ACCA

Paper P4
Advanced Financial
Management

On-line Final Mock Examination

Question Paper

Time allowed 3 hours

This paper is divided into two sections

Section A Two compulsory questions and MUST be attempted

Section B TWO questions ONLY to be attempted

Instructions:
Please attempt this exam under test conditions and attach the frontsheet complete with your name and address
to your script. The completed package should be sent to BPP Marking Department.
Take a few moments to review the notes on the inside of this page titled, ‘Get into good exam habits now!’ before
attempting this exam.

DO NOT OPEN THIS PAPER UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS

ACP4FM10(D)
Annuity Table
1 − (1 + r)−n
Present value of an annuity of 1 ie
r
where r = discount rate
n = number of periods
Interest rates (r)
Periods Discount rates (r)
(n) 1% 2% 3% 4% 5% 6% 7% 8% 9% 10%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.935 0.926 0.917 0.909
2 1.970 1.942 1.913 1.886 1.859 1.833 1.808 1.783 1.759 1.736
3 2.941 2.884 2.829 2.775 2.723 2.673 2.624 2.577 2.531 2.487
4 3.902 3.808 3.717 3.630 3.546 3.465 3.387 3.312 3.240 3.170
5 4.853 4.713 4.580 4.452 4.329 4.212 4.100 3.993 3.890 3.791
6 5.795 5.601 5.417 5.242 5.076 4.917 4.767 4.623 4.486 4.355
7 6.728 6.472 6.230 6.002 5.786 5.582 5.389 5.206 5.033 4.868
8 7.652 7.325 7.020 6.733 6.463 6.210 5.971 5.747 5.535 5.335
9 8.566 8.162 7.786 7.435 7.108 6.802 6.515 6.247 5.995 5.759
10 9.471 8.983 8.530 8.111 7.722 7.360 7.024 6.710 6.418 6.145
11 10.37 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.26 10.58 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.13 11.35 10.63 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.00 12.11 11.30 10.56 9.899 9.295 8.745 8.244 7.786 7.367
15 13.87 12.85 11.94 11.12 10.38 9.712 9.108 8.559 8.061 7.606

11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
1 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 1.713 1.690 1.668 1.647 1.626 1.605 1.585 1.566 1.547 1.528
3 2.444 2.402 2.361 2.322 2.283 2.246 2.210 2.174 2.140 2.106
4 3.102 3.037 2.974 2.914 2.855 2.798 2.743 2.690 2.639 2.589
5 3.696 3.605 3.517 3.433 3.352 3.274 3.199 3.127 3.058 2.991
6 4.231 4.111 3.998 3.889 3.784 3.685 3.589 3.498 3.410 3.326
7 4.712 4.564 4.423 4.288 4.160 4.039 3.922 3.812 3.706 3.605
8 5.146 4.968 4.799 4.639 4.487 4.344 4.207 4.078 3.954 3.837
9 5.537 5.328 5.132 4.946 4.772 4.607 4.451 4.303 4.163 4.031
10 5.889 5.650 5.426 5.216 5.019 4.833 4.659 4.494 4.339 4.192
11 6.207 5.938 5.687 5.453 5.234 5.029 4.836 4.656 4.486 4.327
12 6.492 6.194 5.918 5.660 5.421 5.197 4.988 4.793 4.611 4.439
13 6.750 6.424 6.122 5.842 5.583 5.342 5.118 4.910 4.715 4.533
14 6.982 6.628 6.302 6.002 5.724 5.468 5.229 5.008 4.802 4.611
15 7.191 6.811 6.462 6.142 5.847 5.575 5.324 5.092 4.876 4.675

