MGT ACC3

O LYMPIA B USINESS S CHOOL
SCHOOL OF ACCOUNTING & FINANCE
ADVANCED DIPLOMA IN ACCOUNTING
F ILO -T EXT
MANAGEMENT ACCOUNTING III

May, 1999
R AFFLES E DUCATION G ROUP

Kuala Lumpur w Petaling Jaya w Penang w Singapore w Jakarta w Bangkok w Beijing w London w New-York
School Of Accounting & Finance
Management Accounting III
T ABLE
OF
C ONTENTS
TABLE OF CONTENTS............................................................................................................................... 2
ASSESSMENT............................................................................................................................................... 4
INDIVIDUAL ASSIGNMENT ............................................................................................................................ 4
MID-TERM E XAMINATION ............................................................................................................................ 4
TEAM PROJECT ............................................................................................................................................ 4
FINAL E XAMINATION ................................................................................................................................... 5
ATTENDANCE ............................................................................................................................................. 5
FEES .............................................................................................................................................................. 5
CONTACT-TIME ......................................................................................................................................... 6
FULL-TIME ................................................................................................................................................... 6
PART-TIME................................................................................................................................................... 6
THE ACADEMIC TEAM ............................................................................................................................. 7
THE ACADEMIC PLANNER ...................................................................................................................... 8
INTRODUCTION ......................................................................................................................................... 9
THE SUBJECT CORPORATE FINANCE ............................................................................................................ 9
WEEK 1 ....................................................................................................................................................... 10
WEEK 2 ....................................................................................................................................................... 13
WEEK 3 ....................................................................................................................................................... 18
WEEK 4 ....................................................................................................................................................... 21
WEEK 5 ....................................................................................................................................................... 24
WEEK 6 ....................................................................................................................................................... 29
WEEK 7 ....................................................................................................................................................... 32
WEEK 8 ...................................................................................................................................................... 35
WEEK 9 ....................................................................................................................................................... 36
WEEK 10 ..................................................................................................................................................... 39
WEEK 11 ..................................................................................................................................................... 42
WEEK 12 ..................................................................................................................................................... 45
Olympia Business School
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HOW TO USE THE FILO TEXT ?
The Filo-text is a tool to assist you in your study at Olympia Business School. It provides
general information on the course structure and also details on the syllabus that you will be
covering throughout your course.
The general information, provided at the beginning of this document, includes information
on the following:
Assessment
Attendance
Fees
Contact time
The academic team
The academic planner
To assist you in your classes and revision, this filo-text also provides information on the
topics you will be covering in each of the classes you will be attending. This information
includes the following:
The topic
The objective(s) of the lecture
The textbook, the chapter(s) and page(s) related to the given topic
Other reference books available on the topic
Additional reference material for your own research
The objective(s) of the tutorial
Questions to prepare for discussion during the tutorial
Questions for your personal research and self-assessment
Use the Filo-text to prepare yourself prior to the lecture, between the lecture and the tutorial
and after the tutorial.
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A SSESSMENT
Student assessment will be evaluated based on the following:
1)
Individual Assignment
15 %
2)
Mid-Term Examination
15 %
3)
Team Project
20 %
4)
Final Examination
50 %
Total
100 %
INDIVIDUAL ASSIGNMENT
An individual assignment will be given to the student on the first week and will have to be
returned no later than on the 8th week. The marked assignment will be returned to the student no
later than on week 10.
The assignment will be related to the topics covered between week 1 and week 6 inclusive.
It will comprise a written report of approximately 500 words.
Should the student fail to submit his/her assignment on week 8, the result will automatically
be zero.
MID-TERM EXAMINATION
A mid-term examination will be conducted during the lecture session of week 10. It will
assess the students knowledge and understanding of the topics covered up to week 8.
The results, together with the answer scripts, will be returned to the students no later than on
week 12.
Should a student be absent without a valid apology, the result will automatically be zero.
TEAM PROJECT
A team project will be assigned to students during the first week. The team will comprise of
4 to 6 students.
The report of the team project will have to be submitted to the subject lecturer by no later
than week 12 and will be presented on week 13. Late submission wont be entertained and will
automatically result in no marks being awarded.
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FINAL EXAMINATION
The final examination will be conducted two weeks after you have completed your syllabus.
The examination will take 3 hours.
Registration for the examination is open from week 5 and closes on week 8. Make sure you
register on time. No late registration will be entertained.
The format of the examination is as follows:
Section A -
Short Questions
Section C -
Essay-type Questions
Total
5 * 4 Points
Any 4 out of 6 * 20 Points
100 Points
A TTENDANCE
Attendance for both the lectures and the tutorials is compulsory. Any student not attending a
class should provide a medical certificate or a written justification (signed by a parent or
guardian in the case of a full-time student). Should a student fail to do so, he / she will be
considered truant.
If a students attendance for a given subject is lower then 70%, he / she will not be allowed
to sit for the final examination.
Punctuality is equally important. The lecturer is entitled to refuse entry into the classroom to
any student coming late for classes.
F EES
The registration fee is to be paid upon registration.
The course fee is paid either in full, per semester or by instalments. For payments made in
full, the payment is due before the first lecture. For payments made by semester, the payment
per semester is due on the first day of the semester. For monthly instalments, the first payment
is due on the first day of class while subsequent payments are due on the first day of each
subsequent month.
Should any student have difficulty to pay his / her fees on time, he / she must meet with the
(Deputy) Principal to arrange an alternative. Any student who has not settled his / her fees and
has not met with the (Deputy) Principal will not be allowed to attend classes or sit for an
examination.
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C ONTACT -T IME
FULL-TIME
Classes are conducted over a period of 12 weeks. Contact time consists of 1 1/2 hours of
lecture and 1 1/2 hours of tutorial per week.
PART-TIME
Classes are conducted over a period of 12 weeks. Contact time consists of 1 hours of
lecture per week.
For each hour of contact, the student is expected to spend at least 2 hours of unsupervised
work, either individually or in groups.
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T HE A CADEMIC T EAM
At the beginning of the first lecture, please fill-in the following:
Day
Time
Starting
Room
Finishing
Lecture
Lecturer
Consultation
Tutorial
Tutor
Consultation
Class Lecturer
Consultation
Lecturer-in-Charge
Consultation
Principal
Consultation
Head of Department
Consultation
Subject Representative
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T HE A CADEMIC P LANNER
This is an outline of the topics you will cover for this subject. Please ensure you fill-in the
dates of the respective lectures during the first lecture.
Week
Date
Lecture Topic
The Finance Function
Capital Markets, Market Efficiency and Ratio Analysis
Investment Appraisal: Application & risk (1 )
Investment Appraisal: Application & risk (2 )
Sources Of Long-term Finance: Equity Finance
Sources Of Long-term Finance: Debt Finance, Hybrid

