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1、AnswersFundamentals Level Skills Module, Paper F9Financial ManagementSection A1AMonetary value of return = $3·10 x 1·197 = $3·71Current share price = $3·71 $0·
2、;21 = $3·50December 2014 Answers23BC4AThe hedge needs to create a peso liability to match the 500,000 peso future income.6-month peso borrowing rate = 8/2 = 4%6-month
3、0;dollar deposit rate = 3/2 = 1·5%Dollar value of money market hedge = 500,000 x 1·015/(1·04 x 15) = $32,532 or $32,50056BC7CTotal cash flow($)36,00014,00032,00010,00016,
4、000(6,000)Joint probability EV of cash flow($)0·1125 4,0500·0375
5、0; 5250·4500 14,4000·1500
6、60; 1,5000·1875 3,0000·0625 &
7、#160; (375)23,100Less initial investment (12,000)EV of the NPV 11,10089BAMV = (7 x&
8、#160;5·033) + (105 x 0·547) = $92·6710D11D12A1713BInventory = 15,000,000 x 60/360 = $2,500,000Trade receivables = 27,000,000 x 50/360 = $3,750,000Trade payables = 15,000,000
9、160;x 45/360 = $1,875,000Net investment required = 2,500,000 + 3,750,000 1,875,000 = $4,375,00014C15D16C17AGearing = (4,000 x 1·05) + 6,200 + (2,000 x 0·8)/(8,000 x
10、;2 x 5) = 12,000/80,000 = 15%18B19DDividend growth rate = 100 x (33·6/32) 1) = 5%MV = 33·6/(0·13 0·05) = $4·2020DSection B1(a)Cash balances at
11、the end of each month:Sales (units)Selling price ($/unit)Sales ($000)Month receivedProduction (units)Raw materials (units)Raw materials ($000)Month payableProduction (units)Variable costs ($000)Month payab
12、leDecember1,200800960JanuaryDecember1,2502,500500JanuaryDecember1,250125DecemberJanuary1,2508001,000FebruaryJanuary1,3002,600520FebruaryJanuary1,300130JanuaryFebruary1,3008401,092MarchFebruary1,4002,800560MarchFebruary1,400140FebruaryMarch1,4008401,176AprilMarch1,5003,000600AprilMarch1,500150MarchAp
13、ril1,50018Monthly cash balances:ReceivablesLoanIncome:Raw materialsVariable costsMachineExpenditure:Opening balanceNet cash flowClosing balanceJanuary$00096096050013063040330370February$0001,0001,000520140660370340710March$0001,0923001,3925601504001,1107102829
14、92(b)Calculation of current ratioInventory at the end of the three-month period:This will be the finished goods for April sales of 1,500 units, which can be assumed to
15、60;be valued at the cost of productionof $400 per unit for materials and $100 per unit for variable overheads and wages. The value of the inventory is therefore1,500
16、 x 500 = $750,000.Trade receivables at the end of the three-month period:These will be March sales of 1,400 x 800 x 1·05 = $1,176,000.Cash balance at the e
17、nd of the three-month period:This was forecast to be $992,000.Trade payables at the end of the three-month period:This will be the cash owed for March raw materials
18、of $600,000.Forecast current ratioAssuming that current liabilities consists of trade payables alone:Current ratio = (750,000 + 1,176,000 + 992,000)/600,000 = 4·9 times(c)If Flit C
19、o generates a short-term cash surplus, the cash may be needed again in the near future. In order to increaseprofitability, the short-term cash surplus could be invested,&
20、#160;for example, in a bank deposit, however, the investment selectedwould normally not be expected to carry any risk of capital loss. Shares traded on a large stock
21、;market carry a significant riskof capital loss, and hence are rarely suitable for investing short-term cash surpluses.(a)2Average historical share price growth = 100 x (10·90
22、/9·15)1/3 1) = 6% per yearFuture share price after 7 years = 10·90 x 1·067 = $16·39 per shareConversion value of each loan note = 16·39 x
23、160;8 = $131·12The investor is faced with the choice of redeeming the loan notes at their nominal value of $100 or converting them intoshares worth $131·12. The
24、 rational choice is to maximise wealth by taking the conversion option.Market value of each loan note = (8 x 5·033) + (131·12 x 0·547) = 40·26 +&
25、#160;71·72 = $111·98(b)The average price/earnings ratio (P/E ratio) of listed companies similar to Par Co has been recently reported to be 12 timesand the most recen
26、t earnings per share (EPS) of Par Co is 62 cents per share. The share price calculated using the P/E ratiomethod is therefore $7·44 (12 x 62/100).One problem
27、60;with using the P/E ratio valuation method relates to the selection of a suitable P/E ratio. The P/E ratio used hereis an average P/E ratio of similar companies
28、60;and Par Co is clearly not an average company, as evidenced by its year-end shareprice being $10·90 per share, some 47% more than the calculated value of $7
29、183;44. The business risk and financial risk ofPar Co will not be exactly the same as the business risk and financial risk of the similar companies, for example,
30、0;because ofdiversification of business operations and differing capital structures. Par Co may be a market leader or a rising star comparedto similar companies.The P/E ratio
31、method is more suited to valuing the shares of unlisted companies, rather than listed companies such asPar Co. If the stock exchange on which its shares are traded
32、160;is efficient, which is likely as it is a large stock exchange, theshare price of Par Co will be a fair reflection of its value and its prospects. As a&
33、#160;listed company, Par Co would in fact contributeto the average P/E ratio for its business sector, used in valuing similar unlisted companies.19Looking at the P/E ratio
34、0;of Par Co, it can be seen that this is not constant, but has increased each year for four years, from14·3 times in 2011 to 17·6 times in 2014.
