ACCA Fundamentals Level

Paper F9
Financial Management

Final mock – December 2014

Question Paper

Time allowed

Reading and Planning 15 minutes

Writing 3 hours
This paper is divided into TWO sections.
Section A – ALL TWENTY questions are compulsory and MUST be attempted
Section B – ALL FIVE questions are compulsory and MUST be attempted

During reading and planning time only the question paper may be annotated

Instructions:
Take a few moments to review the notes on the inside of this page titled, ‘Get into good exam
habits now!’ before attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS
Get into good exam habits now!
Take a moment to focus on the right approach for this exam.

Effective time management

 Watch the clock, allow 1.8 minutes per mark. Work out how long you can spend on each
question and do not exceed that time.
 Take a few moments to think what the requirements are asking for and how you are going to
answer them.

Effective planning
 This paper is in exactly the same format as the real exam. You should read through the paper
and plan the order in which you will tackle the questions. Always start with the one you feel
most confident about and take time to choose the questions you will answer in sections with
choice.
 Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
 Identify and make sure you pick up the easy marks available in each question.

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Formulae sheet
Present value table
Present value of 1 ie (1+r)–n
where r = discount rate
n = number of periods until payment
Discount rates (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
2 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386

11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239

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
2 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162

11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065

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Annuity Table
1  (1  r)n
Present value of an annuity of 1 ie
r
where r = discount rate
n = number of periods
Interest rates (r)

(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
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791

6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145

11 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 9.712 9.108 8.559 8.061 7.606

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
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991

6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192

11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675

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Economic Order Quantity

2C o D
=
Ch

Miller – Orr Model

Return point = Lower limit + ( 13  spread)

 3  transaction cos t  var iance of cash flows  13

Spread =3  4 
 Interest rate 
 

The Capital Asset Pricing Model

E(ri)= Rf + i (E (rm) - Rf )
The Asset Beta Formula

 Ve   Vd (1  T) 
a =  βe +  β 
 (Ve  Vd (1- T))   (Ve  Vd (1- T)) d 

The Growth Model

Do (1  g)
Po =
(K e - g)

Gordon's Growth Approximation

g = br
The Weighted Average Cost of Capital

 Ve   Vd 
WACC =   ke +   kd(1-T)
 Ve  Vd   Ve  Vd 

The Fisher Formula

(1 + i) = (1 + r)(1 + h)
Purchasing Power Parity and Interest Rate Parity
(1  hc ) (1  ic )
S1 = S0  F0 = S0  Sf
(1  hb ) (1  ib )

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Section A

ALL TWENTY questions are compulsory and MUST be

attempted
(1) Which of the following statements concerning dividend policy theory is correct?
A The clientele theory assumes that shareholders are happy with fluctuating dividends
B The residual theory states that earnings should be used to fund positive NPV projects and
anything remaining should be used to pay a consistent dividend
C Modigliani and Miller stated that shareholders prefer capital gains to dividends
D A scrip dividend may lead to an increase in gearing
(2) Which one of the following is not an interest bearing money market instrument?
A Treasury bill
B Certificate of deposit
C Repurchase agreement (Repo)
D Money market deposit
(3) Which of the following is the most acceptable reason why the ratio of debt to equity (gearing) may be
high?
A The company is newly established
B Operating gearing is high
C The company operates in a stable environment where cash flows are steady
D The company has few assets to offer as security
(4) A five year project has a net present value of $160,000 when it is discounted at 12%. The project
includes annual cash revenues of $90,000 and annual cash variable costs of $40,000 for each of the
five years. No tax is payable on projects of this type.
What is the sensitivity of this project to the number of units sold?
A 64%
B 89%
C 36%
D 49%
(5) Which one of the following would have the effect of lengthening the working capital cycle?
A Reducing raw material inventory holding
B Increasing credit given to customers
C Delaying payments to suppliers
D Increasing the turnover of finished goods inventory