Finance, And Leasing
Sources Of Long-term Finance: Debt Finance, Hybrid

Finance, And Leasing
Mid-term Exam
The Cost Of Capital And Capital Structure ( 1 )
10
The Cost Of Capital And Capital Structure (2 )
11
Working Capital Management ( 1 )
12
Working Capital Management ( 2 )
13/14
Final Examination
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I NTRODUCTION
THE SUBJECT
CORPORATE FINANCE
Welcome to Corporate Finance

Corporate finance is concerned with the financing and investment decisions made by the
management of companies in pursuit of corporate goals. As a subject, corporate finance has a
theoretical base which has evolved over many years and which continues to evolve. It has a
practical side too, concerned with the study of how companies actually make financing and
investment decisions, and it is often the case that theory and practice disagree.
The value of an option depends upon the extent to which it contributes towards the
achievement of corporate goals. In corporate finance, the fundamental goal is usually taken to
be to increase the wealth of shareholders.
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WEEK 1
Lecture Subject:
THE FINANCE FUNCTION
Lecture Objectives:
On completion of this lecture, the student will be able to understand:
The role of the financial manager
Corporate objectives
How is shareholders wealth maximized?
Agency theory
Corporate governance
Textbook:
Corporate Finance, Denzil Watson & Tony Head, Pitman

Publishing, 1998
Chapter(s)
Pages
1 to 17
Chapter(s)
Pages
Reference Books:
Investment Appraisal & Financial decisions 3rd Edition

By Stephen Lumby
Capital Budgeting and Long term financial Decisions 2nd
Edition By Neil Seitz
Additional Reference Material:

1)
Weston, J. Fred, New Theme in Finance, Journal of Finance , March, 1974.
2)
Myers, S. C. Finance Theory and Financial Strategy, Midland corporation

Finance Journal, Spring, 1987.
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Tutorial Subject:
THE FINANCE FUNCTION
Tutorial Objectives:
On completion of this tutorial, the student will have:
The role of the financial manager
Corporate objectives
How is shareholders wealth maximized?
Agency theory
Corporate governance
Questions to prepare for discussion during the tutorial:

1)
What are the functions and areas of responsibility that fall under the control of the financial
manager?
2)
Give examples to illustrate the high level of interdependence existing between the different
decision areas of corporate finance.
3)
Given the following possible corporate objectives, provide a rational argument explaining
which of them should be the main goal of the financial manager:
(a)
(b)
(c)
(d)
profit maximisation
sales maximisation
maximisation of benefit to employees and the local community
maximisation of shareholder wealth
4)
Explain how a financial manager can, in practice, maximise the wealth of shareholders.
5)
Give some examples of good financial management.
6)
Which of the following will not lead to a reduction of agency problems experienced by
shareholders?
(a)
(b)
(c)
(d)
(e)
increased monitoring by shareholders

salary bonuses for management based on financial performance
the granting of share options to management
the use of restrictive covenants in bond deeds
the use of shorter contracts for management
7)
What is meant by the agency problem in the context of a public limited company?
8)
How is it possible for the agency problem to be reduced in a company?
9)
What goals might be pursued by managers instead of maximisation of shareholder wealth?
10)
Do you consider the agency problem to be of particular relevance to UK public limited

companies?
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Questions available for self-assessment:

1)
The primary financial objective of a company is stated by corporate finance theory to be

the maximisation of the wealth of its shareholders, but this objective is usually replaced by
the surrogate objective of maximisation of the companys share price. Discuss the ways in
which this substitution can be justified.
2)
Explain why maximisation of a companys share price is preferred as a financial objective

to the maximisation of its sales.
3)
Discuss the ways in which the concepts of agency theory can be used to explain the
relationships that exist between the managers of a listed company and the providers of its
equity finance. Your answer should include an explanation of the following terms:
(a) asymmetry of information
(b) agency costs
(c) the free-rider problem
4) Discuss ways in which the shareholders of a company can encourage its managers to act in
a way which is consistent with the objective of maximisation of shareholder wealth.
5) The primary financial objective of financial management is usually taken to be the
maximisation of shareholder wealth. Discuss what other objectives may be important to a public
limited company and whether such objectives are consistent with the primary objective of
shareholder wealth maximisation.
6) Discuss the significance of the Cadbury Report in the context of corporate governance in
the UK. Have its recommendations led to improvements?
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WEEK 2
Lecture Subject:
CAPITAL MARKETS, MARKET EFFICIENCY AND RATIO

ANALYSIS
Lecture Objectives:
On completion of this lecture, the student will be able to:
Sources of business finance
The capital markets
Ratio analysis
Textbook:

Publishing, 1998
Chapter(s)
Pages
23 to 44
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)

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Tutorial Subject:
RATIO ANALYSIS
CAPITAL MARKETS, MARKET EFFICIENCY AND
Sources of business finance
The capital markets
Ratio analysis

1)
Explain the difference between retained earnings and retained profit.
2) Describe the factors that influence the relative proportions of internal and external finance
used in capital investment.
3)
What is the relevance of the efficient market hypothesis for corporate financial managers?
4)
Which of the following statements about the efficient market hypothesis is not correct?
(a) if the stock market shows weak form efficiency, then chartists cannot make consistently
superior returns;
(b) if the market is strong form efficient, only people with insider information can beat the
market;
(c) if the market is semi-strong form efficient, then fundamental analysis will not bring
abnormal returns to analysts;
(d) if the market is semi-strong form efficient, all past and current publicly available
information is reflected in the share price;
(e) if the market is weak form efficient, then all historic information about a share is
embodied in its current market price.
5)
Describe the features of a perfect capital market.
6) Explain the difference between allocational efficiency, pricing efficiency and operational
efficiency.
7)
Why is it difficult to test for strong form efficiency?
8)
Describe the different benchmarks that can be used for ratio analysis.
9) Describe the five categories of ratios and list and define the ratios in each category. In each
case, without referring to the calculations in the text, calculate the relevant ratio for Boater plc.
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10) What are the potential problems associated with using ratio analysis to analyse the
financial health and performance of companies?
11)
1) Distinguish between the primary and secondary capital markets in the UK and discuss the
role played by these markets in financial management. What are the desirable characteristics of
primary and secondary capital markets?
2) While there is a large body of evidence in support of the efficient market hypothesis, it has
been suggested that this evidence only shows that it is not possible to prove that markets are
inefficient. Recent research has explored anomalies in the behaviour of prices of securities.
Briefly describe these anomalies and suggest possible explanations.
3)
The following financial statements are extracts from the accounts of Hoult plc.
Profit and loss accounts for years ending 31 December
1995
1996
1997
$000
$000
$000
Sales
960
1080
1220
Cost of sales
670
780
885
Gross profit
290
300
335
Administration expenses
260
270
302
Operating profit
30
30
33
Interest
13
14
18
Profit before taxation
17
16
15
Profit after taxation
15
15
14
Dividends
Retained profit
15
15
10
Taxation
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Balance sheets for years to 31 December

1995
$000
Net fixed assets
1996
$000
$000
160
1997
$000
$000
120
$000
100
Current assets:
Stock
200
210
225
Debtors
160
180
250
Cash
360
390
475
Trade creditors
75
80
145
Overdraft
70
80
110
145
160
255
Current liabilities:
Net current assets
215
230
220
current liabilities
375
350
320
8% debentures
120
255
80
270
40
280
Ordinary shares
160
160
160
Profit and loss
95
110
120
255
270
280
Total assets less
Capital and reserves:
The 8% debentures are redeemable in installments and the final installment is due to be paid in
1998.
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The finance director is concerned about the poor liquidity of Hoult plc. and has asked you to
report on the companys recent performance. After calculating appropriate ratios, comment on
the performance and financial health of Hoult plc.
4) You have been approached by Mr. Dayton, who is seeking advice about his investment
portfolio. He is considering purchasing shares in companies listed on either the Unlisted Securities
Market or the Alternative Investment Market. Mr. Green, a friend of Mr. Dayton, has told him that
he should invest only in shares that are listed on markets that are efficient, since otherwise he cannot
be sure that he is paying a fair price for them. Mr. Dayton has explained to you that he is not sure
what an efficient market is.
5)
Critically discuss the following statements about stock market efficiency.