35、This raises questions about using a P/E ratio based on historical information asa way of valuing future activity.Ideally, the P/E ratio method should use forecast maintainable
36、 earnings, but the calculated value of $7·44 has used thehistorical EPS of 2014. As this was the lowest EPS over the four years, forecasting future maintainable
37、;earnings may be aproblem here.WorkingsYearEarnings per share (cents)Year-end share price ($)P/E ratio (times)Value of Par Co ($m)2011649·1514·3274·52012689·8814·5296·420137010·4915
38、3;0314·720146210·9017·6327·0(Note: It is assumed that the number of ordinary shares has remained constant)3(a)The current dollar value of the future euro receipt =1,200,000/4&
39、#183;2080 = $285,171If a forward contract is taken out, PZK Co can lock into the six-month forward exchange rate of 4·2606 euros per dollar.Future dollar value using
40、 the forward contract =1,200,000/4·2606 = $281,651Loss using the forward contract = 285,171 281,651 = $3,520If PZK Co chooses not to hedge the future euro receipt,&
41、#160;it will be able to exchange the euros for dollars at the future spotexchange rate prevailing when the payment is made. This future spot exchange rate may give
42、160;a better or worse dollar valuethan using the six-month forward exchange rate. At the current time, PZK Co may prefer the certainty offered by the forwardexchange cont
43、ract to the uncertainty of leaving the future euro receipt unhedged. In addition, the forward exchange rate is anunbiased estimator of the future spot exchange rate.(b)The
44、0;implied interest rate in the foreign country can be calculated using interest rate parity.From the formulae sheet, F0 = S0 x (1 + ic)/(1 + ib)Hence 4·3132 =
45、160;4·2080 x (1 + ic)/1·04Rearranging, (1 + ic) = 4·3132 x 1·04/4·2080 = 1·066(c)The implied annual interest rate in the foreign country is 6·6%.One
46、160;of the simplest ways for PZK Co to avoiding exchange rate risk is to invoice in its home currency, which passes theexchange rate risk on to the foreign cust
47、omer, who must effectively find the dollars with which to make the payment.This strategy may not be commercially viable, however, since the companys foreign customers will
48、0;not want to take on theexchange rate risk. They will instead transfer their business to those competitors of PZK Co who invoice in the foreign currencyand who ther
49、efore shoulder the exchange rate risk.If PZK Co is concerned about exchange rate risk, it will need to consider other hedging methods. For example, if the companyregularl
50、y receives receipts and makes payments in euros, it could open a bank account denominated in euros.204(a)Revised draft evaluation of investment proposalSales revenueVariable costsFixed&
51、#160;costsCash flow before taxTA depreciationTaxable profitTaxationAfter-tax profitTA depreciationAfter-tax cash flowDiscount at 12%Present values1$0002,475(1,097)(155)1,223(450)7737734501,2230·8931,0922$0002,714(1,323)(159)1,232(338)8
52、94(170)7243381,0620·7978463$0004,413(2,084)(164)2,165(253)1,912(197)1,7152531,9680·7121,4014$0004,775(2,370)(169)2,236(759)1,477(421)1,0567591,8150·6361,1545$000(325)(325)(325)0·567(184)Present value of cash inflowsCost of machineNPV$0004,309(1,800)2
53、,509The revised draft evaluation of the investment proposal indicates that a positive net present value is expected to be produced.The investment project is therefore financially
54、160;acceptable and accepting it will increase the wealth of the shareholders ofUftin Co.WorkingsYearSales (units/year)Selling price ($/unit)Inflated by 4·2% ($/unit)Sales revenue ($000/year)YearS
55、ales (units/year)Variable costs ($/unit)Inflated by 5% ($/unit)Variable costs ($000/year)YearFixed costs ($000/year)Inflated by 3% ($000/year)YearTax allowable depreciation ($/year)Tax benefits at 22%
56、;($/year)195,0002526·052,475195,0001111·551,09711501551450,00099,0002100,0002527·142,7142100,0001213·231,32321501592337,50074,2503150,0002629·424,4133150,0001213·892,08431501643253,12555,6884150,0002731·834,7754150,0001315·802,37041501694759,375167,063Alternat
57、ive calculation of after-tax cash flowSales revenueVariable costsFixed costsCash flow before taxTax liabilityTAD tax benefitsAfter-tax cash flow1$0002,475(1,097)(155)1,2231,2232$0002,714(1,323)(159)1,232(269)991,0623$000
