Chapter 1&2

Question 1

What is the primary objective of financial strategy

Answer 1

To maximize shareholder wealth

Question 2

What are the 4 key decisions you have to consider in financial strategy

Answer 2

Financing
Investment
Dividend
Risk management

Question 3

What are 8 other stakeholders

Answer 3

Shareholder
Lenders
Directors
Employees
Customers
Suppliers
Government
Community

Question 4

What are the 4 ethical considerations directors have to face

Answer 4

Dealing with customers

Fair treatment of employees

Use of suppliers who may make use of child/ slave labour

Protection of the environment

Question 5

Define sustainability

Answer 5

Meeting the needs of current generations without compromising the needs of future generations

Question 6

Define sustainable development

How have governments promoted sustainable development (3)

Answer 6

Recognizes the interdependence between business, society and the environment.

Taxes and subsidies
Voluntary codes
Stakeholder engagement

Question 7

What 6 things should a sustainability report include

Answer 7

Environmental factors eg water usage, emissions

Social factors eg employment practices

Governance factors eg procedures to manage ESG performance

Climate related disclosures

Policies, practice and performance

Targets for each ESG factor

Question 8

Name 2 ESG metrics for each factor

Answer 8

Environmental
Absolute emissions eg CO2
Percentage of waste recycled

Social
Staff satisfaction
Number of notifiable accidents

Governance
Number of women in the management team
Employee anti-corruption training

Question 9

What are the 4 problems that make it hard to measure ESG performance

Answer 9

Subjectivity involved in choosing appropriate KPI

Difficulty in measuring qualitative effects eg employee satisfaction

Difficulty in measuring ‘vague’ KPI eg reducing environmental damage

Comparison of different businesses can be problematic

Question 10

What is the only measure which uses profit

Answer 10

ARR

Question 11

How do you calculate ARR

Answer 11

ARR= average annual profit / average (or initial) investment

Average investment = (initial outlay + scrap value) / 2

Question 12

What is the formula for a perpetuity

Answer 12

PV = cash flow * 1/r

Question 13

What are the pros of payback period (4)

Answer 13

Simple to calculate and understand

Can use as an initial screening tool

Recognizes importance of liquidity

Focuses on nearest (most certain) cash flows

Question 14

What are the cos of payback period (4)

Answer 14

Ignores time value of money

Only considers the cash flows up to the payback date

Encourages short termism

No clear decision rule

Question 15

What are the pros of ARR or ROCE (3)

Answer 15

Simple to calculate and understand

Looks at the entire life of the project

Reflects the way that external investors judge the organization (% return)

Question 16

What are the cons of ARR or ROCE (4)

Answer 16

Ignores the time value of money

Based on profits, not relevant cash flows

Doesn’t consider the length of the project (and hence liquidity)

No clear decision rule

Question 17

What are the pros of NPV (5)

Answer 17

Takes into account the time value of money

Shows shareholders the wealth created by a project

Can allow for risk ( by adjusting COC)

Clear decision

Looks at the entire project

Question 18

What are the cons of NPV (4)

Answer 18

Requires COC to be estimated several years into the future

Calculations can be time consuming and easily misunderstood

Doesn’t factor in liquidity/ time taken to generate return

Assumes you can reinvest proceeds at COC

Question 19

What are the pros of IRR (4)

Answer 19

Allows for time value of money

Does not require an exact cost of funds to be estimated

Easy to interpret (% return of a project)

Looks at entire project

Question 20

What are the cons of IRR (3)

Answer 20

Ignores the size of the investment required and total cash inflows

Can give conflicting answer to NPV when evaluating mutually exclusive projects

Assumes you can reinvest proceeds at the IRR

Question 21

How do you calculate deprival value

Answer 21

The lower of replacement cost and (higher of NRV and value in use)

Question 22

What are the two types of inflation rate

Answer 22

Specific inflation rate

General inflation rate

Question 23

What is the formula that links real and nominal rates

Answer 23

(1+m) = (1+r) (1+i)

m = money rate
r = real rate
i = general inflation

Question 24

What is the equation for a growing perpetuity

Answer 24

DF = 1 / (r-g)

Question 25

What is the equation for equivalent annual cost (EAC)

Do you choose higher or lower

Answer 25

EAC = NPV / annuity factor for the project life

Lower

Question 26

What are the two types of capital rationing

Answer 26

Hard capital rationing - no stakeholder is prepared to invest any more funds - impossible for more funding

Soft capital rationing - organsiation could raise more funds but has decided not to

Question 27

How do you calculate the profitability index

Answer 27

Profitability index = NPV / initial investment

Question 28

What are the 7 value drivers in SVA

And how can you positively impact these drivers

Answer 28

Sales growth rate - increase the rate or prevent decline using marketing, new products

Operating profit margin - increase price or reduce operating costs

Corporation tax rate - reduce the effective rate using tax planning

Investment in noncurrent assets - reduce investment without impacting business eg increase useful life of assets

Investment in working capital - reduce investment without impacting business eg reduce stock levels with inventory management

Cost of capital - reduce the COC by finding cheaper sources of capital

Life of projected cash flows - increase the life of projected cash flows eg face lift older products

Question 29

What is a real option

Answer 29

As a result of doing a project, may enable us to do something else which has value

Question 30

What are the 5 types of real options and give an example

Answer 30

Follow on options: ability to launch future products off the back of this one

Abandonment options: ability to exit project early and sell the assets eg in a joint venture and get paid out by partner

Timing options: ability to delay start of project and wait for favorable market conditions

Growth options: ability to dip your toe in the water with a small investment and then grow

Flexibility options: ability to change suppliers/ materials/ location if a cheaper option comes available

Question 31

What 6 ways can a government restrict exploitation of its country by multinationals

Answer 31

Quotas - limit on quantity of goods

Tariffs - extra tax or duty applied to imports to make domestic goods more competitive

Non tariff barriers - extra quality or safety checks applied on imported goods

Restrictions - eg foreign companies prevented from buying domestic companies in certain industries

Nationalization - of foreign owned companies and their assets (sometimes without compensation)

Minimum shareholding - insistence of minimum shareholding in companies by residents

Question 32

What are the 4 ways to deal with political risks

Answer 32

Negotiations with host government

Insurance - the ECGD (Exports Credits Guarantee Department) provide protection against nationalisation, war etc

Production strategies - contract out some production to local sources

Management structure - use of joint ventures with domestic companies

Question 33

What are the 4 headings environmental costs can be classified into
Describe them
Give a few examples

Answer 33

Prevention costs:
Costs to prevent impacts before they occur eg staff training, costs to prevent pollution

Appraisal costs:
Costs to ensure compliance with environmental standards eg site inspections, cost of monitoring activities

Internal failure costs:
Costs incurred if org. has created waste but not released into environment eg waste disposal costs, product take back costs

External failure costs:
Costs incurred if org. has released harmful waste into the environment eg fines, cost of cleaning up oil spills