Accounts & Finance Exam revision

EXAM A

2 – Dart Group PLC is listed on the London Stock Exchange.  The London Stock Exchange is believed to be efficient at the ‘semi-strong form’ level. Examining the share price data for Dart Group PLC from January 2007 to December 2009, it can be seen that share prices peaked at 158.75p in January 2007, and recorded a low at 11.25p in June 2008.

a) Explain what is meant by ‘efficiency’ and ‘semi-strong form’ in this context and discuss whether such wide price fluctuations can be regarded as supporting evidence against the efficient markets hypothesis.[14 marks]

b) What would be the implications for Dart Group PLC if the London Stock Exchange was not efficient at the semi-strong level?

3. Wood Plc needs to replace its machinery, which has come to the end of its useful economic life.  Two new machines are available, the associated costs and capacity levels are as follows:

£ millions Machine 1 Machine 2
Purchase price of machine £20 million £30 million
Processing capacity (number of products per annum) 1 million  1.5 million
Contribution per unit £10 £10
Working capital requirement £5 million £9 million
Resale value after 3 years £6 million £6 million

The company’s Return on Capital Employed is 26% and its cost of capital is 7%.

Required:

a) For each machine calculate the Payback Period, Accounting Rate of Return, Net Present Value and Internal Rate of Return. [12 marks]

b) Advise the company which machine should be purchased and why. [3 marks]

c) Discuss why a company might use a range of capital investment appraisal techniques to assess a project.

4.a) Participative budgets are budgets in which all budget holders are given the opportunity to participate in setting their own budgets.  Critically assess the advantages and disadvantages of participative budgets. [12 marks]

4b.) participative budgets can be linked to budget slack.  Explain what this is, why managers may do this, and provide advice on how this can be overcome within a participative budget system.

Exam B

1. What is behavioural finance and to what extent does this theory explain the anomalies of the efficient market hypothesis? [10 marks]

2. Shingles Ltd is considering the launch of a new product, which has an outlay of £400,000.  The product is expected to generate cash flows over two years.  Due to uncertain economic outlook there are a number of possible outcomes for which Shingles Ltd has assigned probabilities on the basis of likely expectation.

Optimistic outlook

If the product is well received by the market it will generate a contribution of £360,000 in year 1.  There is a 75% chance that this will happen.  If competitors release a similar product in year 2, which has a likelihood of 60%, contribution will fall to £200,000.  If no competing product is launched, contribution will remain unchanged.

Pessimistic outlook

There is a 25% chance that the product take-up by the market will be slow, resulting in an expected contribution of only £200,000 in year 1.  In the second year there is a 70% chance that the market will continue to grow, resulting in a contribution of £250,000.   If this does not happen, there will be a loss of £60,000 in year 2.

The company’s Return on Capital Employed is 23% and its cost of capital is 7%.

Required:

a)    Calculate the Expected Net Present Value (ENPV) for the product launch, and advise the company whether to invest or not. [14 marks]

b)    The standard deviation for the product launch is 135,777.  Explain what this means and how this information can assist in the decision whether to launch the product or not. [6 marks]  [TOTAL 20 marks]

4.a)    What are the main arguments put forward by the Beyond Budgeting debate against traditional budgeting?  To what extent are these criticisms justified? [8 marks]

4.b)  A major criticism of traditional budgeting is that it only focuses on a financial approach to managing the activities of an organisation.  The balanced scorecard developed by Kaplan and Norton focuses on four different perspectives: financial, customer, learning and growth, internal business processes.  Briefly explain what a balanced score card is and then using Dart Group PLC as an example illustrate how a balanced scorecard can be applied in practice.[12 marks] [TOTAL 20 marks]

Exam C

1. a)    The following are all entries in the accounts of Imperial Tobacco Group PLC.  Explain how the recognition of each items impacts the accounting equation:

Assets = Liabilities + Capital

  • Depreciation;
  • Trade accounts payables;
  • Impairment of property plant and equipment.

 

2. a)    Empirical evidence suggests that the London Stock Exchange is efficient in the ‘semi-strong’ form.  Explain what this means and discuss how this can be so when recent trends in the FTSE 100 index shows both erratic movements in prices and a downward adjustment from a peak of 6252 on May 19th 2008 to a low point of 3781 on November 21st 2008, as indicated in the graph below:  [10 marks]

  

3. Arnold Plc are interested in expanding operations and have consequently undertaken some market research, the results of which suggest that the outcome is highly dependent upon the extent to which the current economic downturn will effect business in the next few years.    In order to assess the risk of the various outcomes the projected results have been classified as scenarios 1-3 and are as follows:

£ millions Scenario 1 Scenario 2 Scenario 3
Sales per annum 2.5 3.1 4.1
Variable costs per annum 1 1.24 1.64
Fixed overheads per annum excluding depreciation 1.1 1.1 1.0
Deprecation per annum 0.4 0.4 0.4
Working capital requirement 0.25 0.31 0.41
Immediate one-off recruitment and training costs 0.125 0.155 0.205

 The project will involve an initial investment of £1.2 million to purchase plant and machinery.  The machinery is highly specialized and Arnold Plc will have to pay £15,000 to have it dismantled and disposed of at the end of the project.  The project will last for 3 years.  The company’s cost of capital is 6%.

