Professional Documents
Culture Documents
ANF913
1
How have the syllabus learning outcomes been examined?
Syllabus learning outcomes
How syllabus outcomes are
examined Example past papers
Purpose of financial management,
and relationship to financial &
management accounting.
Discussion question examining
importance of shareholder
wealth maximisation.
Discuss the relationship
between investment decisions,
dividend decisions and
financing decisions
QSX
- June 2010, part (c), 8 marks
Financial objectives and relationship
with corporate strategy.
Use of ratio analysis to assess
achievement of objectives.
NG
- Dec 2009, part (b), 9 marks
QSX
- June 2010, part (c), 10 marks
YNM
- June 2011, part (a) 13 marks
Bar Co
- Dec 2011, parts (b) & (c) 11 marks
GWW Co
- Dec 2012, part (c) 5 marks
Stakeholders and impact on
corporate objectives.
Discussion of how to motivate
managers to achieve objectives.
Discussion of conflict between
stakeholders
Dartig
- Dec 2008, part (e), 8 marks
Zigto
- June 12, part (a), 4 marks
Financial and other objectives in
not-for-profit organisations.
Comparison of objectives of not
for profit and profit seeking
organisations
Bar
- Dec 2011, part (d), 11 marks
Financial management
and financial objectives
1: FINANCIAL MANAGEMENT AND FINANCIAL OBJECTIVES
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Overview
Linking to
Corporate objectives
Needs for other stakeholders
Dividend decision Investment decision Financing decision
Maximisation of
shareholder wealth
Pay out or reinvest?
New projects
Acquisitions
Working capital
Raising capital to finance
investment
Minimise cost of capital
Reporting / monitoring
Financial accounting
Management accounting
Value for money if a not for
profit organisation
Encouraged by
Corporate governance
Agency theory
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1 Financial objectives
1.1 Profit maximisation is often assumed to be the main objective of a business. However,
shareholders sometimes express disappointment in a companys performance even when
profits are rising; this suggests that profit is not sufficient as a business objective.
Lecture example 1 Exam standard for 8 marks
At the end of 2007 Ryanair announced, as part of a stock market briefing, that pre-tax profit for the
year had risen by 33%. Immediately after the announcement the share price fell by 8%.
Required
(a) Discuss why shareholders might be dissatisfied, despite higher profits? (6 marks)
(b) What other measure could be used to assess Ryanairs performance? (2 marks)
Solution
1.2 For a profit making company, maximisation of shareholder wealth is assumed to be the
financial objective. The ability of a firm to create wealth for shareholders is measure by total
shareholder return.
Total shareholder return =
dividend+ change in share price
share price at the start of the year
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2 A framework for maximising shareholder wealth
Investment decisions
2.1 Investment decisions (in projects, takeovers or working capital) need to be analysed to
ensure that they are beneficial to the investor; this is covered in later chapters.
2.2 Investments can help a firm to achieve key corporate objectives such as market share,
quality etc; these will be monitored by the management accounting department. Investments
also help a firm to achieve key financial objectives such as improving earnings per share.
Lecture example 1
Exam standard question for 12 marks
Ben is a wholesaler of motorcycle helmets, it is 1 January 20X2.
Credit sales in the last quarter of 20X1 were as follows:
Helmets
October 2,000
November 2,000
December 2,500
His credit sales in the first quarter will be as follows:
Helmets
January 3,000
February 5,000
March 4,500
Customers are given 60 days' credit and the average selling price is 10. His biggest customer,
Mickster, is given a 2% discount for paying cash when the sale is made. Mickster is planning to
buy 150 helmets in January and 250 Helmets in March. The sales to Mickster are in addition to
those credit sales stated above.
Purchases (an average of 30 days credit) are 4 per helmet. Ben plans to buy in the helmets a
month in advance of selling them. Total overheads are 2,000 per month, this includes 400
depreciation and wages of 1,000. All other overheads are paid for after a credit period of 30 days.
Ben plans to inject a further 5,000 of his own money into the business in March to help to buy
non-current assets for 24,000. These assets will be depreciated over 5 years.
Required
Prepare a monthly cash flow forecast for the 1st quarter of 20X2; the opening balance is negative
4,550.
Solution
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4 Mathematical models
4.1 The cash flow forecast calculates the cash needed for a period eg 1.5m might be needed
to fund forecast cash outflows expected by a division in a particular year. Some businesses
pay the expenses of a particular department or division from a separate sub account. If so, it
is not sensible to deposit the 1.5m into this sub-account at the start of the year because
this will lead to a loss of interest earned from a high interest account or from securities.
Instead, it is better to gradually transfer the funds as they are needed.