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(6) B plc is considering investing in a new machine. The machine will cost $20,000 and has an expected
life of five years with a residual value of $4,000. The machine will increase the operating cash flows of
the company as follows.
Increase in
Operating Cash
Year flow ($)
1 3,000
2 4,500
3 6,500
4 5,200
5 4,000
What is the Accounting Rate of Return based upon the average investment?
A 38.7%
B 14.4%
C 46.4%
D 12.0%
(7) You have the following information on a company:
$
PBIT 4,000,000
Interest expenses 400,000
Taxes 170,000
Preferred dividends 300,000
Ordinary dividends 200,000
There are 10 million ordinary shares.
What is the EPS of this company?
A $0.31
B $0.36
C $0.34
D $0.29
(8) Which of the following is most likely to lead to a rise in the price of a company’s shares?
A A fall in the level of interest rates in the country
B An increase in the rate of taxation on dividend income
C Increased borrowing by the firm
D A fall in the company’s EPS

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(9) Which of the following statements is/are true?
1 According to purchasing power parity theory the country with the higher rate of inflation will
see its currency weaken against the country with the lower rate of inflation
2 According to interest rate parity theory the country with the higher rate of interest will see its
currency strengthen against the country with the lower rate of interest
A 1 only
B 2 only
C both 1 and 2
D Neither
(10) A company uses additional debt to finance a new investment. Equity capital and the level of operating
risk are unchanged.
What is the most likely effect upon the company’s cost of equity capital according to traditional
theory?
A It remains constant
B It increases
C It decreases
D It either increases or decreases
(11) Company X and Company Y operate in the same industry, but have different price earning (P/E) ratios
as follows:
P/E ratio
Company X 7
Company Y 13
Which of the following is the most probable explanation of the difference in the P/E ratios between the
two companies?
A Company Y has a greater profit this year than Company X
B Company Y is higher risk than Company X
C Company Y has higher expected growth than Company X
D Company Y has higher gearing than Company X
(12) A company is considering whether to purchase or lease two different machines. It has a cost of capital
of 10%.
Machine 1 can be purchased for $100,000, payable immediately, with a residual value of $10,000
after 5 years. It can be leased for six annual rentals of $20,000, the first one being payable
immediately.
Machine 2 can be purchased for $48,000, payable immediately, with a zero residual value. It can be
leased for four annual rentals of $14,500, the first being payable in two years’ time.
What is the appropriate action for purchasing or leasing the machines in order to minimise the cost in
present value terms?
Machine 1 Machine 2
A Purchase Purchase
B Purchase Lease
C Lease Purchase
D Lease Lease

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(13) A company’s shares have gone ex div having just declared a dividend of 20c per share, but the market
expects this dividend to decline by 2% each year in perpetuity. The cost of equity is 8%.
What is the ex dividend price per share?
A $1.96
B $2.00
C $2.24
D $3.27
(14) Which one of the following is least likely to act as a financial intermediary?
A Bank
B Pension fund
C Credit rating agency
D Unit trust
(15) Are the following statements true or false?
Statement 1 If share prices move randomly, then technical analysis (chartism) will normally fail to
predict future share price movements
Statement 2 If a stock market is semi-strong efficient, then share prices will not respond to new
information
Statement 1 Statement 2
A True False
B True True
C False False
D False True
(16) A company currently has 10 million $1 shares in issue with a market value of $3 per share. The
company wishes to raise new funds using a 1 for 4 rights issue.
If the theoretical ex rights price per share turns out to be $2.80, how much new finance was raised?
A $2,500,000
B $4,000,000
C $5,000,000
D $7,000,000
(17) A bond has a fixed annual coupon rate of 7% and it will be repaid at its face value of $100 in one
year’s time. Similar bonds have a redemption yield (yield to maturity) of 8%.
Ignoring tax, what is the current ex interest value of the bond?
A $99.08
B $100.00
C $100.93
D $106.07

