B8AF106

Quality & Qualifications Ireland (QQI)

BA (Hons) Accounting and Finance
Level 3

APRIL 2021 EXAMINATION

Module Code: B8AF106

Module Description: Advanced Financial Management

Examiner: Mr. Michael Kealy

Internal Moderator: Ms. Mazlinda Binti Hussin

External Examiner: Eoin Langan

Date: Monday, 26th April 2021

Time: 16.30 – 18:30

INSTRUCTIONS TO CANDIDATES
Time allowed is THREE (3) Hours
Answer any FOUR (4) Questions
All Questions carry 25 MARKS
Show All Workings
Formulae and Mathematical Tables Attached
_______________________________________________________________________________

Page 1 of 13
 B8AF106

QUESTION 1

John O’Brien has recently retired from the public sector. On his retirement, he received a large
lump sum and is considering how to invest it.
He has approached you for investment advice and tells you that he is considering an investment in
a specific company quoted on the Stock Market.
He asks you whether he should invest all of his money into a company called Kurt plc. He also asks
you to advise him on the related risk of this strategy.
John has given you the following information for Kurt plc:

Financial statistics Industry average

Share price €2.50 N/A
Dividend yield 1% 0.80%
Earnings per share 25c N/A
Return on investment (ROE) 18% 12%

Kurt plc has an equity beta of 1.3. The risk free-rate is 4% and the expected market return is 10%.

Required

(a) Outline the main implications of portfolio theory and the capital asset pricing model (CAPM)
for John O’Brien. (6 Marks)

(b) Calculate the following ratios for Kurt plc:

(i) Price/earnings ratio. (2 Marks)

(ii) Dividend per share. (2 Marks)

(iii) Dividend cover. (2 Marks)

(c) Calculate the required rate of return from an investment in the shares of Kurt plc. (5 Marks)

(d) Discuss with specific reasons whether you would recommend John O’Brien to invest in the
shares of Kurt plc. (8 Marks)

Total 25 marks

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 B8AF106

QUESTION 2

Mark Ltd is planning to manufacture a new product, which it has thoroughly tested over the last two
years.

The following information for this new investment proposal has been supplied to you:

Year 1 2 3
Anticipated sales volumes per annum 80,000 90,000 120,000

(1) The initial investment will be €900,000

(2) The unit sales prices will be €15 at current price terms, and the selling price is expected to increase
by inflation at a rate of 4% per annum.

(3) Variable cost per unit will be €10 at current price terms, and the variable cost is expected to
increase by inflation at a rate of 2% per annum.

(4) Fixed costs are estimates to be €170,000 per annum and are expected to increase by inflation at
a rate of 2% per annum.

(5) Research and development costs of €800,000 have been incurred and no further related
expenditure is planned.

(6) The company’s real required rate of return is 5%, but the company believes that a real rate of
return of 4% would be acceptable from a project with this level of business risk.

(7) General inflation rate is expected to be 2% per annum.

(8) Estimated corporation tax rate is 30% and corporation tax is payable one year in arrears.

(9) Tax allowance depreciation on the new machine is available at 25% reducing balance basis.

Required

(a) Calculate the following for this investment proposal:

(i) Net present value (10 Marks)

(ii) Internal rate of return (4 Marks)

(b) Evaluate your findings at (b) and advise whether the investment proposal is financially acceptable.
(3 marks)

(c) Explain the advantages and disadvantages of using the Internal rate of return method
(8 marks)

Total 25 marks

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 B8AF106

QUESTION 3

The Board of Arthur plc are unhappy with their commercial progress. They have asked you to meet
them and discuss growth strategies.
They have asked you to brief them on specific aspects of acquisitions.

Required:

Explain the advice you will give them on each of the following topics:

a) Reasons for Acquisitions (8 marks)

b) Corporate issues arising on Acquisitions (8 marks)

c) Information needed for the appraisal of Acquisitions. (9 marks)

Total 25 marks

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 B8AF106

# QUESTION 4

Grange Ltd is seeking expansion opportunities. It identified a variety of companies for

consideration, but has now narrowed its search down to two.

One company which operates in a much riskier segment of the market than Grange’s current
business.

The other company is similar to Grange and will enable it to expand its current business. It is
anticipated that there will be little change in the company’s debt to equity levels.

Additional information for Grange Ltd before the expansion is as follows:

equity €m
Ordinary shares (€0.50) 400
equity Retained earnings 1,000
6% bank loan 500
Rebt

Additional information:

• Corporation tax rate is 30%.