(a) The weak form of the efficient market hypothesis implies that it is possible for an
investor to generate abnormal returns by analysing changes in past share prices.
(b) The semi-strong form of the efficient market hypothesis implies that it is possible for an
investor to earn superior returns by studying company accounts, newspapers and
investment journals, or by purchasing reports from market analysts.
(c) The strong form of the efficient market hypothesis implies that since security prices
reflect all available information, there is no way that investors can achieve abnormal
returns.
6)
Discuss the importance of the efficient market hypothesis to the following parties:
(a) shareholders concerned about the maximisation of their wealth;
(b) corporate financial managers making capital investment decisions; and
(c) investors analysing the annual reports of listed companies.
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WEEK 3
Lecture Subject: INVESTMENT APPRAISAL: APPLICATION & RISK (1)
Lecture Objectives:
Relevant project cash flows
Taxation and capital investment decisions
Inflation and capital investment decisions
Investment appraisal and risk
Textbook:
Publishing, 1998
Chapter(s)
Pages
83 to100
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)

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Tutorial Subject: INVESTMENT APPRAISAL : APPLICATION & RISK
Relevant project cash flows
Taxation and capital investment decisions
Inflation and capital investment decisions
Investment appraisal and risk

1) A machine is to be purchased by Blake Ltd for $100 000. The expected life of the machine
is four years, at the end of which it will have zero value and will be scrapped. Blake Ltd. pays
corporation tax at a rate of 33% and its discount rate for investment purposes is 8%. What are the
present values of the tax benefits arising to Blake Ltd from the purchase of the machine in the
following circumstances:
(a) first year capital allowances of 100% are available;
(b) capital allowances are available on a straight-line basis over the assets life;
(c) capital allowances are available on a 25% reducing balance basis?
1)
Discuss which cash flows are relevant to investment appraisal calculations.
2)
Explain, with the aid of a short example, how 25% reducing balance capital allowances are
calculated.
3)
Explain the difference between the nominal (or money) terms approach and the real terms
approach to dealing with inflation in the context of investment appraisal.
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1)
Explain whether general or specific inflation should be taken into account in investment
appraisal.
2)
Explain the difference between risk and uncertainty.
3)
Critically discuss the use of the following techniques as methods of dealing with risk in
the appraisal of capital investment projects:
a)
Sensitivity analysis
b)
Risk-adjusted discount rate
c)
Adjusted payback
d)
Monte Carlo methods.
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WEEK 4
Lecture Subject: AN OVERVIEW OF INVESTMENT APPRAISAL METHODS (2)
Lecture Objectives:
The problem of unequal project lives
Empirical investigation of investment appraisal
Calculation of an optimum replacement cycle
Textbook:
Corporate Finance Co, Denzil Watson & Tony Head,

Pitman Publishing, 1998
Reference Books:
Chapter(s)
Pages
100 to 112
Chapter(s)
Pages

By Stephen Lumby

1)
2)

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Tutorial Subject: INVESTMENT APPRAISAL: APPLICATION & RISK (2)

The problem of unequal project lives
Empirical investigation of investment appraisal
Calculation of an optimum replacement cycle

1) The financial manger of Logar plc is considering the purchase of a finishing machine which will
improve the appearance of the companys range of decorated fudges. She expects that the
improved output will lead to increased sales of $110 000 per year for a period of five years. At
the end of the five-year period, the machine will be scrapped. Two machines are being
considered and the relevant financial information on the capital investment proposal form is as
follows:
Machine A
Machine B
Initial cost ($)
200 000
250 000
Labour cost ($ per year)
10 000
7 000
Power cost ($ per year)
9 000
4 000
Nil
25 000
Scrap value ($)
The following forecasts of average annual rates of inflation have been prepared by the
planning department of Logar plc:
Sales prices:
6% per year
Labour costs:
5% per year
Power costs:
3% per year
Logar plc pays corporation tax of 31% one year in arrears and has a nominal after-tax cost of
capital of 15%. Capital allowances are available on a 25% reducing balance basis.
Advise the financial manager of Logar plc on her choice of machine.
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2) Discuss how sensitivity analysis can help management to assess the risk of an
investment project.
3) Why is payback commonly used as a way of dealing with risk in investment projects?
4) Discuss the use of risk-adjusted discount rates in the evaluation of investment projects.
1) Explain the meaning of the term Monte Carlo simulation.
2) Explain the difference between the lowest common multiple (LCM) and the equivalent
annual cost (EAC) methods of deciding when to replace identical assets.
3)
Nodil Ltd wishes to determine the optimal replacement cycle for its capping machine. The
finance department has estimated the following costs and resale values for the next four years.
Year
Initial
investment
($)
(50 000)
Operating
costs ($)
(14 000)
(17 000)
(20 000)
(24 000)
(3 000)
(4 500)
(7 000)
(18 000)
(11 000)
(6 000)
Maintenance
costs ($)
Scrap
($)
value
(30 000)
If the cost of capital of Notodil Ltd is 12%, determine the optimum replacement cycle using:
(a) the equivalent annual cost method;
(b) the lowest common multiple method.
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WEEK 5
Lecture Subject:
SOURCES OF LONG-TERM FINANCE: EQUITY FINANCE
Lecture Objectives:
Equity finance
The new issues market
Rights issues
Scrip issues, stock splits, scrip dividends and share repurchases
Preference shares
Textbook:

Chapter(s)
Pages
122 to 136
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)

Finance Journal, Spring, 1987
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Tutorial Subject:
SOURCES OF LONG-TERM FINANCE: EQUITY FINANCE
Equity finance
The new issues market
Rights issues
Scrip issues, stock splits, scrip dividends and share repurchases
Preference shares

1) Explain the reason why the return required by ordinary shareholders is different from the
return required by debenture holders.
2)
Briefly outline some of the important rights of shareholders.
3) Briefly explain the various ways in which a company may obtain a quotation for its
ordinary shares on the London Stock Exchange.
4) Outline the advantages and disadvantages which should be considered by a currently unquoted
company which is considering obtaining a listing on a recognised stock exchange.
5) What are pre-emptive rights and why are they important to shareholders?
6) Discuss the advantages and disadvantages of a rights issue to a company.
7) XTC is planning a 1 for 4 rights issue at a 20% discount to the current market price of $2.50. If
an investor is to sell their rights per share how much should they sell it for?
(a) 10 cents
(b) 20 cents
(c) 30 cents
(d) 40 cents
(e) 50 cents
8) A conversion of existing capital reserves into ordinary shares, which are then distributed pro
rata to existing shareholders. This statement best defines:
(a) scrip dividends
(b) a rights issue
(c) bonus bonds
(d) scrip issues
(e) stock splits
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9) Explain why preference shares do not enjoy great popularity as a source of finance for
companies.
2) Which one of the following statements best describes a cumulative preference share?
(a) It has the right to be converted into ordinary shares at a future date.
(b) It entitles the shareholder to a share of residual profits.
(c) It carries forward the right to receive unpaid dividends to the next year.
(d) It entitles the shareholder to a fixed rate of dividend.
(e) It gives its holder voting rights at a companys annual general meeting.
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1) Brand plc. generates profit after taxation of 15% on shareholders funds. Its current capital
structure is as follows:
$
Ordinary shares of 50 cents each
200 000
Share premium
87 500
Reserves
312 500
600 000
The board of Brand plc. wishes to raise $160 000 from a rights issue in order to expand
existing operations. Its return on shareholders funds will be unchanged. The current ex-dif
market price of Brand plc. is $1.90. Three different rights issue prices have been suggested by
the finance director: $1.80, $1.60 and $1.40.
Determine the number of shares to be issued, the theoretical ex-rights price, the expected
earnings per share and the form of the issue for each rights issue price. Comment on your
results.
2) Maltby plc., a company quoted on the London Stock Exchange, has been making regular
annual after-tax profits of $7 000 000 for some years and has the following long-term capital
structure.
$000
Ordinary shares, 50 cents each
4 000
16% debentures
9 000
13 000
The debenture issue is not due to be redeemed for some time and the company has become
increasingly concerned about the need to continue paying interest at 16% when the interest rate
on newly issued government stock of a similar maturity is only 7%.
A proposal has been made to issue 2 000 000 new shares in a rights issue, at a discount of
20% to the current share price of Maltby plc, and to use the funds raised to pay off part of the
debenture issue. The current share price of Maltby plc is $3.50 and the current market price of
the debentures is $112 per $100 block.
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Alternatively, the funds raised by the rights issue could be invested in a new project giving
an annual after-tax return of 20%. Whichever option is undertaken, the stock market view of the
companys prospects will be unchanged and its P/E ratio will remain unchanged. Maltby plc.
pays corporation tax at a rate of 31%.
By considering the effect on the share price of the two alternative proposals, discuss whether
the proposed rights issue can be recommended as being in the best interests of the ordinary
shareholders of Maltby plc. Your answer should include all relevant calculations.
3) It has become increasingly common for companies to offer their shareholders a choice
between a cash dividend or an equivalent scrip issue of shares. Briefly consider the
advantages of scrip dividends from the point of view of:
(a) the company
(b) the shareholders
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WEEK 6
Lecture Subject: SOURCES OF LONG-TERM FINANCE: DEBT FINANCE, HYBRID
FINANCE, AND LEASING ( 1)
Lecture Objectives:
Loan Stock and debentures
Bank and institutional debt
International debt finance
Hybrid finance
Textbook:

Chapter(s)
Pages
145 to 150
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)

FinanceJournal,Spring,1987
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Tutorial Subject:
SOURCES OF LONG-TERM
HYBRID FINANCE, AND LEASING
FINANCE:
DEBT
FINANCE,
Loan Stock and debentures
Bank and institutional debt
International debt finance
Hybrid finance

1)
Discuss briefly the key features of debentures and ordinary loan stock.
2) Briefly explain what is meant by the following terms that refer to fixed interest debt
securities:
(a) restrictive covenant
(b) debenture sinking fund
(c) redemption window
3) Explain the meaning of the following terms and state the circumstances under which their
issue would be beneficial to lenders and borrowers:
(a) deep discount bonds
(b) zero coupon bonds
(c) warrants
(d) convertible loan stock
4)
What are the advantages and disadvantages of raising finance by issuing Eurobonds?
5) Explain the difference between a conversion premium and a rights premium with respect to
a convertible debenture.
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1) Bugle plc has some surplus funds that it wishes to invest in corporate bonds. The company
requires a return of 15% on such bonds, and you have been asked to advise on whether it should
invest in either of the following stocks which have been offered to it:
(a) Stock 1: 12% debentures redeemable at par at the end of 2 more years, current market
value per $100 block is $95.
(b) Stock 2: 8% debentures redeemable at $110 at the end of 2 more years, current market
value per $100 block is also $95.
2) Discuss, with the aid of a diagram, the relationship between the conversion premium, the
rights premium and the market value of a convertible debenture.
3) Discuss the reasons for the growth in popularity of leasing during the last 15 years. What
significant changes affecting leasing occurred in 1984?
Page 31
SoAF PJ/CI//1999
WEEK 7
Lecture Subject:
SOURCES OF LONG-TERM FINANCE:

HYBRID FINANCE, AND LEASING ( 2 )
DEBT
FINANCE,
Lecture Objectives:
The valuation of fixed interest debt securities
The valuation of convertible loan stock
Leasing
Chapter(s)
Pages
153 to157
Chapter(s)
Pages
Textbook:
Reference Books:
By Stephen Lumby

1)
2)

Page 32
SoAF PJ/CI//1999
Tutorial Subject:
SOURCES OF LONG-TERM FINANCE: DEBT FINANCE,
HYBRID FINANCE, AND LEASING
The valuation of fixed interest debt securities
The valuation of convertible loan stock
Leasing

1) A company has in issue a 10% debenture, redeemable at the option of the company between
one and five years from now. What factors do you think will be considered by the company in
reducing a decision on when to redeem the debenture?
2) Briefly outline the advantages and disadvantages to a company of issuing convertible loan
stock?
3) What is the gearing effect of warrants?
4)
A company has in issue some 9% debentures, which are redeemable at par in 3 years
time.
Investors now require an interest yield of 10%. What will be the current ex-interest
market value of $100 worth of debentures? What would the current ex-interest market value be
if the issue had been one of irredeemable loan stock?
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SoAF PJ/CI//1999

1 ) Discuss the reasons for the growth in popularity of leasing during the last 15 years. What
significant changes affecting leasing occurred in 1984?
2 ) Explain the difference between a finance lease and an operating lease, and discuss the
importance of the distinction for corporate finance?
Page 34
SoAF PJ/CI//1999
WEEK 8
MID-TERM EXAMINATION
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SoAF PJ/CI//1999
WEEK 9
Lecture Subject:
THE COST OF CAPITAL AND CAPITAL STRUCTURE (1)
Lecture Objectives:
Calculating the cost of individual sources of finance
Calculating the weighted average cost of capital
Average vs marginal cost of capital
The practical application of WACC
Gearing: its measurement and implications
The concept of an optimal capital structure
The traditional approach to capital structure

Chapter(s)
Pages
198 to 213
Chapter(s)
Pages
Textbook:
Reference Books:
By Stephen Lumby
1)
2)

Page 36
SoAF PJ/CI//1999
Tutorial Subject: THE COST OF CAPITAL AND CAPITAL STRUCTURE

Calculating the cost of individual sources of finance
Calculating the weighted average cost of capital
Average vs marginal cost of capital
The practical application of WACC
Gearing: its measurement and implications
The concept of an optimal capital structure
The traditional approach to capital structure

