an investment project with an expected life of four years, as follows:
Year 1 2 3 4
Sales revenue ($000) 1,250 2,570 6,890 4,530
Costs ($000) 500 1,000 2,500 1,750
These forecast cash flows are before taking account of general inflation of 47% per year. The capital
cost of the investment project, payable at the start of the first year, will be $2,000,000. The investment
project will have zero scrap value at the end of the fourth year. The level of working capital investment
at the start of each year is expected to be 10% of the sales revenue in that year.
E
Tax-allowable depreciation would be available on the capital cost of the investment project on a 25%
reducing balance basis. Darn Co pays tax on profits at an annual rate of 30% per year, with tax being
paid one year in arrears. Darn Co has a nominal (money terms) after-tax cost of capital of 12% per
year.
Required:
(a)
(b)
PL
Calculate the net present value of the investment project in nominal terms and comment
on its financial acceptability.
its financial acceptability.

(10 marks)
Calculate the net present value of the investment project in real terms and comment on
(5 marks)
(15 marks)
Question 21 REPLACEMENT CYCLES

M
(a) Discuss the problems faced when undertaking investment appraisal in the following
areas and comment on how these problems can be overcome:
(i) assets with replacement cycles of different lengths;
(ii) an investment project has several internal rates of return;

SA
(iii) the business risk of an investment project is significantly different from the
business risk of current operations. (8 marks)
(b) A company with a cost of capital of 14% is trying to determine the optimal replacement cycle
for the notebook computers used by its sales team. The following information is relevant to
the decision:
The cost of each notebook is $2,400. Maintenance costs are payable at the end of each full
year of ownership, but not in the year of replacement (e.g. if the notebook is owned for three
years, then the maintenance cost is payable at the end of year 1 and at the end of year 2).
Interval between Trade-in Value ($) Maintenance cost ($)

Replacement (years)
1 1200 Zero
2 800 75 (payable at end of Year 1)
3 300 150 (payable at end of Year 2)
Answer 1 COMPANY OBJECTIVES
Financial management is concerned with making decisions about the provision and use of a firms
finances. A rational approach to decision-making requires a clear idea of the objectives of the decision
maker or, more importantly, the objectives of those on behalf of whom the decisions are being made.
There is little agreement in the literature as to what objectives of firms are or even what they ought to
be. However, most financial management textbooks make the assumption that the objective of a
limited company is to maximise the wealth of its shareholders. This assumption is normally justified in
terms of classical economic theory. In a market economy firms that achieve the highest returns for their
investors will be the firms that are providing customers with what they require. In turn these
companies, because they provide high returns to investors, will also find it easiest to raise new finance.
Hence the so called invisible hand theory will ensure optimal resource allocation and this should
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automatically maximise the overall economic welfare of the nation.
This argument can be criticised on several grounds. Firstly it ignores market imperfections. For
example it might not be in the public interest to allow monopolies to maximise profits. Secondly it
ignores social needs like health, police, defence etc.
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From a more practical point of view directors have a legal duty to run the company on behalf of their
shareholders. This however begs the question as to what do shareholders actually require from firms.
Another justification from the individual firms point of view is to argue that it is in competition with
other firms for further capital and it therefore needs to provide returns at least as good as the
competition. If it does not it will lose the support of existing shareholders and will find it difficult to
raise funds in the future, as well as being vulnerable to potential take-over bids.
Against the traditional and legal view that the firm is run in order to maximise the wealth of ordinary
shareholders, there is an alternative view that the firm is a coalition of different groups: equity
shareholders, preference shareholders and lenders, employees, customers and suppliers. Each of these
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groups must be paid a minimum return to encourage them to participate in the firm. Any excess
wealth created by the firm should be and is the subject of bargaining between these groups.
At first sight this seems an easy way out of the objectives problem. The directors of a company could
say Lets just make the profits first, then well argue about who gets them at a later stage. In other
words, maximising profits leads to the largest pool of benefits to be distributed among the participants
in the bargaining process. However, it does imply that all such participants must value profits in the
same way and that they are all willing to take the same risks.
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In fact the real risk position and the attitude to risk of ordinary shareholders, loan payables and
employees are likely to be very different. For instance, a shareholder who has a diversified portfolio is
likely not to be as worried by the bankruptcy of one of his companies as will an employee of that
company, or a supplier whose main customer is that company. The problem of risk is one major reason
why there cannot be a single simple objective which is common to all companies.
Separate from the problem of which goal a company ought to pursue are the questions of which goals
companies claim to pursue and which goals they actually pursue.
Many objectives are quoted by large companies and sometimes are included in their annual accounts.
Examples are:
(a) to produce an adequate return for shareholders;

(b) to grow and survive autonomously;
(c) to improve productivity;
(d) to give the highest quality service to customers;
(e) to maintain a contented workforce;
(f) to be technical leaders in their field;
(g) to be market leaders;
(h) to acknowledge their social responsibilities.
Some of these stated objectives are probably a form of public relations exercise. At any rate, it is
possible to classify most of them into four categories which are related to profitability:
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(a) Pure profitability goals (e.g. adequate return for shareholders).
(b) Surrogate goals of profitability (e.g. improving productivity, happy workforce).
(c) Constraints on profitability (e.g. acknowledging social responsibilities, no pollution, etc.).
(d) Dysfunctional goals.
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The last category are goals which should not be followed because they do not create benefit in the long
run. Examples here include the pursuit of market leadership at any cost, even profitability. This may
arise because management assumes that high sales equal high profits which is not necessarily so.
In practice the goals which a company actually pursues are affected to a large extent by the
management. As a last resort, the directors may always be removed by the shareholders or the
shareholders could vote for a take-over bid, but in large companies individual shareholders lack voting
power and information. These companies can, therefore, be dominated by the management.
There are two levels of argument here. Firstly, if the management do attempt to maximise profits, then
they are in a much more powerful position to decide how the profits are carved up than are the
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shareholders.
Secondly, the management may actually be seeking prestige goals rather than profit maximisation:
Such goals might include growth for its own sake, including empire building or maximising revenue for
its own sake, or becoming leaders in the technical field for no reason other than general prestige. Such
goals are usually dysfunctional.
The dominance of management depends on individual shareholders having no real voting power, and in
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this respect institutions have usually preferred to sell their shares rather than interfere with the
management of companies. There is some evidence, however, that they are now taking a more active
role in major company decisions.
From all that has been said above, it appears that each company should have its own unique decision
model. For example, it is possible to construct models where the objective is to maximise profit subject
to first fulfilling the target levels of other goals. However, it is not possible to develop the general
theory of financial management very far without making an initial simplifying assumption about
objectives. The objective of maximising the wealth of equity shareholders seems the least
objectionable.
Answer 2 THE FINANCIAL MANAGEMENT FUNCTION
(a) Decisions that are within the scope of financial management include:
How should the business be financed? The main choices here are internal finance
(reinvestment of surplus cash from operations) or external finance (issuing equity or
debt).
On which proposed investments should the funds be spent? This requires evaluation
of potential projects to establish which would have the greatest impact on
shareholder wealth.
How much dividend should be paid to the shareholders? The dividend decision is
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closely linked to financing and investing decisions as a rise in dividend reduces the
amount of internal finance available for reinvestment.
How much working capital should the organisation have and how should it be
financed? In this context working capital refers to net operating current assets (i.e.
inventory plus receivables less payables).
(b)

