ACCA FM (F9) – Mock Exam Solution March 2021

SECTION A
1 – A)

Payable days = (Trade payables / Credit purchases) x 365

Payable days = ($4,932 / $100,000) x 365

Payable days = 18 days

Cash conversion cycle = Receivable days + Inventory days – Payable days

45 = Receivable days + 20 - 18 days

Receivable days = 45 - 20 + 18

Receivable days = 43 days

2 – A)

ROCE Can be used to compare different divisions with same age of assets. It usually drive under
investment in assets. Data is available in financial reports.

3–B

$5,256,000 - $1,576,000 - $4M x 12% = $3, 20,000 divided by 2M shares, $1.60 is EPS.

4–C

Financial management objective to maximize shareholders’ wealth but both rewarding by performance
and maximizing benefits cannot achieve that. Corporate governance is not for minimizing Risk.

5 – B)

The first 4 years will recover $60,000. The remaining amount of $5,000 will be recovered part-way into
the year 5 as follows:

$5000 / $10,000 = 0.5

Therefore, the project will recover it initial investment in a period of 4.5 years.

6 – A)

Traditional view suggests there is an optimal capital structure giving the maximum company’s value.

Pecking order theory suggests financing should start from internal resources such as retained earnings.

7 – A)

Dividend growth rate is (0.0618/0.0555) (1/2) – 1 = 6% Apply dividend growth model which is P
=0.0618 * (1 + 6%) / (12%-6%) = 1.09

8–D
ACCA FM (F9) – Mock Exam Solution March 2021
By linear interpolation, we find two net present values by adopting two discount rates, says 5% and 20%
NPV for 5% is 22.6 while 20% is 26.9. So the best estimate of the cost of these loan notes is 11.5%

9–D

Creditor hierarchy refers to the claim seniority when the company goes into bankrupt.

10 – B

Earnings yield is earnings per share divided by price per share

11 – D

Corporation tax rate is irrelevant in valuation as investor pay market price and receive grass interest

2 step to get the answer

First find out the annuity of 3 years coupon which is $8 X 2.487 (required rate at 10%).The amount is
$19.9. Next,

The present value of redeemable amount of $ 110 which is $110 X 0.751 (required rate at 10%). The
amount is $82.61. The sum of these amounts give the answer of $102.51

12 – D

Market value of shares before the rights issue = $1.5 x 2,000,000 = $3,000,000

Cash raised from rights issue = ($2,000,000 / 4) x $1.3 = $650,000

No. of shares after rights issue = 2,000,000 + 500,000 = 2,500,000

Theoretical ex-rights price = ($3,000,000 + $650,000) / 2,500,000 = $1.46

13 – D

You need to apply Gordon Growth approximation and dividend growth model to value the company.

Growth rate is: g = rb which is 20% x 60% = 12%. So, the market value is $30m X (1 + 12%) / (22% - 12%)
= $336 m

14 – C

Statement 1 is not correct because option contract premium should be paid when it is purchased and
not exercised.

15 – C

Interest rate parity should be adopted for forward rate quote. Based on interest rate parity, 3 month
forward rate is 1.3 X (1+6%/4) / (1+3%/4), which is 1.3097

SECTION B
ACCA FM (F9) – Mock Exam Solution March 2021
16 – B

$000

Freehold land and buildings 9,600

Plant and machinery 3,200

Current assets (4.3 – 0.2 – 0.4) 3,700

Less: debt: 6% debentures (8,000)

Current liabilities (2,200)

––––

Total equity value 6,300

17 - B

The net asset (revalued) method would tend to under value a business such as Rose as it ignores the
value of any internally generated intangibles such as the staff, of company reputation.

Income based valuation methods, such as the PE ratio method, are particularly good for valuing majority
shareholdings.

When using the PE ratio method for valuing a private company with fewer internal controls, the PE ratio
of a similar public company could be used and adjusted downwards to reflect the higher risk and lower
value of the private company.

18 - A

MV calculations are done from the investor’s point of view rather than the company’s, so the interest
does not need to be adjusted for taxation.

MV of irredeemable debt = I/r = (interest in $ / investors’ required return)

I = $100 × 6% = $6 (interest is always based on nominal value, assume nominal value of one debenture is
$100)

MV = $6 ÷ 0.075 = $80.