• Grange’s shares are currently trading at €5.00

• Grange Ltd’s equity beta is estimated to be 1.3. The systematic risk of debt can be assumed
to be zero.
Rf RM

• The risk free rate is 4% and the return on the market 10%.
Be .

• The equity beta of the main competitor in the same industry as the new venture is 1.8, and
the competitor’s capital gearing is 60% equity, 40% debt by market values.

Required:

(a) Calculate the current weighted average cost of capital of Grange Ltd. (9 Marks)

(b) Estimate the risk adjusted cost of capital that Grange Ltd should use as the discount rate
for its proposed investment in the new venture. State any assumptions that you make.
(9 Marks)

(c) Identify and briefly discuss the advantages and disadvantages of the CAPM when being
used to calculate the required return on equity. (7 Marks)

Total 25 marks
Page 5 of 13
a cost of (Ke)
equity
① New Beta - Ba : 1 8x
.

60
= 1 .

23 %
60 + 40(1 -
0 .

3)

② 1 .
23 =
 B8AF106

QUESTION 5

Corinth Ltd is considering investing in one of two portfolios of two financial investments.

The company’s objective is to reduce risk through diversification and it believes that the return on
any individual investment is not correlated with the return on any other investment.

The market return is estimated to be 8% and the risk-free rate is 4%.

The amount invested, the expected return, the standard deviation and betas are given as follows:

Portfolio 1

Investment Amounts invested Expected return Total risk σ Equity beta β

Company X €120 million 9% 6% 1.1
Company Y €90 million 12% 4% 1.2

Portfolio 2

Investment Amounts invested Expected return Total risk σ Equity beta β

Company X €60 million 13% 8% 1.3
Company Y €80 million 15% 10% 1.7

Required

(a) Estimate the expected return of the two portfolios. (5 Marks)

(b) Calculate the risk of the two portfolios. (5 Marks)

(c) Calculate the Sharpe ratio (2 Marks)

(d) Estimate the required rate of return on the two portfolios using the capital asset pricing model
and advise which portfolio should be selected. (5 Marks)

(e) Explain diversification in the context of Systematic and Unsystematic risk.

(8 Marks)

Total 25 marks

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 B8AF106

QUESTION 6

(a) Explain each of the following types of foreign currency exchange risk:

(i) Economic Risk (3 marks)

(ii) Transaction risk (3 marks)
(iii) Translation risk (3 marks)

(b) Explain any two types of internal hedging techniques

(6 marks)

(c) A UK Company, Redhill plc. must make a payment to its USA supplier of US$400,000
in three months time.
Its Financial Controller has obtained the following rates:

US$ / Stg£
Spot: 1.3835 – 1.3860
3 months forward: 1.3945 – 1.3870

Current money market rates (pa) are as follows:

Borrowing Deposit
US$: 2% 1%
Stg£: 4% 2.5%

Show how the company can hedge its exposure to FX risk using:
(i) The forward markets (2 marks)
(ii) The money markets (6 marks)
(iii) Determine and explain which is the best hedging technique.
(2 marks)

(Note: Interest rates can be time-apportioned).

Total 25 marks

END OF EXAMINATION

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 B8AF106

MATHEMATICAL TABLES AND FORMULAE

HOLDING PERIOD RETURN

r = DV1 + (PV1 – PVo)

PVo

INTERNAL RATE OF RETURN

IRR = DCF (A) + [ NPV (A)____ x (DCF(B) – DCF(A))]

NPV(A) – NPV(B)

PRESENT VALUE OF A SHARE

PVo = DV0 x (1+g)

(ke – g)

CAPITAL ASSET PRICING MODEL

Ke = rf + [E(rm) – rf] x Bj

MODIGLIANI AND MILLER PROPOSITION 2 WITH TAX

Keg = Keu + [(1-t) x (Keu – Kd) x D ÷ E]

COST OF EQUITY CAPITAL

Ke = DVo x (1+g) + g
PVo

GORDON’S GROWTH APPROXIMATION

g = bre

WEIGHTED AVAERAGE COST OF CAPITAL

Ko = Ke x E + Kd (1-t) x D
E+D E+D

ASSET BETA FORMULA

β a = βe x E + βd x D(1-t)_
E + D(1-t) E + D(1-t)

VALUE OF A GEARED COMPANY

Vg = Vu + PV tax shield

TOTAL PRESENT VALUE MODEL

PV0 = Free cash flows x (1+g)

