Centre for Professional

Accounting Programmes

Association of Chartered Certified

Accountants (ACCA)

Student Name:
Student ID:

Progressive Test 1
Paper AFM
Advanced Financial Management
Examiner: Mr Yoong Mun Yen
Day: FRIDAY
Date: 27th Aug 2021
Writing time: 1 hour 50mins

Instructions:
1. All questions must be attempted.
2. DO NOT OPEN THIS PAPER UNTIL INSTRUCTED BY THE INVIGILATOR.

Page 1 of 12
(Section A : 14 questions – approximate time 65 minutes)

Q1 Which of the following factors is least likely to explain why the capital asset pricing model may

not accurately predict the return expected by investors?

A No adjustment is made for the extra risk faced when investing a small company

B Share prices are significantly influenced by behavioural factors such as herding

C Some investors do not have diversified portfolios

D Some events (eg an earthquake) cannot be predicted (2 marks)

Q2 Tryme plc issued its 7% irredeemable debentures at £98. Issue costs are 2% of the nominal

value. The company is paying corporation tax at a rate of 28%. The cost of capital to the

company of these debentures is

A 5.1%

B 5.0%

C 7.3%

D 5.3% (2 marks)

Data for questions 3–4

The dividends and earnings of Sparsholt plc over the last five years have been as follows:

Dividends Earnings

Year £ £

20X1 400,000 813,000

20X2 416,500 835,000

20X3 434,500 864,000

20X4 461,000 894,000

20X5 479,000 598,750

The company is all-equity financed and there are 2 million shares in issue, with a market value of
£1.78 ex-div.

Page 2 of 12
Q3 On the assumption that the data for 20X1–20X5 provides a basis for estimating future trends,

what is the cost of equity?

A 18.7%

B 17.7%

C 18.1%

D 17.2% (2 marks)

Q4 One of the directors has criticised the use of historic data, and has suggested that since the

company is now paying out a greater percentage of earnings each year, an estimate of dividend

growth based on the current reinvestment level would be more appropriate. Using the current

reinvestment level, and assuming a 20% return on equity, what is the cost of equity?

A 31.6%

B 18.0%

C 29.5%

D 17.5% (2 marks)

Data for questions 5–6

It is now 2007. Spinethorne plc’s equity has a beta factor of 0.9. The company is financed by a
mixture of equity, preference shares and redeemable long-term debt capital, as follows.

£1 Ordinary shares: 40 million shares, market value £2 per share

7% Preference shares of £1 each: 20 million shares, market value 100p per share

2012 5% Debt capital £20,000,000, market value £90, redeemable at par

The market rate of return is 8%, the risk-free rate of return is 5% and the rate of corporation tax
30%.

Q5 What is Spinethorne’s cost of equity (Ke), cost of debt (Kd, post-tax, to the nearest %) and cost

of preference shares (Kp)?

A Ke = 7.7%, Kd = 6%, Kp = 7%

B Ke = 12.2%, Kd = 8%, Kp = 7%

C Ke = 7.7%, Kd = 8%, Kp = 7%

D Ke = 12.2%, Kd = 6%, Kp = 7% (4 marks)

Page 3 of 12
Q6 What is Spinethorne’s WACC?

A 7.1%

B 7.3%

C 9.0%

D 6.0% (2 marks)

Q7 Cranmoor Limited is about to embark on a project to install eco friendly air-conditioning

systems. It involves an initial outlay of £120,000 and cash inflows, at current prices, of £50,000,

£60,000, and £40,000 at the end of years 1,2 and 3 respectively. Inflation is expected to be

running at 10% p.a. during the life of the project, and the real cost of capital is 10%. What is the

net present value of the project?

A £30,000

B £6,100

C £5,050

D (£15,300) (2 marks)

Q8 Extreme Wildlife plc is branching out into the pet accessory market. A company in this

market, Gould Fisher Pond plc, has a beta factor of 1.20 and a debt:equity ratio of 1:4.

Extreme Wildlife plc has a beta factor of 1.50 and is ungeared. The rate of corporate tax is

28%, the risk-free return is 4% and the market return is 8%. Assume that the debt beta is

zero.

The project will change Extreme Wildlife’s gearing, because it will be 100% debt financed.

What would be the cost of capital for Extreme Wildlife to use to appraise the project’s cash

flows as part of an APV appraisal?

A 8.8%

B 8.1%

C 4.7%

D 7.6% (4 marks)

Q9 Extreme Wildlife (from Question 8) has identified the following project cash flows relating to

the new investment in the pet accessory market: contribution is estimated at £2m per annum

for the first year and then is estimated to rise at 20% per year for years 2, 3 and 4 and 5%

Page 4 of 12
 per year after that. Investment costs are estimated at £1.5m, of which £200,000 is the

estimated cost of planned market research.