1) Gorky plc has in issue 500 000 $1 ordinary shares whose current ex-dividend market price
is $1.50 per share. The company has just paid a dividend of 27 cents per share, and dividends are
expected to continue at this level for some time. If the company has no debt capital, what is the
weighted average cost of capital?
2) Five years ago, Eranio plc issued 12% irredeemable debentures at $103, a $3 premium to
their par value of $100. The current market price of these debentures is $94. If the company pays
corporation tax at a rate of 35 % what is its current cost of debenture capital?
3) Pollock plc has a capital structure consisting of 1 million ordinary shares, par value 25
cents and $100 000 of 10% irredeemable debentures. The current ex-dividend market price of the
ordinary shares is 49 cents per share, and the current ex-interest market price of the debentures is
$72 per $100 block. The company has just paid a dividend of 9 cents per share and dividends are
expected to continue at this level indefinitely. If the company pays corporation tax at a rate of 33 %,
what is its weighted average cost of capital?
4) Should companies use their weighted average cost of capital as the discount rate when
assessing the acceptability of new projects?
5) A company incorporates increasing amounts of debt finance into its capital structure while
leaving its operating risk unchanged. Assuming that a perfect capital market exists with no taxation,
will the companys weighted average cost of capital:
(a) fall slowly
(b) fall quickly
(c) remain the same
Page 37
SoAF PJ/CI//1999
(d) fall to a minimum and then rise

(e) rise steadily

1)
Smith plc, a quoted company, has the following long-term capital structure:
$000
Ordinary shares, 50 cents each
4000
16% debentures
9000
13000
The current share price of Smith plc is $3.50 and the current market price of the debentures
is $112 per $100 block. Smith plc pays corporation tax at a rate of 33%.
Calculate the capital gearing of Smith plc based on (a) market values, and (b) book values,
and discuss why a market-based estimate of capital gearing is generally considered to be
superior.
2) The calculation of WACC is straightforward in theory, but in practice is not an easy task.
Outline any possible difficulties that might be experienced when trying to calculate WACC.
Page 38
SoAF PJ/CI//1999
WEEK 10
Lecture Subject:
THE COST OF CAPITAL AND CAPITAL STRUCTURE (2)
Lecture Objectives:
Miller & Modigliani (I) net income approach
Miller & Modigliani (II) and market imperfections
Miller and personal taxation
Peeking order theory
Does an optimal capital structure exist?
Textbook:
Chapter(s)
Pages
214 to 222
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)
Page 39
SoAF PJ/CI//1999
Tutorial Subject:
THE COST OF CAPITAL AND CAPITAL STRUCTURE
Miller & Modigliani (I) net income approach
Miller & Modigliani (II) and market imperfections
Miller and personal taxation
Peeking order theory
Does an optimal capital structure exist?
1) One-third of the total market value of Johnson plc consists of loan stock, which has a
cost
of 10%. Another company, York, is identical in every aspect to Johnson plc, except that its
capital structure is all-equity, and its cost of equity is 16%. According to Modigliani and
Miller, if we ignored taxation and tax relief on debt capital, what would be the cost of equity of
Johnson plc?
2) Which of the following statements concerning capital structure is incorrect?
(a) Bankruptcy risk is ignored in Miller and Modiglianis first model.
(b) Debt holders are not subject to the effects of financial risk.
(c) The traditional approach assumes that capital markets are perfect.
(d) Miller and Modiglianis second paper takes into account the effects of corporate taxation.
(e) Miller and Modiglianis first model argues that no optimal capital structure exists and
supports this proposition with arbitrage theory.
3)
If a company finds that its cost of capital has changed does this affect the profitability
of the company?
4) What is the significance of the arbitrage proof for Miller and Modiglianis first paper
on the cost of capital?
Page 40
SoAF PJ/CI//1999

1) Critically discuss whether you consider that companies, by integrating a sensible level of
gearing into their capital structure, can minimise their weighted average cost of capital.
2)
Briefly explain the traditional view that an optimal capital structure exists.
Page 41
SoAF PJ/CI//1999
WEEK 11
Lecture Subject:
WORKING CAPITAL MANAGEMENT (1)
Lecture Objectives:
The objectives of working capital management
Working capital policies
Working capital and the cash conversion cycle
Over trading
Textbook:

Chapter(s)
Pages
10
267 to 275
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)
Page 42
SoAF PJ/CI//1999
Tutorial Subject:
WORKING CAPITAL MANAGEMENT
The objectives of working capital management
Working capital policies
Working capital and the cash conversion cycle
Over trading

1)
Explain the different strategies a firm may follow in order to finance its cumulative
capital requirements.
2)
Describe the cash conversion cycle and explain its significance in determining the
working capital needed by a company.
3)
Describe the strategies that could be followed by a company seeking to deal with the
problem of over trading.
4)
Explain the difference between factoring and invoice discounting.
5)
Discuss the possible reasons why a company might experience cash flow problems and
suggest ways in which such problems might be alleviated.
6)
Explain why a company may choose to have reserves of cash.
7)
Discuss ways in which a company might invest its short-term cash surpluses, explaining
8)
9)
briefly the factors which it should consider in making its selection.

