A BIG THANKS TO

FOR THIS MOCK

 MOCK EXAM

FM
ACCA
FINANCIAL MANAGEMENT

Time allowed

3 hours and 15 minutes

This paper 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, 4 and 5

Section A – ALL 15 questions are compulsory and MUST be attempted Each
question is worth 2 marks.

1 Velocity Co has a cash conversion cycle of 45 days. The inventory is kept for an average
period of 20 days. The trade payables outstanding at the end of the period are $4,932 and the
business has made total credit purchases of $100,000.
Calculate the average trade receivable days.
A 43 days
B 37 days
C 27 days
D 25 days
2 Plasma Co has estimated that a project with an initial investment of $65,000 will generate
the following aftertax cash inflows:
Year Cash flow
1 $20,000
2 $20,000
3 $10,000
4 $10,000
5 $10,000
What is the payback period of the investment?
A 4.2 years
B 4.5 years
C 3.5 years
D 5.3 years

3 Company B is based in France with the major customers of the business operating in Japan.
One of its main competitors is based in Malaysia supplying the same products to the Japanese
customers.
Which of the following risks will rise if the Malaysian currency weakens against the Japanese
currency?
A Transaction risk and business risk
B Economic risk and business risk
C Translation risk and financial risk
D Business risk and financial risk
4 ABC Co currently has 2 million shares in issue. The market value of each share is $1.50. The
business is about to announce 1 for 4 rights issue @ $1.30 each.
Assuming that the rights issue is fully subscribed, what will the theoretical ex-rights price
following the issue of the new shares?
A $1.37
B $1.62
C $1.32
D $1.46
5 A company has sold its trade receivables at a discount to another party with possible
recourse.
This arrangement is best described as:
A Letter of credit
B Factoring
C Forfaiting
D Invoice discounting

6 The average payout ratio of Abbott Co, over the past 5 years, has remained at 40%. The
latest earnings per share (EPS) of the business is 80 cents. The cost of equity is 10%.
Based on the dividend growth model,
what will be the theoretical price of each share of Abbott Co?
A $4.40
B $6.28
C $8.48
D $9.32

7 Consider the following statements in the context of Islamic finance:

(i) Mudaraba is an agreement between two parties, whereby both parties
provide finance and share the profits on the pre-agreed terms.
(ii) Musharaka is an arrangement, where one party provides the funds and
the other party provides the required expertise.
Which of the statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
8 Beat Co is facing high level of financial risk. The ratio of the debt in the capital structure is
very high, the interest cover ratio is very low and the business has defaulted on the last two
interest payments.
Under the principles of optimal theory of capital structure, which of the following
statement is correct?
A An increase in the gearing will increase the weighted average cost of capital.
B An increase in the gearing will decrease the weighted average cost of capital.
C A decrease in the gearing will increase the weighted average cost of capital.
D An increase or decrease in the gearing will have no effect on the weighted average cost of
capital.

9 AZ Co expects to receive a constant annual cash inflow of $15,000 for the foreseeable future.
Its cost of capital is 8% and the business pays corporation tax at 30%, one year in arrears.
What is the present value of annual cash flow after tax?
A $131,250
B $135,413
C $160,583
D $171,250
10 A UK based company has received an invoice of $4 million from one of its overseas
suppliers. The invoice is
to be paid in 3 month’s time. The following financial information is relevant:
Spot rates: 1.3512 – 1.3518 US $ per £
Forward rates: 1.3500 – 1.3512 US $ per £
Calculate the cost of paying this invoice if forward rates are used.
A £2,960,332
B £2,962,963
C £5,400,000
D £5,404,800

11 Consider the following statements in the context of pecking order theory:

(i) Debt should always be considered as the last resort to raise finance.
(ii) Retained earnings should always be used first because of no issuance costs.
Which of these statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
12 Mark Co is commencing a 5 year project with an initial investment of $8,000. The project
will generate annual cash flows of $3,500 for 5 years with an additional cash inflow of $1,000
at the end of year 5. The cost of capital is 5%.
What is the net present value of the project?
A $3,734
B $4,236
C $6,632
D $7,936
13 Consider the following statements about equity beta and asset beta:
(i) An equity beta includes an element of business as well as financial risk.
(ii) An asset beta includes only the financial risk.
Which of these statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2