Tax is 28%, ignore capital allowances and inflation.

Extreme Wildlife estimates that its ungeared cost of equity is 8%.

What would be the NPV of this project if it was ungeared (in £ million)?

A 68.92

B 68.72

C 64.02

D 62.22 (4 marks)

Q10 Extreme Wildlife (from Question 9) will fund the £1.5m investment using a ten year loan a

pre-tax cost of 5%. Tax is at 28%, and the ungeared cost of equity is estimated at 8%.

Using an ‘adjusted present value’ approach, what would be the present value of the tax

saved from using debt finance (in £'000s)?

PV of tax saved

A 262.50

B 140.91

C 420.00

D 162.16 (4 marks)

Q11 How much would the APV of the project increase by (in £'000s) if Extreme Wildlife plc was

offered subsidised debt finance at 1% (instead of its normal borrowing rate of 5%) by the

government as an incentive to make this investment?

A 289.87

B 402.60

C 333.59

D 463.32 (4 marks)

Q12 Sturgeon plc is branching out into the fish food market. A company in this market,

Piranha plc, has a cost of equity of 12% and a debt:equity ratio of 1:4, and a debt beta of

0.2. The risk free rate is 3% and the market return is 7% and tax is at 30%.

Sturgeon has a debt to equity ratio of 1:2 and a debt beta of 0.25.

The project will not change Sturgeon's gearing.

Page 5 of 12
 What would be the cost of equity for Sturgeon to use to appraise the project’s cash flows

(which are not given)?

A 13.15%

B 13.22%

C 10.78%

D 12.15% (4 marks)

Q13 Using Example Q12 estimate the weighted average cost of capital that Sturgeon should use to

appraise the project’s cash flows?

A 8.58%

B 9.70%

C 10.10%

D 9.00% (2 marks)

Q14 Cranmoor Limited is about to embark on a project to install eco friendly air-conditioning

systems. It involves an initial outlay of £120,000 and cash inflows, at current prices, of

£50,000, £60,000, and £40,000 at the end of years 1, 2 and 3 respectively.

Cranmoor’s real cost of capital is 10%.

What is the project duration for this project ?

A 2.4 years

B 1.9 years

C 2.3 years

D 2.1 years (4 marks)

Page 6 of 12
0123456ÿ8ÿ9 54 31ÿ341ÿÿ46ÿ
ÿÿÿ
ÿ!"#ÿ#$ÿ"ÿ%ÿ&''ÿ$'ÿ!"ÿ!(ÿ)&#ÿ'"ÿ)ÿ$#&$ÿ*ÿ!ÿ"+ÿ
#ÿ!ÿ,ÿ-ÿ!.ÿ/"+ÿ"'!ÿ00$ÿ!"ÿ""&ÿ$"$ÿ*ÿ!ÿ$'ÿ%&&ÿ)ÿ
-12111ÿÿ"ÿ"ÿ')ÿÿÿ*ÿ"ÿ34ÿ"ÿ$"(5ÿ'ÿ"$ÿ!"ÿ!ÿ$'ÿ%&&ÿ!"#ÿ"ÿ
&*ÿ*ÿ*#ÿ("ÿ'ÿ*&&(ÿ$#&$.ÿ6&''ÿ$'ÿ'ÿ"ÿ#(ÿ#&"&2ÿ!%#.ÿ7ÿÿ
#"0$ÿ!"ÿ'ÿ*&"ÿ%&&ÿ"#"0ÿ"ÿ-8ÿ)ÿ!ÿ"$"$ÿ$#"ÿ*ÿ')ÿÿÿ
%&&ÿ)ÿ918.ÿ
:'ÿ!ÿ$'ÿÿ*&&(ÿ$#&$ÿ!ÿ'"(ÿ%&&ÿ$ÿÿ$ÿ3421112111ÿÿ;&0ÿÿ*ÿ
ÿ*"'ÿÿ$ÿÿ$"+ÿ$'ÿ!0!2ÿ0#ÿ!ÿ#&"&(ÿÿ'ÿÿ!ÿ"+2ÿÿÿ
)(ÿÿ"ÿ'"ÿ!"ÿÿ%&&ÿ'!ÿÿÿÿ$'2ÿ'"&&(ÿ*ÿ'ÿ!"#ÿ
*"&&ÿ$""'"&&(.ÿ
ÿ
ÿ!"#ÿ"ÿ'ÿ*ÿ'""&ÿ*ÿ-8ÿ"$ÿ+;*ÿ"ÿ"ÿ<8.ÿ
=>$ÿ
?"@ÿA"&'&"ÿ!ÿ",ÿ$#&ÿ'ÿ!"ÿÿ!&$ÿ)ÿ"$ÿÿ"(ÿ$"(ÿÿ
ÿÿÿÿÿÿ'"ÿ"ÿÿÿ$#&ÿ!ÿB'2ÿ"0ÿ"(ÿ'"(ÿ".ÿÿÿ 9CDÿ Eÿ
?)@ÿF'ÿ!ÿ&+&(ÿ"'ÿÿ!ÿ")#ÿ$'ÿ"0ÿ*ÿ"(ÿ ÿÿ"ÿ*ÿ"(ÿ*ÿ!ÿ
ÿÿÿÿÿÿ*0ÿ#$$.ÿÿ ÿ ÿ ÿ ÿ ÿ ÿ ÿ ÿ 9Gÿ Eÿ
9H53IÿJÿKLÿ Eÿ

