×××× Mock FinancialManagement F9FM-Mock1-Z08-Q Time allowed Reading and planning: 15 minutes Writing: hours ALL FOUR questions are compulsory and MUST be attempted Formulae sheet, present value and annuity tables are on pages – 10 Do NOT open this paper until instructed by the supervisor During reading and planning time only the question paper may be annotated You must NOT write in your answer booklet until instructed by the supervisor Accountancy Tuition Centre Ltd ATC INTERNATIONAL Amber plc operates a daily return high speed train service between the UK and mainland Europe, via the channel tunnel In an attempt to reduce overheads, the company is considering using an outside supplier to take over responsibility for all on-train catering services Amber invited tenders for a five-year contract, and at the same time the senior management accountant drafted a schedule of costs for in-house provision of an equivalent service This cost schedule, together with the details of the lowest price tender which was received, are given below (See Table and additional information) Table 1: In-House Provision of Train Catering Services Schedule of Costs, Amber plc Variable Costs Direct material Variable overhead Pence Per £ Sales 55 12 Fixed Costs (allocated to products) Labour (Year 1) Purchase/storage management Depreciation (catering equipment) Insurance Total cost 10 86 The train service operates 360 days per year and a single restaurant carriage is adequate to service the catering needs of a train carrying up to 600 passengers The tendered contract (and the in-house schedule of costs) is for the provision of one catering carriage per train Past sales data indicates that 45% of passengers will use the catering service, spending an average of £4.50 each per single journey, or £9.00 per return journey This is expected to remain unchanged over the next five years, unless Amber invests in quality improvements Statistical forecasts of the level of demand for the train service, under differing average weather conditions and average exchange rates over the next five years are shown in Table Table 2: Forecast Passenger Figures (per single journey) UK WEATHER CONDITIONS Exchange rate Euro per £ 1.52 1.54 1.65 Poor 500 550 600 Reasonable 460 520 580 Good 420 450 500 The differing weather conditions are all assumed to be equally likely Based upon historical trends, the probability of each different exchange rate occurring is estimated as follows: Rate Probability 0.2 0.5 0.3 1.52 1.54 1.65 Accountancy Tuition Centre (International Holdings) Ltd 2008 Additional Information: (1) Labour costs are expected to rise at a rate of 5% per year over the next five years (2) Variable costs per £ sales are expected to remain unchanged over the next five years (3) Some catering equipment will need to be replaced at the end of Year at a cost of £500,000 This would increase the depreciation charge on catering equipment to pence per £ sales The equipment value at the end of Year is estimated to be £280,000 (4) The outside supplier (lowest price tender) has agreed to purchase immediately (for cash) the existing catering equipment owned by Amber plc at a price equal to the current book value i.e £650,000 The supplier would charge Amber a flat fee of £250 per day for the provision of this catering service, and Amber would receive 5% of gross catering receipts where these exceeded an average of £2,200 per day in each 360 day period The quality of the catering service is expected to be unaffected by contracting out (5) In the event of Amber deciding to contract out the catering, the following fixed costs will be saved: Depreciation Purchasing/storage costs Insurance Labour costs (6) £35,000 per year £18,000 per year £3,000 per year £74,844 (Year 1) The cost of capital for Amber plc is 12% Assume that all cash flows occur at the end of each year Taxation may be ignored in answering this question Required: (a) Calculate the expected number of passengers per single journey for the train service (4 marks) (b) Draft a table of annual cash flows and, using discounted cash flow analysis, determine which of the two alternatives (in-house provision or contracting out) is preferred (12 marks) (c) Comment on the limitations of using demand forecasts, such as that given in Table 2, for