ACCA

Financial Management (FM)

Final Mock – December 2018

Time allowed
3 hours 15 minutes

This exam 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 3–5.

Instructions:
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 EXAM UNTIL YOU ARE READY TO START UNDER
EXAMINATION CONDITIONS
Get into good exam habits now!
Take a moment to focus on the right approach for this exam.

Effective time management

 Watch the clock, allow 1.95 minutes per mark. Work out how long you can spend on each
question and do not exceed that time.
 Take a few moments to think what the requirements are asking for and how you are going to
answer them.

Effective planning
 This exam is in exactly the same format as the real exam. You should read through the
questions and plan the order in which you will tackle the questions.
 Read the requirements carefully: focus on mark allocation, question words (see below) and
potential overlap between requirements.
 Identify and make sure you pick up the easy marks available in each question.

Effective layout
 Present your numerical solutions using the standard layouts you have seen. Show and
reference your workings clearly.
 With written elements try and make a number of distinct points using headings and short
paragraphs. You should aim to make a separate point for each mark.
 Ensure that you explain the points you are making, ie why is the point a strength, criticism or
opportunity?
 Give yourself plenty of space to add extra lines as necessary, it will also make it easier for the
examiner to mark.

Common terminology
Identify List relevant points
Discuss Explain the opposing arguments
Describe Present the characteristics of
Summarise State briefly the essential points
Recommend Present information to enable the recipient to take action
Analyse Determine and explain the constituent parts of
Explain Set out in detail the meaning of
Illustrate Use an example to explain something
Appraise/assess/
evaluate Judge the importance or value of

2
Formulae sheet
Present value table
Present value of 1 ie (1 + r)–n
where r = discount rate
n = number of periods until payment
Discount rates (r)
Periods

(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 0.980 0.961 0.943 0.925 0.907 0.890 0.873 0.857 0.842 0.826
3 0.971 0.942 0.915 0.889 0.864 0.840 0.816 0.794 0.772 0.751
4 0.961 0.924 0.888 0.855 0.823 0.792 0.763 0.735 0.708 0.683
5 0.951 0.906 0.863 0.822 0.784 0.747 0.713 0.681 0.650 0.621

6 0.942 0.888 0.837 0.790 0.746 0.705 0.666 0.630 0.596 0.564
7 0.933 0.871 0.813 0.760 0.711 0.665 0.623 0.583 0.547 0.513
8 0.923 0.853 0.789 0.731 0.677 0.627 0.582 0.540 0.502 0.467
9 0.914 0.837 0.766 0.703 0.645 0.592 0.544 0.500 0.460 0.424
10 0.905 0.820 0.744 0.676 0.614 0.558 0.508 0.463 0.422 0.386

11 0.896 0.804 0.722 0.650 0.585 0.527 0.475 0.429 0.388 0.350
12 0.887 0.788 0.701 0.625 0.557 0.497 0.444 0.397 0.356 0.319
13 0.879 0.773 0.681 0.601 0.530 0.469 0.415 0.368 0.326 0.290
14 0.870 0.758 0.661 0.577 0.505 0.442 0.388 0.340 0.299 0.263
15 0.861 0.743 0.642 0.555 0.481 0.417 0.362 0.315 0.275 0.239

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 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

6 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162

11 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065

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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)

(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 10.368 9.787 9.253 8.760 8.306 7.887 7.499 7.139 6.805 6.495
12 11.255 10.575 9.954 9.385 8.863 8.384 7.943 7.536 7.161 6.814
13 12.134 11.348 10.635 9.986 9.394 8.853 8.358 7.904 7.487 7.103
14 13.004 12.106 11.296 10.563 9.899 9.295 8.745 8.244 7.786 7.367
15 13.865 12.849 11.938 11.118 10.380 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

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Economic Order Quantity

2C o D
=
Ch

Miller – Orr Model

Return point = Lower limit + ( 13  spread)