WACC – g

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 B8AF106

FREE CASH FLOW

PBIT x (1-t) + depreciation – capital spending +/- working capital

COST OF IRREDEEMABLE DEBT CAPITAL

Kd = Annual interest (1-t) x 100%

Market value of debt

PERPETUITY GROWTH FORMULA

PV0 = cn
r-g

STANDARD DEVIATION OF RETURNS OF A TWO ASSET PORTFOLIO

________________________________________
σAB = √y2σ2A + (1-y)2σ2B + 2 x y x (1-y) x PAB x σA x σB

THE FISHER FORMULA

1+ rnominal = (1+rreal) x (1+inflation)

INTEREST RATE PARITY FORMULA

F0 = S0 x (1+ic)
(1+ib)

PURCHASING POWER PARITY FORMULA

S1 = S0 x (1+hc)
(1+hb)

Page 9 of 13
 B8AF106

PRESENT VALUE TABLES

Periods 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 0.874 0.857 0.841 0.826
3 0.970 0.942 0.916 0.889 0.864 0.840 0.817 0.794 0.772 0.751
4 0.960 0.924 0.889 0.855 0.823 0.792 0.764 0.735 0.708 0.683
5 0.950 0.906 0.863 0.822 0.784 0.747 0.714 0.681 0.650 0.621

6 0.941 0.888 0.838 0.790 0.747 0.705 0.667 0.631 0.596 0.565
7 0.932 0.871 0.814 0.760 0.711 0.665 0.623 0.584 0.547 0.514
8 0.923 0.854 0.790 0.731 0.677 0.627 0.582 0.541 0.502 0.467
9 0.914 0.837 0.767 0.703 0.645 0.592 0.544 0.501 0.461 0.425
10 0.905 0.821 0.745 0.676 0.614 0.558 0.508 0.464 0.423 0.386

11 0.896 0.805 0.723 0.650 0.585 0.526 0.475 0.430 0.388 0.351
12 0.887 0.789 0.702 0.625 0.557 0.496 0.444 0.398 0.356 0.319
13 0.878 0.774 0.682 0.601 0.530 0.468 0.415 0.369 0.327 0.290
14 0.869 0.759 0.662 0.578 0.505 0.442 0.388 0.342 0.300 0.264
15 0.860 0.744 0.643 0.556 0.481 0.417 0.363 0.317 0.275 0.240

16 0.851 0.729 0.624 0.535 0.458 0.393 0.339 0.294 0.252 0.218
17 0.843 0.715 0.606 0.514 0.436 0.371 0.317 0.272 0.231 0.198
18 0.835 0.701 0.588 0.494 0.415 0.350 0.296 0.252 0.212 0.180
19 0.827 0.687 0.571 0.475 0.395 0.330 0.277 0.233 0.194 0.164
20 0.819 0.674 0.554 0.457 0.376 0.311 0.259 0.216 0.178 0.149

Periods 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 0.757 0.743 0.731 0.718 0.706 0.694
3 0.732 0.712 0.693 0.675 0.658 0.641 0.625 0.608 0.593 0.578
4 0.659 0.636 0.613 0.592 0.572 0.553 0.534 0.515 0.498 0.482
5 0.594 0.568 0.542 0.519 0.497 0.477 0.456 0.436 0.418 0.402

6 0.535 0.507 0.480 0.455 0.432 0.411 0.390 0.369 0.351 0.335
7 0.482 0.453 0.425 0.399 0.376 0.354 0.333 0.313 0.295 0.279
8 0.434 0.404 0.376 0.350 0.327 0.305 0.285 0.265 0.248 0.233
9 0.391 0.361 0.333 0.307 0.284 0.263 0.244 0.225 0.208 0.194
10 0.352 0.322 0.295 0.269 0.247 0.227 0.209 0.191 0.175 0.162

11 0.317 0.288 0.261 0.236 0.215 0.196 0.179 0.162 0.147 0.135
12 0.286 0.257 0.231 0.207 0.187 0.169 0.153 0.137 0.124 0.113
13 0.258 0.229 0.204 0.182 0.163 0.146 0.131 0.116 0.104 0.094
14 0.232 0.204 0.181 0.160 0.142 0.126 0.112 0.098 0.087 0.078
15 0.209 0.182 0.160 0.140 0.123 0.109 0.096 0.083 0.073 0.065

