FINAL VERSION: TO BE USED FOR MARKING

The Association of Business Executives

QCF
Corporate Finance
Assessment Guide

Unit Title: Corporate Finance

Unit Code: 6CF

QCF Level: 6

Session: June 2015

Structure of paper: Answer all three sections

Section A: Answer all five questions Q1

Q2
Q3
Q4
Q5

Section B: Answer one question Either Q6 or Q7

Section C: Answer one question Either Q8 or Q9

 FINAL VERSION: TO BE USED FOR MARKING

This assessment guide covers the answers that candidates may be expected to provide.
However, the examples provided are not intended to be wholly prescriptive or exhaustive.

If a candidate makes points which are not covered in the guidance and which the marker
accepts as valid, the marker must use his or her professional judgment to award an
appropriate grade, following the guidance laid down herein.

If a candidate is deemed, in the professional judgment of the marker, not to have achieved
the Learning Outcome then a pass grade (Grade C or above) cannot be awarded.
 FINAL VERSION: TO BE USED FOR MARKING

Section A
Candidates must answer all six questions in this section.

Question 1

(a) Explain the justifications for mergers and acquisitions.

(b) Discuss how the benefits of mergers and acquisitions can be measured.

Exemplar answer:

(a) The justifications supporting mergers and acquisitions are:

 For economic factors. If company managers believe that shareholder wealth will be enhanced
then that is a good reason for going ahead with an acquisition. The managers therefore believe
that the two companies t (target) and p (predator) will be worth more in combination than as
separate entities.
 To achieve synergy. Synergy is the creation of wealth due to an increase in the output of the
combined companies over the sum of outputs of the separate companies, using the same
resources.
 To gain economies of scale. These are similar to the synergy effect, but economies of scale are
due to the benefits that occur because of the larger scale of operations after the merger or
acquisition.
 To eliminate poor management. A company may be poorly run because managers are
satisfying their own requirements, instead of seeking to maximize shareholders’ wealth. The
share price may therefore decline and attract prospective buyers who believe that they may
manage the company’s assets more efficiently.
 To enter new markets. Companies may want to develop new areas by product, business type,
or geographically. To achieve these aims, a merger or an acquisition may be a quicker option. It
will also be a cheaper option because there will be no costs of acquiring new premises, and
additional personnel and marketing costs. This strategy is particularly popular in the retail trade
where starting from scratch is costly and time-consuming. An example was Iceland’s acquisition
of Bejam in 1987. Through that acquisition Iceland was able to break into the North of England
geographical market instead of competing there with Bejam from a zero base.
 To achieve critical mass. Smaller businesses may merge to achieve critical mass. Small
companies may lack credibility because of their:
-Small size, which usually means that they have a shortage of buying power, knowledge, etc.
-Lack of resources for research and development.
-Lack of investment in brands.
Merging companies can pool resources to provide a critical mass to finance the above
requirements. Smaller companies involved in such mergers may then take advantage of an
existing brand and an existing knowledge base.
 To achieve growth. A takeover provides a quick solution for further growth. For instance, British
American Tobacco, which took over Allied Dunbar and Eagle Star, both financial institutions, as
part of their growth strategy, using surplus cash.
 To gain market share or market power. Swallowing up the competition gives such business the
ability to earn monopoly profits. However, a legislative obstacle of referral to the Monopolies
and Merger Commission may cause financial damage and damage to the reputation of a
company.
 To reduce risk. A company may acquire another company in a different line of business. Such
diversification may be justified in terms of reducing shareholder risk. For example, a business
that sells both ice cream and umbrellas can reduce the total overall business risk. When the
weather is hot and sunny, people will buy ice cream, but they will not need to buy umbrellas.
When the weather is cold and rainy, people will need to buy umbrellas, but they are less likely to
buy ice cream.
 FINAL VERSION: TO BE USED FOR MARKING

(b) The success of mergers and acquisitions is measured by whether the value of the buyer is
enhanced by the action. However, the practical constraints of mergers, which often prevent the
expected benefits from being fully achieved. Alas, the synergy promised by deal makers might just
fall short.

Assessment Guide:

Learning Outcome
1. Understand the role of the Corporate Finance Manager and its main links to business objectives
including mergers and acquisitions.