4.2 How much to transfer can be calculated by using mathematical models, there are two
mathematical models that you need to be aware of:
(a) Baumols model
(b) Miller-Orrs model
Baumol model
4.3 The Baumol Model is an adaptation of the EOQ Model to manage cash. It assumes that
cash is used at a steady rate during the year, which will often not be the case.
The Economic Order =
Quantity of Cash
cash holding of cost interest Net
required cash Annual cash ordering of Cost 2
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Solution
4.6 This model assumes that cash flows are unpredictable, in fact an experienced financial
controller should be able to predict the cash flows so enabling a company to operate on
lower cash levels than the Miller-Orr model calculates.
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5 Managing cash flow surpluses
5.1 Most companies would want to avoid risk on short-term cash surpluses that are invested
because the funds will be needed in the near future. Desirable investments would generally
be low risk and liquid. These could include:
Investments Definition
Treasury bills Short-term government IOUs, can be sold when needed.
Term deposits Fixed period deposits.
Certificates of
deposit
Issued by banks, entitle the holder to interest + principal, can be
sold when needed.
Commercial paper Short-term IOUs issued by companies, unsecured.
5.2 Long term cash surpluses may be used to fund:
(a) Investments new projects or acquisitions
(b) Financing repay debt, buy back shares
(c) Dividends
6 Managing cash flow shortages
Working capital funding policy
6.1 Cash shortages can be funded by either long-term finance or short-term borrowings; these
will be covered in detail in later chapters.
6.2 In between these extremes is a matching policy which uses short-term finance to fund
fluctuating current assets and long term finance to fund permanent current assets
and non-current assets.
6.3 The likelihood of a company adopting an aggressive approach depends on:
(a) Management attitude to risk
(b) Strength of relationship with the bank providing an overdraft
(c) Ability to raise long-term finance
Short-term
Usually cheaper so some companies
adopt an aggressive approach & rely
mainly on short-term finance. Risky but
potentially results in higher profits.
Long-term
Other companies adopt a conservative
approach and rely mainly on long-term
finance.
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7 Chapter summary
Section Topic Summary
1 Management
of cash
Working capital movements have cash flow
implications that need to be carefully managed.
2 & 3 Forecasting Cash flow forecasts will be prepared continuously
during the year and will allow a business to plan how
to deal with expected cash flow surpluses or
shortages.
4 Mathematical
models
There are two mathematical models that you need to
be aware of:
(a) Baumols model
(b) Miller-Orrs model
5 Managing cash
flow surpluses
Desirable investments would generally be low risk
and liquid
6 Managing cash
flow shortages
A matching policy which uses short-term finance to
fund fluctuating current assets and long term finance
to fund permanent current assets and non-current
assets.
END OF CHAPTER
Q3
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Checkpoint 1 Progress Review
To reinforce your learning to date you should now follow the study guidance in the
following pages. On completion, your progress towards full exam preparation will be:
Key messages from Stage 1
You have now completed Stage 1 of the course. Dont worry if you are finding this paper challenging, not
many people have practical experience (at this stage in their careers) of using the techniques in this paper
and many people find it difficult as a result.
Take some time to reflect on the knowledge and skills you covered during Stage 1. If you feel you need
further clarification on any of the key areas listed below, you can use the on-line lecture for the relevant
chapter. The Course Notes section for each chapter (starting overleaf) provides helpful guidance (and time
commitments) on how to focus your review on the key learning points in your notes.
Key knowledge
The main aim of financial management is to construct investment, financing and dividend policies that
will help to maximise shareholder wealth.
You need to be able to calculate a number of key ratios including: return on capital employed, gearing,
interest cover, earnings per share and total shareholder return.
You need to be able to discuss the objectives of working capital management and to measure the
operating cycle and the sales/net working capital ratio.
You need to be able to evaluate inventory management using the EOQ model.
You need to be able to evaluate cash flow management using forecasts and mathematical models.
Key skills
You need to be able to analyse the meaning of a number of key ratios including: return on capital employed,
gearing, interest cover, earnings per share and total shareholder return.
You need to be able to discuss the conflict between the objectives of working capital management and to
analyse the impact of the operating cycle and the sales/net working capital ratio.
You need to be able to analyse and discuss the management of each individual type of working capital.
You need to be able to analyse and discuss the impact of a cash flow forecast.
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Checkpoint 1 Study Support
Chapter 1 Financial management and financial objectives 70 mins
Key areas
The framework for maximising shareholder wealth, and for value for money
The needs of internal, connected and external stakeholders
Calculation of profitability, debt, liquidity and shareholder investor ratios
Course Notes
This chapter sets up the framework for the paper; carefully review section 2 to
check your understanding.