14 The money cost of capital of Ledger Co is 12%. The inflation rate is 3%.
What is Ledger Co's real cost of capital?
A 6.24%
B 7.77%
C 8.74%
D 9.23%
15 The following information corresponds to the earnings made and dividends distributed
by ABC Co:
2016 2017 2018
Earnings $84 million $68 million $96 million
Dividends $21 million $17 million $24 million

Which of the following best describes the dividend policy of ABC Co?
A Constant growth
B Residual dividends
C Constant pay-out
D High pay-out
Section B – ALL 15 questions are compulsory and MUST be attempted
The following scenario relates to questions 16 to 20.
Alpha Co has decided to acquire one of its major competitors Gamma Co. It is now in the
process of collecting relevant information in order to decide an appropriate bid to offer. Both
the businesses are listed on the stock exchange and operate in the same industry.
Gamma Co has issued 8 million ordinary shares and the price of each ordinary share is $4.50.
The latest earnings per share of the business is 80 cents. Gamma Co has a history of paying 60%
of the total earnings as dividends. The industry average price / earnings ratio is 7. The equity
beta applicable to Gamma Co is 1.3. The taxation rate is 30%.
The risk free rate in the market is 4% and the equity risk premium is 6%.
16 What is the cost of equity of Gamma Co?
A 7.20%
B 9.80%
C 10.00%
D 11.80%
17 Assuming that the cost of equity of Gamma Co is 9%, calculate the applicable growth rate.
A 3.60%
B 4.60%
C 5.40%
D 6.00%
18 Assuming a cost of equity of 9% and a dividend growth rate of 5.00%, calculate the value
of Gamma Co using the dividend growth model.
A $95.40 million
B $100.80 million
C $104.20 million
D $106.60 million

19 Consider the following statements in the context of the dividend growth model:
(i) Dividend growth model cannot be applied if the business has a policy of retaining 100% of
its earnings.
(ii) Dividend growth model can only be applied if the growth rate is lower than the cost of
equity.
Which of the statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
 20 Calculate the value of Gamma Co using the price/earnings ratio method.
A $32.80 million
B $36.80 million
C $44.80 million
D $52.80 million

The following scenario relates to questions 21 to 25.

Royal Co is a UK-based exporter. Most of the customers, as well as the suppliers, of the
business are located in United States.
The company is expecting the following transactions in the upcoming months:

One month: Expected payment of $200,000

Three months: Expected receipt of $400,000
Other relevant financial information is as follows:
Short-term £ deposit rate 4.2% per year
Short-term $ borrowing rate 6.4% per year
Spot rate: $1.242 / £1
One month forward rate: $1.344 / £1
21 Calculate the expected sterling payments in one month’s time using a forward hedge.
A £248,400
B £148,810
C £161,031
D £232,310

22 Calculate the expected sterling receipts in three months using a money market hedge.
A £298,200
B £310,312
C £320,318
D £430,318
23 Which of the following best describes the risk faced by Royal Co in these transactions?
A Transaction risk
B Translation risk
C Economic risk
D Business risk
24 The finance director strongly believes that the dollar will strengthen against the pound in
three
month’s time. How should Royal Co deal with the receipt of $400,000 in three months time?
A Hedge the transaction using a forward rate agreement.
B Hedge the transaction using a money market hedge.
C Request the customer in US to make an early payment.
D Leave the transaction without hedging.
25 Consider the following statements about forward contracts:
(i) They are openly traded on the exchange.
(ii) They are less flexible than futures contracts.
Which of the statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2

The following scenario relates to questions 26 to 30.