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Should risk be managed and, if so, how? Key risks may include foreign exchange
risk (e.g. the risk that an appreciating home currency damages the value of export
earnings) and interest rate risk (e.g. the risk that interest rates will rise and increase
the firms cost of debt finance).
How management accounting information can assist the financial manager
The budgeting process may identify potential cash deficits/surpluses which the
financial manager must plan to finance/invest. Advance warning is particularly
important in the case of potential deficits, giving the financial manager time to
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arrange bridging loans, for example.
Analysis of costs into fixed and variable elements may assist financial management
decisions. Some costs may be semi-variable in nature and splitting them into fixed
and variable elements (e.g. using linear regression) will be critical for decision such
as business expansion,
Variance analysis may help to control the costs of new projects. At the planning
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stage the project committee should set budgets for both capital expenditure and
project operating costs and the management accountant should check for overspends
during the implementation stage.
Answer 3 FINANCIAL MANAGEMENT DECISIONS
Investment decisions, dividend decisions and financing decisions have often been called the decision
triangle of financial management. The study of financial management is often divided up in accordance
with these three decision areas. However, they are not independent decisions, but closely connected.
For example, a decision to increase dividends might lead to a reduction in retained earnings and hence a
greater need for external finance in order to meet the requirements of proposed capital investment
projects. Similarly, a decision to increase capital investment spending will increase the need for
financing, which could be met in part by reducing dividends.
The question of the relationship between the three decision areas was investigated by Miller and
Modigliani. They showed that, if a perfect capital market was assumed, the market value of a company
and its weighted average cost of capital (WACC) were independent of its capital structure. The market
value therefore depended on the business risk of the company and not on its financial risk. The
investment decision, which determined the operating income of a company, was therefore shown to be
important in determining its market value, while the financing decision, given their assumptions, was
shown to be not relevant in this context. In practice, it is recognised that capital structure can affect
WACC and hence the market value of the company.
Miller and Modigliani also investigated the relationship between dividend policy and the share price of
a company (i.e. the market value of a company). They showed that, if a perfect capital market was
assumed, the share price of a company did not depend on its dividend policy (i.e. the dividend decision
was irrelevant to value of the share). The market value of the company and therefore the wealth of
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shareholders were shown to be maximised when the company implemented its optimum investment
policy, which was to invest in all projects with a positive NPV. The investment decision was therefore
shown to be theoretically important with respect to the market value of the company, while the dividend
decision was not relevant.
In practice, capital markets are not perfect and a number of other factors become important in
discussing the relationship between the three decision areas. Pecking order theory, for example,
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suggests that managers do not in practice make financing decisions with the objective of obtaining an
optimal capital structure, but on the basis of the convenience and relative cost of different sources of
finance. Retained earnings are the preferred source of finance from this perspective, with a resulting
pressure for annual dividends to be lower rather than higher.
Answer 4 VALUE FOR MONEY
The objectives of public sector organisations are often difficult to define. Even though the cost of
resources used can be measured, the benefits gained from the consumption of those resources can be
difficult, if not impossible, to quantify. Because of this difficulty, public sector organisations often
have financial targets imposed on them, such as a target rate of return on capital employed.
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Furthermore, they will tend to focus on maximising the return on resources consumed by producing the
best possible combination of services for the lowest possible cost. This is the meaning of value for
money, often referred to as the pursuit of economy, efficiency and effectiveness.
Economy refers to seeking the lowest level of input costs for a given level of output. Efficiency refers
to seeking the highest level of output for a given level of input resources. Effectiveness refers to the
extent to which output produced meets the specified objectives (e.g. in terms of provision of a required
range of services).
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In contrast, private sector organisations have to compete for funds in the capital markets and must offer
an adequate return to investors. The objective of maximisation of shareholder wealth equates to the
view that the primary financial objective of companies is to reward their owners. If this objective is not
followed, the directors may be replaced or a company may find it difficult to obtain funds in the market,
since investors will prefer companies that increase their wealth. However, shareholder wealth cannot
be maximised if companies do not seek both economy and efficiency in their business operations.
Answer 5 NON-FOR-PROFIT
A key financial objective for a stock exchange listed company is to maximise the wealth of
shareholders. This objective is usually replaced by the objective of maximising the companys share
price, since maximising the market value of the company represents the maximum capital gain over a
given period. The need for dividends can be met by recognising that share prices can be seen as the
sum of the present values of future dividends.
Maximising the companys share price is the same as maximising the equity market value of the
company, since equity market value (market capitalisation) is equal to number of issued shares
multiplied by share price. Maximising equity market value can be achieved by maximising net
corporate cash income and the expected growth in that income, while minimising the corporate cost of
capital. Listed companies therefore have maximising net cash income as a key financial objective.
Not-for-profit (NFP) organisations seek to provide services to the public and this requires cash income.
Maximising net cash income is therefore a key financial objective for NFP organisations as well as
listed companies. A large charity seeks to raise as much funds as possible in order to achieve its
charitable objectives, which are non-financial in nature.
Both listed companies and NFP organisations need to control the use of cash within a given financial
period, and both types of organisations therefore use budgets. Another key financial objective for both
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organisations is therefore to keep spending within budget.
The objective of value for money (VFM) is often identified in connection with NFP organisations. This
objective refers to a focus on economy, efficiency and effectiveness. These three terms can be linked to
input (economy refers to securing resources as economically as possible), process (resources need to be
employed efficiently within the organisation) and output (the effective use of resources in achieving the
organisations objectives).
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Described in these terms, it is clear that a listed company also seeks to achieve value for money in its
business operations. There is a difference in emphasis, however, which merits careful consideration. A
listed company has a profit motive, and so VFM for a listed company can be related to performance
measures linked to output (e.g. maximising the equity market value of the company). An NFP
organisation has service-related outputs that are difficult to measure in quantitative terms and so it
focuses on performance measures linked to input (e.g. minimising the input cost for a given level of
output).
Both listed companies and NFP organisations can use a variety of accounting ratios in the context of
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financial objectives. For example, both types of organisation may use a target return on capital
employed, or a target level of income per employee, or a target current ratio.
Comparing and contrasting the financial objectives of a stock exchange listed company and a not-for-
profit organisation, therefore, shows that while significant differences can be found, there is a
considerable amount of common ground in terms of financial objectives.
Answer 6 QSX CO
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Dividend yield is calculated as the dividend divided by the share price at the start of the year.
2014: Dividend yield = 100 385/740 = 52%

2015: Dividend yield = 100 400/835 = 48%
The capital gain is the difference between the opening and closing share prices, and may be expressed
as a monetary amount or as a percentage of the opening share price.
2014: Capital gain = 835 740 = 95c or 128% (100 95/740)