Discussion questions will require you to understand the concept of agency theory
(section 3) and how it can be managed by corporate governance and incentive
schemes.
Review Lecture Example 4 and make sure that you understand the types of
profitability, debt, liquidity and shareholder investor ratios (including total
shareholder return) and how they are calculated remember that you will not be
given the definition of these ratios in the real exam.
20 mins
Question practice
Do an answer plan for Question 1 (Earnings per share) from the Study Text
Question Bank; this is a good test of your understanding of shareholder and
stakeholder needs.
20 mins
Additional Resources
Real-life example
In the real-life examples section you will find a recent web article illustrating the
relationship between the investment decision and the dividend decision. It is strongly
recommended that you read this to help you understand how businesses make such
decisions.
Study Text
Work through section 1.5 to ensure that you understand the difference between
management and financial accounting, and financial management. Review sections
2.1 2.2; the achievement of a range of corporate objectives (shareholder wealth
maximisation is arguably the most important) requires sound financial management
(investment / financing / dividend decisions). These corporate objectives address
the needs of a number of stakeholders; the likely needs of these stakeholders are
outlined in section 3.
Review section 4.4.4 and note that return on equity is also referred to as return on
shareholders funds.
Read section 6 and make sure you can give examples of economy, efficiency and
effectiveness. This area is likely to be tested in the exam as part of a question on
objectives.
10 mins
10 mins
10 mins
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Checkpoint 1 Study Support (cont)
Chapter 2 Economic environment for business 70 mins
Key areas
How government economic policy affects a business
Course Notes
Carefully work the lecture examples in this chapter, and make sure that you
understand the meaning of each of the policy types.
This is not an economics exam you need to understand that as a government tries
to achieve its three main macroeconomic targets, the policies that it uses may affect
the financial strategy of a business.
30 mins
Question Practice
Question 2 (News for you) from the Study Text Question Bank plan out an answer
to this question to ensure you are comfortable with the issues involved; concentrate
on part (a).
20 mins
Additional Resources
Study Text
Read the practical examples in sections 5.4, 5.7 and 7.2 to see the relevance of the
topics covered in this chapter.
Carefully review section 5; competition policy is an area of government policy that
directly affects companies and is a likely area to be tested as a part of an exam
question.
5 mins
15 mins
Chapter 3 - Financial markets and institutions 25 mins
Key areas
The functions of financial intermediaries
The difference between the money market and the capital market, and the link
between risk and return for the securities traded on these markets
The importance of the stock market and of the Euromarkets
Course Notes
Review the chapter. Make sure that you understand the difference between financial
institutions / intermediaries and financial markets.
Also make sure that you can discuss the money markets and the capital markets -
concentrate on the learning points from Lecture Example 1. The Euromarkets are an
emerging an important source of capital so carefully review section 7 of this chapter.
10 mins
Additional resources
Real-life example
In the real-life examples section you will find a recent article which explains the
growing use of bonds and also an article explaining Eurobonds in more detail. It is
strongly recommended that you read these to develop your understanding of
sources of finance.
15 mins
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Checkpoint 1 Study Support (cont)
Chapter 4 Working capital 60 mins
Key areas
The two objectives of working capital management and how they may conflict
Calculation of cash operating cycle and use of the sales/net working capital ratio
The problem of overtrading and how it can be managed
Course Notes
Review the chapter ensuring you can calculate all ratios involved in the calculation
of the operating cycle and that your rework example 4 to make sure that you
understand the importance of the sales / net working capital ratio.
10 mins
Question Practice
Attempt Question 4 (Gustaffson) in the Study Text Question Bank this tests
calculations, the key liquidity ratios and the concept of overtrading.
45 mins
Additional Resources
Study Text
Read section 2 to reinforce the objectives of working capital management and
section 3 which contains a practical case study.
5 mins
Chapter 5 Managing working capital 20 mins
Key areas
Different approaches to inventory management (EOQ, JIT)
The key features of accounts receivable management, including foreign accounts
receivable
Course Notes
This is an important chapter and needs to be carefully reviewed. It would be
sensible to rework as many of the lecture examples as you can.
Make sure that you understand the impact of bulk purchase discounts and buffer
inventory on the EOQ; rework Lecture Example 2.
Ensure that you understand the potential benefits of JIT.
Review paragraph 2.2, this is a useful framework for discussing the management of
receivables. Finally, management of foreign exchange receivables is an area of this
chapter that is easy to neglect; make sure that you cover this section carefully.
10 mins
5 mins
5 mins
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Checkpoint 1 Study Support (cont)
Chapter 6 Working capital finance 30 mins
Key areas
Preparation of a cash flow forecast, including the use of cash management models
Management of cash flow surpluses and deficits
Course Notes
This chapter was tested in the pilot paper and in June 2009. Rework examples 2 & 3
to make sure that you can use the Baumol & Miller-Orr models.