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(18) The current annual risk free rate of return is 6% and the required rate of return on a security with a
beta of 1.2 is 15.6%.
Using the capital asset pricing model, what is the required annual rate of return on the market
portfolio?
A 11.52%
B 13%
C 14%
D 17.52%
(19) A company has a current ratio of 1.5:1 and it decides to use surplus cash balances to settle 30% of its
total current liabilities.
What will happen to the current ratio?
A It will decrease by more than 30%
B It will decrease by less than 30%
C It will increase by more than 30%
D It will increase by less than 30%
(20) Are the following statements true or false with respect to the Miller-Orr cash management model?
Statement 1 The greater the variability in cash flows, the greater is the spread between the upper
and lower cash balances
Statement 2 The return point is the lower limit plus one third of the spread
Statement 1 Statement 2
A True False
B True True
C False False
D False True

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Section B – ALL FIVE questions are compulsory and MUST
be attempted
Question 1 MJG Co
MJG Co has annual sales revenue of $15 million and all sales are on 30 days’ credit, although customers on
average take fifteen days more than this to pay. Contribution represents 65% of sales and the company
currently has no bad debts. Accounts receivable are financed by an overdraft at an annual interest rate of 6%.
MJG Co plans to offer an early settlement discount of 2% for payment within 10 days and to extend the
maximum credit offered to 60 days. The company expects that these changes will increase annual credit sales
by 4%, while also leading to additional incremental costs equal to 0.25% of turnover. The discount is expected
to be taken by 40% of customers, with the remaining customers taking an average of 60 days to pay.
Required
(a) Evaluate whether the proposed changes in credit policy will increase the profitability of MJG Co.
(6 marks)
(b) Exporters have to address the problems of larger accounts receivable and an increased risk of bad
debts due to the transportation time and additional paperwork involved in sending goods abroad.
Explain the measures available to exporters to overcome these problems. (4 marks)
(Total = 10 marks)

Question 2 JKL
JKL SA, a French company, has agreed a sale of $2,350,000 to a US company on three months credit.
Assume that the date is currently the 14th of April.
Currency market rates on 14 April:
Per €
Spot rate $1.2358 +/– 0.0004
Three months forward rate $1.2362 +/– 0.0028
Money market rates pa on 14 April:
Euro 2.2%
US 1.2%
Required
(a) Recommend the most appropriate method for JKL to use to hedge its foreign exchange risk for the
next three months. (7 marks)
(b) Comment on the advantages of using derivatives to hedge this risk. (3 marks)
(Total = 10 marks)

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Question 3 JEH
Predator Co is listed on a major stock market and is preparing to make a bid to buy a rival unlisted company,
JEH. Both companies are in the same business sector. The price/earnings ratio of Predator Co is seven times.
Financial information on JEH is as follows:

JEH
$m
Assets
Non-current assets 63
Current assets 18
Total assets 81
Equity and liabilities
Ordinary shares, nominal value 50c 15
Retained earnings 14
Total equity 29
Non-current liabilities
9% bonds, redeemable at par in two years’ time 50
Current liabilities 2
Total liabilities 81

JEH has a cost of equity of 15% per year and has maintained a dividend payout ratio of 45% for several
years. The current earnings per share of the company is 90c per share and its earnings have grown at an
average rate of 4·5% per year in recent years.
Required
(a) Calculate the total value of the target company, JEH, using the following valuation methods:
(i) Price/earnings ratio method, using the price/earnings ratio of Predator Co
(ii) Dividend growth model. (5 marks)
(b) Discuss the relative merits of a rights issue, a placing and an issue of bonds as ways of raising the
finance for the acquisition. (5 marks)
(Total = 10 marks)

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Question 4 NMG Co
NMG Co is listed on a major stock market.