58、4,413(2,084)(164)2,165(271)741,9684$0004,775(2,370)(169)2,236(476)561,8165$000(492)167(325)(b)The following revisions to the original draft evaluation could be discussed.InflationOnly one years inflation had been applied
59、 to sales revenue, variable costs and fixed costs in years 2, 3 and 4. The effect ofinflation on cash flows is a cumulative one and in this case specific
60、160;inflation was applied to each kind of cash flow.21Interest paymentsThese should not have been included in the draft evaluation because the financing effect is included in&
61、#160;the discount rate. Ina large company such as Uftin Co, the loan used as part of the financing of the investment is very small in comparison toexisting finance
62、160;and will not affect the weighted average cost of capital.Tax allowable depreciationA constant tax allowable depreciation allowance, equal to 25% of the initial investment, had&
63、#160;been used in each year.However, the method which should have been used was 25% per year on a reducing balance basis, resulting in smallerallowances in years 2 a
64、nd 3, and a balancing allowance in year 4. In addition, although tax allowable depreciation had beendeducted in order to produce taxable profit, tax allowable depreciation
65、0;had not been added back in order to produce after-taxcash flow.Year 5 tax liabilityThis had been omitted in the draft evaluation, perhaps because a four-year period was
66、 being used as the basis for theevaluation. However, this year 5 cash flow needed to be included as it is a relevant cash flow, arising as a result of
67、;the decisionto invest.Examiners Note: Explanation of onlyTWO revisions was required.5(a)Cost of equityUsing the capital asset pricing model, Ke = 4 + (1·15 x 6) = 10
68、3;9%Cost of debt of loan notesAfter-tax annual interest payment = 6 x 0·75 = $4·50 per loan note.Year$5% discountPV4% discountPV($)($)0166(103·50)4·50106·001·0005·0760
69、83;746(103·50)22·8479·081·0005·2420·790(103·50)23·5983·74(1·58)3·83Kd = 4 + (1 x 3·83)/(3·83 + 1·58) = 4 + 0·7 = 4·7% per yearMarket va
70、lues of equity and debtNumber of ordinary shares = 200m/0·5 = 400 million sharesMarket value of ordinary shares = 400m x 5·85 = $2,340 millionMarket value of
71、60;loan notes = 200m x 103·5/100 = $207 millionTotal market value = 2,340 + 207 = $2,547 millionMarket value WACCK0 = (10·9 x 2,340) + (4·7 x 207)/2,5
72、47 = 26,479/2,547 = 10·4%Book value WACCK0 = (10·9 x 850) + (4·7 x 200)/1,050 = 10,205/1,050 = 9·7%CommentMarket values of financial securities reflect current&
73、#160;market conditions and current required rates of return. Market valuesshould therefore always be used in calculating the weighted average cost of capital (WACC) when they
74、are available. If bookvalues are used, the WACC is likely to be understated, since the nominal values of ordinary shares are much less than theirmarket values. The c
75、ontribution of the cost of equity is reduced if book values are used, leading to a lower WACC, asevidenced by the book value WACC (9·7%) and the market val
76、ue WACC (10·4%) of Tinep Co.(b)A rights issue raises equity finance by offering new shares to existing shareholders in proportion to the number of shares theycurrently
77、60;hold. Existing shareholders have the right to be offered new shares (the pre-emptive right) before they are offered tonew investors, hence the term rights issue. There
78、;are a number of factors which Tinep Co should consider.Issue priceRights issues shares are offered at a discount to the market value. It can be difficult to judge
79、160;what the amount of the discountshould be.Relative costRights issues are cheaper than other methods of raising finance by issuing new equity, such as an initial public
80、;offer (IPO)or a placing, due to the lower transactions costs associated with rights issues.Ownership and controlAs the new shares are being offered to existing shareholders,
81、there is no dilution of ownership and control, providingshareholders take up their rights.Gearing and financial riskIncreasing the weighting of equity finance in the capital structure of Tinep Co can decrease its gearing and its finan
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