16 0.188 0.163 0.142 0.123 0.107 0.094 0.082 0.070 0.061 0.054
17 0.169 0.146 0.126 0.108 0.093 0.081 0.070 0.059 0.051 0.045
18 0.152 0.130 0.112 0.095 0.081 0.070 0.060 0.050 0.043 0.038
19 0.137 0.116 0.099 0.083 0.070 0.060 0.051 0.042 0.036 0.032
20 0.123 0.104 0.088 0.073 0.061 0.052 0.044 0.036 0.030 0.027

Page 10 of 13
 B8AF106

PRESENT VALUE TABLES

Periods 21% 22% 23% 24% 25% 26% 27% 28% 29% 30%
1 0.826 0.820 0.813 0.806 0.800 0.794 0.787 0.781 0.775 0.769
2 0.683 0.672 0.661 0.650 0.640 0.630 0.620 0.610 0.601 0.592
3 0.564 0.551 0.537 0.525 0.512 0.500 0.488 0.477 0.466 0.455
4 0.466 0.451 0.437 0.423 0.410 0.397 0.384 0.373 0.361 0.350
5 0.386 0.370 0.355 0.341 0.328 0.315 0.303 0.291 0.280 0.269

6 0.319 0.303 0.289 0.275 0.262 0.250 0.239 0.227 0.217 0.207
7 0.263 0.249 0.235 0.222 0.210 0.198 0.188 0.178 0.168 0.159
8 0.218 0.204 0.191 0.179 0.168 0.157 0.148 0.139 0.130 0.123
9 0.180 0.167 0.155 0.144 0.134 0.125 0.116 0.108 0.101 0.094
10 0.149 0.137 0.126 0.116 0.107 0.099 0.092 0.085 0.078 0.073

11 0.123 0.112 0.103 0.094 0.086 0.079 0.072 0.066 0.061 0.056
12 0.102 0.092 0.083 0.076 0.069 0.062 0.057 0.052 0.047 0.043
13 0.084 0.075 0.068 0.061 0.055 0.050 0.045 0.040 0.037 0.033
14 0.069 0.062 0.055 0.049 0.044 0.039 0.035 0.032 0.028 0.025
15 0.057 0.051 0.045 0.040 0.035 0.031 0.028 0.025 0.022 0.020

16 0.047 0.042 0.036 0.032 0.028 0.025 0.022 0.019 0.017 0.015
17 0.039 0.034 0.030 0.026 0.023 0.020 0.017 0.015 0.013 0.012
18 0.032 0.028 0.024 0.021 0.018 0.016 0.013 0.012 0.010 0.009
19 0.027 0.023 0.020 0.017 0.014 0.012 0.011 0.009 0.008 0.007
20 0.022 0.019 0.016 0.014 0.012 0.009 0.008 0.007 0.006 0.005

Page 11 of 13
 B8AF106

ANNUITY TABLES

Periods 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 1.941 1.914 1.887 1.859 1.833 1.808 1.783 1.759 1.735
3 2.941 2.883 2.829 2.776 2.723 2.673 2.624 2.577 2.531 2.486
4 3.902 3.807 3.717 3.631 3.546 3.465 3.387 3.312 3.239 3.169
5 4.853 4.713 4.580 4.453 4.330 4.212 4.100 3.993 3.889 3.790

6 6.795 5.601 5.417 5.243 5.076 4.917 4.766 4.623 4.485 4.354
7 6.728 6.472 6.230 6.003 5.787 5.582 5.389 5.206 5.032 4.867
8 7.651 7.325 7.019 6.734 6.464 6.209 5.971 5.746 5.534 5.334
9 8.565 8.162 7.785 7.437 7.109 6.801 6.515 6.246 5.994 5.758
10 9.470 8.982 8.529 8.113 7.723 7.359 7.023 6.709 6.416 6.144

11 10.37 9.786 9.251 8.763 8.308 7.886 7.498 7.138 6.804 6.494
12 11.26 10.57 9.952 9.388 8.865 8.383 7.942 7.535 7.160 6.813
13 12.14 11.34 10.63 9.989 9.395 8.852 8.357 7.903 7.486 7.103
14 13.01 12.10 11.29 10.57 9.900 9.294 8.745 8.243 7.785 7.366
15 13.87 12.84 11.93 11.13 10.38 9.711 9.107 8.558 8.060 7.605

16 14.72 13.57 12.55 11.66 10.84 10.10 9.446 8.850 8.312 7.823
17 15.56 14.28 13.16 12.17 11.28 10.47 9.763 9.120 8.543 8.021
18 16.40 14.98 13.75 12.66 11.70 10.82 10.06 9.370 8.755 8.201
19 17.23 15.67 14.32 13.13 12.10 11.15 10.34 9.602 8.949 8.365
20 18.05 16.34 14.87 13.59 12.48 11.46 10.60 9.817 9.127 8.514