Also make sure that you can discuss how to manage cash flow surpluses and
shortages, this is covered in sections 5 & 6.
10 mins
Question Practice
Attempt Question 7 (SF) from the Study Text Question Bank plan out an answer
to the question and review the solution.
20 mins
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Checkpoint 1 - Progress Test
Having completed the home study guidance contained on pages 65 to 69, you are now ready to attempt the
Progress Test. You should aim to complete the test in 1 hour. If you find it takes you significantly longer to
do so then please contact your course tutor for guidance.
The multiple choice questions contained within this Progress Test will thoroughly test your understanding of
the material and your ability to perform the required calculations. Note that the F9 exam does not contain
multiple choice questions. The four short questions that follow will test your ability to apply your knowledge.
These skills will prove important when answering exam standard questions.
It is important that you continually review your progress (solutions are on page 73) and revise further any
areas where you feel your understanding is weak.
A Multiple choice questions (10 questions approximate time 40
minutes)
Data for questions 1 and 2
A company has the following income statement and statement of financial position extracts:
$
$
P.B.I.T
500,000
Non-current assets
5,000,000
Interest
(50,000)
PBT
450,000
Current assets
2,500,000
Tax (50%)
(225,000)
225,000
Less:
Current Liabilities
(1,500,000)
Preference Dividend
(25,000)
Ordinary Dividend
(100,000)
Net Assets
6,000,000
Dividend Retained
100,000
1 The ROCE is:
A 10%
B 7.5%
C 8.3%
D 3.75% (2 marks)
2 Dividend cover is:
A 1.8
B 2
C 1.0
D 1.4 (2 marks)
3 Interest cover(age) is:
A 9.0
B 4.5
C 10.0
D 2.0 (2 marks)
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4 Extracts of financial details of a company are as follows:
$
Sales
500,000
Cost of sales
420,000
Purchases
280,000
Receivables
62,500
Payables
42,000
Inventory
185,000
The operating cycle to the nearest whole day is:
A 190 days
B 140 days
C 152 days
D Cannot be calculated (4 marks)
5 Using the data from Question 4, the sales to net working capital ratio is:
A 2.43
B 8.00
C 1.46
D Cannot be calculated (2 marks)
6 Using the data from Questions 5 and 6 the increase in cash required to support a sales increase of
30%, to the nearest $000 is:
A $6
B $215
C $62
D $65 (2 marks)
7 You are given the following details.
Share capital 500,000 5c shares
Income Statement
$
Profit before tax
400,000
Tax
(100,000)
Earnings
300,000
Dividends
(100,000)
Retained
200,000
The EPS is:
A 80c
B 40c
C 60c
D 30c (2 marks)
8 A company faces demand of 500 units per month for imported ipods that it purchases for $50 per
unit. The cost of an order is $100 and holding costs are 10% p.a. of inventory value. The economic
order quantity (to the nearest unit) is:
A 100
B 490
C 333
D 1,000 (2 marks)
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9 A company with annual sales of $960,000 has average receivables of two months are considering
offering a 2% prompt payment discount. They estimate that half of their customers will take up this
discount and that that this will have the effect of reducing average receivables to one month. This
company currently has a bank overdraft which costs 15% p.a.
The net benefit / (cost) of this change will be:
A ($7,200) cost
B $70,400 benefit
C ($22,400) cost
D $2,400 benefit (2 marks)
10 Bonds that are issued by a company at a large discount to their eventual redemption value, but on
which no interest is paid until redemption, are called:
A Debentures
B Zero coupon bonds
C Equity bonds
D Floating rate bonds (2 marks)
B Short written questions (4 questions approximate time 20 minutes)
1 Compare the objectives of a listed company with those of a not for profit organisation (6 marks)
2 Identify the three key elements of a financial strategy (3 marks)
3 Discuss the impact of a devaluation of the pound on a UK firm exporting to the USA (3 marks)
4 Describe the functions of a financial intermediary (3 marks)
END OF PROGRESS TEST
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Checkpoint 1 - Progress Test solutions
Section A
1 C ROCE = 500/6,000 = 8.3%
2 B Dividend cover = times 2
$100,000
$200,000
dividend Ordinary
dividend preference after Profit
3 C Interest cover = times 10
$50,000
$500,000
interest
PBIT
4 C Inventory days = 365
$420,000
$185,000
= 161 days
Receivables days = 365
$500,000
$62,500
= 46 days
Payables days = 365
$280,000
$42,000
=
55 days
=
152 days
5 A Sales / net working capital = 500,000 / (185,000 + 62,500 42,000) = 2.43
6 C Sales increase = $150,000, divide this by 2.43 = $62,000 approx
7 C EPS = 60c
500,000
$300,000
issue in Shares
Earnings
8 B (2 x $100 (500 12 months) / 5) = 490
9 D The net benefit / (cost) of this change will be:
Cost = 0.5 $960,000 0.02 = $9,600
Benefit = reduction of 1 month = 1/12 $960,000 = $80,000 reduction in receivables leading
to an overdraft saving of $80,000 0.15 = $12,000
Net benefit = $12,000 $9,600 = $2,400
10 B Zero coupon bonds are rare. Floating rate bonds are bonds on which the interest rate is altered
periodically to bring it into line with current market rates of interest.
