A BIG THANKS TO

FOR THIS MOCK

 ACCA MOCK A
ACCA
FINANCIAL MANAGEMENT
Jun 21
Time allowed

3 hours and 15 minutes

This paper is divided into three sections:

Section A ‐ All 15 questions are compulsory

and MUST be attempted Section B ‐ All 15

questions are compulsory and MUST be

attempted Section C ‐ BOTH questions are

compulsory and MUST be attempted

Formulae sheet, present value and annuity

tables are on pages 3, 4 and 5

Section A
1. A
Payable days = (Trade payables / Credit purchases) x 365
Payable days = ($4,932 / $100,000) x 365
Payable days = 18 days
Cash conversion cycle = Receivable days + Inventory days – Payable days
45 = Receivable days + 20 - 18 days
Receivable days = 45 - 20 + 18
Receivable days = 43 days

2. B
The first 4 years will recover $60,000. The remaining amount of $5,000 will be
recovered part-way into the year 5 as follows:
$5000 / $10,000 = 0.5
Therefore, the project will recover it initial investment in a period of 4.5 years.

3. B
The long-term risk of unexpected currency fluctuations is known as economic risk.
The change in currency of Malaysia will indirectly affect the business of Company B
which is based in France. Company B will also lose some competitive advantage
thereby giving rise to business risk.

4. D
Market value of shares before the rights issue = $1.5 x 2,000,000 = $3,000,000
Cash raised from rights issue = ($2,000,000 / 4) x $1.3 = $650,000
No. of shares after rights issue = 2,000,000 + 500,000 = 2,500,000
Theoretical ex-rights price = ($3,000,000 + $650,000) / 2,500,000 = $1.46
5. B
Factoring is a financial arrangement whereby the business sells its trade receivables
to the factor (usually a bank) and receives the cash payment. Forfaiting is a similar
arrangement but is always without recourse.
6. C
The average payout ratio has remained 40%. This means that the average retention
ratio has remained 60%.
We can estimate the growth using Gordon growth model:
g = b x re
g = 60% x 10% g = 6.00%
Dividend per share = 0.80 cents x 40%
Dividend per share = 0.32 cents
Po = Do (1 + g) / (re – g)
Po = 0.32 (1.06) / (0.10 – 0.06)
Po = $8.48

7. D
Both the statements are incorrect. Mudaraba is an agreement in which one party
provides the funds and the other party is responsible for managing the investment.
Conversely, both the parties provide the funds in a Musharaka agreement and
distribute the profits on pre-agreed terms.

8. A
Under the principles of the optimal theory of capital structure, debt is usually
cheaper than the equity as it is tax deductible. This is true until an optimal point.
Once a business starts facing high level of financial risk, the providers of debt
finance become cautious. At this point, further involvement of debt raises the
weighted average cost of capital. Therefore, for Beat Co, an increase in the gearing
will further increase the overall cost of capital.
9. B
Present value of cash inflow = $15,000 x (1 / 0.08) = $187,500
Value of tax in one year’s time = $15,000 x 30% x (1 / 0.08) = $56,250
Present value of tax = $56,250 x 0.926 = $52,088
Present value of annual cash flow = $187,500 - $52,088 = $135,413

10. B
The rate which results in a higher expense or a lower income is always used. In this
case, the forward rate of 1.3500 is used
$4,000,000 / 1.3500 = £2,962,963
11. B
Pecking order theory suggests utilising the retained earnings first as a source of
finance. This is because there are no associated issuance costs with retained
earnings. The first statement is incorrect because equity, and not debt, should be
considered as the last option to raise finance.

12. D
Annuity factor for 5 years = $3,500 x 4.329 = $15,152
Discount factor for year 5 = $1,000 x 0.784 = $784
Net present value = $15,152 + $784 - $8,000 = $7,936

13. A
An equity beta includes both business and financial risk. On the other hand, an asset
beta only reflects the business risk.

14. C
(1 + r) × (1 + h) = (1 + i)
(1 + r) × (1.03) = (1.12)
(1 + r) = 1.12 / 1.03
(1 + r) = 1.0874 r = 1.0874 - 1 r = 8.74%

15. C
ABC Co appears to have a constant pay-out dividend policy. Each year, 25% of the
total earnings is distributed as dividends.
Section B

16. D
The cost of equity (Ke) can be calculated using the Capital Asset Pricing Model:
Ke = Rf + Be (Rm - Rf)
Ke = 4% + 1.3 (6%)
Ke = 11.80%

17. A
g = b x re
Since Gamma Co has a historical payout ratio of 60%, the retention rate must be
40%.
g = 40% x 9.00% g = 3.60%