the purposes of the decision in question (3 marks) (d) Identify and critically comment upon three non-financial factors which need to be taken into account when a business is considering this type of decision (6 marks) (25 marks) Accountancy Tuition Centre (International Holdings) Ltd 2008 (a) (b) Discuss: (i) the significance of trade payables in a firm’s working capital cycle, and (5 marks) (ii) the dangers of over-reliance on trade credit as a source of finance (6 marks) Keswick plc traditionally follows a highly aggressive working capital policy, with no long-term borrowing Key details from its recently compiled accounts appear below: Sales (all on credit) Earnings before interest and tax (EBIT) Interest payments for the year Shareholders’ funds (comprising $1m issued share capital, par value 25c, and $1m retained earnings) Receivables Inventory Trade payables Bank overdraft $m 10.00 2.00 0.50 2.00 0.40 0.70 1.50 3.00 A major supplier which accounts for 50% of Keswick’s cost of sales, is highly concerned about Keswick’s policy of taking extended trade credit The supplier offers Keswick the opportunity to pay for supplies within 15 days in return for a discount of 5% Keswick holds no cash balances but is able to borrow on overdraft from its bank at 12% Tax on corporate profit is paid at 33% Required: Determine the costs and benefits to Keswick of making this arrangement with its supplier, and recommend whether Keswick should accept the offer Your answer should include the effects on: – – – – – – The working capital cycle Interest cover Profits after tax Earnings per share Return on equity Capital gearing (14 marks) (25 marks) Accountancy Tuition Centre (International Holdings) Ltd 2008 You are in charge of developing long term plans for your business, Plankers Ltd Plans are developed on the basis that the business has a single objective and seeks to maximise its profits as measured by profit after tax The company has a loan facility from its bank of $8m at 8% annually The outstanding liability at 31 December 2008 is $7m It is possible to extend the facility up to $12m but only at an interest cost of 9% on the whole outstanding balance The condition attached to this loan is that interest cover should at least be equal to If the condition is breached then the loan becomes repayable immediately Interest charges in the income statements are calculated on year end balance Targets set by the directors of Plankers are as follows: (1) cash balances must not fall below $1m, and (2) it is desirable that earnings per share should not fall below 20c per share The company has in issue 4m $1 ordinary shares The constraint set by the bank and the targets set by the directors are measured and assessed at each year end The summary income statement for the year just ended (31 December 2008) and a summary statement of financial position are shown below: 31 Dec 2008 $m 1·89 (0·56) 1·33 (0·40) 0·93 (0·47) 0·46 5·91 8·48 (7·00) 7·39 EBIT Interest charges Profit before tax Tax Profit after tax Dividends Retained Non cash net assets Cash Loan liabilities Shareholders’ funds The company is planning a major building programme on January 2009 at which time a cash outflow of $12m would have to be paid The building programme would lead to a 5% increase in EBIT (before depreciation) 50% of the expenditure will be depreciated at the rate of 15% per annum (the company has no other depreciable assets) This depreciation has been agreed as allowable for tax purposes with the tax authorities The directors of Plankers are considering utilising the loan facility to help meet the funding requirements of the building programme but are wondering whether their targets will be met or whether the loan conditions will be breached They have asked you to conduct a forecast of the company’s financial position at 31 December 2009 assuming the building programme begins on January 2009 For 2009 only, the company will not pay any dividends in order to minimise its refinancing needs The corporation tax rate is 30% Accountancy Tuition Centre (International Holdings) Ltd 2008 Required: (a) (i) Prepare a forecast summary income statement for the year to 31 December 2009 assuming that the building programme is undertaken at January 2009 and that any additional funds are provided by an