 3  transaction cos t  var iance of cash flows  1

3
Spread =3  4 
 Interest rate 
 

The Capital Asset Pricing Model

E(ri)= Rf + i (E (rm) – Rf )
The Asset Beta Formula

 Ve   Vd (1  T) 
βa   βe  +  βd 
 (Ve  Vd (1  T))   (Ve  Vd (1  T)) 

The Growth Model

D0 (1 g) D0 (1 g)
P0  Re  g
(Re  g) P0

Gordon's Growth Approximation

g = br
The Weighted Average Cost of Capital

 Ve   Vd 
WACC =   ke +   kd (1 – T)
 Ve  Vd   Ve  Vd 

The Fisher Formula

(1 + i) = (1 + r)(1 + h)
Purchasing Power Parity and Interest Rate Parity
(1 hc ) (1 ic )
S1  S0  F0  S0  S
(1 hb ) (1 ib ) f

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6
Section A

ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.
1 Which of the following statements concerning dividend policy theory is correct?
A Clientele theory assumes that shareholders will not be happy with fluctuating dividends.
B The residual theory states that earnings should be used to fund positive NPV projects and
anything remaining should be used to pay a dividend.
C Modigliani and Miller stated that shareholders prefer capital gains to dividends.
D A scrip dividend may lead to an increase in gearing.
2 Which one of the following is NOT an interest bearing money market instrument?
A Treasury bill
B Certificate of deposit
C Repurchase agreement (Repo)
D Money market deposit
3 Which of the following statements is correct?
A One of the problems with maximising accounting profit as a financial objective is that
accounting profit can be manipulated.
B A target for a minimum level of dividend cover is a target for a minimum dividend payout ratio.
C Staff turnover is a financial objective.
D One reason shareholders are interested in EPS is that accounting profit takes account of risk.
4 A five year project has a net present value of $160,000 when it is discounted at 12%.
The project is expected to generate total cash revenues of $450,000 over the five year life of the
project and total cash variable costs of $200,000 over the five year life of the project. Revenues and
costs are expected to be the same in each year.
What is the sensitivity of this project to the number of units sold (ignoring tax)?
A 64%
B 89%
C 36%
D 49%
5 Which ONE of the following would have the effect of lengthening the working capital cycle?
A Ordering raw materials closer to the date they are needed in the factory
B Increasing credit limits given to customers
C Delaying payments to suppliers
D Increasing the turnover of finished goods inventory

7
6 B plc is considering investing in a new machine. The machine will cost $20,000 and has an expected
life of five years with a residual value of $4,000. The machine will increase the operating cash flows of
the company as follows.
Increase in
Operating cash
Year flow
($)
1 3,000
2 4,500
3 6,500
4 5,200
5 4,000
What is the Accounting Rate of Return based upon the average investment?
A 38.7%
B 7.2%
C 23.2%
D 12.0%
7 You have the following information on a company:
$
PBIT 4,000,000
Interest expenses 400,000
Taxes 170,000
Preferred dividends 300,000
Ordinary dividends 200,000
There are 10 million ordinary shares.
What is the EPS of this company?
A $0.31
B $0.36
C $0.34
D $0.29
8 A company uses additional debt to finance a new investment. Equity capital and the level of operating
risk are unchanged.
What is the most likely effect on the company's weighted average cost of capital according to
traditional theory of gearing?
A It remains constant
B It increases
C It decreases
D It either increases or decreases

8
9 Which of the following statements are correct?
(1) Share option schemes always reward good performance by managers.
(2) Performance-related pay can encourage dysfunctional behaviour.
(3) Value for money as an objective in not-for-profit organisations requires the pursuit of
economy, efficiency and effectiveness.
A 1 and 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
10 A company's shares have gone ex div having just declared a dividend of 20c per share, but the market
expects this dividend to decline by 2% each year in perpetuity. The cost of equity is 8%.
What is the ex dividend price per share?
A $1.96
B $2.00
C $2.24
D $3.27
11 Which of the following are financial intermediaries?
(1) Venture capital organisation
(2) Pension fund
(3) Merchant bank
A 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3
12 Which of the following statements are correct?
(1) If a capital market is weak form efficient, an investor cannot make abnormal returns by using
technical analysis.
(2) Operational efficiency means that efficient capital markets direct funds to their most productive
use.
(3) Tests for semi-strong form efficiency focus on the speed and accuracy of share price
responses to the arrival of new information.
A 1 and 2 only
B 1 and 3 only
C 2 and 3 only
D 1, 2 and 3