Section B
1 A listed companys primary objective will be to maximise shareholder wealth; it will also have other
financial objectives such as improving earnings and sometimes dividend per share. To reflect the
importance of other stakeholders, there may be corporate objectives for improving market share or
reducing CO
2
emissions etc.
A not for profit organisation must try to achieve its objectives while operating within its budget. A
typical objective for this type of business is to maximise value for money, ie achieve good economy
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(in purchasing inputs) efficiency (in the use of these inputs) and effectiveness (time or quality
targets).
2 These are:
Investment planning finding investments that will achieve a good return for shareholders
Financial planning using a mix of debt and equity that is acceptable to the stakeholders of a business
Dividend planning identifying whether it is better to pay out a dividend or re-invest it into the
business.
3 The value of the $ will have gone up, so the value of $ receipts will be higher. This will mean that the
exports are more profitable, which is likely to stimulate UK exports to the USA.
4 Financial intermediaries provide the following functions: (remember as MAP)
Functions Description
Maturity transformation A bank can make a 10 year loan (long-term) while still allowing its
depositors to take money out whenever they want; so short-term
deposits become long-term investments.
Aggregation of funds A bank can aggregate lots of small amounts of money into a large
loan.
Pooling losses Any losses sustained from a bad debt will not impact directly on an
individual depositor.
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Checkpoint 1 Real-life examples
Case 1 - Ryanair ponders sober maturity
Financial Times December 2009
Rebellious youths often mellow into conformity later in life. Does the same hold true for upstart companies?
The question was raised on Friday by the announcement from Ryanair that it was planning to scale back its
rapid expansion in order to maximise the distribution of cash to shareholders between 2012 and 2015.
Such a move would be a big strategic shift, given that the abrasively successful Irish group has reinvested
cash in the business instead of paying a dividend during its 12 years as a listed company.
But fast-growing companies that decide to reinvent themselves as income generators risk losing something
valuable in the transition, says Joseph Lampel, a professor of strategy at Londons Cass Business School.
He views Ryanair as a classic breakthrough company whose appeal is its ability to tear up the rule book, in
this case by undermining the higher-cost business model that constrained older airlines, such as British
Airways.
Shifting to a consolidation strategy can make innovative managers too focused on delivering stable income
to investors, sacrificing sparkle for steadiness, says Prof Lampel.
The financial forces push them towards conformity with other corporations, he says, adding that
companies in this position often end up diversifying as a way of spreading risk.
He also adds that upstarts that embrace a consolidation strategy usually shut the door on their past: few are
able to rediscover a freewheeling style should they tire of sober maturity.
Freek Vermeulen, an associate professor of strategic and international management at London Business
School, agrees that it is very difficult for a company to regain its innovative edge after it has shifted focus
from exploration to exploitation.
He cites the example of Microsoft, which became much more a part of the corporate mainstream when it
started paying dividends in 2003 but which has struggled to replicate the enormous PC-based success of
Windows on the internet.
That said, Prof Vermeulen suggests that Ryanairs move to distributing cash would not be such an extreme
step for the group, given that the roll-out of its low-cost network involved a fair amount of repetition as well
as innovation.
In a conference call with analysts in November, Michael OLeary, Ryanair chief executive, appeared to
anticipate fears that the company might become too focused on steady disbursements to shareholders.
He said that any cash distributions resulting from a change in strategy were likely to be one-offs rather than
regular payments.
This approach may limit Ryanairs appeal to conventional income investors in the UK, who seek out
companies that offer a steady stream of payments, and who have had to weather a succession of dividend
cuts recently.
Were not going to get into some kind of dividend stream, Mr OLeary says.
But I think youll see very substantial one-off distributions every two or three years.
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Case 2 Bonds
Times January 2010
Their word is their bond but whose credit do you trust? A famous football club, an 800-year old university or
the Treasury? All would like to borrow your money or tap your pension fund.