Marble Co is evaluating four potential projects for business expansion. However, the limitation
of funds implies that only one project can be selected. The following information is relevant:
Project Initial investment Present value
Project A $200,000 $232,000
Project B $150,000 $152,000
Project C $100,000 $190,000
Project D $120,000 $150,000
In addition, the business is evaluating a separate project to launch Product K. The initial
investment in this project will be $50,000. It will generate the following net cash inflows:
Year Net cash inflows
1 $15,500
2 $32,500
3 $8,000
4 $2,500
26 Which of these projects should be selected on the basis of profitability index (PI)?
A Project A
B Project B
C Project C
D Project D
27 Consider the following statements about profitability index (PI):
(i) An index value of less than 1 indicates that the project is not financially worthwhile.
(ii) Profitability index (PI) takes in account the scale of investment and the size of actual cash
flows.
Which of the statements is / are correct?
A 1 only
B 2 only
C Both 1 and 2
D Neither 1 nor 2
28 Which of these projects should be selected on the basis of net present value?
A Project A
B Project B
C Project C
D Project D

29 Marble Co expects the cost of capital to rise in the future. What will be the impact of this
increase on the net present value and IRR?
A Net present value will increase and IRR will decrease.
B Net present value will decrease and IRR will increase.
C Net present value and IRR will both decrease.
D Net present value will decrease and IRR will remain the same.

30 What is the payback period of the investment in Product K?

A 2 years 2 months
B 2 years 3 months
C 3 years 2 months
D 3 years 3 months.
Section C – BOTH questions are compulsory and MUST be attempted
Please write your answers to all parts of these questions on the lined pages
within the Answer Booklet.
31 Aroma Co produces and sells luxury perfumes. After spending $100,000 on the research,
the business has developed a unique perfume, which can turn out to be commercially successful.
Aroma Co is now performing the financial evaluation of the project in order to make a decision
regarding the commercial production of the perfume.
The project has a useful life of four years. Information regarding the future cash flows of this
project is as follows:
Year 1 2 3 4
Sales volume (units) 15,000 19,000 14,000 10,000
Selling price ($/unit) 395 485 425 350
Variable cost ($/unit) 250 260 270 280
In addition, the following information is relevant:
• The initial investment for the project is $4,500,000, which is to be used in the procurement of a
new machine.
• The fixed costs are expected to be $800,000 per annum. 75% of these costs are incremental
fixed costs, whereas 25% are general overheads of Aroma Co.
• After year 1, selling price is expected to undergo an inflation of 6.0% per year. Similarly, fixed
and variable costs are expected to increase by 4.0% per year.
• At the end of year 4, the machine will be sold for an estimated value of $500,000.
• Aroma Co can claim tax allowable depreciation on the cost of the machine at 25% reducing
balance basis. A balancing charge or allowance is available at the end of the fourth year of
operation.
• Aroma Co pays corporation tax at 30% per year, one year in arrears.
• The after-tax cost of capital of the business is 10% per annum.
Aroma Co has also successfully developed a high-endurance sport deodorant that is yet to be
commercially produced. The net present value of the project, related to the deodorant, has
turned out to be $1.3 million. The initial investment of both the projects is similar. However,
the deodorant will be sold for a period of 8 years with most of the cash flows being recovered
after year 5.
Required:
(a) Calculate the after-tax net present value of the project.
(15 marks)
(b) Advise whether the business should launch the perfume or the sport deodorant.
(5 marks)

(20 marks)
32 Parker Co, a toy manufacturer, has 20 million ordinary shares in issue. The market value of
each ordinary share is $12.50. The company has also issued 8% bonds having a total nominal
value of $15 million. The nominal value of each bond is $100 and the market value is $105.
The bonds are to be redeemed in 7 years’ time at the nominal value. The existing equity beta
of Parker Co is 0.8.
The risk free rate of return in the market is 5% and the equity risk premium is 6%. The
corporate taxation rate is 30%.
Parker Co is now planning to enter the crockery manufacturing business. A similar business in
the crockery manufacturing is Gamma Co. Gamma Co has an equity beta of 1.3. The market
value of the equity issued by Gamma Co is $50 million and the market value of debt is $20
million.
The finance director has suggested using the book values of the equity and debt in the
calculation of weighted average cost of capital while evaluating the new project. She believes
that this approach will lower the weighted average cost of capital and will make the project
more attractive.

(a) Calculate the current weighted average cost of capital of Parker Co.
(9 marks)

(b) Calculate the cost of equity that Parker Co should use in evaluating the new project.
(6 marks)

(c) Explain the difference between market value based weighted average cost of capital and
book value based weighted average cost of capital. Discuss which one is more suitable when
making investment decisions.
(5 marks)

(20 marks)