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13 A company currently has 10 million $1 shares in issue with a market value of $3 per share. The
company wishes to raise new funds using a 1 for 4 rights issue.
If the theoretical ex rights price per share turns out to be $2.80, how much new finance was
raised?
A $2,500,000
B $4,000,000
C $5,000,000
D $7,000,000
14 A bond has a fixed annual coupon rate of 7% and it will be repaid at its face value of $100 in one
year's time. Similar bonds have a redemption yield (yield to maturity) of 8%.
What is the current ex interest value of the bond?
A $99.08
B $100.00
C $100.93
D $106.07
15 A newspaper article has recently been published referring to a growing trend whereby the proprietors
and managers of small and medium-sized enterprises (SMEs) are replacing traditional bank finance
with funding from wealthy individuals who are willing to invest their own cash in new business
ventures in return for relatively high financial returns. The investor often contributes expertise and the
benefit of experience as well as their financial capital.
Which of the following best describes this kind of SME funding?
A Crowd funding
B Securitisation
C Business angel financing
D Underwriting

10
Section B

ALL 15 questions are compulsory and MUST be attempted

Each question is worth 2 marks.
The following scenario relates to questions 16–20.
MJG Co currently manufactures and sells garden equipment in Country M, where the currency is the M$.
MJG Co is planning to expand into markets outside Country M in the next few years.
MJG has annual sales revenue of M$15m and all sales are on 30 days' credit, although customers on average
take fifteen days more than this to pay. Contribution represents 65% of sales. Accounts receivable are
financed by an overdraft at an annual interest rate of 6%.
MJG Co plans to offer an early settlement discount of 2% for payment within 10 days and to extend the
maximum credit offered to 60 days. The company expects that these changes will increase annual credit sales
by 4%, while also leading to additional incremental costs equal to 0.25% of turnover. The discount is expected
to be taken by 40% of customers, with the remaining customers taking an average of 60 days to pay.
MJG Co is concerned that allowing payment after 60 days may attract some customers with liquidity problems
and may increase the exposure of the company to bad debts.
Assume a 360 day year.
16 If the new policy is implemented how much will the change in receivables cause the financing
costs of MJG Co to change by?
A Financing costs will rise by M$8,384
B Financing costs will fall by M$8,500
C Financing costs will rise by M$8,500
D Financing costs will fall by M$8,384
17 What is the cost of the new policy to MJG (ignoring financing costs resulting from a change in
receivables)?
A M$163,800
B M$351,000
C M$4,024,800
D M$4,212,000
18 What will be the overall financial impact on MJG of the new policy?
A To reduce profits
B To increase profits
C No impact
D Not possible to say using the available information
19 Which of the following would be an appropriate policy for dealing with the risk of bad debts for
MJG?
A A with-recourse debt factor
B A bill of exchange
C A letter of credit
D A certificate of deposit

11
20 Which of the following government policies would be likely to cause a move in the exchange rate
that would help to support MJG's export sales?
A A contractionary fiscal policy
B A tightening of health and safety laws in Country M
C An increase in real interest rates
D An increase in the money supply

The following scenario relates to questions 21–25.