The University of Cambridge wants 400 million to finance property development, Manchester United wants
twice as much to cut its debt and the Government is hoping to raise more than 200 billion to pay for
everything from nurses salaries to new helicopters for the Army. At the same time, the corporate sector is
throwing bonds about like confetti. Non-financial companies issued more than $1 trillion in bonds last year
as businesses rushed to take advantage of cheaper money and easier terms in the global capital markets.
Instead of borrowing from banks, companies are going direct to the prime source of cash the pension
funds of ordinary savers. They are offering bonds, which are promises to pay a sum at a fixed interest rate
and instruments that can be bought and sold like an equity share.
The reason for the surge in bond finance is that the crippled banks have been shut out of the lending market.
Required to boost their reserves after suffering stupendous losses, the banks want to lend at high rates of
interest and charge big fees to arrange loans. Businesses find better terms in the capital markets, where bond
investors are hankering for income at a time when bank deposits yield almost nothing.
Bond markets are less developed in Britain than in the United States, where every municipality issues bonds
to fund infrastructure. Some institutions, such as the Crown Estate, are prohibited by law from borrowing.
Britains public sector bond market was virtually shut down by Margaret Thatcher when she sought to get a
grip on spendthrift local authorities. Since then, the Treasury calls the tune but there is a growing clamour for
more fund-raising by local government. Transport for London has issued bonds and many local authorities
would like to raise funds for housing or transport with bonds backed by rents or bus fares.
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Case 3 Eurobonds
Financial Management May 2008
What is a eurobond?
Eurobonds are defined as bonds which are outside the control of the country in whose currency they are
denominated; but dont make the mistake of thinking that they are issued in Europe, or only denominated in
euros - the eurobond market is global and involves a wide range of currencies (although dollars and euros
are the most common).
Eurobonds are normally repaid after 5-15 years, and are for major amounts of capital ie $10m or more.
Large companies with excellent credit ratings regularly issue eurobonds, recent examples include: Cadbury-
Schweppes (1,200m 2004) and VW (34 trillion Turkish lira 2004).
What are the advantages of Eurobonds?
Eurobonds are bearer instruments, which means that the certificate is the sole title to ownership. Interest is
paid gross of tax. Eurobonds are useful because they create a liability in a foreign currency to match against
a foreign currency asset. The motive behind Walt Disney Corp issuing eurobonds in 1992 was to finance the
launch of Euro Disney. Without this matching effect Walt Disney Corp would have faced the risk that a
declining euro would have reduced the dollar value of their overseas investment.
Eurobonds are often cheaper than a foreign currency bank loan because they can be sold on by the investor,
who will therefore accept a lower yield in return for this greater liquidity. Eurobonds also are extremely
flexible. Most eurobonds are fixed rate but they can be floating rate or linked to the financial success of the
company. For example, in 1992 Walt Disney Corp issued a $300m Eurobond with a 3% coupon plus the
right to benefit from the success of 13 named films which meant that the bonds could potentially provide a
13.5% p.a. yield.
Eurobonds are typically issued by companies with excellent credit ratings and are normally unsecured, which
makes it easier for companies to raise debt finance in the future. Eurobond issues are not normally advertised
because they are placed with institutional investors (this is discussed below); this reduces issue costs.
The eurobond market can be used by companies to raise debt in dollars or euros (the majority of eurobond
issues involve these currencies) and swap this into another currency using a currency swap; most eurobond
issues are swapped in this way. For example, in 1984 Disney issued 80m of euro-denominated Eurobonds
and swapped them into yen to act as a hedge to the yen revenue from Disneys Japanese operations.
Eurobonds are an extremely important source of finance for major companies with strong credit ratings.
Eurobonds accounted for about 70% of all funds raised by UK listed companies in 2007.
Like any form of debt finance there will be issue costs to consider (approximately 2% of funds raised in the
case of eurobonds) and there may also be problems if gearing levels are too high. For example, Walt Disney
Corp recently had to suspend royalty payments made by its European subsidiary because of financial
difficulties at Euro Disney caused in part by the high levels of debt that it has taken on.
Doug Haste is an education specialist working at BPP Professional Education.