4
Standard normal distribution table

(x − μ) 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
Z=
σ
0.0 .0000 .0040 .0080 .0120 .0160 .0199 .0239 .0279 .0319 .0359
0.1 .0398 .0438 .0478 .0517 .0557 .0596 .0636 .0675 .0714 .0753
0.2 .0793 .0832 .0871 .0910 .0948 .0987 .1026 .1064 .1103 .1141
0.3 .1179 .1217 .1255 .1293 .1331 .1368 .1406 .1443 .1480 .1517
0.4 .1554 .1591 .1628 .1664 .1700 .1736 .1772 .1808 .1844 .1879
0.5 .1915 .1950 .1985 .2019 .2054 .2088 .2123 .2157 .2190 .2224
0.6 .2257 .2291 .2324 .2357 .2389 .2422 .2454 .2486 .2517 .2549
0.7 .2580 .2611 .2642 .2673 .2704 .2734 .2764 .2794 .2823 .2852
0.8 .2881 .2910 .2939 .2967 .2995 .3023 .3051 .3078 .3106 .3133
0.9 .3159 .3186 .3212 .3238 .3264 .3289 .3315 .3340 .3365 .3389
1.0 .3413 .3438 .3461 .3485 .3508 .3531 .3554 .3577 .3599 .3621
1.1 .3643 .3665 .3686 .3708 .3729 .3749 .3770 .3790 .3810 .3830
1.2 .3849 .3869 .3888 .3907 .3925 .3944 .3962 .3980 .3997 .4015
1.3 .4032 .4049 .4066 .4082 .4099 .4115 .4131 .4147 .4162 .4177
1.4 .4192 .4207 .4222 .4236 .4251 .4265 .4279 .4292 .4306 .4319
1.5 .4332 .4345 .4357 .4370 .4382 .4394 .4406 .4418 .4429 .4441
1.6 .4452 .4463 .4474 .4484 .4495 .4505 .4515 .4525 .4535 .4545
1.7 .4554 .4564 .4573 .4582 .4591 .4599 .4608 .4616 .4625 .4633
1.8 .4641 .4649 .4656 .4664 .4671 .4678 .4686 .4693 .4699 .4706
1.9 .4713 .4719 .4726 .4732 .4738 .4744 .4750 .4756 .4761 .4767
2.0 .4772 .4778 .4783 .4788 .4793 .4798 .4803 .4808 .4812 .4817
2.1 .4821 .4826 .4830 .4834 .4838 .4842 .4846 .4850 .4854 .4857
2.2 .4861 .4864 .4868 .4871 .4875 .4878 .4881 .4884 .4887 .4890
2.3 .4893 .4896 .4898 .4901 .4904 .4906 .4909 .4911 .4913 .4916
2.4 .4918 .4920 .4922 .4925 .4927 .4929 .4931 .4932 .4934 .4936
2.5 .4938 .4940 .4941 .4943 .4945 .4946 .4948 .4949 .4951 .4952
2.6 .4953 .4955 .4956 .4957 .4959 .4960 .4961 .4962 .4963 .4964
2.7 .4965 .4966 .4967 .4968 .4969 .4970 .4971 .4972 .4973 .4974
2.8 .4974 .4975 .4976 .4977 .4977 .4978 .4979 .4979 .4980 .4981
2.9 .4981 .4982 .4982 .4983 .4984 .4984 .4985 .4985 .4986 .4986
3.0 .4987 .4987 .4987 .4988 .4988 .4989 .4989 .4989 .4990 .4990
This table can be used to calculate N(d1), the cumulative normal distribution functions needed for the Black-
Scholes model of option pricing. If d1>0, add 0.5 to the relevant number above. If d1<0, subtract the relevant
number above from 0.5.