How might the creditworthiness of a new customer be checked?
10)
Is it worth offering discounts to debtors to encourage prompt payment?
11)
Suggest ways in which companies can exercise control over their levels of working
capital.
Page 43
SoAF PJ/CI//1999

1) Sec plc. uses a large quantity of salt in its production process. Annual consumption is 60
000 tonnes over a 50-week working year. It costs $100 to initiate and process an order and delivery
follows 2 weeks later. Storage costs for the salt are estimated at 10 cents per tonne per annum. The
current practice is to order twice a year when the stock falls to 10 000 tonnes. Recommend an
appropriate ordering policy for Sec plc, and contrast it with the cost of the current policy.
2) MW Ltd has budgeted its sales to be $700 000 per annum. Its costs as a percentage of sales
are as follows:
%
Raw materials
20
Direct labour
35
Overheads
15
Raw materials are carried in stock for two weeks and finished goods are held in stock before
sale for three weeks. Production takes 4 weeks. MW Ltd takes 4 weeks credit from suppliers
and gives 8 weeks credit to its customers. If both overheads and production are incurred evenly
throughout the year, what is MW Ltds total working capital requirement?
3) A company is considering offering a discount for payment within 10 days to its customers,
who currently pay after 45 days. Only 40% of credit customers would take the discount, although
administrative cost savings of $4450 per year would be gained. If sales, which are unaffected by the
discount, are $1 600 000 per year and the cost of short-term finance is 11%, what is the maximum
discount that could be offered?
Page 44
SoAF PJ/CI//1999
WEEK 12
Lecture Subject:
WORKING CAPITAL MANAGEMENT (2)
Lecture Objectives:
The management of stock
The management of cash
The management of debtors
Textbook:

Chapter(s)
Pages
10
276 to 284
Chapter(s)
Pages
Reference Books:

By Stephen Lumby

1)
2)
Page 45
SoAF PJ/CI//1999
Tutorial Subject:
WORKING CAPITAL MANAGEMENT
The management of stock
The management of cash
The management of debtors

1) Explain why a company may choose to have reserves of cash.
2) Discuss ways in which a company might invest its short-term cash surpluses, explaining
briefly the factors which it should consider in making its selection.
3) How might the creditworthiness of a new customer be checked?
4) Is it worth offering discounts to debtors to encourage prompt payment?
5) Suggest ways in which companies can exercise control over their levels of working
capital.

1) A company is considering offering a discount for payment within 10 days to its
customers, who currently pay after 45 days. Only 40% of credit customers would take the
discount, although administrative cost savings of $4450 per year would be gained. If sales,
which are unaffected by the discount, are $1 600 000 per year and the cost of short-term
finance is 11%, what is the maximum discount that could be offered?
Page 46
SoAF PJ/CI//1999

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O LYMPIA B USINESS S CHOOL

SCHOOL OF ACCOUNTING & FINANCE

ADVANCED DIPLOMA IN ACCOUNTING

MANAGEMENT ACCOUNTING III

R AFFLES E DUCATION G ROUP

School Of Accounting & Finance

Management Accounting III

Olympia Business School

School Of Accounting & Finance

Management Accounting III

HOW TO USE THE FILO TEXT ?

The academic team

The academic planner

The objective(s) of the lecture

Other reference books available on the topic

Additional reference material for your own research

The objective(s) of the tutorial

Questions to prepare for discussion during the tutorial

Questions for your personal research and self-assessment

Olympia Business School

School Of Accounting & Finance

Management Accounting III

Olympia Business School

School Of Accounting & Finance

Management Accounting III

Olympia Business School

School Of Accounting & Finance

Management Accounting III

Olympia Business School

School Of Accounting & Finance

Management Accounting III

Olympia Business School

School Of Accounting & Finance

Management Accounting III

The Finance Function

Capital Markets, Market Efficiency and Ratio Analysis

Investment Appraisal: Application & risk (1 )

Investment Appraisal: Application & risk (2 )

Sources Of Long-term Finance: Equity Finance

Sources Of Long-term Finance: Debt Finance, Hybrid

Sources Of Long-term Finance: Debt Finance, Hybrid

The Cost Of Capital And Capital Structure ( 1 )

The Cost Of Capital And Capital Structure (2 )

Working Capital Management ( 1 )

Working Capital Management ( 2 )

Olympia Business School

School Of Accounting & Finance

Management Accounting III

Welcome to Corporate Finance

Olympia Business School

School Of Accounting & Finance

Management Accounting III

THE FINANCE FUNCTION

The role of the financial manager

How is shareholders wealth maximized?

Corporate Finance, Denzil Watson & Tony Head, Pitman

Investment Appraisal & Financial decisions 3rd Edition

Additional Reference Material:

Weston, J. Fred, New Theme in Finance, Journal of Finance , March, 1974.

Myers, S. C. Finance Theory and Financial Strategy, Midland corporation

Olympia Business School

School Of Accounting & Finance

Management Accounting III