extension of the bank loan Assume that tax is paid in the year in which incurred Work to decimal places of $m in your answer (ii) Assess whether, at 31 December 2009 and based on the scenario in (i) above, the loan condition would be breached and whether the directors’ targets would be achieved Work to decimal places of $m in your answer (b) (5 marks) (3 marks) (iii) Identify options the company could use, assuming it faced a cash shortfall, to ease any cash shortage (5 marks) (iv) Explain, without further computations, whether each of the options in (a)(iii) is likely to meet Planker’s requirements for additional capital and also the constraint set by the bank (3 marks) Whilst the financial plans of the business are based on a single objective, it faces a number of constraints that put pressure on the company to address more than one objective simultaneously Required: What types of constraints might the company face when assessing its long-term plans? Specifically refer in your answer to: (i) responding to various stakeholder groups; and (ii) the difficulties associated with managing organisations with multiple objectives (5 marks) (4 marks) (25 marks) Accountancy Tuition Centre (International Holdings) Ltd 2008 You are an accountant with a practice, which includes a large proportion of individual clients, who often ask for information about traded investments You have extracted the following data from a leading financial newspaper (dated 2008) (i) Stock Buntam plc Zellus plc (ii) Earnings and dividend data for Crazy Games plc are given below: EPS Div per share (gross) Price 160c 270c P/E ratio Dividend yield (% gross) 20 15 3·33 2004 5c 2005 6c 3c 3c 2006 7c 3·5c 2007 10c 2008 12c 5c 5·5c The estimated pre-tax return on equity required by investors in Crazy Games plc is 20% (iii) The gross redemption yield (yield to maturity) on gilts is as follows: Treasury 8·5% 2010 Exchequer 10·5% 2018 Treasury 8% 2028 7·20% 6·60% 6·20% Required: Draft a report for circulation to your private clients which explains: (a) the factors to be taken into account (including risks and returns) when considering the purchase of different types of traded investments (4 marks) (b) the meaning and the relevance to the investor of each of the following: (i) (ii) (iii) Gross dividend (cents per share) EPS Dividend cover Include calculation of, and comment upon, the gross dividends, EPS and dividend cover for Buntam plc and Zellus plc, based on the information given above (12 marks) (c) how to estimate the market value of a share Illustrate your answer by reference to the data in (ii) on Crazy Games plc, using the information to calculate the market value of 1,000 shares in the company (5 marks) (d) the shape of the yield curve for gilts, based upon the information given in (iii) above, which you should use to construct the curve (4 marks) (25 marks) Accountancy Tuition Centre (International Holdings) Ltd 2008 Formula Sheet Economic order quantity = 2Co D Ch Miller – Orr Model Return point = Lower limit + (1/3 × spread) 3 3 × transaction cost × variance of cash flows Spread = interest rate The Capital Asset Pricing Model E(ri) = Rf + i(E(rm)–Rf) The asset beta formula Vd(1 − T ) Ve d e + (Ve + Vd(1 − T )) (Ve + Vd(1 − T )) a= The Growth Model PO = D O (1 + g ) (re − g ) Gordon’s growth approximation g = bre The weighted average cost of capital Ve Vd Ke + Kd(1 − T ) WACC = Ve + Vd Ve + Vd The Fisher formula (1+i) = (1+r) (1+h) Purchasing power parity and interest rate parity s1 = s0 x (1 + h c ) (1 + h b ) Accountancy Tuition Centre (International Holdings) Ltd 2008 f0 = S0 x (1 + i c ) (1 + i b ) Present Value Table Present value of i.e (1 + r)–n where r = discount rate n = number of periods until payment Discount rate (r) Periods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0.990 0.980 0.971 0.961 0.951 0.980 0.961 0.942 0.924 0.906 0.971 0.943 0.915 0.888 0.863 0.962 0.925 0.889 0.855 0.822 0.952 0.907 0.864 0.823 0.784 0.943 0.890 0.840 0.792 0.747 0.935 0.873 0.816 0.763 0.713 0.926 0.857 0.794 0.735 0.681 0.917 0.842 0.772 0.708 0.650 0.909 0.826 0.751 0.683 0.621 10 0.942 0.933 0.923 0.914 0.905 0.888 0.871 0.853 0.837 0.820 0.837 0.813 0.789 0.766 0.744 0.790 0.760 0.731 0.703 0.676 0.746 0.711 0.667 0.645 0.614 0.705 0.665 0.627 0.592 0.558 0.666 