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Formulae provided to P4 candidates

6
7
8
SECTION A

BOTH questions are compulsory and MUST be attempted

1 Reacher Trading
Reacher Trading is an unlisted company with two divisions. Its oldest division provides electronic
equipment to the defence industry and accounts for three quarters of its annual revenue of $40 million.
However the latest division to be opened has seen a move into satellite communications and accounts for
the remainder of its revenue.
Reacher Trading has 20 million $1 shares in issue and at the end of its last financial year it had net
assets at book value of $80 million, earnings per share of 90c and dividend per share of 30c. The
company has seen good earnings growth for the past few years and the 5 year historic figures show that
this has averaged 15% per annum over that period. The ratio of debt to total market capitalisation
(defined as value of debt plus value of equity) is estimated at 25%. The future growth rate for earnings in
the electronic equipment sector is estimated to be 5% per annum.
Neagly Co is a small company listed on a small company investment market which is also involved in the
provision of electronic equipment to the defence industry. Neagly Co has net assets at a book value of
$38 million, earnings per share of 40c and dividend per share of 20c. It has an estimated ratio of debt to
total market capitalisation (value of debt plus equity) of 10% and its 40 million shares are currently
trading at 420c per share. The estimated beta factor for Neagly Co is 1.2 and its five year historic
earnings growth is 6% per annum.
In the satellite communications sector the average beta factor is 1.5 with an average ratio of debt to total
market capitalisation (value of debt plus equity) of 30%. The future growth rate for revenue in the
satellite communications sector is estimated to be 6% per annum.
The rate of return on short-dated government stocks is 5.5% and the equity risk premium is 4.5%. Both
Reacher Trading and Neagly Co can raise debt finance at 3% above the risk free rate. Tax on corporate
profits is 30%.
Reacher Trading is considering either an imminent flotation of the company or an outright sale of the
company.
Assume that the beta of debt is zero.
Required:
Write a report to the Board of Directors of Reacher Trading which includes the following:
(a) An estimate of both the cost of equity capital and the weighted average cost of capital for Reacher
Trading including an explanation of the circumstances where each of the two rates would be used.
(12 marks)
(b) A range of the likely issue or sale prices for the company. (9 marks)
(c) Discussion of the advantages and disadvantages of a public listing versus a sale to another
company in order to dispose of the business. (7 marks)
Report format (2 marks)
(Total: 30 marks)

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2 Hopkins Constructors
Hopkins Constructors is a business that has been in the building construction industry for many years. In
recent years there has been a significant downturn in the market for building houses and a subsequent
reduction in profitability for the company. In response to this situation the company has been attempting
to boost its building work for low cost foreign supermarket chains which are taking advantage of the
consumer requirements for lower cost groceries and other goods.
This reduction in profitability together with the long term nature of building new supermarkets has led to a
decline in Hopkins’ share price over the last three years. However it is generally felt in the market that this
move towards development of in-town and out-of town low cost supermarkets has an assured future.
Hopkins have taken the decision to rationalise its operations although keeping most of its workforce in
place. In 2007 it sold many of its smaller construction operation sites in order to concentrate on only a few
strategically placed sites from which the larger supermarket work can be sourced.
The summary financial statements for Hopkins for the last three years are as follows:
Income statements for years ended 31 December:
2008 2007 2006
$m $m $m
Revenue 43.6 52.9 54.1
Cost of sales 26.4 30.3 34.8
Gross profit 17.2 22.6 19.3
Operating costs 15.7 15.1 14.4
Operating profit 1.5 7.5 4.9
Finance costs 0.9 0.8 1.5
Profit before tax 0.6 6.7 3.4
Income tax expense at 25% 0.2 1.7 0.8
Profit for the period 0.4 5.0 2.6

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Statements of financial position as at 31 December:
2008 2007 2006
$m $m $m
Non-current assets
Property, plant and equipment 10.2 26.2 48.4

Current assets
Inventory 7.1 4.0 4.9
Receivables 21.8 13.3 10.5
Cash 33.7 32.9 16.0
Total current assets 62.6 50.2 31.4
Total assets 72.8 76.4 79.8

Equity and liabilities

Paid up share capital
Ordinary shares (50c) 15.0 15.0 12.0
Other reserves 7.2 7.2 6.0
Retained earnings 24.5 24.1 19.1
Total equity 46.7 46.3 37.1