Assessment Criterion
1.3 Explain the main justifications for, and dangers of, mergers and takeovers (financial and
otherwise).

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

Question 2

(a) If the company does not develop the retail facility and dividends continue to grow at the
historical rate, calculate the value of the company’s ordinary shares, using the dividend growth
model formula on page 8.
(b) If the company develops the retail facility and dividends are reduced for the following three
years, calculate the value of the company’s ordinary shares. Use the discount tables and the
growing perpetuity formula on page 8.
(c) Discuss whether the company is correct to reduce its dividends in the next three years to 6.0p
per share. Include non-financial factors in your discussion.

Exemplar answer:

(a) (1+G)4 = (9/7)

(1+G)4 = 1.286
(1+G)4 = 4√1.286
G = 1.065 – 1
G = 6.5%

Using the dividend growth model:

S = v(1+G) / (Ke – G)
S = £0.09 x 1.065 / (0.12 – 0.065) = £1.74
Therefore the value of the company would be £1.74 x 1,650,000 = £2,871,000

(b) Dividend (pence) Discount factor (12%) PV (pence)

Year 1 6 x 0.893 5.36
Year 2 6 x 0.797 4.78
Year 3 6 x 0.712 4.27
Year 4 10 x 0.636 6.36
 FINAL VERSION: TO BE USED FOR MARKING

Year 4 270* x 0.636 171.72

192.49

Therefore the value of the company would be £1.92 x 1,650,00 = £3,168,000

(c) Based on the above calculations the company is correct to reduce its dividends in the next
three years to 6.0 per share.

Assessment Guide:

Learning Outcome
5. Understand the factors that determine a company’s dividend policy.

Assessment Criterion
5.1. Explain and discuss the effects of dividends on shareholder wealth and the main dividend
policies that companies may adopt including: constant dividends, increasing dividends, zero
dividends, and fixed percentage dividends.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

Question 3

(a) Explain the advantages to a company of issuing loan stock convertible to shares.
(b) Advise an investor who holds some of Convex plc’s convertible loan stock as to which of the
following courses of action to take:
(i) Sell the convertible loan stock now
(ii) Convert it in two years’ time
(iii) Hold the loan stock to maturity

Exemplar answer:

(a) There are three key advantages associated with companies issuing loan stock convertible to
shares. A loan stock and the associated documentation is often much shorter and easier to
compile than preferred stock documentation. In addition, there often are not many terms to
negotiate and this can cut down on back and forth time between founders and investors. As the
documentation is easier, the legal fees associated with them are cheaper. Preferred share offering,
for instance, would often cost twice as much as issuing loan stock. Given the relative complexity,
loan stock is also faster. Convertible debt allows new business to get necessary investment funds
without setting a valuation on the company before institutional investors enter the picture. Another
advantage of loan stocks is that they can eliminate the risk of overvaluing how much the business
is worth. For example, convertible debt can eliminate the risk of a situation where a venture capital
fund later buys shares at a price that is lower than what is expected or paid by the original
investors. Moreover, at the early stages of a company, most company’s technology, business
models and cash flows are largely untested and unproved making any valuation difficult to do.

(b) (i) If converted now: 3.20 x 25 = £80

 FINAL VERSION: TO BE USED FOR MARKING

If sold in the market: £93

(ii) Convert in two years:
Expected share price = 3.20 x 1.142 = £4.16
Value if converted = 25 x 4.16 = £104
Present value = 104 x 0.797 = £82.89
Interest received = 10 x 1.690 = £16.90
Total present value = 82.89 + 16.90 = £99.79
(iii) If held until maturity: (10 x 5.650) + (100 x 0.322) = £88.70
On these figures, the investor will convert in two years, since this gives the greatest present value
of returns.

Assessment Guide:

Learning Outcome
2: Understand the main sources of debt and equity funding and the significance of financial
gearing.

Assessment Criterion
2.3 Identify and explain the main sources of debt finance available to any size of business.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

Question 4

(a) Discuss the advantages and limitations of using the weighted average cost of capital (WACC)
method of investment appraisal.
(b) If Lucky John plc’s weighted average cost of capital (WACC) is used as the cost of capital to
appraise the project, discuss whether the project should be undertaken.