2015: Capital gain = 648 835 = (187c) or (224%) (100 187/835)
The total shareholder return is the sum of the percentage capital gain and the dividend yield, or the sum
of the dividend paid and the monetary capital gain, expressed as a percentage of the opening share
price.
2014: Total shareholder return = 100 (95 + 385)/740 = 180% (52% + 128%)
2015: Total shareholder return = 100 (187 + 40)/835 = 176% (48% 224%)
(i) The return on equity predicted by the CAPM
The actual return for a shareholder of QSX Co, calculated as total shareholder return, is very
different from the return on equity predicted by the CAPM. In 2014 the company provided a
better return than predicted and in 2015 the company gave a negative return while the CAPM
predicted a positive return.
Year 2014 2014

Total shareholder return (176%) 180%
Return on equity predicted by CAPM 8% 12%
Because the risk-free rate of return is positive and the equity risk premium is either zero or
positive, and because negative equity betas are very rare, the return on equity predicted by the
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CAPM is invariably positive. This reflects the reality that shareholders will always want a
return to compensate for taking on risk. In practice, companies sometimes give negative
returns, as is the case here. The return in 2014 was greater than the cost of equity, but the
figure of 10% quoted here is the current cost of equity; the cost of equity may have been
different in 2014.
(ii) Other comments
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QSX Co had revenue growth of 3% in 2014, but did not generate any growth in revenue in
2015. Earnings per share grew by 41% in 2014, but fell by 83% in 2015. Dividends per
share also grew by 41% in 2014, but unlike earnings per share, dividend per share growth
was maintained in 2015. It is common for dividends to be maintained when a company
suffers a setback, often in an attempt to give reassurance to shareholders.
There are other negative signs apart from stagnant revenue and falling earnings per share.
The shareholder will be concerned about experiencing a capital loss in 2015. He will also be
concerned that the decline in the price/earnings ratio in 2015 might be a sign that the market
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is losing confidence in the future of QSX Co. If the shareholder was aware of the proposal by
the finance director to suspend dividends, he would be even more concerned. It might be
argued that, in a semi-strong form-efficient market, the information would remain private. If
QSX Co desires to conserve cash because the company is experiencing liquidity problems,
however, these problems are likely to become public knowledge fairly quickly, for example
through the investigations of capital market analysts.
Tutorial note: It would be useful to benchmark the firms performance to its peers and to
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compare its shareholders returns to those on the relevant stock market index.
WORKINGS
Year 2015 2014 2013

Closing share price $648 $835
Price/earnings ratio 11 times 13 times
Year 2015 2014 2013

Dividend per share 400c 385c 370c
Dividend cover 15 times 17 times 17 times
Earnings per share growth (83%) 41%
Dividend per share growth 39% 41%
Revenue growth nil 3%
Answer 7 AGENCY PROBLEM
Tutorial note: The agency problem refers to the fact that, in practice, actual total shareholder returns
(TSR) are usually below the theoretically possible TSR. The resulting loss in shareholder wealth is
known as agency costs and is caused by sub-optimal performance by management and the costs
incurred in controlling the management.
The primary financial management objective of a company is usually taken to be the maximisation of
shareholder wealth. In practice, the managers of a company acting as agents for the principals (the
shareholders) may act in ways which do not lead to shareholder wealth maximisation. The failure of
managers to maximise shareholder wealth is referred to as the agency problem.
Shareholder wealth increases through payment of dividends and through appreciation of share prices.
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Since share prices reflect the value placed by buyers on the right to receive future dividends, analysis of
changes in shareholder wealth focuses on changes in share prices. The objective of maximising share
prices is commonly used as a substitute objective for that of maximising shareholder wealth.
The agency problem arises because the objectives of managers differ from those of shareholders:
because there is a divorce or separation of ownership from control in modern companies; and because
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there is an asymmetry of information between shareholders and managers which prevents shareholders
being aware of most managerial decisions.
One way to encourage managers to act in ways that increase shareholder wealth is to offer them share
options. These are rights to buy shares on a future date at a price which is fixed when the share options
are issued. Share options will encourage managers to make decisions that are likely to lead to share
price increases (such as investing in projects with positive net present values), since this will increase
the rewards they receive from share options. The higher the share price in the market when the share
options are exercised, the greater will be the capital gain that could be made by managers owning the
options.
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Share options therefore go some way towards reducing the differences between the objectives of
shareholders and managers. However, it is possible that managers may be rewarded for poor
performance if share prices in general are increasing. It is also possible that managers may not be
rewarded for good performance if share prices in general are falling. It is difficult to decide on a share
option exercise price and a share option exercise date that will encourage managers to focus on
increasing shareholder wealth while still remaining challenging, rather than being easily achievable.
Due to the potential problems with share option schemes it may be advisable to consider performance-
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related pay as an alternative method of managing the agency problem. Performance-related pay is a
financial reward system for managers where some, or all, of their compensation is related to how their
performance is assessed relative to stated criteria. The criteria may include profitability targets and
whilst profit maximisation is not necessarily consistent with shareholder wealth maximisation at least
management should feel a direct link between their performance and profits, whereas the firms share
price may be influenced more by overall stock market conditions.
Answer 8 LISTED COMPANY OBJECTIVES
A listed company is likely to have a range of financial objectives. Maximisation of shareholder wealth
is often suggested to be the primary financial objective, and this can be substituted by the objective of
maximising the companys share price. Other financial objectives could relate to earnings per share
(for example, a target EPS value for a given period), operating profit (for example, a target level of
profit before tax or PBIT), revenue (for example, a desired increase in revenue or sales) and so on.
These examples of financial objectives can all be quantified, so that progress towards meeting them can
be measured over time.
New investments should lead to increased revenue and operating profit (profit before interest and tax),
so financial objectives relating to these accounting figures will be supported.
Whether a financial objective relating to increasing earnings per share (EPS) will be supported will
depend on how the investment is financed. For example, raising equity finance by issuing new shares
will dilute (decrease) EPS, while raising debt finance will increase interest payments, which will also
dilute EPS.
An investment with a positive net present value (NPV) should increase the market value of the
company by the amount of the NPV. This increases the wealth of shareholders irrespective of how the
investment is financed, since financing costs were accounted for by the discount rate (whether nominal
or real). The investment would therefore support the objective of shareholder wealth maximisation.
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Answer 9 GOAL CONGRUENCE
The company directors can be encouraged to achieve the objective of maximising shareholder wealth
through managerial reward schemes and through regulatory requirements.
Managerial reward schemes
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As agents of the companys shareholders, directors may not always act in ways which increase the
wealth of shareholders, a phenomenon called the agency problem. They can be encouraged to increase
or maximise shareholder wealth by managerial reward schemes such as performance-related pay and
share option schemes. Through these methods, the goals of shareholders and directors may increase in
congruence.
Performance-related pay links part of the remuneration of directors to some aspect of corporate
performance, such as levels of profit or earnings per share. One problem here is that it is difficult to
choose an aspect of corporate performance which is not influenced by the actions of the directors,
leading to the possibility of managers influencing corporate affairs for their own benefit rather than the
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benefit of shareholders, for example, focusing on short-term performance while neglecting the longer
term.
Share option schemes bring the goals of shareholders and directors closer together to the extent that
directors become shareholders themselves. Share options allow directors to purchase shares at a
specified price on a specified future date, encouraging them to make decisions which exert an upward
pressure on share prices. Unfortunately, a general increase in share prices can lead to directors being
rewarded for poor performance, while a general decrease in share prices can lead to managers not being
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rewarded for good performance. However, share option schemes can lead to a culture of performance
improvement and so can bring continuing benefit to stakeholders.
Regulatory requirements
Regulatory requirements can be imposed through corporate governance codes of best practice and stock
market listing regulations. Corporate governance codes of best practice, such as the UK Corporate
Governance Code, seek to reduce corporate risk and increase corporate accountability. Responsibility
is placed on directors to identify, assess and manage risk within an organisation. An independent
perspective is brought to directors decisions by appointing non-executive directors to create a balanced
board of directors, and by appointing non-executive directors to remuneration committees and audit
committees.
Stock exchange listing regulations can place obligations on directors to manage companies in ways
which support the achievement of objectives such as the maximisation of shareholder wealth. For
example, listing regulations may require companies to publish regular financial reports, to provide
detailed information on directorial rewards and to publish detailed reports on corporate governance and
corporate social responsibility.
Answer 10 MONEY MARKETS
The principal roles of the money markets are to:
transfer money from parties with surplus funds to parties with a deficit;
allow governments and businesses to raise short-term funds;
help governments to implement monetary policy;
determine short-term interest rates.
Common money market instruments include:
Certificate of Deposit (CD) a savings certificate issued by a commercial bank entitling the
holder to receive interest. A CD bears a maturity date, a specified fixed interest rate and can
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be issued in any denomination. CDs are generally issued for terms from one month to five
years. The holder can either keep the CD until its maturity date or resell it on the secondary
market.
Bills of exchange a short-term financial instrument consisting of a written order addressed