18. B
Dividend = 0.80 cents x 60%
Dividend = 0.48 cents
Po = Do (1 + g) / (re – g)
Po = 0.48 (1.05) / (0.09 – 0.05)
Po = $12.60
Total value = Price of each share x No. of shares
Total value = $12.60 x 8,000,000
Total value = $100,800,000

19. C
Both the statements are correct. These are actually the limitations of the dividend
growth model. If the business has a retention rate of 100%, it implies that the
business does not pay any dividends. The dividend growth model, however, can
only be used if dividends have been paid or are expected to be paid. Similarly,
dividend growth model assumes that the cost of equity is always higher than the
dividend growth rate.
20. C
Market value = P/E ratio × Earnings per share
EPS = 80 cents
Average sector P/E ratio = 7
Value of shares = 0.80 × 7 = $5.60 per share
No. of shares = 8,000,000
Total value = Price of each share x No. of shares
Total value = $5.60 x 8,000,000
Total value = $44,800,000
21. B
Expected sterling payment = $200,000 / 1.344 = £148,810

22. C
Expected receipt after three months = $400,000
Dollar interest rate in three months = 6.4 / 4 = 1.60% Dollars Royal Co must borrow
now to set-off $400,000 in three months = $400,000 / 1.0160 = $393,701
Convert $ into £ at spot = $393,701 / 1.242 = £316,989
Sterling interest rate in three months = 4.2 / 4 = 1.05%
Value in three months of sterling deposit = £316,989 x 1.0105 = £320,318

23. A
Transaction risk arises whenever a company is expecting a payment or receipt in the
foreign currency. This is because the foreign exchange movements may result in
unexpected losses for the company.

24. D
If the dollar is expected to strengthen, the company is not facing any risk. It will
receive a higher amount than it would expect to receive in the current scenario.
Hedging will only be necessary if the dollar is expected to weaken against the
pound.

25. D
Both the statements are incorrect. Forward contracts are not traded on the
exchange. Similarly, forward contracts are far more flexible than the futures
contracts.
26. C
PI = PV of future cash flows / PV of initial investment
Project A = $232,000 / $200,000 = 1.16
Project B = $152,000 / $150,000 = 1.01
Project C = $190,000 / $100,000 = 1.90
Project D = $150,000 / $120,000 = 1.25
Project C has the highest profitability index.

27. A
The second statement is incorrect. Profitability index (PI) ignores the scale of
investment and the size of actual cash flows.

28. C
Net present value = PV of future cash flows - PV of initial investment
Project A = $232,000 - $200,000 = $32,000
Project B = $152,000 - $150,000 = $2,000
Project C = $190,000 - $100,000 = $90,000
Project D = $150,000 - $120,000 = $30,000
Project C has the net present value.

29. D
An increase in the cost of capital will reduce the net present value of the projects.
IRR will remain unaffected by any change in the cost of capital.

30. B
The first 2 years will recover $15,500 + $32,500 = $48,000
The remaining amount of $2,000 will be recovered in year 3 as follows:
$2000 / $8,000 = 0.25
Product K will, therefore, recover it initial investment in a period of 2.25 years.
This can be converted to months as follows:
2 + (0.25 x 12) = 2 years 3 months
Section C

Part (a)
Year 0 ($’000) 1 ($’000) 2 ($’000) 3 ($’000) 4 ($’000) 5 ($’000)
Sales (W1) 5,925 9,768 6,685 4,169
Variable costs (W2) (3,750) (5,138) (4,088) (3,150)
Fixed costs (W3) (600) (624) (649) (675)
Taxable cash flow 1,575 4,006 1,948 344
Taxation (473) (1,202) (584) (103)
Initial investment (4,500)
Scrap value 500
Tax benefit of dep (W4) 338 253 190 420
Net cash flows (4,500) 1,575 3,872 999 450 317
Discount factor at 10% 1 0.909 0.826 0.751 0.683 0.621

Present value (4,500) 1,432 3,198 750 307

197
NPV = 1,384,000 (rounded)
Working 1 – Sales
Year 1 $395 x 15,000 = $5,925,000
Year 2 $485 x 19,000 x 1.06 = $9,768,000
Year 3 $425 x 14,000 x 1.062 = $6,685,000
Year 4 $350 x 10,000 x 1.063 = $4,169,000

Working 2 – Variable cost

Year 1 $250 x 15,000 = $3,750,000
Year 2 $260 x 19,000 x 1.04 = $5,138,000
Year 3 $270 x 14,000 x 1.042 = $4,088,000
Year 4 $280 x 10,000 x 1.043 = $3,150,000

Working 3 – Fixed cost

Year 1 $800,000 x 75% = $600,000
Year 2 $800,000 x 75% x 1.04 = $624,000
Year 3 $800,000 x 75% x 1.042 = $648,960
Year 4 $800,000 x 75% x 1.043 = $674,918
Working 4 – Tax benefit on WDA
Year 1 $4,500,000 x 25% x 30% = $337,500
Year 2 $3,375,000 x 25% x 30% = $253,125
Year 3 $2,531,250 x 25% x 30% = $189,844
Year 4 $1,898,438 – 500,000 (scrap value) x 30% = $419,531

Since the tax is paid in the following year, the benefit of WDA must also be
recorded in the corresponding year.