Periods 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 1.646 1.626 1.605 1.586 1.565 1.546 1.527
3 2.444 2.402 2.361 2.321 2.284 2.246 2.210 2.174 2.139 2.106
4 3.103 3.038 2.974 2.913 2.856 2.798 2.744 2.690 2.638 2.588
5 3.696 3.605 3.517 3.432 3.353 3.274 3.200 3.127 3.057 2.990

6 4.231 4.112 3.997 3.888 3.785 3.684 3.590 3.497 3.409 3.325
7 4.713 4.564 4.422 4.288 4.161 4.038 3.923 3.811 3.705 3.604
8 5.147 4.968 4.798 4.639 4.488 4.343 4.208 4.077 3.954 3.837
9 5.538 5.329 5.131 4.947 4.772 4.606 4.451 4.302 4.163 4.031
10 5.890 5.651 5.426 5.217 5.019 4.833 4.659 4.493 4.339 4.193

11 6.207 5.938 5.687 5.454 5.234 5.028 4.837 4.655 4.487 4.328
12 6.493 6.195 5.918 5.662 5.421 5.196 4.989 4.792 4.611 4.440
13 6.751 6.424 6.122 5.844 5.584 5.341 5.119 4.908 4.715 4.533
14 6.983 6.629 6.303 6.004 5.725 5.466 5.230 5.007 4.803 4.611
15 7.192 6.812 6.463 6.144 5.848 5.574 5.325 5.091 4.877 4.676

16 7.380 6.975 6.604 6.267 5.955 5.667 5.406 5.162 4.939 4.730
17 7.550 7.121 6.729 6.375 6.048 5.747 5.475 5.222 4.991 4.775
18 7.703 7.251 6.840 6.470 6.129 5.816 5.534 5.273 5.035 4.813
19 7.841 7.367 6.938 6.553 6.199 5.876 5.585 5.316 5.072 4.844
20 7.965 7.471 7.025 6.626 6.260 5.927 5.628 5.353 5.103 4.870

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 B8AF106

ANNUITY TABLES

Periods 21% 22% 23% 24% 25% 26% 27% 28% 29% 30%
1 0.826 0.820 0.813 0.807 0.800 0.794 0.787 0.781 0.775 0.770
2 1.509 1.492 1.474 1.457 1.440 1.424 1.407 1.392 1.376 1.361
3 2.074 2.042 2.011 1.981 1.952 1.923 1.896 1.868 1.842 1.816
4 2.540 2.494 2.448 2.404 2.362 2.320 2.280 2.241 2.203 2.166
5 2.926 2.864 2.804 2.745 2.689 2.635 2.583 2.532 2.483 2.436

6 3.245 3.167 3.092 3.021 2.951 2.885 2.821 2.750 2.700 2.643
7 3.508 3.416 3.327 3.242 3.161 3.083 3.009 2.937 2.868 2.802
8 3.726 3.619 3.518 3.421 3.329 3.241 3.156 3.076 2.999 2.925
9 3.905 3.786 3.673 3.566 3.463 3.366 3.273 3.184 3.099 3.092
10 4.054 3.923 3.800 3.682 3.571 3.465 3.364 3.269 3.178 3.109

11 4.177 4.035 3.902 3.776 3.656 3.544 3.437 3.335 3.239 3.147
12 4.279 4.127 3.985 3.851 3.725 3.606 3.493 3.387 3.286 3.190
13 4.362 4.203 4.053 3.912 3.780 3.656 3.538 3.427 3.322 3.223
14 4.432 4.265 4.108 3.962 3.824 3.695 3.573 3.459 3.351 3.249
15 4.489 4.315 4.153 4.001 3.859 3.726 3.601 3.483 3.373 3.268

16 4.536 4.357 4.189 4.033 3.887 3.751 3.623 3.503 3.390 3.283
17 4.576 4.391 4.219 4.059 3.910 3.771 3.640 3.518 3.403 3.295
18 4.608 4.419 4.243 4.080 3.930 3.786 3.654 3.529 3.413 3.304
19 4.635 4.442 4.263 4.097 3.942 3.799 3.664 3.539 3.421 3.312
20 4.657 4.460 4.279 4.110 3.954 3.808 3.673 3.546 3.427 3.316

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