by the seller of goods to the buyer requiring the latter to pay a certain sum of money on

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demand or at a future time. Bills of exchange are often used in international transactions, and
the holder of such a bill may convert it immediately into cash by selling it to a bank at a
discount.
Repurchase agreements short-term loans-normally for less than two weeks and frequently
for one day-arranged by selling securities to an investor with an agreement to repurchase them
at a fixed price on a fixed date.
Commercial paper unsecured but high quality corporate debt with a fixed maturity of one to
270 days; usually sold at a discount to face value and carrying a zero coupon interest rate.
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Municipal notes short-term notes issued by municipalities in anticipation of tax receipts or
other revenues.
Treasury bills short-term debt obligations of a national government that are issued to mature
in three to twelve months. Usually issued at a discount to face value and carry zero coupon.
Tutorial note: Only four examples were required

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Answer 11 TAGNA
Consequence of a substantial interest rate increase
(i) Sales
As a manufacturer and supplier of luxury goods, it is likely that Tagna will experience a sharp
decrease in sales as a result of the increase in interest rates. One reason for this is that sales of
luxury goods will be more sensitive to changes in disposable income than sales of basic
necessities, and disposable income is likely to fall as a result of the interest rate increase.
Another reason is the likely effect of the interest rate increase on consumer demand. If the
increase in demand has been supported, even in part, by the increase in consumer credit, the
substantial interest rate increase will have a negative effect on demand as the cost of
consumer credit increases. It is also likely that many chain store customers will buy Tagnas
goods by using credit.
(ii) Operating costs
Tagna may experience an increase in operating costs as a result of the substantial interest rate
increase, although this is likely to be a smaller effect and one that occurs more slowly than a
decrease in sales. As the higher cost of borrowing moves through the various supply chains
in the economy, producer prices may increase and material and other input costs for Tagna
may rise by more than the current rate of inflation. Labour costs may also increase sharply if
the recent sharp rise in inflation leads to high inflationary expectations being built into wage
demands. Acting against this will be the deflationary effect on consumer demand of the
interest rate increase. If the Central Bank has made an accurate assessment of the economic
situation when determining the interest rate increase, both the growth in consumer demand
and the rate of inflation may fall to more acceptable levels, leading to a lower increase in
operating costs.
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(iii) Earnings
The earnings (profit after tax) of Tagna are likely to fall as a result of the interest rate
increase. In addition to the decrease in sales and the possible increase in operating costs
discussed above, Tagna will experience an increase in interest costs arising from its overdraft.
Answer 12 FINANCIAL INTERMEDIARIES

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The combination of these effects is likely to result in a sharp fall in earnings. The level of
reported profits has been low in recent years and so Tagna may be faced with insufficient
profits to maintain its dividend, or even a reported loss.
The role of financial intermediaries in providing short-term finance for use by business organisations is
to provide a link between investors who have surplus cash and borrowers who have financing needs.
The amounts of cash provided by individual investors may be small, whereas borrowers need large
amounts of cash: one of the functions of financial intermediaries is therefore to aggregate invested
funds in order to meet the needs of borrowers. In so doing, they provide a convenient and readily
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accessible route for business organisations to obtain necessary funds.
Small investors are likely to be averse to losing any capital value, so financial intermediaries will
assume the risk of loss on short-term funds borrowed by business organisations, either individually or
by pooling risks between financial intermediaries. This aspect of the role of financial intermediaries is
referred to as risk transformation. Financial intermediaries also offer maturity transformation, in that
investors can deposit funds for a long period of time while borrowers may require funds on a short-term
basis only, and vice versa. In this way the needs of both borrowers and lenders can be satisfied.
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Answer 13 PAYBACK AND ROCE
(a) Payback
Contribution per unit = 300 165 = $135 per unit

Total annual contribution = 20,000 135 = $27,000 per year
Annual cash flow after fixed costs = 27,000 10,000 = $17,000 per year
Payback period = 50,000/17,000 = 29 years
(assuming that cash flows occur evenly throughout the year)
The payback period calculated is greater than the maximum payback period used by Umunat
of two years and on this basis should be rejected. Use of payback period as an investment
appraisal method cannot be recommended, however, because payback period does not
consider all the cash flows arising from an investment project, as it ignores cash flows outside
of the payback period. Furthermore, payback period ignores the time value of money.
The fact that the payback period is 29 years should not therefore be a reason for rejecting the project.
The project should be assessed using the net present value method as this would indicate the potential
dollar increase (or fall) in shareholder wealth due to the project.
(b) ROCE
Annual cash flow after fixed costs = $17,000 (from above)

Annual depreciation = (50,000 10,000)/5 = $8,000
Annual operating profit = 17,000 - 8,000 = $9,000
Average investment = (50,000 + 10,000)/2 = $30,000
ROCE = 9,000/30,000 = 30%
Although the projects ROCE of 30% exceeds the directors target of 25% it does not
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guarantee that the project would increase the wealth of shareholders. Although ROCE does
consider the whole life of the project it ignores the time value of money. Furthermore the
directors target return of 25% may be connected more with personal objectives (such as
receiving a bonus) then with the required return of shareholders. The final decision as to
whether to accept the project should be based upon a net present value appraisal.
Answer 14 DIRECTORS VIEWS
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Evaluation using either payback or return on capital employed
Both payback period and return on capital employed (ROCE) are inferior to discounted cash flow
(DCF) methods such as net present value (NPV) and internal rate of return (IRR). Payback ignores the
time value of money and cash flows outside of the payback period. ROCE uses profit instead of cash
flow. Both payback and ROCE have difficulty in justifying the target value used to determine
acceptability. Why, for example, use a maximum payback period of two years? DCF methods use the
weighted average cost of capital of an investing company as the basis of evaluation, or a project-
specific cost of capital, and both can be justified on academic grounds.
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The company should also clarify why either method can be used, since they assess different aspects of
an investment project.
Regarding the directors policies on net present value (NPV) calculations the following comments can
be made:
Evaluation over a four-year planning period

