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suggested answers

Please note:

They are only suggested answers - the official ACCA answers will not

be published until closer to the results day. These answers are not

guaranteed to be 100% correct (although I certainly guarantee that they

would score very high marks :-) )

Answers to the written parts of the questions are not intended to be full

answers but an indication of the sort of points that could be mentioned

I have set out my calculations the way I find the easiest, however if you

set them out in a different way then that is no problem (provided,

obviously, that they are clear for the marker to follow) - marks are for

each part of the workings rather than for the final answer.

me know in the Ask the Tutor Forum if I have :-)

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ACCA F9

June 2015 Answers Section A

1!

2!

3!

4!

5!

6!

7!

8!

9!

10!

11!

12!

13!

14!

15!

16!

17!

18!

19!

20!

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Section B

Question 1

(a)

Using the forward market, the receipt in 6 months time will be fixed at:

750,000 / 2.412 = $310,945

- Borrow for 6 months at 4% (6/12 x 8%)

750,000 / 1.04 =

721,154

- Convert at spot

721,154 / 2.349 =

$307,005

307,005 x 1.01 =

$310,075

bank charges, which have been ignored).

(b)

A forward rate agreement (FRA) is the fixing of an interest rate for a loan of a fixed amount,

for a fixed term, starting on a fixed future date.

When the loan starts, the company will pay whatever interest rate is being quoted on that

date, but they will then settle with the provider of the FRA such that the resultant net

interest is fixed at the agreed rate.

A company can use FRAs as a way of protecting themselves against changes in the

interest rates both between now and the date on which the loan starts, and during the

period of the loan.

Note that the question asked for both an explanation of FRAs, and for a discussion of how

an FRA could be used.

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Section B

Question 2

(a)

Current retention rate = 100 - 41.4 = 58.6%

Therefore estimate of future growth = Re x b = 12.5% x 58.6% = 7.325%

Using the dividend valuation formula,

Market value = (5.72976M x 1.07325) / (0.125 - 0.07325) = $118,830,240

Note:

(i)

(ii)

(b)

multiply by the number of shares

Although the future expected growth rate is what is needed for the

dividend valuation model, I would expect that the examiner will give

full marks if the past growth rate had been used instead.

Therefore equity market value = $13.84M / 8.2% = $168,780,488

(c)

Theoretically, the market value is be the present value of future expected dividends

discounted at the shareholders required rate of return, and this is what the dividend growth

model is calculating.

However, the problem is knowing what growth rate shareholders are expecting, and the

assumption that they are expecting it to be a constant growth rate.

The earnings yield method (similar to the PE ratio method) is more practical in that the

information is readily available.

However it does assume that similar listed companies are similar in all respects - in

particular with regard to their future growth potential.

Section B

Question 3

(a)

Depending on what material you studied from, there are two alternative approaches - both

of which give the same net benefit and are therefore both acceptable

This question was almost identical to one that the same examiner set many years ago

(which is why it appears in the Revision/Exam Kits :-) )

Approach 1:

Benefits per year of using the factor:

50,000

(70% x 1% x $26.75M)

187,250

Saved interest:

Current receivables

4,458,000

New receivables (W1) 520,139

Saving:

5% x 3,937,861 =

Total benefits:

196,893

Annual fee

(0.75% x $26.75M)

200,625

(7% x 80% x $26.75M x 35/360)

145,639

W1

Total costs:

Net benefit:

The remaining 20% will take 35 days. So average overall collection period

is 20% x 35 days = 7 days. 7/360 x $26.75M = $520,139

Approach 2:

Benefits per year of using the factor:

50,000

(70% x 1% x $26.75M)

187,250

Saved interest:

Current receivables

New receivables

(35/360 x $26.75M)

Saving:

4,458,000

2,600,694

5% x 1,857,306 =

Total benefits:

92,865

Annual fee

(0.75% x $26.75M)

200,625

(2% x 80% x $26.75M x 35/360)

41,611

Total costs:

Net benefit:

Whichever approach you used , since there is a net benefit the company should employ

the factor.

(b)

- checking with credit agencies

- asking for references from other suppliers used by the customers

- asking for references from their bank

- examination of their financial statements

Section B

Question 4

(a)

The current PE ratio = total market value / total earnings = 70M / 8.4M = 8.3333

The loan notes will be repaid at a cost of $104 x 1.05 = $109.20 per $100 nominal

Therefore nominal value of loan notes repaid = $11.2M x 100/109.20 = $10.25641M

So interest saved (after tax relief) = 8% x $10.25641M x 70% = $574,359 per year

Therefore new total earnings will be 8,400,000 + 574,358 = $8,974,358 per year

Given that the PE ratio is to remain as before at 8.3333,

the new total market value will equal:

8.3333 x $8,974,358 = $74,786,018

74,786,018 - 70,000,000 = $4,786,018

(b)

Modigliani and Miller proved that in the absence of tax then there is no optimal capital

structure and that the cost of capital and total market value of a business is independent of

the level of gearing.