CHECKPOINT 1
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Answers to
Lecture Examples
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Chapter 1
Lecture Example 1a
- Profits are historic, shareholders care about the future perhaps they were concerned by the
potential impact of the recession. Ryanair were still planning expansion at that time investment
decisions are very important to investors
- Investment decisions require new finance , shareholders care about debt levels perhaps they
were concerned by information in the press briefing concerning this financing decisions are
very important to investors
- Profits are not cash flows, shareholders often want to see what returns they will be getting as
dividends perhaps they were concerned by information in the press briefing concerning the level
of dividend that Ryanair was planning to pay (zero, but this policy has now changed) dividend
decisions are very important to investors
- Also profit can be manipulated by depreciation policy and by short-termism
Lecture Example 1b
- The share price is generally felt to capture shareholders feelings about future cash flows and risk
Lecture Example 2
m Last year Current year
Profits before interest and tax 22,300 23,726
Interest 3,000 3,000
Tax 5,790 6,218
Profits after interest and tax 13,510 14,508
Preference dividends 200 200
Earnings 13,310 14,308
Earnings per share 13.3p 14.3p
Growth rate = (14.3 / 13.3) 1 = 0.075 or 7.5%
Dividends 7,986 8,585
Dividend per share = (0.086/ 0.08) 1 = 0.075 or 7.5%
Magneto has failed to hit these financial objectives but short term profit based measures are not a
sufficient basis on which to fully assess the performance of Magneto.
Lecture Example 3
- Not enough NEDs (min 50%)
- NEDs dont seem to be independent, and should not be paid share options
- Remuneration should not be discussed by the main board
- Audit committee should only include NEDs
- No split between Chair & Chief Executive
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Lecture Example 4
The question does not tell us what the share price has been over the period, but it does provide the
price/earnings (P/E) ratio. We can derive the share price at the time of the announcement of the results
as follows:
Previous year
Current year
ROCE
8700/33900 =25.7% 9
9500/34700 = 27.4%
Gearing
1130
11300/22600 = 50%
9000/25700 = 35%
Interest cover 8700/1200 = 7.25 9500/1000 = 9.5
Share price
17 5100/9000 = 9.63
18 5700/9000 = 11.40
Dividend yield
(2000/9000) / 9.63 = 2.3%
2
(2200/9000) / 11.40 = 2.1%
Total shareholder return
0.244 dividend + 1.77 increase in share price
9.63 start of year share price
= 21%
- Gearing does not appear to be a problem, and interest cover is high; and
- The P/E ratio, which is influenced by perceived growth potential, has improved.
- Total shareholder return looks impressive
Chapter 2
Lecture Example 1
Policy Impact on a businesss planning & decision making
Fiscal policy
- boosting spending
- cutting taxes
Bidding for government contracts
Higher consumer spending
Higher profits from investments
Monetary policy
- increasing money
supply
- lower interest rates
Higher consumer demand
More likely to use debt finance
Exchange rate policy
- lower exchange rates
Possibly caused by lower interest rates
Overseas suppliers become more expensive
Export markets become more attractive
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Lecture Example 2
Policy Impact on a businesss planning & decision making
Fiscal policy
- cutting spending
- raising taxes
Lower consumer spending, export markets attractive
Higher prices (if VAT) so lower sales
Lower profits from investments
Dividend policy affected if taxes on dividends increased
Monetary policy
- higher interest rates
Less likely to use debt finance, consumer demand falls
Exchange rate policy
- higher exchange rates
Export markets become less attractive
Lecture Example 3
Policy Impact on a businesss planning & decision making
Fiscal policy
- cutting spending
- raising taxes
Designed to cut spending on imports but will have a knock on effect
on domestic sales
Monetary policy
- higher interest rates
Designed to attract capital into the domestic economy from abroad,
but reduces investment by local firms.
Exchange rate policy
- lower exchange rates
Designed to make exports more competitive,
Chapter 3
Lecture Example 1
(a) The main Stock Market
Public profile, investor confidence (audited accounts, regular briefings, NEDs, 3 years of
successful trading history), access to wider pool of equity finance, allows owners to realise some
of their investment
(b) The Alternative Investment Market
Lower membership fees & compliance requirements (no successful trading history or corporate
governance requirements)
(c) Bonds are a liquid investment, so will often be cheaper than a bank loan. A bond will be called in
if its terms are breached, a bank may be more willing to renegotiate a loan whose terms have
been breached (they hope to do more business with the company). Another advantage of bonds
is that often they can be redeemed over a range of dates at the companys discretion.
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Chapter 4
Lecture Example 1
(a) Profits
Higher inventory means greater availability & possibly more choice to the customer of different
variants of the product and therefore higher sales and higher profits. Higher receivables may
mean better payment terms, which may lead to higher sales and this again may lead to higher
profits.
(b) Liquidity
Higher inventory & higher receivables mean more cash tied up in the short term which may lead to
cash flow problems.
There is sometimes a conflict between these 2 objectives.