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Using a planning period or a specified investment appraisal time horizon is a way of reducing the
uncertainty associated with investment appraisal, since this increases with project life. However, it is
important to determine the expected life of an investment project if at all possible, since evaluation over
the whole life of a project may help a company avoid sub-optimal investment decisions.
Inflation is ignored
If selling prices and costs have different inflation rates then the only way to accurately calculate NPV is
to forecast each cash flow in nominal terms (incorporating the specific inflation rate affecting that cash
flow) and discount the total nominal cash flow at the firms nominal cost of capital (incorporating the
general inflation rate in the economy).
The only situation where ignoring inflation will lead to the correct NPV figure is when revenues and
costs all increase at the general inflation rate - in which case uninflated cash flows can be discounted at
the firms real cost of capital.
Scrap value is ignored
Scrap value, salvage value or terminal value must be included in the evaluation of a project since it is a
cash inflow. Ignoring scrap value will reduce the NPV and may lead to rejection of an otherwise
acceptable investment project.
Working capital recovery is ignored
If an investment project ends, then working capital can be recovered and it must be included in the
evaluation of an investment project, since it is a cash inflow.
A balancing allowance is claimed at the end of the fourth year of operation
E
Introducing a balancing allowance which can only be claimed when allowed by the taxation authorities
will distort the taxation aspects of the investment appraisal. If it is anticipated that a project will
continue beyond the fourth year, including a balancing allowance in the evaluation will overstate cash
inflows and hence the NPV, potentially leading to incorrect investment decisions being made.
Answer 15 OKM CO
(a)
PL
Errors in the original investment appraisal
Inflation was incorrectly applied to selling prices and variable costs in calculating
contribution, since only one years inflation was allowed for in each year of operation.
The fixed costs were correctly inflated, but included $200,000 per year of sunk costs which
are not relevant for decision making.
Depreciation is not a cash cost and therefore not relevant.
Straight-line accounting depreciation had been used in the tax calculation, but this
depreciation method is not acceptable to the tax authorities. The approved method using 25%
M
reducing balance tax-allowable depreciation should be used.
Interest payments have been shown as a project cash flow whereas finance costs are already
implied by the discounting process.
The interest rate on the debt finance has been used as the discount rate whereas surplus cash
from the project will accrue to the firms shareholders. The discount rate should therefore
reflect both the cost of debt and the cost of equity (i.e. weighted average cost of capital).
SA
(b) Revised NPV
Tutorial note: As the cash flows will be forecast in nominal terms the WACC also needs to be
restated as nominal. Rather than simply adding the general inflation rate to the real WACC
the Fisher formula should be used.
Nominal weighted average cost of capital = (107 1047) - 1 = 012 (i.e. 12% per year).
NPV calculation
Year 1 2 3 4 5
$000 $000 $000 $000 $000
Contribution 1,330 2,264 3,010 1,600
Fixed costs (318) (337) (357) (379)
E

Taxable cash flow 1,012 1,927 2,653 1,221
Taxation (304) (578) (796) (366)
Allowable depreciation
tax benefits 150 112 84 178

After-tax cash flow
Scrap value
After-tax cash flows

Discount at 12%
Present values
PL 1,012

1,012
0893

904

1,773

1,773
0797

1,413

2,187

2,187
0712

1,557

509
250

759
0635

482

(188)

(188)
0567

(107)

$000
Present value of future cash flows 4,249
M
Initial investment 2,000

Net present value 2,249

The net present value is positive and so the investment is financially acceptable.
SA
Alternative NPV calculation using taxable profit calculation
Year 1 2 3 4 5
$000 $000 $000 $000 $000
Contribution 1,330 2,264 3,010 1,600
Fixed costs (318) (337) (357) (379)

Taxable cash flow 1,012 1,927 2,653 1,221
Tax-allowable depreciation (500) (375) (281) (594)

Taxable profit 512 1,552 2,372 627
Taxation (154) (466) (712) (188)

E
Profit after tax 512 1,398 1,906 (85) (188)
Tax-allowable depreciation 500 375 281 594

After-tax cash flow 1,012 1,773 2,187 509 (188)
Scrap value 250

After-tax cash flows
Discount at 12%
Present values
PL
Present value of future cash flows
Initial investment
1,012
0893

904

1,773
0797

1,413

$000
4,249
2,000
2,187
0712

1,557

759
0635

482

(188)
0567

(107)

Net present value 2,249
M

WORKINGS
Annual contribution
Year 1 2 3 4
SA


Contribution ($/unit) 532 566 602 640

Contribution ($/year) 1,330,000 2,264,000 3,010,000 1,600,000
Tax-allowable depreciation tax benefits
Tutorial note: Assuming that the capital expenditure is made at the start of the first year the
initial tax-allowable depreciation will be claimed at the end of year 1 and the related tax
saving received at the end of year 2.
Year Tax depreciation Tax benefit

$ $
1 500,000 150,000
2 375,000 112,500
3 281,250 84,375
4 Balancing allowance 593,750 178,125
Scrap value 250,000

2,000,000
Answer 16 LIMITATIONS OF NPV
NPV is a commonly used technique in investment appraisal but is subject to a number of restrictive
assumptions and limitations which call into question its general relevance. Nonetheless, if the
Difficulties with NPV

PL
assumptions and limitations are understood then its application is less likely to be undertaken in error.
NPV assumes that firms pursue an objective of maximising the wealth of their shareholders.
This is questionable given the wider range of stakeholders who might have conflicting
interests to those of the shareholders.
NPV is largely redundant if organisations are not wealth maximising. For example, public
sector organisations may wish to invest in capital assets but will use non-profit objectives as
part of their assessment.
M
Estimating the correct discount rate to use. This is particularly so when questions arise as to
the incorporation of risk premiums in the discount rate since an evaluation of the risk of the
business, or of the project in particular, will have to be made and which may be difficult to
discern. Alternative approaches to risk analysis, such as sensitivity and decision trees are
subject to fairly severe limitations.
NPV assumes that cash surpluses can be reinvested at the discount rate. This is subject to
SA
other projects being available which produce at least a zero NPV at the chosen discount rate.
NPV can most easily cope with cash flows arising at period ends and is not a technique that is
used easily when complicated, mid-period cash flows are present.
NPV is not universally employed, especially in a small business environment. The available
evidence suggests that businesses assess projects in a variety of ways (payback, IRR,
accounting rate of return). The fact that such methods are used calls into question the
practical benefits of NPV and therefore hints at certain practical limitations.
If reported profits are important to businesses then it is possible that there may be a conflict
between undertaking a positive NPV project and potentially adverse consequences on
reported profits. This will particularly be the case for projects with long horizons, large initial
investment and very delayed cash inflows. In such circumstances, businesses may prefer to
use accounting measures of investment appraisal.
Managerial incentive schemes may not be consistent with NPV, particularly when long time
horizons are involved. Thus managers may be rewarded on the basis of accounting profits in
the short term and may be encouraged to act in accordance with these objectives and thus
ignore positive NPV projects.
NPV treats all time periods equally with the exception of discounting far cash flows more
than near cash flows. In other words, NPV only accounts for the time value of money. To
many businesses, distant horizons are less important than near horizons, if only because that
is the environment in which they work. For example, in the long term, nearly all aspects of
the business may change and hence a too-narrow focus on discounting means that NPV is of
limited value and more so the further the time horizon considered.
NPV does not take account of non-financial information which may even be relevant to
E
shareholders who want their wealth maximised. For example, issues of strategic benefit may
arise against which it is difficult to immediately quantify the benefits but for which there are
immediate costs. NPV would treat such a situation as an additional cost since it could not
incorporate the indiscernible benefit.
Answer 17 RIDAG CO
(a)
Sales revenue
Variable costs
PL
Calculation of net present value (NPV)
As nominal after-tax cash flows are to be discounted, the nominal after-tax weighted average
cost of capital of 7% must be used.
Year 1
$000
1,300
(513)
2
$000
2,466
(1,098)
3
$000
3,622
(1,809)
4
$000
2,018
(1,035)
5
$000