NMG Co
$m
Assets
Non-current assets 90
Current assets 18
Total assets 108
Equity and liabilities
Ordinary shares, nominal value 50c 40
Retained earnings 26
Total equity 66
Non-current liabilities
7% bonds, redeemable at par in seven years’ time 35
Current liabilities 7
Total liabilities 108

Other relevant financial information:

Risk-free rate of return 2%
Average return on the market 8%
Taxation rate 30%
The ex div share price of NMG Co is $3.75 per share and it has an equity beta of 1·3. The 7% bonds of the
company are trading on an ex interest basis at $92.60 per $100 bond. The price/earnings ratio of NMG Co is
seven times.
Required
(a) Calculate the weighted average cost of capital of NMG Co on a market value weighted basis.
(8 marks)
(b) Explain the limitations of the capital asset pricing model. (4 marks)
(c) Explain the difference between ‘conventional finance’ and Islamic finance. (3 marks)
(Total = 15 marks)

Question 5 SWH Co
SWH Co is evaluating a significant investment in equipment and the development of a website.
Due to the fast-changing nature of the equipment and the Internet software, SWH's management has set a
project lifetime of three years.
The new equipment will cost $50,000 payable at the start of the first year of operation. It is not expected to
have any scrap value.
SWH has estimated that sales revenue will increase as a result of the investment by the following amounts in
real terms.
Year 1 Year 2 Year 3
$ $ $
Increase in sales revenue at Year 0 prices 48,000 60,000 72,000

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SWH estimated final sales for the current year are $1,200,000. The company's costs behave in such a way
that its contribution to sales ratio for the current year is expected to be 40% and its net margin 10%. A
considerable proportion of SWH's total fixed costs are marketing expenses. The proposed project will lead to
savings in this area. So, in year 1, fixed costs (at Year 0 prices) will total $316,800.
From 1 January Year 1, inflation will have the following effects on SWH’s operations.
(i) Sales prices will increase by 5% per annum.
(ii) All costs (ie variable and fixed) will increase by 10% per annum.
Initial investment of $20,000 in working capital would also be required, followed by incremental annual
investment to maintain the purchasing power of working capital (assume 5% inflation).
The website would be designed and installed during the first four months of Year 1. It will cost $100,000 (at
Year 0 prices) payable at the end of Year 1. The suppliers will be paid a retaining/advisory fee of $10,000 in
both Year 2 and Year 3. These are Year 0 prices and it is anticipated that, due to inflation, they will increase at
the same rate as all other costs.
SWH has a nominal cost of capital of 10% and pays tax at an annual rate of 30% in the year profits are
earned. It can claim tax allowable depreciation on a 25% reducing balance basis.
Required
(a) Calculate the net present value of the proposed investment. (10 marks)
(b) Explain the difference between risk and uncertainty in the context of investment appraisal, and
describe how probability analysis can be used to incorporate risk into the investment appraisal
process, discussing the weaknesses of probability analysis. (5 marks)
(Total = 15 marks)

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Student self-assessment
Having completed this paper take a few minutes to consider what you did well and what you found difficult.
Use this as a basis to focus your future study on effectively improving your performance.

Common problems Future emphasis if you answer Yes

Timing and planning
Did you finish too early? Y/N Focus your planning time on generating more ideas.
Use models to help develop breadth to your thinking.
Did you overrun? Y/N Focus on allocating your time better.
Practise questions under strict timed conditions.
If you get behind leave space and move on.
Did you waffle? Y/N Focus your planning time on developing a logical structure to
your answer.

Layout
Was your answer difficult to follow? Y/N Use headings and subheadings.
Use numbering sequences when identifying points.
Leave space between each point.
Did you fail to explain each
point clearly? Y/N Show why the point identified answers the question set.
Did you fail to show any workings
or were your workings unclear? Y/N Give yourself time and space to make the marker's job easy.

Content
Did you struggle with:
Interpreting the questions? Y/N Learn the meaning of common terminology (inside front cover).
Learn subject jargon (key terms in study text).
Read questions carefully noting all the parts.
Practise as many questions as possible.
Understanding the subject? Y/N Review your notes/text.
Work through easier examples first.
Classroom students please contact your tutor for further help.
Home Study students please contact ACCA queries for further
help (accaqueries@bpp.com).
Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop
your memory as well as your understanding of a subject.

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