Required:

a)    Calculate the net present value for scenarios 1, 2 and 3. [8 marks]

b)    Calculate the expected net present value for the project on the assumption that the probabilities of each scenario occurring are 20%, 45% and 35% respectively. [3 marks]

c)    Advise the company on whether to go ahead with the project or not, and suggest other factors that should be considered before a decision is made.  You should justify your answer. [4 marks]

d)    Explain the extent to which the ENPV is an effective measure of risk and how an assessment of standard deviation can help assess investment projects. [5 marks][TOTAL 20 marks]

4.a)    Budgets are only as effective as their implementation.  Critically discuss. [TOTAL 20 marks]

EXAM D

1.  a) Explain what is meant by the following entries taken from the accounts of Imperial Tobacco Group PLC: 

  • Rights issue;
  • Goodwill;
  • Impairment of property plant and equipment.

2.a)    What is meant by efficiency in the context of an efficient stock market? [3 marks]

2.b)    Describe the three forms of the efficient market hypothesis (EMH). [9 marks]

2.c)    Given the following situations, determine in each case which level of EMH is violated.  You should fully justify your answer:

  1. ABC Plc announced a profit warning on 1st April that profits are expected to be down 20% for the year.  The share price for ABC Plc closed at 3% up from 31st March;
  2. Investors in the stock market this year are expected to receive, on average, a negative return;
  3. A friend has designed a forecasting model based on share price, earnings and date variables.  He has achieved a 75% success rate with his predictions and as a consequence doubled his investment;
  4. There are strict laws forbidding insider trading and many individuals have been prosecuted for insider trading over the years. [8 marks]

 

3. Davide has recently inherited £600,000 and has asked you for some investment advice.  He is the managing director of a small firm that designs and manufactures bespoke fire alarm systems.  The company has been trading for 40 years and has reached the ‘mature’ stage of its life cycle.  Davide would like to know how an investment in some new machinery would compare to an investment on the stock market, or in the housing market. He is planning on taking early retirement in 2013, and so is looking for a three year investment. Preliminary estimates of costs and revenues for the three options are detailed overleaf:

Option 1: Expansion at Bespoke Fire Alarm Systems (BFAS) £
Purchase of two new machines 550,000
Additional immediate investment in working capital 100,000
Annual running costs 60,000
Additional annual cash income from new orders 300,000
Resale value of the two machines after three years 200,000
Payback period  
Option 2: Investment on the stock market £
Initial investment in a mixed FTSE-100 portfolio of shares 588,000
Broker’s fees on purchase of shares 5,880
Annual dividends 45,000
Resale value, assuming constant growth in line with historic growth rate of 5% per annum 680,683
Broker’s fees on sale of shares 6,807
   
Option 3: investment in UK house market £
Purchase price of property 550,000
Taxes and legal fees payable on purchase 17,000
Annual maintenance 2,000
Annual rental income 25,000
Resale value, assuming constant growth in line with historic growth rate 723,000
Estate agent’s fees and solicitor’s fee on resale 11,500

 

a)    Assess each option using the payback period, accountant’s rate of return and net present value. [14 marks]

b)    Write a report to Davide that:

  • clearly states the investment advice that you would give, on the basis of your calculations in a);
  • explains the three capital appraisal methods that you have used;
  • highlights a range of additional factors Davide should consider prior to investment;
  • highlights any concerns that you have in relation to the calculations undertaken.  [6 marks] [TOTAL 20 marks]

 

4.a)    Budgets have been severely criticized over the years.  Outline such criticisms and form an opinion in terms of how valid the arguments put forward are.[10 marks]

b)    A number of alternatives to budgeting have been suggested.  Clearly outline two such alternatives and explain the extent to which they overcome the problems highlighted in part a) above.[10 marks]

EXAM E

1. a)    Explain what is meant by the following terms contained within the 2009 Annual report for Vodafone:

                                                  i.    Free cash flow;

                                                ii.    EBITDA;

                                               iii.    Share premium account. [6 marks]

1.b)    Assess the profitability and efficiency of Vodafone for the year ended 31 March 2009.  Your answer should refer to relevant ratios, segment analysis and trend analysis where appropriate.   [22 marks]

1.c)    Explain, with reference to the cash flow statement and income statement of Vodafone, why profit does not equal cash. [12 marks] [TOTAL 40 marks]