M
Contribution 787 1,368 1,813 983
Fixed costs (105) (115) (125) (125)

Taxable cash flow 682 1,253 1,688 858
Tax liabilities (205) (376) (506) (257)
Tax-allowable depreciation tax benefits 113 84 63 160

After-tax cash flow 682 1,161 1,396 415 (97)
SA
Scrap value 100

Net cash flow 682 1,161 1,396 515 (97)
Discount at 7% 0935 0873 0816 0763 0713

Present values 638 1,014 1,139 393 (69)

$000
Present value of cash inflows 3,115
Cost of machine (1,500)

NPV 1,615

Project 1 has a positive NPV of $1,615,000 and so it is financially acceptable to Ridag Co.
However, the discount rate used here is the current weighted average after-tax cost of capital.
As this is a recently-developed product, it may be appropriate to use a project-specific
discount rate that reflects the risk of the new product launch.
WORKINGS
Sales revenue
Year 1 2 3 4
Inflated selling price ($/unit) 2600 2596 2587 2691
E
Sales revenue ($/year) 1,300,000 2,466,200 3,621,800 2,018,250
Variable cost
Year 1 2 3 4
1
2
3
PL
Inflated variable cost ($/unit)
Sales volume (units/year)
Variable costs ($/year)
Allowable depreciation
1025
50,000
1,500,000 025 = $375,000

1,125,000 025 = $281,250
843,750 025 = $210,938
1156
95,000
Tax benefit
1292
140,000
1380
75,000
512,500 1,098,200 1,808,800 1,035,000
Tax-allowable depreciation tax benefits
Year
375,000 03 = $112,500
281,250 03 = $84,375
210,938 03 = $63,281
Year benefit received
2
3
4
4 $532,812* 5 32,812 03 = $159,844 5
M
*843,750 210,938 100,000 = $532,812
Alternative calculation of net cash flow
Year 1 2 3 4 5
$000 $000 $000 $000 $000
Taxable cash flow 682 1,253 1,688 858
SA
Tax-allowable depreciation (375) (281) (211) (533)

Taxable profit 307 972 1,477 325
Taxation (92) (292) (443) (98)

After-tax profit 307 880 1,185 (118) (98)
Add back allowances 375 281 211 533

After-tax cash flow 682 1,161 1,396 415 (98)
Scrap value 100

Net cash flow 682 1,161 1,396 515 (98)
Discount at 7% 0935 0873 0816 0763 0713

Present values 638 1,014 1,139 393 (70)

There are slight differences due to rounding.
(b) Calculation of equivalent annual cost for machine 1
Since taxation and tax-allowable depreciation are to be ignored, and where relevant all
information relating to project 2 has already been adjusted to include future inflation, the
correct discount rate to use here is the nominal before-tax weighted average cost of capital of
12%.
Year 0 1 2 3 4
Maintenance costs ($) (25,000) (29,000) (32,000) (35,000)
Investment and scrap ($) (200,000) 25,000

Net cash flow ($) (200,000) (25,000) (29,000) (32,000) (10,000)
Discount at 12% 1000 0893 0797 0712 0636
E

Present values (200,000) (22,325) (23,113) (22,784) (6,360)

Present value of cash flows $274,582
Cumulative present value factor 3037
Equivalent annual cost = 274,582/3037 = $90,412
Maintenance costs ($)

Investment and scrap ($)
Net cash flow ($)

Discount at 12%
PL
Calculation of equivalent annual cost for machine 2
Year
(225,000)
0

(225,000) (15,000) (20,000)
1000 0893 0797

1
(15,000)
2
(20,000)
3
(25,000)
50,000

25,000
0712

Present values (225,000) (13,395) (15,940) 17,800
M

Present value of cash flows $236,535
Cumulative present value factor 2402
Equivalent annual cost = 236,535/2402 = $98,474
The machine with the lowest equivalent annual cost should be purchased and calculation
shows this to be Machine 1. If the present value of future cash flows had been considered
alone, Machine 2 (cost of $236,535) would have been preferred to Machine 1 (cost of
SA
$274,582). However, the lives of the two machines are different and the equivalent annual
cost method allows this to be taken into consideration.
Answer 18 BQK CO
(a) NPV calculation
Year 1 2 3 4 5
$000 $000 $000 $000 $000
Sales revenue 5,614 7,214 9,015 7,034
Variable costs (3,031) (3,931) (5,135) (4,174)

Contribution 2,583 3,283 3,880 2,860
Fixed costs (1,530) (1,561) (1,592) (1,624)

Before-tax cash flow 1,053 1,722 2,288 1,236
E
Tax liability (316) (517) (686) (371)
Tax-allowable depreciation tax benefits 300 300 300 300

Discount at 12% 0893 0797 0712 0636 0567

Present values
PL
PV of future cash flows
Initial investment
$000
940

4,276
(4,000)

276

1,360

1,475

541

(40)

Comment: Since the proposed investment has a positive net present value of $276,000, it is
financially acceptable.
M
WORKINGS
Sales revenue
Year 1 2 3 4
Sales of small houses (houses/year) 15 20 15 5
Sales of large houses (houses/year) 7 8 15 15
SA
Small house selling price ($000/house) 200 200 200 200

Large house selling price ($000/house) 350 350 350 350
Sales revenue (small houses) ($000/year) 3,000 4,000 3,000 1,000
Sales revenue (large houses) ($000/year) 2,450 2,800 5,250 5,250

Total sales revenue ($/year) 5,450 6,800 8,250 6,250

Inflated sales revenue ($/year) 5,614 7,214 9,015 7,034
Variable costs of construction
Year 1 2 3 4
Sales of small houses (houses/year) 15 20 15 5
Sales of large houses (houses/year) 7 8 15 15
Small house variable cost ($000/house) 100 100 100 100
Large house variable cost ($000/house) 200 200 200 200
Variable cost (small houses) ($000/year) 1,500 2,000 1,500 500
Variable cost (large houses) ($000/year) 1,400 1,600 3,000 3,000