Page 7 of 12
 Formulae

Modigliani and Miller Proposition 2 (with tax)

Vd
k e = kie + (1 – T)(kie – k d )
Ve

Two asset portfolio

sp = w2a s2a + w2b s2b + 2wawbrab sasb

The Capital Asset Pricing Model

E(ri ) = Rf + βi (E(rm ) – Rf )

The asset beta formula

 Ve   V (1 – T) 
βa =  βe  +  d
βd 
 (Ve + Vd (1 – T))   (Ve + Vd (1 – T)) 

The Growth Model

Do (1 + g)
Po =
(re – g)

Gordon’s growth approximation

g = bre

The weighted average cost of capital

 V   V 
WACC =  e  ke +  d  k (1 – T)
 Ve + Vd   Ve + Vd  d

The Fisher formula

(1 + i) = (1 + r)(1+h)

Purchasing power parity and interest rate parity

(1+hc ) (1+ic )
S1 = S0 x F0 = S0 x
(1+hb ) (1+ib )

Page 8 of 12
 Modified Internal Rate of Return

1
 PV  n
MIRR =  R  1 + re – 1
 PVI 
( )

The Black-Scholes option pricing model

c = PaN(d1) – PeN(d2 )e –rt

Where:

ln(Pa / Pe ) + (r+0.5s2 )t
d1 =
s t

d2 = d1 – s t

The Put Call Parity relationship

p = c – Pa + Pee –rt

Page 9 of 12 [P.T.O.
 Present Value Table

Present value of 1 i.e. (1 + r)–n

Where r = discount rate
n = number of periods until payment

Discount rate (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 1
2 0·980 0·961 0·943 0·925 0·907 0·890 0·873 0·857 0·842 0·826 2
3 0·971 0·942 0·915 0·889 0·864 0·840 0·816 0·794 0·772 0·751 3
4 0·961 0·924 0·888 0·855 0·823 0·792 0·763 0·735 0·708 0·683 4
5 0·951 0·906 0·863 0·822 0·784 0·747 0·713 0·681 0·650 0·621 5

6 0·942 0·888 0·837 0·790 0·746 0·705 0·666 0·630 0·596 0·564 6
7 0·933 0·871 0·813 0·760 0·711 0·665 0·623 0·583 0·547 0·513 7
8 0·923 0·853 0·789 0·731 0·677 0·627 0·582 0·540 0·502 0·467 8
9 0·941 0·837 0·766 0·703 0·645 0·592 0·544 0·500 0·460 0·424 9
10 0·905 0·820 0·744 0·676 0·614 0·558 0·508 0·463 0·422 0·386 10

11 0·896 0·804 0·722 0·650 0·585 0·527 0·475 0·429 0·388 0·305 11
12 0·887 0·788 0·701 0·625 0·557 0·497 0·444 0·397 0·356 0·319 12
13 0·879 0·773 0·681 0·601 0·530 0·469 0·415 0·368 0·326 0·290 13
14 0·870 0·758 0·661 0·577 0·505 0·442 0·388 0·340 0·299 0·263 14
15 0·861 0·743 0·642 0·555 0·481 0·417 0·362 0·315 0·275 0·239 15

(n) 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 1
2 0·812 0·797 0·783 0·769 0·756 0·743 0·731 0·718 0·706 0·694 2
3 0·731 0·712 0·693 0·675 0·658 0·641 0·624 0·609 0·593 0·579 3
4 0·659 0·636 0·613 0·592 0·572 0·552 0·534 0·516 0·499 0·482 4
5 0·593 0·567 0·543 0·519 0·497 0·476 0·456 0·437 0·419 0·402 5