0.623 0.582 0.544 0.508 0.630 0.583 0.540 0.500 0.463 0.596 0.547 0.502 0.460 0.422 0.564 0.513 0.467 0.424 0.386 10 11 12 13 14 15 0.896 0.887 0.879 0.870 0.861 0.804 0.788 0.773 0.758 0.743 0.722 0.701 0.681 0.661 0.642 0.650 0.625 0.601 0.577 0.555 0.585 0.557 0.530 0.505 0.481 0.527 0.497 0.469 0.442 0.417 0.475 0.444 0.415 0.388 0.362 0.429 0.397 0.368 0.340 0.315 0.388 0.356 0.326 0.299 0.275 0.350 0.319 0.290 0.263 0.239 11 12 13 14 15 (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 0.901 0.812 0.731 0.659 0.593 0.893 0.797 0.712 0.636 0.567 0.885 0.783 0.693 0.613 0.543 0.877 0.769 0.675 0.592 0.519 0.870 0.756 0.658 0.572 0.497 0.862 0.743 0.641 0.552 0.476 0.855 0.731 0.624 0.534 0.456 0.847 0.718 0.609 0.516 0.437 0.840 0.706 0.593 0.499 0.419 0.833 0.694 0.579 0.482 0.402 10 0.535 0.482 0.434 0.391 0.352 0.507 0.452 0.404 0.361 0.322 0.480 0.425 0.376 0.333 0.295 0.456 0.400 0.351 0.308 0.270 0.432 0.376 0.327 0.284 0.247 0.410 0.354 0.305 0.263 0.227 0.390 0.333 0.285 0.243 0.208 0.370 0.314 0.266 0.225 0.191 0.352 0.296 0.249 0.209 0.176 0.335 0.279 0.233 0.194 0.162 10 11 12 13 14 15 0.317 0.286 0.258 0.232 0.209 0.287 0.257 0.229 0.205 0.183 0.261 0.231 0.204 0.181 0.160 0.237 0.208 0.182 0.160 0.140 0.215 0.187 0.163 0.141 0.123 0.195 0.168 0.145 0.125 0.108 0.178 0.152 0.130 0.111 0.095 0.162 0.137 0.116 0.099 0.084 0.148 0.124 0.104 0.088 0.074 0.135 0.112 0.093 0.078 0.065 11 12 13 14 15 Accountancy Tuition Centre (International Holdings) Ltd 2008 Annuity Table Present value of an annuity of i.e where − (1 + r ) − n r r = discount rate n = number of periods Discount rate (r) Periods (n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 0.990 1.970 2.941 3.902 4.853 0.980 1.942 2.884 3.808 4.713 0.971 1.913 2.829 3.717 4.580 0.962 1.886 2.775 3.630 4.452 0.952 1.859 2.723 3.546 4.329 0.943 1.833 2.673 3.465 4.212 0.935 1.808 2.624 3.387 4.100 0.926 1.783 2.577 3.312 3.993 0.917 1.759 2.531 3.240 3.890 0.909 1.736 2.487 3.170 3.791 10 5.795 6.728 7.652 8.566 9.471 5.601 6.472 7.325 8.162 8.983 5.417 6.230 7.020 7.786 8.530 5.242 6.002 6.733 7.435 8.111 5.076 5.786 6.463 7.108 7.722 4.917 5.582 6.210 6.802 7.360 4.767 5.389 5.971 6.515 7.024 4.623 5.206 5.747 6.247 6.710 4.486 5.033 5.535 5.995 6.418 4.355 4.868 5.335 5.759 6.145 10 11 12 13 14 15 10.37 11.26 12.13 13.00 13.87 9.787 10.58 11.35 12.11 12.85 9.253 9.954 10.63 11.30 11.94 8.760 9.385 9.986 10.56 11.12 8.306 8.863 9.394 9.899 10.38 7.887 8.384 8.853 9.295 9.712 7.499 7.943 8.358 8.745 9.108 7.139 7.536 7.904 8.244 8.559 6.805 7.161 7.487 7.786 8.061 6.495 6.814 7.103 7.367 7.606 11 12 13 14 15 (n) 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 0.901 1.713 2.444 3.102 3.696 0.893 1.690 2.402 3.037 3.605 0.885 1.668 2.361 2.974 3.517 0.877 1.647 2.322 2.914 3.433 0.870 1.626 2.283 2.855 3.352 0.862 1.605 2.246 2.798 3.274 0.855 1.585 2.210 2.743 3.199 0.847 1.566 2.174 2.690 3.127 0.840 1.547 2.140 2.639 3.058 0.833 1.528 2.106 2.589 2.991 10 4.231 4.712 5.146 5.537 5.889 4.111 4.564 4.968 5.328 5.650 3.998 4.423 4.799 5.132 5.426 3.889 4.288 4.639 4.946 5.216 3.784 4.160 4.487 4.772 5.019 3.685 4.039 4.344 4.607 4.833 3.589 3.922 4.207 4.451 4.659 3.498 3.812 4.078 4.303 4.494 3.410 3.706 3.954 4.163 4.339 3.326 3.605 3.837 4.031 4.192 10 11 12 13 14 15 6.207 6.492 6.750 6.982 7.191 5.938 6.194 6.424 6.628 6.811 5.687 5.918 6.122 6.302 6.462 5.453 5.660 5.842 6.002 6.142 5.234 5.421 5.583 5.724 5.847 5.029 5.197 5.342 5.468 5.575 4.836 4.988 5.118 5.229 5.324 4.656 4.793 4.910 5.008 5.092 4.586 4.611 4.715 4.802 4.876 4.327 4.439 4.533 4.611 4.675 11 12 13 14 15 End of Question Paper Accountancy Tuition Centre (International Holdings) Ltd 2008 10 ... information about traded investments You have extracted the following data from a leading financial newspaper (dated 2008) (i) Stock Buntam plc Zellus plc (ii) Earnings and dividend data for Crazy... overhead Pence Per £ Sales 55 12 Fixed Costs (allocated to products) Labour (Year 1) Purchase/storage management Depreciation (catering equipment) Insurance Total cost 10 86 The train service operates... purposes of the decision in question (3 marks) (d) Identify and critically comment upon three non -financial factors which need to be taken into account when a business is considering this type of