Exemplar answer:

(a) The advantages of using WACC include:

 WACC takes into account the return required by both equity and debt investors when evaluating
the returns from new investments.
 WACC takes systematic risk into account and therefore, WACC ensures that positive NPV
projects provide returns commensurate with the level of systematic risk the company faces.
 CAPM provides a standard, recognised theoretical approach for deriving a company’s WACC
which can be used for both listed and unlisted companies due to widely available published data
on company betas.

WACC is having the following limitations:

 WACC assumes that the average investor has successfully diversified away all unsystematic
risk, but this may not be the case in practice.
 There are potential problems in making decisions about projects that will occur in the future
based on historic data (past business risk and financial risk may not be indicative of risk profiles
 FINAL VERSION: TO BE USED FOR MARKING

in the future; the risk free rate may not be constant over time; the market risk premium may also
vary over time).
 It is unlikely to be appropriate for PPT to use the same discount rate when evaluating all
projects. PPT’s WACC can only be used if the project under consideration has the same
business risk as PPT and will not change PPT’s structure in the long term.

(b) If shareholders’ equity is E and the net financial debt is D then the relative proportions of equity
and debt in the total financing are:

E / (E +D) and D / (E + D)
E / (E + D) = 2/3
D / (E + D) = 1/3

Cost of equity Ke= 18%

Return on financial debt Kd = 12%

WACC = (2/3 x 18%) + {1/3 x 12% (1-40%)} = 12% + 2.4% = 14.4%

The present value of future cash flows in perpetuity = annual cash flows / annual discount rate % =
£35,000 / 0.144 = £243,056

Net present value, NPV = £243,056 - £200,000 = +£43,056

Using WACC to discount the cash flows of the project, the result is a positive NPV of £43,056 and
therefore the project should be undertaken.

Assessment Guide:

Learning Outcome
6. Understand the concept of, and know how to calculate, the cost of capital of a business.

Assessment Criterion
6.3. Calculate the weighted average cost of capital and discuss its usefulness.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

Question 5

Discuss the practical issues to be considered when determining a company’s dividend policy.

Exemplar answer:

The practical issues associated with determining a company’s dividend policy are:
Financial needs of the company:
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Retained earnings can be a source of finance for creating profitable investment opportunities.
When internal rate of return of a company is greater than return required by shareholders, it would
be advantageous for the shareholders to re-invest their earnings. Risk and financial obligations
increase if a company raises debt through issue of new share capital where floatation costs are
involved. Mature companies having few investment opportunities will show high pay-out ratios;
share prices of such companies are sensitive to dividend charges. Some small portion of the
earnings is kept to meet emergent and occasional financial needs. Growth companies, on the other
hand, have low pay-out ratios. They are in need of funds to finance fast growing fixed assets.

Distribution of earnings reduces the funds of the company. They retain all the earnings and declare
bonus shares to offset the dividend requirements of the shareholders.

Constraints on Paying Dividends

(i) Legal: Under Section 205(1) of the Companies Act 1956, dividend is to be paid out of current
profits or past profits after depreciation. The Central Government can allow a company to pay
dividend for any financial year out of profits of the company without providing for depreciation if it is
in the public interest. Dividend is to be paid in cash but a company is
allowed to capitalise profits or reserves (retained earnings) for issuing fully paid bonus shares.
Capital profit may also be distributed as dividends if articles permit.
(ii) Liquidity: Payment of dividends means outflow of cash. Ability to pay dividends depends on
cash and liquidity position of the firm. A mature company does not have much investment
opportunities, nor are funds tied up in permanent working capital and, therefore has a sound cash
position. For a growth oriented company in spite of good profits, it will need funds for
expanding activities and permanent working capital and therefore it is not in a position to declare
dividends.
(iii) Access to the Capital Market: By paying large dividends, cash position is affected. If new
shares have to be issued to raise funds for financing investment programmes and if the existing
shareholders cannot buy additional shares, control is diluted. Payment of dividends may be
withheld and earnings are utilised for financing firm’s investment opportunities.
(iv) Investment Opportunities: If investment opportunities are inadequate, it is better to pay
dividends and raise external funds whenever necessary for such opportunities.