6 0·535 0·507 0·480 0·456 0·432 0·410 0·390 0·370 0·352 0·335 6
7 0·482 0·452 0·425 0·400 0·376 0·354 0·333 0·314 0·296 0·279 7
8 0·434 0·404 0·376 0·351 0·327 0·305 0·285 0·266 0·249 0·233 8
9 0·391 0·361 0·333 0·308 0·284 0·263 0·243 0·225 0·209 0·194 9
10 0·352 0·322 0·295 0·270 0·247 0·227 0·208 0·191 0·176 0·162 10

11 0·317 0·287 0·261 0·237 0·215 0·195 0·178 0·162 0·148 0·135 11
12 0·286 0·257 0·231 0·208 0·187 0·168 0·152 0·137 0·124 0·112 12
13 0·258 0·229 0·204 0·182 0·163 0·145 0·130 0·116 0·104 0·093 13
14 0·232 0·205 0·181 0·160 0·141 0·125 0·111 0·099 0·088 0·078 14
15 0·209 0·183 0·160 0·140 0·123 0·108 0·095 0·084 0·074 0·065 15

Page 10 of 12
 Annuity Table

– (1 + r)–n
Present value of an annuity of 1 i.e. 1————––
r

Where r = discount rate

n = number of periods

Discount rate (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 1
2 1·970 1·942 1·913 1·886 1·859 1·833 1·808 1·783 1·759 1·736 2
3 2·941 2·884 2·829 2·775 2·723 2·673 2·624 2·577 2·531 2·487 3
4 3·902 3·808 3·717 3·630 3·546 3·465 3·387 3·312 3·240 3·170 4
5 4·853 4·713 4·580 4·452 4·329 4·212 4·100 3·993 3·890 3·791 5

6 5·795 5·601 5·417 5·242 5·076 4·917 4·767 4·623 4·486 4·355 6
7 6·728 6·472 6·230 6·002 5·786 5·582 5·389 5·206 5·033 4·868 7
8 7·652 7·325 7·020 6·733 6·463 6·210 5·971 5·747 5·535 5·335 8
9 8·566 8·162 7·786 7·435 7·108 6·802 6·515 6·247 5·995 5·759 9
10 9·471 8·983 8·530 8·111 7·722 7·360 7·024 6·710 6·418 6·145 10

11 10·37 9·787 9·253 8·760 8·306 7·887 7·499 7·139 6·805 6·495 11
12 11·26 10·58 9·954 9·385 8·863 8·384 7·943 7·536 7·161 6·814 12
13 12·13 11·35 10·63 9·986 9·394 8·853 8·358 7·904 7·487 7·103 13
14 13·00 12·11 11·30 10·56 9·899 9·295 8·745 8·244 7·786 7·367 14
15 13·87 12·85 11·94 11·12 10·38 9·712 9·108 8·559 8·061 7·606 15

(n) 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 1
2 1·713 1·690 1·668 1·647 1·626 1·605 1·585 1·566 1·547 1·528 2
3 2·444 2·402 2·361 2·322 2·283 2·246 2·210 2·174 2·140 2·106 3
4 3·102 3·037 2·974 2·914 2·855 2·798 2·743 2·690 2·639 2·589 4
5 3·696 3·605 3·517 3·433 3·352 3·274 3·199 3·127 3·058 2·991 5

6 4·231 4·111 3·998 3·889 3·784 3·685 3·589 3·498 3·410 3·326 6
7 4·712 4·564 4·423 4·288 4·160 4·039 3·922 3·812 3·706 3·605 7
8 5·146 4·968 4·799 4·639 4·487 4·344 4·207 4·078 3·954 3·837 8
9 5·537 5·328 5·132 4·946 4·772 4·607 4·451 4·303 4·163 4·031 9
10 5·889 5·650 5·426 5·216 5·019 4·833 4·659 4·494 4·339 4·192 10

11 6·207 5·938 5·687 5·453 5·234 5·029 4·836 4·656 4·486 4·327 11
12 6·492 6·194 5·918 5·660 5·421 5·197 4·988 4·793 4·611 4·439 12
13 6·750 6·424 6·122 5·842 5·583 5·342 5·118 4·910 4·715 4·533 13
14 6·982 6·628 6·302 6·002 5·724 5·468 5·229 5·008 4·802 4·611 14
15 7·191 6·811 6·462 6·142 5·847 5·575 5·324 5·092 4·876 4·675 15

