AFM

Question 1

Positive NPV

Answer 1

1. Payback of project costs is achieved.
2. The project delivers the required annual return of the investor (wacc%) represented by the discount rate.
3. The +NPV represents a surplus return in addition to the required annual return (WACC)

Question 2

NPV: future cash flows

Answer 2

Relevant costs & revenues
Tax on operating cash flows & Tax saved on capital allowances
Expected values
Working capital
Inflation

Question 3

NPV: Relevant costs

Answer 3

Future, incremental cash flows.
Do not consider sunk costs
Do not consider fixed/committed costs
Do not consider non cash items

Question 4

Triple bottom line:

Answer 4

Social justice
Environmental quality
Economic prosperity

Question 5

Triple bottom line: social justice

Answer 5

Making sure that our operation involve no discrimination or human rights violations e.g. ensuring that workers are paid a fair wage and have good working conditions

Question 6

Triple bottom line: environmental quality

Answer 6

Ensuring that any negative environmental impact of our operations are minimised. e.g. monitoring the emissions levels from our factories.

Question 7

Triple bottom line: economic prosperity.

Answer 7

Gauging the financial impacts that our operations have on the local community e.g. measuring the impact of employment of workers and increased business for local business

Question 8

Relative merits of NPV over IRR:

Answer 8

It provides a clear decision. i.e accept if positive, reject if negative.
It always gives the correct decision
It always gives a single answer
It maximises the shareholders wealth

Question 9

Relative merit of IRR over NPV:

Answer 9

It is much easier for non-accountants to accept
It does not require the exact cost of funds to be known

Question 10

Criteria for establishing credit ratings:

Answer 10

Financial flexibility
Industry risk
Company’s management
Earnings protection

Question 11

Credit rating criteria: financial flexibility

Answer 11

Refers to the ease with which the company can raise new finance, measured by:

Past performance in raising equity finance
Relationships with lenders e.g banks
Restrictions on raising future finance
Cash reserves

Question 12

Credit rating criteria: industry risk

Answer 12

Measures the inherent risk present within the industry:
Measured by the following factors in said industry:

Volatility of past earnings of companies
Average beta scores of companies
Frequency of instances of insolvency
Fluctuations in levels of demand as compared to the state of the economy
Future prospects (regarding technology)

Question 13

Credit rating criteria: company’s management

Answer 13

Relates to the perceived strength of management and leadership can be assessed by reviewing:
Capabilities of the companies existing management
The extent to which the company’s had a succession plan
Previous evidence of management controls over spending and performance

Question 14

Credit rating criteria: Earnings protection

Answer 14

Refers to the robustness of the profits of a company changing external factors and can be measured by:

Volatility in past earnings
Historical profit margins
Diversity of products offered by the company

Question 15

Define: Financial distress cost

Answer 15

Costs associated with very high levels of gearing as a result of providing assurance to stakeholders that the company will remain solvent.

Direct financial distress cost: higher interest payments imposed by the bank

Indirect financial distress cost: loss of sales to customers or lack of credit from suppliers

Question 16

APV assumption w/ regards to discount rate

Answer 16

That there are sufficient profits available in a business to be able to take advantage of the interest payment being tax deductible

Question 17

APV assumptions:

Answer 17

The risk free rate could be used to present value the financing side effects.
The debt capacity could change as a result of undertaking the project.

Question 18

Intrinsic value of an option:

Answer 18

Difference between it’s current value and exercise price

Question 19

interest rate option:
Borrowing:
Lending:

Answer 19

Borrowing: put option to sell IR futures contract
Lending: call option to buy IR futures contract

Question 20

Forward rate agreement:
Borrowing:
Lending:

Answer 20

Borrowing: buy FRA
Lending: sell FRA

Question 21

Drawback of DVM

Answer 21

Difficult to estimate future dividend growth
Inaccurate to assume that growth will be constant to infinity
N/a to non dividend paying companies

Question 22

Main advantage of a multilateral netting system

Answer 22

Netting off intra group balances before settlement reduces the number of settlements made. This reduces costs and administration.