Desire of Shareholders
The desire of shareholders (whether they prefer regular income by way of dividend or maximize
their wealth by way of gaining on sale of the shares). In this connection it is to be noted that as per
the current provisions of the Income Tax Act, 1961, tax on dividend is borne by the corporate as
(Dividend Distribution Tax) and shareholders need not pay any tax on income received by way of
dividend from domestic companies. To the extent small shareholders who are concerned with
regular dividend income or who do not form a dominant group or retired and old people investing
their savings, pension to purchase shares may prefer regular income and hence select shares of
companies paying regular and liberal dividend. As compared to those shareholders who prefer
regular dividend as source of income, there are shareholders who prefer to gain on sale of shares
at times when shares command higher price in the market. For such of those who prefer to gain on
sale of shares, as per the provisions of the Income Tax Act, 1961, tax on capital gains (short-term
@ 15%) are attracted if they sell the shares on holding less than one year and there is no tax on
long-term sale (if held for more than one year). However, shareholders have to pay Securities
Transaction Tax (STT) on sale of shares. The dividend policy, thus pursued by the company
should strike a balance on the desires of the shareholders who may belong either of the group as
explained above. Also the dividend policy once established should be continued as long as
possible without interfering with the needs of the company to create clientele effect.

Assessment Guide:

Learning Outcome
4. Understand and be able to calculate the main methods for valuing company shares.

Assessment Criterion
 FINAL VERSION: TO BE USED FOR MARKING

4.1. Explain and calculate the share value of a business based on: net asset value (NAV), price
earnings (PER); free cash flow and dividend valuation and discuss the relative merits of each
method.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.
 FINAL VERSION: TO BE USED FOR MARKING

Section B
Candidates must answer only question from this section.

EITHER Question 6

(a) Calculate the Accounting Rate of Return (ARR) for the following projects based on the average
investment, and show which ones would be selected if the target rate of return is 12%. Assume
straight line depreciation over the life of the project, with zero scrap value.

Project A Project B Project C

(£) (£) (£)
Initial investment 10,000 15,000 20,000
Net cash inflows:
Year 1 5,000 5,000 10,000
Year 2 5,000 5,000 8,000
Year 3 2,000 5,000 4,000
Year 4 1,000 10,000 2,000
Year 5 5,000

(b) Discuss the problems of relying on ARR as a method of appraising investments.

(c) Suggest one reason why managers might not accept the ranking given by ARR.

Exemplar answer:

(a) Project A
Average annual accounting profit = (13,000 – 10,000) /4 = £750
Average annual investment = 10,000 / 2 = £5,000
Accounting rate of return = (750 x 100) / 5000 = 15%

Project B
Average annual accounting profit = (30,000 – 15,000) / 5 = £3,000
Average annual investment = 15,000 / 2 = £7,500
Accounting rate of return = (3000 x 100) / 7,500 = 40%

Project C
Average annual accounting profit = (24,000 – 20,000) / 4 = £1,000
Average annual investment = 20,000 / 2 = £10,000
Accounting rate of return = (1,000 x 100) / 10,000 = 10%

If the target rate is 12%, projects A and B will be accepted.

(b) The ARR method can provide an overview of a new project but it lacks the sophistication of
other methods. Then impact of cash flows and time on the value of money really should be
considered in investment appraisal. Also, ARR is based on accounting profit rather than cash
flows. It is a relative measure and so no account is taken of the size of the project. ARR ignores
timing of cash flows and the cost of capital.

(c) The managers might not accept the ranking given by ARR based on (b).

Assessment Guide:

Learning Outcome
3. Be able to evaluate investment decisions using a variety of appraisal techniques.

Assessment Criterion
3.1. Explain the principles, benefits and limitations of the following different methods of investment
appraisal: accounting rate of return, payback, net present value (NPV), Profitability Indices, and the
 FINAL VERSION: TO BE USED FOR MARKING

internal rate of return (IRR) and be able to perform calculations in order to access investment
value.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

OR Question 7

Discuss the assumptions and limitations that may be encountered in applying the capital asset
pricing model (CAPM) in investment appraisal.