Page 11 of 12 [P.T.O.
 Standard normal distribution table

0·00 0·01 0·02 0·03 0·04 0·05 0·06 0·07 0·08 0·09
0·0 0·0000 0·0040 0·0080 0·0120 0·0160 0·0199 0·0239 0·0279 0·0319 0·0359
0·1 0·0398 0·0438 0·0478 0·0517 0·0557 0·0596 0·0636 0·0675 0·0714 0·0753
0·2 0·0793 0·0832 0·0871 0·0910 0·0948 0·0987 0·1026 0·1064 0·1103 0·1141
0·3 0·1179 0·1217 0·1255 0·1293 0·1331 0·1368 0·1406 0·1443 0·1480 0·1517
0·4 0·1554 0·1591 0·1628 0·1664 0·1700 0·1736 0·1772 0·1808 0·1844 0·1879

0·5 0·1915 0·1950 0·1985 0·2019 0·2054 0·2088 0·2123 0·2157 0·2190 0·2224
0·6 0·2257 0·2291 0·2324 0·2357 0·2389 0·2422 0·2454 0·2486 0·2517 0·2549
0·7 0·2580 0·2611 0·2642 0·2673 0·2704 0·2734 0·2764 0·2794 0·2823 0·2852
0·8 0·2881 0·2910 0·2939 0·2967 0·2995 0·3023 0·3051 0·3078 0·3106 0·3133
0·9 0·3159 0·3186 0·3212 0·3238 0·3264 0·3289 0·3315 0·3340 0·3365 0·3389

1·0 0·3413 0·3438 0·3461 0·3485 0·3508 0·3531 0·3554 0·3577 0·3599 0·3621
1·1 0·3643 0·3665 0·3686 0·3708 0·3729 0·3749 0·3770 0·3790 0·3810 0·3830
1·2 0·3849 0·3869 0·3888 0·3907 0·3925 0·3944 0·3962 0·3980 0·3997 0·4015
1·3 0·4032 0·4049 0·4066 0·4082 0·4099 0·4115 0·4131 0·4147 0·4162 0·4177
1·4 0·4192 0·4207 0·4222 0·4236 0·4251 0·4265 0·4279 0·4292 0·4306 0·4319

1·5 0·4332 0·4345 0·4357 0·4370 0·4382 0·4394 0·4406 0·4418 0·4429 0·4441
1·6 0·4452 0·4463 0·4474 0·4484 0·4495 0·4505 0·4515 0·4525 0·4535 0·4545
1·7 0·4554 0·4564 0·4573 0·4582 0·4591 0·4599 0·4608 0·4616 0·4625 0·4633
1·8 0·4641 0·4649 0·4656 0·4664 0·4671 0·4678 0·4686 0·4693 0·4699 0·4706
1·9 0·4713 0·4719 0·4726 0·4732 0·4738 0·4744 0·4750 0·4756 0·4761 0·4767

2·0 0·4772 0·4778 0·4783 0·4788 0·4793 0·4798 0·4803 0·4808 0·4812 0·4817
2·1 0·4821 0·4826 0·4830 0·4834 0·4838 0·4842 0·4846 0·4850 0·4854 0·4857
2·2 0·4861 0·4864 0·4868 0·4871 0·4875 0·4878 0·4881 0·4884 0·4887 0·4890
2·3 0·4893 0·4896 0·4898 0·4901 0·4904 0·4906 0·4909 0·4911 0·4913 0·4916
2·4 0·4918 0·4920 0·4922 0·4925 0·4927 0·4929 0·4931 0·4932 0·4934 0·4936

2·5 0·4938 0·4940 0·4941 0·4943 0·4945 0·4946 0·4948 0·4949 0·4951 0·4952
2·6 0·4953 0·4955 0·4956 0·4957 0·4959 0·4960 0·4961 0·4962 0·4963 0·4964
2·7 0·4965 0·4966 0·4967 0·4968 0·4969 0·4970 0·4971 0·4972 0·4973 0·4974
2·8 0·4974 0·4975 0·4976 0·4977 0·4977 0·4978 0·4979 0·4979 0·4980 0·4981
2·9 0·4981 0·4982 0·4982 0·4983 0·4984 0·4984 0·4985 0·4985 0·4986 0·4986

3·0 0·4987 0·4987 0·4987 0·4988 0·4988 0·4989 0·4989 0·4989 0·4990 0·4990

This table can be used to calculate N(d), the cumulative normal distribution functions needed for the Black-Scholes model
of option pricing. If di > 0, add 0·5 to the relevant number above. If di < 0, subtract the relevant number above from 0·5.

End of Question Paper

Page 12 of 12