Non-current liabilities
Loans 15.0 15.0 25.0
Provision for deferred tax 4.7 6.5 2.7
Total non-current liabilities 19.7 21.5 27.7

Current liabilities
Trade payables 3.7 4.4 4.7
Accrued expenses 1.6 1.7 2.1
Tax payable 0.2 1.7 3.7
Dividend payable 0.0 0.0 3.0
Interest payable 0.9 0.8 1.5
Total current liabilities 6.4 8.6 15.0
Total equity and liabilities 72.8 76.4 79.8
Summary cash flow statements year ending 31 December:
2008 2007 2006
$m $m $m
Operating cash flow -2.4 15.3 21.0
Less: interest -0.8 -1.5 -1.5
Less: income tax -1.9 -1.1 -3.9
Free cash flow before reinvestment -5.1 12.7 15.6

Dividend paid 0.0 -3.0 - 8.6

Capital expenditure 6.1 15.6 18.0
Financing 0.0 -5.8 0.0
Net cash flow 1.0 19.5 25.0

Market value of equity ($ million) 20.0 41.5 50.4

Despite the recent decline in profitability the board feels that this new direction could turnaround the
company’s profitability situation and have the following strategy for this turnaround:
It is felt that the company can be returned to its 2007 levels of profitability by a mixture of cost savings
and other measures.
Although revenue has been falling in recent years the directors believe that 2009 revenue will be 8%
higher than that in 2008.

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As the company is fairly cash rich it is suggested that 15% of the share capital is repurchased at the
current share price plus a premium of 50%.
In order to concentrate production an investment of $21 million is required in non-current assets and it is
felt that this will increase the value of the company by $12.1 million.
Working capital management is to be improved. By improvements in credit control it is felt that the
receivables balances can be returned to their 2007 levels and that strict inventory controls can reduce the
amount of inventory held by 12 days less than the current inventory holding period.
Average depreciation rates are 10% per annum.
The average rate of inflation over the past three years has been 3% per annum.
In order to fund this strategy Hopkins may need a further loan from its bank. The bank have been
approached regarding this and as a consultant working for the bank you have been asked to assess the
viability of the company and of its new strategy. The bank has asked you to provide a report evaluating
the position of the company and the bank is particularly concerned about the continuing viability of the
company and the prospect of survival over the short to medium term. As part of the review of the risk of
failure you believe that it will be necessary to calculate a Z-score for the company at the end of 2008 and
compare this to the anticipated Z-score if the strategy for improvement is implemented.
In the calculation of ratios using figures in the statement of financial position you may use year-end
figures throughout.
Note:
The Altman Z-score is calculated as follows:
Z= 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5
Where:
X1 = working capital/total assets
X2 = retained earnings/total assets
X3 = earnings before interest and tax/total assets
X4 = market value of equity/book value of debt
X5 = sales/total assets
In Altman’s model, a Z-score of 3 or more indicates a high likelihood of non-failure, 1.8 or less indicates a
high likelihood of failure.
Required:
Prepare a report for the bank containing an analysis of the company’s position. Your report should
include:
(a) An introduction outlining the principal causes of financial distress in a business. (5 marks)
(b) An appraisal of the company at the end of 2008 and the previous year and the impact of the
proposed strategy on the company’s performance, efficiency, risk and liquidity. Your appraisal of
the company’s exposure to risk should include an assessment of the risk of failure using Altman’s
Z-score at the end of each of the last three years and after the strategy has been implemented.
(22 marks)
Appropriateness of the format and presentation of the report and the effectiveness with which its advice is
communicated. (3 marks)
(Total: 30 marks)