Assume that the date is currently 14 April.
JKL Co is an environmental consultancy operating in Country C, where the currency is the C$.
JKL has signed a contract on a project that will result in the receipt of €2,350,000 from a French company in
three months' time.
Currency market rates on 14 April:
Per C$
Spot rate €1.2358 +/– 0.0004
Three months forward rate €1.2362 +/– 0.0028
Annual money market rates on 14 April:
Country C 2.2%
Euro 1.2%
JKL is also considering using exchange traded futures or options to manage this risk. Contracts on these
markets are available in standard contract sizes of €125,000.
Over the longer term JKL is worried about the impact that inflation differences between Country C and Europe
may have on the exchange rate.
21 If JKL uses a forward contract, how much revenue will be received in C$s in three months' time?
A C$2,911,650
B C$1,905,302
C C$1,896,691
D C$2,898,490
22 If JKL uses a money market hedge, how much revenue will be received in C$s in three months'
time?
A C$1,905,725
B C$1,947,127
C C$1,878,446
D C$1,919,771
23 Which of the following benefits to JKL could result from using futures contracts, compared to a
forward contract for this transaction?
A The ability to take advantage of an increase in the value of the C$
B If the maturity date is beyond three months ahead, JKL could still use the futures rate if the
customer pays late
C Futures are a simpler agreement due to standard contract sizes
D A futures contract to buy could result in a better outcome than a forward

12
24 Which of the following is NOT a benefit to JKL from using exchange traded option contracts,
compared to a forward contract for this transaction?
A The ability to take advantage of a favourable change in the value of the C$
B If the maturity date is beyond three months ahead, JKL could still use the option rate if the
customer pays late
C Lower transaction costs
D A put option could result in a better outcome than a forward
25 Which of the following statements is/are true?
(1) According to purchasing power parity theory the country with the higher rate of inflation will
see its currency weaken against the country with the lower rate of inflation.
(2) Importers face higher input costs if their own currency becomes stronger relative to other
currencies.
A 1 only
B 2 only
C Both 1 and 2
D Neither

The following scenario relates to questions 26–30.

Predator Co is a company that is listed on a major stock market and is preparing to make a bid to buy a rival
unlisted company, JEH. Predator Co has a lower level of financial gearing than JEH. Both companies are in
the same business sector.
The price/earnings ratio of Predator Co is 7.
The latest financial information on JEH is as follows:
$m
Assets
Non-current assets 63
Current assets 18
Total assets 81
Equity and liabilities
Ordinary shares, nominal value 50c 15
Retained earnings 14
Total equity 29
Non-current liabilities
9% bonds, redeemable at par in two years' time 50
Current liabilities 2
Total liabilities 81

JEH has an estimated cost of equity of 15% per year and has maintained a policy of reinvesting 55% of post-
tax profits. Dividends have grown on average by 4.5% per year in recent years.
JEH's most recent operating profits were $38.25m. The rate of tax on corporate profits is 20%.

13
26 Which of the following statements are problems in using Predator's P/E ratio to value JEH?
(1) It does not take any account of JEH's business risk.
(2) It does not take into account JEH's financial risk.
(3) It may undervalue JEH because of JEH's status as an unlisted company.
A 1 only
B 2 only
C 1 and 2 only
D 2 and 3 only
27 What is the value of a JEH share, using the P/E valuation method?
A $8.93
B $7.14
C $12.6
D $6.3
28 What is the value of a JEH share, using the dividend growth model?
A $4.71
B $4.93
C $4.03
D $3.86
29 Predator Co and Fierce Co operate in the same industry, but have different price earning (P/E) ratios
as follows:
P/E ratio
Predator 7
Fierce 13
Which of the following is the most probable explanation of the difference in the P/E ratios between
the two companies?
A Fierce Co has a greater profit this year than Predator Co
B Fierce Co is higher risk than Predator Co
C Fierce Co has higher expected growth than Predator Co
D Fierce Co has higher gearing than Predator Co
30 According to which theory would the use of debt finance definitely be advantageous to Predator Co
as a way of financing this acquisition?
A Traditional theory
B Modigliani & Miller theory with no tax
C Pecking order theory
D Modigliani & Miller theory with tax

14
Section C

BOTH questions are compulsory and MUST be attempted

31 NMG Co
NMG Co is listed on a major stock market.
NMG Co
$m
Assets
Non-current assets 107.59
Current assets 18.00
Total assets 125.59
Equity and liabilities
Ordinary shares, nominal value 50c 40.00
Retained earnings 26.00
Total equity 66.00
Non-current liabilities
7% bonds, redeemable at par in seven years' time 35.00
Medium term bank loan 17.59
Current liabilities 7.00
Total equity and liabilities 125.59