They further proved that when there is corporation tax (as in the case of Grenarp) that a

company should be as highly geared as possible. Although more gearing makes things

more risky for the shareholders, this is more than compensated for by the tax relief on the

interest payable.

As a result, with higher gearing, the cost of capital will be reduced and the total market

value increased.

Although Modigliani and Miller made various assumptions that may not hold perfectly true

in real life, it is therefore extremely unlikely that by making a rights issue and repaying the

loan notes (and therefore reducing their gearing) that Grenarp would achieve its optimal

capital structure. It is more likely to be the reverse!

Section B

Question 5

(a)

There are several ways of dealing with the uncertainty regarding the future economic

states. The solution can be calculated using the expected selling price per unit (as in the

answer below). Alternatively, the NPV can be calculated three times - using each selling

price - and then an expected NPV calculated. Or, alternatively, the present value of the

revenue can be calculated three times - using each selling price - then an expected present

value of the revenue could be combined with the present value of the other flows.

All three approaches would result in the same final expected NPV (and would deserve full

marks), but the approach below is by far the quickest!

Appreciate that whatever approach is taken, the question specifically required the expected

NPV.

The question asked for the expected NPV only. If you did three separate NPVs then fine provided you then wrote down the expected NPV. However there was no requirement to do

all of that which would obviously have taken a lot more time.

Workings:

Expected selling price (at current prices) = (35% x $25) + (50% x $30) + (15% x $35)

= $29 per unit

Year 1:

Year 2:

Year 3:

Year 4:

250,000 units x $29 x (1.04)2

400,000 units x $29 x (1.04)3

300,000 units x $29 x (1.04)4

=

=

=

=

$4,524,000

$7,841,600

$13,048,422

$10,177,769

Capital allowances:

First 3 years: $5M / 4 = $1,250,000 per year

Fourth year:

Tax written down value = 5,000,000 - (3 x 1,250,000) = 1,250,000

Therefore balancing allowance = 1,250,000 - 500,000 = 750,000

4,524

7,842

13,048

10,178

(2,385)

(4,200)

(7,080)

(5,730)

Overheads

(440)

(484)

(532)

(586)

1,699

3,158

5,436

3,862

(510)

(947)

(1,631)

(1,159)

Revenue

Variable cost

Initial cost

(5,000)

Scrap value

500

Net cash flow

d.f. at 11%

Present values

375

375

375

225

(5,000)

1,564

2,586

4,180

3,428

0.901

0.812

0.731

0.659

(5,000)

1,409

2,100

3,056

2,259

The expected net present value is positive and therefore the project is financially

acceptable.

However, this is subject, as always, to the accuracy of the cash flow estimates (especially

the inflation rates), and in particular to the fact that the future economic state will result in

one of three selling prices (and therefore one of three revenue streams and one of three net

present values - the expected revenues will not actually occur). This means that the actual

NPV will not equal the expected NPV as calculated and may be higher (if the economic

state is strong or medium) or may be lower (if the economic state is weak).

Note that the tax could have been dealt with in an alternative way - subtracting the capital

allowances from the operating flow, then calculating the tax on the net figure, and then adding back

the capital allowances (as a non-cash flow). The final net cash flows would be exactly the same,

and this would be perfectly acceptable.

(b)

Sensitivity analysis measures the %age change in individual estimates (e.g. the estimate of

the overheads, the estimate of the cost of capital) that can be afforded before the NPV

became negative and therefore the project becomes unacceptable.

It is useful in that it can help identify those estimates that are more critical and to which

therefore more attention needs to be paid.

However, there are two main limitations. One is that it can only examine one factor at a

time, whereas several factors may be inter-related. For example, the inflation applied to the

selling prices - if changed - may impact upon the sales volume.

A much bigger problem in relation to this project is that the revenue and hence the NPV

depends on the future economic state and will not be equal to the expected NPV. This

means that the actual NPV may be higher or lower than the expected NPV. In addition it is

unlikely that there will be only three possibilities - it is more likely to be a range of

possibilities - and even if there were, there is the question as to how reliable are the

probabilities of the different states

A better approach to dealing with the risk would be a simulation approach - calculating the

NPV for each of the whole range of possible outcomes, and then basing the decision on the

likelihood of the eventual NPV being positive.

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