Part (b)
The net present value of the project is $1,384,000. This implies that launching the
perfume will create significant value for the shareholders. As far as the deodorant is
concerned, it is estimated to create a net value of $1,300,000. This is lower than that
of the perfume. Given that the initial investment in both the projects is similar, it is
suggested to proceed with the launch of the perfume since it is supposed to create
an additional value of $1,384,000 - $1,300,000 = $84,000.
However, it is important to acknowledge that most of the cash flows associated with
the deodorant project will be recovered after year 5. This may not be appealing if
Aroma Co wishes to improve its liquidity. Overall, in terms of the net present value,
Aroma Co should proceed with the deodorant project, whereas in terms of the
payback period, the perfume should be launched.
Nevertheless, other non-financial indicators must also be considered. The business
may eventually decide to go with the deodorant if it fulfils, say, a pre-defined
strategic target of launching a new product line.
32. Parker Co Part (a)
In order to calculate the weighted average cost of capital, we need to calculate the
cost of equity, the cost of debt, the market value of equity as well as the market
value of debt.
Step 1: The cost of equity (Ke) can be calculated using the Capital Asset Pricing
Model:
Ke = Rf + Be (Rm - Rf)
Ke = 5% + 0.8 (6%)
Ke = 9.8%
Step 2: The market value of equity (Ve) can be calculated by multiplying the
number of shares with the market value of each share
Market value of equity (Ve) = 20m × $12.50 = $250m

Step 3: The cost of debt (Kd) can be calculated by finding the IRR:
Year Cash flow DF @ 4% PV DF @ 5% PV
0 Market value ($105) 1.00 ($105) 1.00 ($105)
1- 7 Interest (8 x 0.7) $5.6 6.002 33.61 5.786 $32.40
7 Redemption $100 0.760 $76 0.711 $71.10
$4.61 $1.50

Cost of debt (Kd) = 4% + {($4.61) / ($4.61 + $1.50)} x (5% - 4%)

Cost of debt (Kd) = 4.5%

Step 4: Market value of debt (Vd) = ($15m / $100) x $105

Market value of debt (Vd) = $15.75m
Step 5: Weighted average cost of capital = Ke x {( Ve ) / ( Ve + Vd )} + Kd x {( Vd ) / (
Ve + Vd )}
Weighted average cost of capital = 9.8% {($250) / ($250 + $15.75)} + 4.5% {($15.75)
/ ($250 + $15.75)} Weighted average cost of capital = 9.49%
Part (b)
The beta equity of Gamma Co reflects the financial risk faced by the business. We
first need to un-gear the beta equity of Gamma Co in order to find the risk neutral
beta asset. The beta asset will then be converted into beta equity based on the
gearing of Parker Co.

Step 1 – Un-gearing of Beta

Ba = Be x {( Ve ) / ( Ve + Vd (1 – t))}
Ba = 1.3 x {($50) / ($50 + $20 (1 – 30%))}
Ba = 1.016
Step 2 – Re-gearing of Beta
Be = Ba x {(Ve + Vd (1 – t) / ( Ve ))}
Be = 1.016 x {($250 + $15.75 (1 – 0.3)) / ($250)}
Be = 1.06
Step 3 – Calculation of the cost of equity (Ke)
Ke = Rf + Be (Rm - Rf)
Ke = 5% + 1.06 (6%)
Ke = 11.36%

Part (c)
The market value weighted average cost of capital uses the market value of the
equity and the debt, whereas the book value weighted average cost of capital
relies on the book value of the equity and the debt. The book values of the equity
and the debt are easily available from the statement of financial position. On the
other hand, market values are more difficult to calculate. This is true especially
when the entity is not listed and the instruments are not traded. However,
market value weighted average cost of capital is considered more useful and
more reliable in the investment decisions.
Market values are preferred because they reflect the current and up to date value
of the firm. Consider, for example, the equity. Shares are only recorded in the
financial statements at their nominal value. The market value of shares is typically
higher than the book value. Using the book value of equity will significantly
understate its relative proportion in the calculation of weighted average cost of
capital. Since the cost of equity is usually higher than the cost of debt, the overall
result will be a reduction in the weighted average cost of capital. Therefore,
market value based weighted average cost of capital is preferred in the
investment decisions because it reflects the true value of the sources of finance
used by a firm.