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CHAT SESSION WITH ACCA F9 TUTOR

Is there any fixed % that must be used when calculating the IRR... if for e.g. I have a cost of
capital of 10% giving me a positive NPV, does it mean that I can use any % above this
provided it gives me a negative NPV??
ACCA Tutor: This is correct. However, for expedience in the exam I will tend to move in blocks
of 5% at a time. So, in your example I will look for a negative NPV using 15%. If you practice
this approach you will find that you are always looking to find the percentage of the 5% to add
to the 10% in your example.

If they initially give u 13% use 18% to get a negative?

ACCA Tutor: Yes, but you will notice with practice that you can normally choose 5%, 10% 15%
or 20% etc., as you see fit

When calculating the cost of debt for the WACC, we must guess 2% to calculate the IRR
(irredeemable debt) but does it mean that irrespective of the % we guess, we'll get the same
cost of debt?? Does the discounted payback forms part of the syllabus? I mean there's a
difference between payback and the discounted payback...
ACCA Tutor: When calculating the cost of REDEEMABLE debt (after TAX), you use IRR to find it
- Your starting point will be fairly close to the nominal interest rate given in the question -
you'll have to use judgment. Discounted payback is an IMPORTANT part of the syllabus and
there is a big difference between it and normal Payback. Think of the difference that exists
between Payback and NPV!

Please explain the effect of working capital on investment appraisal?

ACCA Tutor: Working Capital is simple really once you learn the rules. Normally you will show
the full amount of the W/C as a cash outflow. You MUST remember to add back the full
amount of the W/c as a cash inflow at the end of the projects life - the same time period as the
last day. The only other variation is when you have to deal with INCREMENTAL CHANGES to
the opening w/c balance... but again any investment must be clawed back as a cash INFLOW
on the last day.

When it is asked to calculate the discounted payback, we'll surely use the NCF discounted by
the cost of capital or we'll have to do e.g. if the rate of return = 6% (10000/ 1.06)^1 ,
(15000/1.06)^2 and so on... which one we'll get??
ACCA Tutor: The discounted payback is calculated in EXACTLY the same way as the normal
payback except that your periodic cash flows for each period are the PRESENT VALUES of the
normal periodic cash flows. You just derive the cumulative PV's instead of the cumulative
NCF's for each of the years

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What else should we be aware of like project risks?

ACCA Tutor: I would have a very thorough knowledge of Replacement Policy, Capital
Rationing, Lease or Buy and Risk and Uncertainty for December. There has been much
emphasis on NPV, IRR, Payback ARR in the past, so I would expect more testing questions to
come on for example Sensitivity Analysis

Do sensibility analysis, expected values etc reduce risk or uncertainty?

ACCA Tutor: Expected values, where probabilities are used, are a means of managing RISK
Sensitivity Analysis is NOT a means of managing risk. However, it is a means of Measuring
Uncertainty

What is meant by sensitivity analysis?

ACCA Tutor: Sensitivity analysis is a means of finding out which are the most critical variables
in a project or situation under review. You would then expend a greater effort analysing the
accuracy and sensitivity of these critical factors to possible changes or in their initial
measurement.

What sort of a question can one expect on Business valuations?

ACCA Tutor: Valuation methods are generally grouped under
1. the Balance Sheet Approach,
2. P/E Models
3. Cash Flow Models
4. Dividend valuation Models.
The most important are P/E models and Div val Models. But don't ignore the Balance Sheet
approaches

If we have to calculate an NPV, all the flows will be in the $000... Can u tell us of a general
approach of how to deal with a decimal??
ACCA Tutor: I usually work to 3 decimal places ... but it depends on the nature of the question

How do we then link this business valuation with the theoretical aspects of market being
weak, semi or strong...in other words what could be a theory question in this topic area?
ACCA Tutor: market efficiency is to do with the speed and accuracy with which information
gets absorbed or reflected in the share price. Theoretical valuations are just that ...
theoretical! The actual share price or valuation may, and usually is, quite different to the
valuations derived using any of the valuation models. Think about any type of company
announcement quickly impacting on the share price or say some sudden economic

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If a market is not fully efficient (it should be like that because otherwise it would be a matter
of insider dealing), does it mean using the dividend valuation model will give us an
erroneous view on the market capitalisation of an entity?
ACCA Tutor: A dividend valuation is based solely on the assumptions of the div. val . model
you are using ... so to the extent that the assumptions of your div model are wrong so also will
be your valuation. The div. valuation model is only one method of ESTIMATING the market
capitalisation of the company ...... there many factors to be considered.
Majority versus minority stakeholding,
Earnings, balance sheet considerations,
replacement values,
net realisable values,
political stability,
Market

With capital rationing, one of the factors to consider is whether it is occurring in a single
period and that the capital is freely available at other times. Please explain
ACCA Tutor: For f9 you need only concern yourself with SINGLE period capital rationing - multi
period capital rationing involves Linear Programming and will not be examined. Basically, you
will ignore all other time periods, as far as the actual rationing is concerned, other than TIME
ZERO. Your solution (the approach you adopt in the exam) will depend on YOU first
determining whether the project in question is DIVISIBLE or INDIVISIBLE i.e. whether you can
invest in fractions of projects or just WHOLE projects. Whichever of the two approaches you
use you are still seeking the same thing ... to find the combination of projects to invest in that
leads to the Highest Total NPV for the company as a whole

Please explain the advantages & disadvantages of ARR and payback?

ACCA Tutor:
Advantage of ARR
1. Simple and easy to understand and calculate.
2. Widely used – circa 50% of companies (Pike).
3. Gives a measure of the effect of Decisions on Short Run Reported Profits.
4. Compatibility with Company Accounting system - can be calculated from available
accounting data.
5. It considers the whole of the investment.
6. Rate of Return Measure – greater acceptability to non-accountants.
7. good for those who want a quick return

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Disadvantages of ARR
1. Ignores the time value of money.
2. Based upon (subjective) accounting profit - Profit is an ambiguous concept and is
unlikely to provide a suitable basis for Decision Making (examples; Accounting Policies,
Depreciation, Stocks, Overhead Absorption Rates, Notional Management Charges,
Transfer Pricing, etc., )
3. It is not an absolute measure of return.

Does the fact that the NPV is expressed in terms of $ and not in terms of percentage is a
disadvantage?
ACCA Tutor: The definition of NPV contains its real significance or advantage ... being linked to
the assumed objective of Financial Management ... the Maximization of Shareholder Wealth.
In a nutshell, the DEFINITION of NPV is ... NPV represents the immediate increase in wealth as
a result of acceptance of a project. In other words as soon as you accept a project with a
positive NPV you can expect the Market capitalisation to immediately increase by the same
amount. It is future increase in cashflow expressed in present value. NPV is the theoretically
superior decision making technique.

ARR is a Rate of Return Measure and has therefore greater acceptability to non-accountants.
However, to accountants NPV, as an absolute measure, has great meaning

What are the reasons for capital rationing in general not specifically linked with the types
and what are the benefits of this process and drawbacks from the company's perspective?
ACCA Tutor: The reasons for capital Rationing are twofold, as far as the exam is concerned are
as follows:
1. Hard Capital rationing
o externally imposed capital rationing
o the company is unable to raise any additional finance
o Think of the Liquidity Crisis! This links in to the whole issue of Sources of finance
(Debt and Equity).

2. Soft capital Rationing

o Internally Imposed
o for example, when divisional Managers treat their Budgets as "Binding
Constraints"

In a nutshell, Capital Rationing is a situation in which the company is unable to finance all
apparently acceptable projects (i.e. positive NPVs/projects).

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