Total variable cost ($/year) 2,900 3,600 4,500 3,500

Inflated total variable cost ($/year) 3,031 3,931 5,135 4,174
E
Fixed infrastructure costs
Year 1 2 3 4
Fixed costs ($000/year) 1,500 1,500 1,500 1,500
Inflated fixed costs ($000/year) 1,530 1,561 1,592 1,624
Alternative NPV calculation
Year
Before-tax cash flow

Tax-allowable depreciation
Taxable profit
Taxation
PL $000
1
1,053
(1,000)

53
2
$000
1,722
(1,000)

722
(16)
3
$000
2,288
(1,000)

1,288
(217)
4
$000
1,236
(1,000)

236
(386)
5
$000
(71)

M
Profit after tax 53 706 1,071 (150) (71)
Add back allowances 1,000 1,000 1,000 1,000

Discount at 12% 0893 0797 0712 0636 0567

Present values 940 1,360 1,475 541 (40)

SA
$000
PV of future cash flows 4,276
Initial investment (4,000)

276

(b) Calculation of return on capital employed (ROCE)
Total before-tax cash flow $6,299,000

Total depreciation $4,000,000

Total accounting profit $2,299,000
Average annual profit ($000/year) = 2,299,000/4 = $574,750

Average investment ($000) = 4,000,000/2 = $2,000,000
ROCE (ARR) = 100 574,750/2,000,000 = 287%
Discussion
The ROCE is greater than the 20% target ROCE of the investing company and so the
proposed investment is financially acceptable. However, the investment decision should be
made on the basis of information provided by a discounted cash flow (DCF) method, such as
net present value or internal rate of return.
Answer 19 HDW CO
(a) Net present value of investment in new machinery
Year 1 2 3 4 5
$000 $000 $000 $000 $000
E
Sales income 6,084 6,327 6,580 6,844
Variable cost (2,374) (2,504) (2,642) (2,787)

Contribution 3,710 3,823 3,938 4,057
Fixed costs (263) (276) (289) (304)

Cash flow
Taxation
Working capital
Scrap value
Net cash flow

PL
tax benefits
After-tax cash flow

3,447

3,447
(24)

3,423
3,547
(689)
250

3,108
(25)

3,083
3,649
(709)
188

3,128
(26)

3,102
3,753
(730)
141

3,164
(27)
250

3,387
(751)
372

(379)

(379)
Discount at 12% 0893 0797 0712 0636 0567
M

Present values 3,057 2,457 2,209 2,154 (215)

$000
Working capital (500)
SA

NPV 4,162

As the net present value of $4161 million is positive, the expansion can be recommended as
financially acceptable.
WORKINGS
Year 1 2 3 4
Sales (units/year) 9,000 9,000 9,000 9,000
Sales income ($000) 6,084 6,327 6,580 6,844
Year 1 2 3 4
Sales (units/year) 9,000 9,000 9,000 9,000
Variable cost ($000) 2,374 2,504 2,642 2,787
Year 1 2 3 4
$000 $000 $000 $000
Tax-allowable depreciation 1,2500 9375 7031 1,8594
Tax benefit 250 188 141 372
Year 1 2 3 4
$000 $000 $000 $000
Working capital 52350 54811 57387 60084
Incremental 24 25 26 27
Alternative NPV calculation where tax-allowable depreciation is subtracted and added back
Year 1 2 3 4 5
E
$000 $000 $000 $000 $000
Cash flow 3,447 3,547 3,649 3,753
Tax-allowable depreciation (1,250) (938) (703) (1,859)

Taxable profit 2,197 2,609 2,946 1,894
Taxation (439) (522) (589) (379)
After-tax profit
After-tax cash flow

Working capital
Scrap value
Net cash flow

PL
2,197
1,250

3,447
(24)

3,423

2,170
938

3,108
(25)

3,083

2,424
703

3,127
(26)

3,101

1,305
1,859

3,164
(27)
250

3,387

(379)

(379)

(379)
Discount at 12% 0893 0797 0712 0636 0567

M
Present values 3,057 2,457 2,208 2,154 (215)

NPV = 9,661 5,000 500 = $4161 million
Tutorial note: The model answer ignores the recovery of working capital at the end of the
four year evaluation period on the justification that the machinery will be replaced and hence
the investment in working capital would continue. However, there is a strong argument that
SA
the recovery of working capital should be shown, in which case there would be a cash inflow
at the end of the fourth year of 575 (500 + 25 +26 + 26).
(b) Nominal v real approach
A nominal (money terms) approach to investment appraisal discounts nominal cash flows
with a nominal cost of capital. Nominal cash flows are found by inflating forecast values
from current price estimates, for example, using specific inflation. Applying specific inflation
means that different project cash flows are inflated by different inflation rates in order to
generate nominal project cash flows.
A real terms approach to investment appraisal discounts real cash flows with a real cost of
capital. Real cash flows are found by deflating nominal cash flows by the general rate of
inflation. The real cost of capital is found by deflating the nominal cost of capital by the
general rate of inflation, using the Fisher equation:
(1 + real discount rate) (1 + inflation rate) = (1 + nominal discount rate)
The net present value for an investment project does not depend on whether a nominal terms
approach or a real terms approach is adopted, since nominal cash flows and the nominal
discount rate are both discounted by the general rate of inflation to give real cash flows and
the real discount rate, respectively. Both approaches give the same net present value.
Tutorial note for illustrative purposes:
The real after-tax cost of capital of HDW Co can be found as follows:
112/1047 = 107 (i.e. the real after-tax cost of capital is 7%).
The following illustration deflates nominal net cash flows (NCF) by the general rate of
inflation (47%) to give real NCF, which are then discounted by the real cost of capital (7%).
E
Year 1 2 3 4 5
$000 $000 $000 $000 $000
Nominal NCF 3,423 3,083 3,102 3,387 (379)
Real NCF 3,269 2,812 2,703 2,819 (301)
Discount at 7% 0935 0873 0816 0763 0713
Present values
PL
3,057

2,455

2,206

2,151

Allowing for rounding, the illustration shows that the present values of the real cash flows are
the same as the present values of the nominal cash flows, and that the real terms approach
NPV of $4154 million is the same as the nominal terms approach NPV of $4161 million.
The two approaches produce identical NPVs and offer the same investment advice.
Answer 20 DARN CO

(215)

M
(a) NPV using nominal method
Calculating the net present value of the investment project using a nominal terms approach
requires the discounting of nominal (money terms) cash flows using a nominal discount rate,
which is given as 12%.
Year 1 2 3 4 5
$000 $000 $000 $000 $000
SA
Sales revenue 1,30875 2,81726 7,90787 5,44358

Costs (52350) (1,09621) (2,86933) (2,10293)

Net revenue 78525 1,72105 5,03854 3,34065
Tax payable (23558) (51632) (1,51156) (1,00220)
tax benefits 15000 11250 8438 25313

After-tax cash flow 78525 1,63547 4,63472 1,91347 (74907)
Working capital (15086) (50906) 24643 54436

Project cash flow 63439 1,12641 4,88115 2,45783 (74907)
Discount at 12% 0893 0797 0712 0636 0567

