Financial management paper f9 monitoring tests F9FM MT1A as d08

Monitoring Test MT1A Financial Management F9FM-MT1A-Z08-A Answers & Marking Scheme Accountancy Tuition Centre Ltd ATC INTERNATIONAL REXEL PLC (a) WDA calculations TJ Project $m WDA Tax relief Year 1.00 0.25 × 0.25 = 0.25 × 0.35 = 0.087 0.75 0.188 × 0.25 = 0.188 × 0.35 = 0.066 0.562 - 0.40 = 0.162 × 0.35 = 0.057 Tax relief Year CSM Project $m WDA 1.75 0.437 × 0.25 = 0.437 × 0.35 = 0.153 1.313 0.328 × 0.25 = 0.328 × 0.35 = 0.115 0.985 - 0.80 = 0.185 × 0.35 = 0.065 Incremental cash flow of TJ Project ($000s) Year Outlay WDA tax saving Revenues Operating costs Corporation tax Sale proceeds Net (1,000) 502 (200) 87 760 (350) (106) _ _ 66 930 (420) (143) 400 _ (1,000) 302 _ 391 _ 833 _ 57 (178) _ (121) _ Incremental cash flow of CSM Project ($000s) Year Outlay WDA tax saving Revenues Operating costs Corporation tax Sale proceeds Net (1,750) 1,114 (346) 153 1,050 (585) (269) _ _ 115 1,030 (650) (163) 800 _ (1,750) 768 _ 349 _ 1,132 _  Accountancy Tuition Centre (International Holdings) Ltd 2008 65 (133) _ (68) _ NPV Analysis TJ project (1,000) 302 391 833 (121) × × × × 0.926 0.857 0.794 0.735 = = = = = (1,000) 280 335 661 (89) _ NPV +187 _ = = = = = (1,750) 711 299 899 (50) _ NPV +109 _ CSM project (1,750) 768 349 1,132 (68) × × × × 0.926 0.857 0.794 0.735 This analysis has estimated the tax charge in two separate components: (i) the tax relief on the capital expenditure, and (ii) the tax charge on the net operating cash flow (revenues less operating costs) The loan interest cash flow, the loan repayment cash flow and the tax relief on loan interest have all been excluded from the analysis Financing cash flows are taken into account by the discounting process itself and tax relief on interest is implied by using of an after-tax discount rate Depreciation has been excluded from the analysis as it is a non-cash item On the basis of the NPV analysis and, under the assumption of no capital rationing, the Trade Journals project (code-named TJ) should be undertaken as this will lead to the greatest increase in shareholder wealth of approximately $187,000 (b) The main items of useful further information would be: (i) Information on the systematic risk of the projects Are they of equal risk and have they got a level of systematic risk for which 8% is an appropriate discount rate? (ii) Are there any non-financial reasons, such as competitors’ activity, existing marketing abilities, etc, which would favour one project rather than the other? (iii) How accurate are the cash flow forecasts, particularly with regard to revenues and operating costs? Has any market research or sensitivity analysis been undertaken? Has inflation been taken into account? (iv) Given the constraint on management resources, are there any other projects that should also be considered?  Accountancy Tuition Centre (International Holdings) Ltd 2008 (c) Not a great deal is known about the business and hence only general recommendations can be made The projects are not expected to last very long and hence both long and medium-term finance could be suggested The following may be suitable: (i) A listing on the AIM (ii) Venture capital (iii) Retained profits (iv) Leasing (v) Government grants or grants from other agencies (vi) Merger/Partnership/Business Angel JESSY PLC (a) (i) New born $ If the advertising campaign goes ahead Sales $300,000 × 1.25 = $375,000 (50%) 187,500 Receivables One month 30/360 days × 187,500 × 10% One and half months 45/360 days × 187,500 × 20% Three months 90/360 days × 187,500 × 67% One month 30/360 days × 187,500 × 10% One and half months 45/360 days × 187,500 × 10% Two months 60/360 days × 187,500 × 79% If the advertising campaign does not go ahead Sales $300,000 total New born (40%) $120,000 Toddler (60%) $180,000 Receivables 90/360 × $120,000 45/360 × $180,000 Toddler $ (50%) 187,500 1,563 4,688 31,406 1,563 2,344 24,688 37,657 28,595 30,000 22,500 Increase in receivables 7,657 6,095 Total increase in receivables = $7,657 + $6,095 $13,752  Accountancy Tuition Centre (International Holdings) Ltd 2008 (ii) Extra sales = 25% × $300,000 = $75,000 a year Extra contribution from extra sales (40% × $75,000) Less bad debts New born 3% × $187,500 Toddler 1% × $187,500 $ 5,625 1,875 _ $ 30,000 Less cost of extra investment in receivables (10% of $13,752) (7,500) (1,375) Incremental benefit 21,125 The maximum amount that should be paid for the advertising campaign is about $21,000 (b) (c) (i) Overdraft - a bank might be prepared to grant