2.a)    The London Stock Exchange (LSE) is said to be efficient in the ‘semi-strong’ form.  Explain what this means and outline the implications this has for companies and investors. [10 marks]

2.b)    Using the data provided for the Vodafone case, calculate the Market to Book Ratio as at 31st March 2008 and 2009 and the total shareholder return (TSR) for the years ended 31st March 2008 and 2009. Comment on your results and explain why the value of the firm as determined by the stock market differs from the balance sheet value. [10 marks][TOTAL 20 marks]

3. Clarkson plc is considering a two-year project that has the following probability distribution of returns:

Year one
Return Probability
£14,000 0.1
£23,000 0.6
£28,000 0.3
 Year Two
Return Probability
£10,000 0.3
£16,000 0.7

The events in each year are independent of other years (that is, there are no conditional probabilities).

An outlay of £30,000 is payable immediately, and other cash flows are receivable at the year ends.

The discount rate is 10%.

 Required:

a)    Explain what is meant by the expected net present value (ENPV) and discuss the strengths and weaknesses of this capital investment appraisal method. [5 marks]

b)    Calculate the expected ENPV.  You may find it useful to construct an event tree, clearly showing the expected cash flow, probability and applicable discount factors.  Comment on your results. [10 marks]

c)    The standard deviation of this project is 4214.1.  Explain what this means and how this information can help in decision making. [5 marks]

[TOTAL 20 marks]

4. Critically examine the extent that the balanced scorecard overcomes the problems associated with budgeting.

a)    Explain what is meant by the following terms contained within the 2009 Annual report for Vodafone:

                                                  i.    Goodwill;

                                                ii.    Investments in associate undertakings;

                                               iii.    Diluted earnings per share (EPS).

5. Clarkson plc is considering a two-year project that has the following probability distribution of returns:

 

 

Year one

Return

Probability

£14,000

0.1

£23,000

0.6

£28,000

0.3

 

Year Two

Return

Probability

£10,000

0.3

£16,000

0.7

 

 

The events in each year are independent of other years (that is, there are no conditional probabilities).

An outlay of £30,000 is payable immediately, and other cash flows are receivable at the year ends.

The discount rate is 10%.

 

Required:

a)    Explain what is meant by the expected net present value (ENPV) and discuss the strengths and weaknesses of this capital investment appraisal method.

[5 marks]

b)    Calculate the expected ENPV.  You may find it useful to construct an event tree, clearly showing the expected cash flow, probability and applicable discount factors.  Comment on your results.

[10 marks]

c)    The standard deviation of this project is 4214.1.  Explain what this means and how this information can help in decision making.

[5 marks]

[TOTAL 20 marks]

 

 

 

6. Critically examine the extent that the balanced scorecard overcomes the problems associated with budgeting.

 

 

EXAM F

 

2.a)    There are two opposing theories which explore the concept of stock market efficiency: behavioural finance and the efficient markets hypothesis (EMH).  Describe each theory and assess the extent to which there is evidence to support each in practice. [12 marks]

2.b)    Given the following situations, determine in each case which level of EMH is violated.  You should fully justify your answer:

  1. A firm of investment brokers has discovered that the following formula will provide an indication of the direction in price movement of a particular stock with a probability of 81%:[(current share price)2 x (Earnings Per Share ÷ market to book ratio)]/100
  2. The human resources manager at Miles Plc purchased 15,000 shares in Miles Plc on 8th May for £12.09 each, following a request from the finance director to establish the number and range of redundancies if a potential take over bid was successful.  He sold the shares on 11th May for £14.56 each.  The take over was announced to the financial press on 10th May.
  3. A colleague on the MBA programme has designed a forecasting model based on the analysis of historic share price movements and is able to predict share price movements accurately enough to earn a 2%, risk adjusted, return in excess of the return on the market, before transaction costs;
  4. Miles Plc made a profit announcement on 1st February that profits are expected to be up 20% for the year.  The share price for Miles Plc closed at 6% down from 31st January. [8 marks] [TOTAL 20 marks]
  1. Geraldine has £250,000 that she wishes to invest and has asked you for some investment advice.  She currently runs a boutique, but is not sure that investing the money in the company would be the most lucrative, but there is an opportunity to become the sole county distributor for 3 major high-end fashion labels (West, Lanza, and Spice).  She also believes that it may be a good time to invest in either stocks and shares or the housing market, due to the current economic recession.  Geraldine is planning on taking a 2 year around the world trip in 2013, and is consequently looking for a three year investment. Preliminary estimates of costs and revenues for the three options are detailed below:

 