Present values 56651 89775 3,47538 1,56318 (42472)

$000

NPV 3,94722

The net present value is $3,947,220 and so the investment project is financially acceptable.
WORKINGS
Year 1 2 3 4
Sales revenue ($000) 1,250 2,570 6,890 4,530
E
Inflated sales revenue ($000) 1,30875 2,81726 7,90787 5,44358
Year 1 2 3 4
Costs ($000) 500 1,000 2,500 1,750
Inflated costs ($000) 52350 1,09621 2,86933 2,10293
Year 1 2 3 4
(b)
Working capital ($000)
Incremental ($000)
Year
PL
Inflated sales revenue ($000)
Tax-allowable depreciation ($000)

Tax benefit ($000)
NPV using real method

1,30875
13088
(13088)
1
50000
15000
2,81726 7,90787 5,44358
28173
2
37500
11250
79079
(15086) (50906)
3
28125
8438
54436
24643
Calculating the net present value of the investment project using a real terms approach
4
84375
25313
requires discounting real terms cash flows with a real discount rate.
M
Real terms cash flows are found by deflating nominal cash flows by the general rate of
inflation. Since only the general rate of inflation is available, the real terms operating cash
flows are those given in the question.
The nominal discount rate is 12% and the general rate of inflation is 47%. The real discount
rate is therefore 7% (112/1047).
Year 1 2 3 4 5
SA
$000 $000 $000 $000 $000

Sales revenue 1,250 2,570 6,890 4,530
Costs (500) (1,000) (2,500) (1,750)

Net revenue 75000 1,57000 4,39000 2,78000
Tax payable (22500) (47100) (1,31700) (83400)
tax benefits 15000 11250 8438 25313

After-tax cash flow 75000 1,49500 4,03150 1,54738 (58087)
Working capital (13200) (43200) 23600 45300

Project cash flow 61800 1,06300 4,2675 2,00038 (58087)
Discount at 7% 0935 0873 0816 0763 0713

Present values 57783 92800 3,48228 1,52629 (41416)

$000

NPV 3,97524

The net present value is $3,975,240 and so the investment project is financially acceptable.
The difference between the nominal terms NPV ($3,947,220) and the real terms NPV is due
primarily to two factors. First, the tax benefits from tax-allowable depreciation are not
affected by inflation and so will have different present values due to the change in discount
rate. Second, the working capital cash flows are timed differently to the sales income on
E
which they depend, and so their inflation effects are timed differently to the related inflation
effects in the discount rate.
WORKING
Year 1 2 3 4
Sales revenue ($000)
Incremental ($000)
discount rate of 7%.
Year
PL
Working capital ($000)
1,250
125
(125)
1
$000
2,570
2
$000
257
(132)
3
$000
6,890
689
(432)
4
$000
5
$000
4,530
453
236
Examiners note: An alternative approach is to deflate the nominal project cash flows from
part (a) by 4.7% per year to give real terms project cash flows, before discounting by the real
Project cash flow 634.39 1,126.41 4,881.15 2,457.83 (749.07)

M
Deflate at 4.7% 605.91 1,027.55 4,252.87 2,045.34 (595.37)
Discount at 7% 0.935 0.873 0.816 0.763 0.713

Present values 566.53 897.05 3,470.34 1,560.59 (424.50)

$000
PV of future cash flows 6,070.01
SA
Initial investment (2,000.00)

Working capital (130.88)

NPV 3,939.13

Answer 21 REPLACEMENT CYCLES
(a) Problems in investment appraisal
(i) Asset replacement decisions
The problem here is that the net present value investment appraisal method may offer
incorrect advice about when an asset should be replaced. The lowest present value of costs
may not indicate the optimum replacement period.
E
PL
M
SA
E
PL ABOUT BECKER PROFESSIONAL EDUCATION
Becker Professional Education provides a single destination
for candidates and professionals looking to advance their
careers and achieve success in:
Accounting
M
International Financial Reporting
Project Management
Continuing Professional Education
Healthcare
For more information on how Becker Professional Education can
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support you in your career, visit www.becker.com.

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This ACCA Revision Question Bank has been reviewed
by ACCA's examining team and includes:
The most recent ACCA examinations with suggested answers

Past examination questions, updated where relevant
PL
Model answers and suggested solutions
Tutorial notes
M
SA
www.becker.com/ACCA | acca@becker.com
2015 DeVry/Becker Educational Development Corp. All rights reserved.

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June 2015 Edition

Becker Professional Education has more than 20

For Examinations to June 2015

Copyright 2015 DeVry/Becker Educational Development Corp. All rights reserved.

Question Page Answer Marks Date worked

MULTIPLE CHOICE QUESTIONS (Section A Questions)

The financial management function

THE FINANCIAL MANAGEMENT FUNCTION

THE FINANCIAL MANAGEMENT ENVIRONMENT

10 Money markets 33 1024 6

DISCOUNTED CASH FLOW TECHNIQUES

Question Page Answer Marks Date worked

APPLICATIONS OF DISCOUNTED CASH FLOW TECHNIQUES

21 Replacement cycles (ACCA J10) 39 1040 15

PROJECT APPRAISAL UNDER RISK

EQUITY FINANCE AND DEBT FINANCE

COST OF CAPITAL AND GEARING

CAPITAL ASSET PRICING MODEL

44 Project-specific discount rate (ACCA D08) 50 1071 10

WORKING CAPITAL MANAGEMENT

49 Blin (ACCA J04) 52 1077 15

Question Page Answer Marks Date worked

55 EOQ and JIT 55 1086 15

58 Baumol model (ACCA D05) 57 1089 10

MANAGEMENT OF ACCOUNTS RECEIVABLE AND PAYABLE

62 PKA (ACCA D07) 59 1096 15

74 NSX (ACCA J10) 67 1110 10

78 Efficient Markets Hypothesis (ACCA D07) 69 1113 10

ACCA SPECIMEN EXAMINATION PAPER

Economic order quantity

Miller Orr Model

Return point = Lower limit + (1/3 spread)

The Capital Asset Pricing Model

The asset beta formula

The Growth Model

The weighted average cost of capital

The Fisher formula

Purchasing power parity and interest rate parity

Present Value Table

Present value of 1 i.e. (1 + r)n

Discount rate (r)

Discount rate (r)

MULTIPLE CHOICE QUESTIONS

1 The Financial Management Function

1.3 Which of the following statements is correct?

Which of the following is the best indicator of shareholder wealth?

Profit before interest and tax

A Managers diverting funds into their own pet projects

A The average cost of capital is increased by a recent financing decision

1.8 Which of the following statements concerning not-for-profit organisations is correct?

A Not-for-profit organisations often have multiple stakeholders with conflicting

Profit after tax PL

What is the operational gearing of IQ Co?

A A change in sales will have a relatively small impact on profits

2 The Financial Management Environment

2.1 Which of the following is least likely to act as a financial intermediary?

A Ordinary share; Unsecured loan; Preference share

2.3 Which of the following best describes commercial paper?

Which of the following would be LEAST likely to be a function of a treasury

Managing relationships with banks

A Unsecured bank loan

(1) Interest-bearing instruments usually trade at less than face value

Which of the following targets relate predominantly to fiscal policy?