overdraft facilities against the security of a floating charge over Jessy’s receivables However, the maximum secured advance might be no more than about 70% of the invoice value of the receivables (ii) Bills of exchange - Jessy might arrange with its customers that the method of payment should be a bill of exchange The company would draw a bill of exchange on the customer, who would then “accept” it, that is, agree to pay it on maturity The company might then arrange with its bank to obtain finance against the security of the accepted bills Finance could be provided either by discounting the bill (the bank would in effect purchase the bill at less than its face value) or by means of a bank advance against the security of the bill (which is a common method for exporters to obtain short term finance) (iii) Invoice discounting - an invoice discounter provides finance, typically 80% of the value of an unpaid debt, against the security of the debt However although the invoice discounter will only agree to this for debts that it “approves” of Jessy must collect the debt itself, and on receipt of payment from the customer, repay the advance from the invoice discounter plus a finance charge The problems faced by a small business include the following: (i) Management skills The lack of experienced managers in all areas of the business may result in one individual having to work in areas in which he/she is unqualified or uninterested This problem is compounded by small firms often having a lack of formal controls and procedures and insufficient and informal training of staff The above problems often result in an impulsive and unpredictable management style, a preoccupation with day to day problems and an emphasis on survival rather than long term planning and future expansion  Accountancy Tuition Centre (International Holdings) Ltd 2008 (ii) The business Even though management is a key feature of any business, it is possible to outline other problems that a small business may face: If the company is just starting up, it will often have to finance itself through a number of loss making years, while its sale volume and reputation grow During this period, obtaining capital and managing cash are a major problem Once a business is fairly well established and starts growing (i.e the situation described for Jessy plc) the key problem becomes managing the growth and particularly obtaining finance for it If growth is rapid, retained profits may not be sufficient and to prevent the company from “overtrading”, new equity capital may be required Small businesses will find the raising of new equity far more difficult than larger companies since the latter are generally perceived as less risky Managing the growth may require the recruitment of more specialised personnel, which the existing managers may be reluctant to (having seen the business through the early years) Some companies stay small for the following reasons: If the owners also manage the business, it may be that their personal goals are satisfied with the firm remaining small Owners are unable or unwilling to delegate responsibilities Nature of business – if a specialist market, it may be that demand will only support a small business Lack of management skills for growth Shortage of funds  Accountancy Tuition Centre (International Holdings) Ltd 2008 Marking Scheme REXEL PLC (a) Tax savings on WDA - TJ Tax savings on WDA - CSM Project TJ: Outlay & proceeds WDA b/f Incremental revenues Incremental operating costs Tax on revenue items Project CSM – as for TJ NPV’s and conclusion (b) mark per reasonable idea (c) mark per reasonable idea JESSY PLC (a) (i) Receivables with advertising Receivables without advertising Marks Marks 2½ 2½ ½ 1 4½ 16 ––– max max ––– 25 ––– 3 (ii) Extra contribution Bad Debts Finance cost Conclusion 1 (b) marks per method (c) mark per well made comment mark per reason 4 25  Accountancy Tuition Centre (International Holdings) Ltd 2008 ... an after-tax discount rate Depreciation has been excluded from the analysis as it is a non-cash item On the basis of the NPV analysis and, under the assumption of no capital rationing, the Trade... any non -financial reasons, such as competitors’ activity, existing marketing abilities, etc, which would favour one project rather than the other? (iii) How accurate are the cash flow forecasts,... operating costs) The loan interest cash flow, the loan repayment cash flow and the tax relief on loan interest have all been excluded from the analysis Financing cash flows are taken into account