Other relevant financial information:

Risk-free rate of return 2%
Average return on the market 8%
Taxation rate 30%
NMG Co's earnings per share is 53.57 cents and it has an equity beta of 1.3.
NMG's bank loan costs 8% per annum pre-tax, it is secured by a fixed charge on NMG's Head Office.
It is due to be repaid in five years' time.
The 7% bonds of the company are trading on an ex interest basis at $92.60 per $100 bond. It is
secured by a general floating charge on NMG's assets.
The price/earnings ratio of NMG Co is seven times.
Required
(a) Calculate the weighted average cost of capital of NMG Co on a market value weighted basis.
(9 marks)
(b) Discuss the differences in the costs of the different types of long-term finance used by NMG
Co. (8 marks)
(c) Explain the difference between 'conventional finance' and Islamic finance. (3 marks)
(Total = 20 marks)

15
32 Duo Co
Duo Co needs to increase production capacity to meet increasing demand for an existing product,
'Quago', which is used in food processing. A new machine, with a useful life of four years and a
maximum output of 600,000 kg of Quago per year, could be bought for $800,000, payable
immediately. The scrap value of the machine after four years would be $30,000. Forecast demand and
production of Quago over the next four years is as follows:
Year 1 2 3 4
Demand (kg) 1.4 million 1.5 million 1.6 million 1.7 million
Existing production capacity for Quago is limited to one million kilograms per year and the new
machine would only be used for demand additional to this.
The current selling price of Quago is $8.00 per kilogram and the variable cost of materials is $5.00 per
kilogram. Other variable costs of production are $1·90 per kilogram. Fixed costs of production
associated with the new machine would be $240,000 in the first year of production, increasing by
$20,000 per year in each subsequent year of operation.
Duo Co pays tax one year in arrears at an annual rate of 30% and can claim tax-allowable depreciation
(capital allowances) on a 25% reducing balance basis. A balancing allowance is claimed in the final
year of operation.
Duo Co uses its after-tax weighted average cost of capital when appraising investment projects. It has
an after tax market value weighted average cost of capital of 10%.
Required
(a) Calculate the net present value of buying the new machine and comment on the acceptability of
the proposed purchase (work to the nearest $1,000). (10 marks)
(b) Calculate the internal rate of return of buying the new machine and comment on the
acceptability of the proposed purchase (work to the nearest $1,000). (3 marks)
(c) Explain the difference between risk and uncertainty in the context of investment appraisal, and
describe how sensitivity analysis and probability analysis can be used to incorporate risk into
the investment appraisal process. (7 marks)
(Total = 20 marks)

16
Student self-assessment
Having completed this exam take a few minutes to consider what you did well and what you found difficult.
Use this as a basis to focus your future study on effectively improving your performance.

Common problems Future emphasis if you answer Yes

Timing and planning for all Sections
Did you miss out any questions? Y/N Attempt all questions.
For multiple choice questions in Sections A and B, it is worth
making a guess at the correct answer.
Did you finish too early? Y/N Make sure you deal with all the information given in the
questions.
Use the extra time to go back over your answers.
Did you overrun? Y/N Focus on allocating your time better.
Practise questions under strict timed conditions.
If you get behind leave space and move on.

Content in all Sections

Did you struggle with:
Interpreting the questions? Y/N Learn the meaning of question words (inside front cover).
Learn subject jargon (study text glossary).
Read questions carefully noting all the parts.
Practise as many questions as possible.
Understanding the subject? Y/N Review your notes/text.
Work through easier examples first.
Contact a tutor for help.
Remembering the notes/text? Y/N Quiz yourself constantly as you study. You need to develop
your memory as well as your understanding of a subject.

Layout in Section C
Was your answer difficult to follow? Y/N Use headings and subheadings.
Use numbering sequences when identifying points.
Leave space between each point.
Did you fail to explain each point? Y/N Show why the point identified answers the question set.
Did you include irrelevant information? Y/N Focus on developing a logical structure to your answer.
Were some of your workings unclear? Y/N Give yourself time and space to make the marker's job easy.

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