19 - $8.33

Dividend yield = D / P = total dividend / total value of shares

Total value of shares = total dividend / dividend yield

Total value = $250,000/0.03 = $8,333,333

Number of shares = $500,000 / $0.5 = 1,000,000

Value per share = 8,333,333/1,000,000 = $8.33 per share

ACCA FM (F9) – Mock Exam Solution March 2021
20 – The Maximum amount paid should be the opportunity cost of having the same business. As cost of
setting up an equivalent business is the opportunity costs having the same income and cashflow, it is the
maximum price Finland Co. should pay.

21 – The correct answer is: $1.566 Forward rate = 1.543 x (1.025/1.01) = €1.566 per $1

22 – The correct answer is: Transaction risk

The euro receipt is subject to transaction risk.

23 – The correct answer is: Currency swap

A currency swap is not a suitable method for hedging a one-off transaction.

24 – The correct answer is: If the dollar inflation rate is less than the euro inflation rate, purchasing
power parity indicates that the euro will appreciate against the dollar: Does not support director's belief

If the dollar nominal interest rate is less than the euro nominal interest rate, interest rate parity
indicates that the euro will depreciate against the dollar: Supports director's belief.

25 – The correct answer is: 'In exchange for a premium, Alfa Co could hedge its interest rate risk by
buying interest rate options' is correct. So the first statement is correct.

26 – The correct answer is: Statements 1 and 4

Deregulation to increase competition should mean managers act to reduce costs in order to be
competitive. The need to reduce costs may mean that quality of products declines.

27 –

The correct answer is: $90,412 Since taxation and capital allowances 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%.

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% 1.000 0.893 0.797 0.712 0.636

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

Present value of cash flows ($274,582)

Cumulative present value factor 3.037

Equivalent annual cost = 274,582/3.037 = $90,412

28 – IRR assumes funds are re invested but it is a disadvantage of IRR

ACCA FM (F9) – Mock Exam Solution March 2021
29 – The correct answer is: $18,868

EV of Year 3 cash flow = (23,000 x 0.2) + (24,000 x 0.35) + (30,000 x 0.45) = 26,500

PV discounted at 12% = 26,500 x 0.712 = $18,868

30 – The correct answer is: The statement about uncertainty increasing with project life is true.

Notes on incorrect answers:

Simulation (not sensitivity analysis) takes into account the interrelationship between project variables.
Probability analysis can be used to assess the risk (not uncertainty) associated with the project.

A lower discount rate of 5% would increase the present value of costs incurred in later years and would
therefore increase their impact.

SECTION C
Solution

a) Project NPV

Sales volume reaches the maximum capacity of the new machine in Year 4.

Year 1 2 3 4 5
$ $ $ $ $
Sales revenue 312,000 432,800 562,500 702,000

Marginal cost (243,300) (337,600) (438,500) (547,200)

Maintenance (10,600) (11,236) (11,910) (12,625)

Fixed cost (10,000) (15,750) (22,050) (28,941)

––––––– ––––––– ––––––– –––––––

Taxable cash flow 48,100 68,214 90,040 113,234

Taxation (14,430) (20,464) (27,012) (33,970)

WDA tax benefit 16,125 12,094 9,070 27,211

––––––– ––––––– ––––––– ––––––– –––––––

Net cash flow 48,100 69,909 81,670 95,292 (6,759)

Discount factors 0·901 0·812 0·731 0·659 0·593

––––––– ––––––– ––––––– ––––––– –––––––

Present values 43,338 56,766 59,701 62,797 (4,008)

––––––– ––––––– ––––––– ––––––– –––––––

ACCA FM (F9) – Mock Exam Solution March 2021
Sum of present values 218,594

Initial investment 215,000

–––––––

Net present value 3,594

–––––––

The positive NPV indicates that the investment in Machine Two is financially acceptable,
although the NPV is so small that there is likely to be a significant possibility of a negative NPV.

WORKINGS

Year 1 2 3 4

Selling price ($/unit) 10·40 10·82 11·25 11·70

Sales (units/year) 30,000 40,000 50,000 60,000

Sales revenue ($/year) 312,000 432,800 562,500 702,000

Year 1 2 3 4

Marginal cost ($/unit) 8·11 8·44 8·77 9·12

Sales (units/year) 30,000 40,000 50,000 60,000

Marginal cost ($/year) 243,300 337,600 438,500 547,200

Year 1 2 3 4

Maintenance ($/year) 10,000 15,000 20,000 25,000

Inflated cost (5%/year) 10,000 15,750 22,050 28,941

Writing down allowances and tax benefits:

Allowances Benefits

$ $

Year 1: 215,000 × 0·25 = 53,750 16,125

Year 2: 161,250 × 0·25 = 40,312 12,094

Year 3: 120,938 × 0·25 = 30,234 9,070

ACCA FM (F9) – Mock Exam Solution March 2021
–––––––

124,296

Year 4: (215,000 – 124,296) = 90,704 27,211

–––––––

215,000

–––––––

b) Pre-tax Accounting Rate of Return (ARR)

Total taxable cash flow = (48,100 + 68,214 + 90,040 + 113,234) = $319,588

Total depreciation = $215,000

Total accounting profit = 319,588 – 215,000 = $104,588

Average annual accounting profit = 104,588/4 = $26,147

Average investment = 215,000/2 = $107,500

Return on capital employed = 100 × 26,147/107,500 = 24·3%

ROCE of 24·3% is slightly less than the target ROCE of 25%, indicating that buying the machine
is not acceptable with respect to this criterion. However, evaluation using the net present value
approach is preferred for investment advice.

32 –

In order to calculate the weighted average cost of capital, we need to calculate the cost of equity, the
cost of debt, the market value of equity as well as the market value of debt.

Step 1: The cost of equity (Ke) can be calculated using the Capital Asset Pricing Model:

Ke = Rf + Be (Rm - Rf)

Ke = 5% + 0.8 (6%)

Ke = 9.8%

Step 2: The market value of equity (Ve) can be calculated by multiplying the number of shares with the
market value of each share

Market value of equity (Ve) = 20m × $12.50 = $250m

Step 3: The cost of debt (Kd) can be calculated by finding the IRR:

Year Cash flow DF @ 4% PV DF@ 5% PV

0 Market value ($105) 1.00 ($105) 1.00 ($105)

ACCA FM (F9) – Mock Exam Solution March 2021
1 – 5 Interest (8 x 0.7) $5.6 6.002 33.61 5.786 $32.40

5 Redemption $100 0.760 $76 0.711 $71.10

$4.61 $1.50

Cost of debt (Kd) = 4% + {($4.61) / ($4.61 + $1.50)} x (5% - 4%)

Cost of debt (Kd) = 4.5%

Step 4: Market value of debt (Vd) = ($15m / $100) x $105

Market value of debt (Vd) = $15.75m

Step 5: Weighted average cost of capital = Ke x {( Ve ) / ( Ve + Vd )} + Kd x {( Vd ) / ( Ve + Vd )}

Weighted average cost of capital = 9.8% {($250) / ($250 + $15.75)} + 4.5% {($15.75) / ($250 + $15.75)}

Weighted average cost of capital = 9.49%

Part (b)

The beta equity of Gamma Co reflects the financial risk faced by the business. We first need to un-gear
the beta equity of Gamma Co in order to find the risk neutral beta asset. The beta asset will then be
converted into beta equity based on the gearing of Smith Co.

Step 1 – Un-gearing of Beta

Ba = Be x {( Ve ) / ( Ve + Vd (1 – t))}

Ba = 1.3 x {($50) / ($50 + $20 (1 – 30%))}

Ba = 1.016

Step 2 – Re-gearing of Beta

Be = Ba x {(Ve + Vd (1 – t) / ( Ve ))}

Be = 1.016 x {($250 + $15.75 (1 – 0.3)) / ($250)}

Be = 1.06

Step 3 – Calculation of the cost of equity (Ke)

Ke = Rf + Be (Rm - Rf)

Ke = 5% + 1.06 (6%)

Ke = 11.36%
ACCA FM (F9) – Mock Exam Solution March 2021

Part (c)

The market value weighted average cost of capital uses the market value of the equity and the debt,
whereas the book value weighted average cost of capital relies on the book value of the equity and the
debt. The book values of the equity and the debt are easily available from the statement of financial
position. On the other hand, market values are more difficult to calculate. This is true especially when
the entity is not listed and the instruments are not traded. However, market value weighted average
cost of capital is considered more useful and more reliable in the investment decisions.

Market values are preferred because they reflect the current and up to date value of the firm. Consider,
for example, the equity. Shares are only recorded in the financial statements at their nominal value. The
market value of shares is typically higher than the book value. Using the book value of equity will
significantly understate its relative proportion in the calculation of weighted average cost of capital.
Since the cost of equity is usually higher than the cost of debt, the overall result will be a reduction in
the weighted average cost of capital. Therefore, market value based weighted average cost of capital is
preferred in the investment decisions because it reflects the true value of the sources of finance used by
a firm.