Lecture Example 2
1 Inventory days
(a) Finished goods
756,000
86,400
365 = 41.7 days
(b) W.I.P
000 675
600 75
,
,
365 = 40.9 days
(c) Raw material
400 518
000 108
,
,
365 = 76.0 days
2 Av. collection period
864,000
172,800
365 = 73.0 days
3 Av. payables period
518,400
96,400
365 = (67,9) days
Cash operating cycle = 163.7
Lecture Example 3
2
s liabilitie Current
assets Current
=
2
15
s Receivable 10
=
+
Receivables = (2 15) 10
= 20
36.5 365
sales Credit
s Receivable
=
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sales Credit
365 20
= 36.5
Credit sales = (20 365)/36.5
= $200m
Lecture Example 4
864,000 1.3 = 1,123,200
1,123,200 / 2.49 = 451,084
Chapter 5
Lecture Example 1
(a) EOQ =
.18 25
32 1,800 2
= 160 units
Average inventory = Q/2 = 80 units
(b) Total cost = Purchasing + C
h
2
Q
+ C
o
Q
D
= 1,800 25 + 4.50
2
160
+ 32
160
1,800
= 45,720
Lecture Example 2
Qualifies for 1% discount so recalculate
0.99 25 0.18
1,800 32 2
EOQ New
= = 161 units
Q Order Holding Purchase Total
cost cost cost
(D/Q C) (Q/2 H) (D P)
161 357.8 358.6 44,550 45,266.4
300 192 661.5 44,100 44,953.5
800 72 1,728 43,200 45,000.0
Order 300 units at a time.
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Lecture Example 3
Cost
Finance cost was 600,000 2/12 10% = 10,000
Finance cost will be 600,000 1.15 3/12 10% = 17,250
Additional cost = 7,250
Benefit
Additional contribution = 600,000 15% 20% = 18,000
Net benefit =
10,750
Lecture Example 4
Cost
$10m 0.2 0.02 = $40,000
Benefit
Current receivables = 90/365 10 = $2,465,753
New receivables = (0.2 10/365 10) + (0.8 90/365 10) = $54,795 + $1,972,603 = $2,027,398
Reduction in receivables = $438,355
Saving in overdraft interest =
$43,836
Net benefit = 3,836
Sales may also rise as a result of the policy.
The policy should be introduced.
Lecture Example 5
Cost of debt factor
m
Factors charge
$480m 5% / 2 (the exchange rate)
12.0
Benefit of the debt factor
(i) Financing costs
Current receivables
($480
12
3
) / 2 = 60m
New receivables ($480 x 2/12 ) / 2= 40m
Reduction in receivables 20m leads to interest saved of
2.0
(ii) Bad debts
($480 2%) / 2
4.8
(iii) Administration savings 8.0
14.8
Use the factor as it is estimated to save 2.8m p.a.
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Lecture Example 6
Cost
Current payables = 30/365 1,000,000 = 82,192
New payables = 10/365 1,000,000 = 27,397
Reduction of 54795 0.1 =
5,480
Benefit
0.025 1,000,000 = 25,000
Saving =
19520
Nb this is an approximate calculation, acceptable for exam purposes many other approaches are
possible
The discount should be accepted
Chapter 6
Lecture Example 1
Jan
Feb
Mar
Inflows
Sales
Mickster (Cash)
(98% 10 150; 250)
1,470
2,450
November sales (2 months credit)
December sales
January sales
20,000
25,000
30,000
Capital
5,000
Total inflows
21,470
25,000
37,450
Outflows
Dec purchases (for Jan sales incl
Mickster)
January purchases (for Feb sales)
February purchases (for March sales)
12,600
20,000
19,000
Overheads
(2,000 400 1,000)
600
600
600
Wages
1,000
1,000
1,000
Fixed assets
24,000
Total outflows
14,200
21,600
44,600
Net cash flow
7,270
3,400
(7,150)
Balance b/f
(4,550)
2,720
6,120
Balance c/f
2,720
6,120
(1,030)
Lecture Example 2
EOQ =
.045
150 1,500,000 2
= 100,000
(ie. Arrange 15 transfers of money into the account of 100,000 each over the year).
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Lecture Example 3
The spread between the upper and the lower cash balance limits is calculated as follows.
Spread = 3
3
1
rate interest
flows cash of variance cost n transactio
4
3
|
.
|
\
|
= 3
3
1
0.00025
4,000,000 50
4
3
|
.
|
\
|
= 25,303, say 25,300
The upper limit and return point are now calculated.
Upper limit = Lower limit + 25,300 = 8,000 + 25,300 = 33,300
Return point = lower limit +
1
/
3
spread = 8,000 +
1
/
3
25,300 = 16,433, say 16,400
If the cash balance reaches 33,300, buy 16,900 (= 33,300 16,400) in marketable securities. If the
cash balance falls to 8,000, sell 8,400 of marketable securities for cash.