Question 23

How does Centralised treasury help with cost reduction

Answer 23

Economies of scale
Avoids duplication of tasks/roles
Greater ability to assess and manage overall company risk exposure
Multilateral netting saves costs
Concentrate the expertise required within a central department.

Question 24

Advantages of decentralising the treasury function

Answer 24

Quicker local decision making
Local management can assess local conditions better
More autonomous decision making will motivate managers and reduce current staff turnover

Question 25

Merger’s & acquisitions: Sell-off

Answer 25

A sell-off involves disposing of a clearly separable part of a business
This disposal could be for cash, share or debt consideration and allows the seller to generate cash for investment and to concentrate on core areas of their business

Question 26

Merger’s & acquisitions: Management buy-in

Answer 26

Involves selling off a separable part of a business to an external group of managers who will come in to run the business
This usually happens when the part of the business being sold is under-valued due to poor management and external managers see an opportunity to acquires it as a low price
This acquisition will often involve the managers securing significant financing from banks and venture capital partners

Question 27

APV assumptions: Modigliani and Miller theory

Answer 27

Holds that the value of a geared company is greater than the value of an ungeared company by the value of the tax saved on its debt

It is appropriate to present value this tax saving using the existing cost of debt

Question 28

Post completion audits

Answer 28

Part of monitoring and appraising capital investment projects

Question 29

Post-completion audit aims

Answer 29

To compare income, costs and timing of projects against the original budget and any subsequent changes to the budget

Question 30

Post completion audits purpose

Answer 30

Tool for managing project more effectively and efficiently
Setting realistic budget targets
Better control of costs
Reaction of bottlenecks to help complete project on time

Question 31

Post completion audit drawbacks

Answer 31

Can be expensive process
Usefulness may be limited to projects which are unique

Question 32

Why not to use fixed discount rate to appraise new projects

Answer 32

Projects will have different risks attached to them and therefore the returns required from these projects would differ.

Question 33

Benefits of debt finance:

Answer 33

Tax benefits
Controlling the actions of managers
Issuing debt finance can be seen as a sign of confidence
Cheaper than equity finance

Question 34

The purpose of degearing an equity beta

Answer 34

To strip out a company’s specific financial risk to get to the asset betas which represent just the business risk element

Question 35

Generic assumptions with cash flows

Answer 35

Input variables are known with certainty or reasonable accuracy.
Variables and factors which determine the variables do not change in the future.

Question 36

What does APV take into account that NPV doesn’t take into account

Answer 36

Changing business risk profile if the project is a diversification.

The changing of financial risk profile

Will provide significantly more info about the sources of value and also about the different levels of risk applicable to different cash flows

Question 37

Drawbacks of NPV

Answer 37

Not possible to tell where the project’s value is generated from, where the value is from undertaking the project or from changing capital structure

Question 38

Drawbacks of NPV

Answer 38

Not possible to tell where the project’s value is generated from, where the value is from undertaking the project or from changing capital structure

Question 39

Drawbacks of APV

Answer 39

Does not take into account cost of financial distress
Possibility of tax exhaustion
And agency costs related to financing using debt.

Question 40

Exam technique: Conclusion

Answer 40

“A sensitivity and scenario analysis should be undertaken because of the assumptions made.”

Report compiled by:
Date:

Question 41

Value at Risk: Definition

Answer 41

The maximum loss of a project, used as a measure of the riskiness of the project. The lower the number the lower the risk

Question 42

Impact on raising finance if credit rating falls: positive

Answer 42

Debt holders may do not react in the same way credit ratings agency do. They may place different weightings to the criteria. Come to different judgements with consideration of external factors

Question 43

The role of the world trade organisation

Answer 43

To implement the general agreement on tariffs and trade. Its main aim is to reduce barriers to international trade. It does so by trying to prevent protectionist measures, such as tariffs quotas and other import restrictions. It also offers a forum for negotiation and dispute resolution.