Option 1: Securing Franchises for Geraldine’s Boutique £
Purchase of sole regional rights to distribute fashion ranges for West, Lanza and Spice for a 3 year period 90,000
Replacement of shop fixtures and fittings as required under rights agreements 90,000
Additional annual cash income from new orders 110,000
Additional immediate investment in inventories 60,000
Additional annual running costs, including marketing and management fees payable under rights agreement 30,000
Fixtures and fittings and regional rights should be depreciated over 3 years on a straight line basis  
   
Option 2: Investment on the London Stock Exchange £
Initial investment in a mixed FTSE-100 portfolio of shares 245,000
Broker’s fees on purchase of shares 5,000
Annual dividends 18,000
Resale value, assuming constant growth in line with historic growth rate of 4.7% 281,194
Broker’s fees on sale of shares 5,000
   
Option 3: Investment in UK Housing Market £
Purchase price of property 240,000
Legal costs and taxes payable on completion of property purchase 7,000
Annual maintenance 1,500
Annual rental income 22,000
Resale value, assuming constant growth in line with historic growth rate of 4% per annum 270,000
Legal and selling costs on resale 4,500

 

a)    Complete the following table, making sure that all workings are clearly shown.  Geraldine’s cost of capital is 8%:   

  Option 1 Option 2 Option 3
Payback 3 years 3 years 3 years
Accounting rate of return ? 6.8% 8.0%
Net present value 13798 ? 16592
Internal rate of return 10.9 10.4 ?

[10 marks]

b)    Write a report to Geraldine that:

  • clearly states the investment advice that you would give, on the basis of the results from the table in a);
  • explains the capital appraisal methods that you have used;
  • highlights a range of additional factors Geraldine should consider prior to investment. [10 marks][TOTAL 20 mark

4.a)    Explain what is meant by the following terms associated with budgeting:

                      i.    Flexed budget (1 marks);

                    ii.    Budgetary control (2 marks);

                   iii.    Budget slack (2 marks);

                   iv.    Beyond budgeting (5 marks).  [10 marks]

4.b)    Critically assess the problems that a company may experience when implementing a new budget. [10 marks][TOTAL 20 marks] 

3.    Geraldine has £250,000 that she wishes to invest and has asked you for some investment advice.  She currently runs a boutique, but is not sure that investing the money in the company would be the most lucrative, but there is an opportunity to become the sole county distributor for 3 major high-end fashion labels (West, Lanza, and Spice).  She also believes that it may be a good time to invest in either stocks and shares or the housing market, due to the current economic recession.  Geraldine is planning on taking a 2 year around the world trip in 2013, and is consequently looking for a three year investment. Preliminary estimates of costs and revenues for the three options are detailed below:

 

Option 1: Securing Franchises for Geraldine’s Boutique

£

Purchase of sole regional rights to distribute fashion ranges for West, Lanza and Spice for a 3 year period

90,000

Replacement of shop fixtures and fittings as required under rights agreements

90,000

Additional annual cash income from new orders

110,000

Additional immediate investment in inventories

60,000

Additional annual running costs, including marketing and management fees payable under rights agreement

30,000

Fixtures and fittings and regional rights should be depreciated over 3 years on a straight line basis

 

 

 

Option 2: Investment on the London Stock Exchange

£

Initial investment in a mixed FTSE-100 portfolio of shares

245,000

Broker’s fees on purchase of shares

5,000

Annual dividends

18,000

Resale value, assuming constant growth in line with historic growth rate of 4.7%

281,194

Broker’s fees on sale of shares

5,000

 

 

Option 3: Investment in UK Housing Market

£

Purchase price of property

240,000

Legal costs and taxes payable on completion of property purchase

7,000

Annual maintenance

1,500

Annual rental income

22,000

Resale value, assuming constant growth in line with historic growth rate of 4% per annum

270,000

Legal and selling costs on resale

4,500

 

 

 

a)    Complete the following table, making sure that all workings are clearly shown.  Geraldine’s cost of capital is 8%:   

 

Option 1

Option 2

Option 3

Payback

3 years

3 years

3 years

Accounting rate of return

? 

6.8%

8.0%

Net present value

13798

?

16592

Internal rate of return

10.9

10.4

?

[10 marks]

b)    Write a report to Geraldine that:

·         clearly states the investment advice that you would give, on the basis of the results from the table in a);

·         explains the capital appraisal methods that you have used;

·         highlights a range of additional factors Geraldine should consider prior to investment.[10 marks][TOTAL 20 marks]

 

4.a)    Explain what is meant by the following terms associated with budgeting:

                      i.    Flexed budget (1 marks);

                    ii.    Budgetary control (2 marks);

                   iii.    Budget slack (2 marks);

                   iv.    Beyond budgeting (5 marks).   [10 marks]

4. b)    Critically assess the problems that a company may experience when implementing a new budget.  [10 marks][TOTAL 20 marks]

 

 

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