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SECTION B

TWO questions only to be attempted

3 Ugrowth
It is now 1 July and Ugrowth, a UK company, has tendered for an export order from a US company to a
value of $12,000,000, which if the tender is won will be received at the end of October. The treasurer of
Ugrowth is to hedge this receipt using either currency options or currency futures.
Spot 1.9804 - 1.9839 $/£
3 month forward 1.9691 – 1.9727 $/£
Philadelphia SE $/£ options £31,250 (cents per pound)
CALLS PUTS
Sept Dec March Sept Dec March
1.9550 4.55 4.95 5.25 4.15 4.85 5.60
1.9800 2.25 2.75 3.85 4.80 5.35 6.10
2.0050 0.95 1.20 1.45 5.15 5.65 6.25
$/£ Currency futures (CME, £62,500)
September 1.9600
December 1.9575
Assume that in four months time the spot rate is 1.9866 – 1.9901 $/£.
Required:
(a) Determine the outcome of the hedge using both currency options and currency futures and
conclude as to which would be the most appropriate in these circumstances (14 marks)
(b) Discuss options strategies that could be considered by the treasurer of Ugrowth in these
circumstances. (6 marks)
(Total: 20 marks)

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4 Silver Sales
Silver Sales is a property company with a well-developed portfolio of properties which specialises in
renting retail space. The directors of Silver Sales have become aware that a much larger quoted
company, BCG, has been purchasing shares in Silver Sales and now owns a 25% stake in the company.
Other than BCG’s stake Sliver Sales has a wide variety of both private and institutional investors.
The five executive and two non-executive directors of Silver Sales have called a meeting to discuss the
situation with BCG. The general consensus of the directors is that they personally would not be happy
with any takeover attempt made by BCG. However not having been in this situation before they are
unsure as to what is likely to happen and what options are available to them.
You are the Chief Financial Officer of Silver Sales and the directors have requested briefing notes from
you regarding this situation.
Required:
(a) Prepare a set of briefing notes which describes the regulatory and ethical issues in this situation.
(10 marks)
(b) Explain any defensive measures (both pre-bid and post-bid) that the directors of Silver Sales
could take if a take-over bid which is perceived to be hostile is made by BCG. (10 marks)
(Total: 20 marks)

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5 Rathran
Rathran is a listed company in the engineering business. The company is considering a major new capital
development project which will require immediate capital expenditure at 1 July 2009 totalling $600 million.
The project will have a five year life and its estimated annual revenues will be:
Year to: $million
30 June 2010 500.0
30 June 2011 670.0
30 June 2012 700.0
30 June 2013 560.0
30 June 2014 240.0
The costs of the project are as follows:
Direct costs will be 50% of revenues each year.
Indirect costs will be $60 million in the first year of operations but increasing by 4% per annum.
The design and construction of the project has already taken place at a cost of $40 million which is to be
charged to the project in the first year of operations.
The introduction of this project will mean that other work in the first year of operations must be cancelled.
This work would have made a contribution before indirect costs of $180 million.
The capital expenditure is to be depreciated on a straight line basis over the five year period after taking
into account an estimated residual value at the end of the period of $120 million.
The company pays tax at the rate of 28% on its taxable profits and can claim 20% writing down
allowances on its capital expenditure on a reducing balance basis each year. Any tax payments or credits
are paid or received one full year after they arise. Any capital allowances from this project can be
absorbed by other profits of the company as well as any profits from this project.
Rathran has a beta factor of 1.2 and currently has $6,000 million of equity and $2,000 million of debt
capital at current market values. The company’s current cost of debt is 6.2% and it wishes to raise further
debt finance at this rate in order to finance this project. The issue of this additional debt finance will incur
issue costs of 2% of the amount raised. The risk free rate of interest is currently 5.0% and the equity risk
premium is 4%.
Required:
(a) Estimate and discuss the adjusted present value of the project resulting from the new investment
and the proposed financing method (assume a debt beta of zero in any beta formulae used).
(15 marks)
(b) Estimate and discuss the modified internal rate of return generated by the project cash flows,
excluding the effects of the proposed financing method. (5 marks)
(Total 20 marks)

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