Exemplar answer:

Problems that could have been discussed in connection with applying the CAPM to investment
appraisal include:
-Determining the excess market return;
-Determining the risk-free rate of return;
-Estimation of the equity and overall betas of a company;
-Determination of the beta for a project;
-The CAPM is a single-period model;
-The CAPM is an ex-ante model;
-National surrogates for market return may be internationally inappropriate.

Assessment Guide:

Learning Outcome
3. Be able to evaluate investment decisions using a variety of appraisal techniques.

Assessment Criterion
3.2. Explain and calculate the influence of risk in the investment appraisal process.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.
 FINAL VERSION: TO BE USED FOR MARKING

Section C
Candidates must answer one question from this section.

EITHER Question 8

(a) Outline the factors to be considered in achieving an optimum debtor management policy.
(b) Assuming the sales revenue levels remain unchanged, calculate whether or not Trumper Ltd
would gain from introducing early settlement discounts.

Exemplar answer:

(a) The aim of the debt management policy is to manage sovereign debt in a manner that is
consistent with key pre-determined objectives, designed to guard against any potential debt
servicing difficulties. Although the primary objective of the debt management policy has been to
meet the ongoing financing needs of the Government, minimizing the cost of financing subject to
an acceptable level of risk is also considered important in all debt management functions. The
objectives of debt management also include developing efficient and deep markets in government
securities, facilitating the domestic financing of Government. In an attempt to manage costs and
risks, the debt manager often uses benchmarks to guide the debt office towards achieving debt
targets. Suitably identified benchmarks can also trigger early warning signals of potential debt
servicing problems, and at the same time provide information to market participants regarding the
consistency of national debt policy objectives and the ability to achieve medium and long-term
macroeconomic stability. There exists, however, key trade-offs while implementing benchmarks for
debt management and, therefore, the role of debt managers becomes an important determining
factor in benchmark implementations.

(b) Proposed trade receivables

Not taking discount 70% x £32m x 75/365 = £4,602,740

Taking discount 30% x £32m x 60/365 = £1,578,082
£6,180,822
Current trade receivables £32m x 75/365 = £6,575,342
Reduction in trade receivables = £394,520
Savings
Financial costs £394,520 X 12% = £47,342
Administrative costs = £20,000
Bad debts = £100,000
Total savings per annum = £167,342
Discount allowed 32m x 30% x 2% = £192,000

The discount allowed exceeds the expected total savings and therefore this policy should not be
adopted by Trumper Ltd.

Assessment Guide:

Learning Outcome
7. Understand the different elements of treasury and working capital and be able to perform
calculations from a given set of data to determine the effect on an element of, or on the entire
working capital of, a business.

Assessment Criterion
7.1. Explain the main areas of treasury and working capital and calculate the working capital cycle
and the cash conversion or operating cycle.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
 FINAL VERSION: TO BE USED FOR MARKING

Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.

OR Question 9

(a) Outline the factors to be considered in achieving an optimum stock management policy.
(b) If both overheads and production are incurred evenly throughout the year, calculate Greenman
Ltd’s total working capital requirement

Exemplar answer:

(a) The stocks in an efficient portfolio are chosen depending on the investor's risk tolerance, an
efficient portfolio is said to be having a combination of at least two stocks above the minimum
variance portfolio. For a given amount of risk, the stock management policy describes how to
select a portfolio with the highest possible expected return. Or, for a given expected return, the
stock management policy explains how to select a portfolio with the lowest possible risk (the
targeted expected return cannot be more than the highest-returning available security, of course,
unless negative holdings of assets are possible). Therefore, the optimum stock management policy
requires a form of diversification. Under certain assumptions and for specific quantitative definitions
of risk and return, the stock management policy explains how to find the best possible
diversification strategy.

(b) Annual costs:

Raw materials: 700,000 x 0.20 = £140,000
Direct labour: 700,000 x 0.35 = £245,000
Overheads: 700,000 x 0.15 = £105,000

Working capital requirement:

£ £
Stocks of raw materials: 140,000 x (2/52) = 5,385
Work-in-progress:
Materials: 140,000 x (4/52) = 10,769
Labour: 245,000 x (4/52) x ½ = 9,423
Overheads: 105,000 x (4/52) x ½ = 4,038
24,230
Finished goods: 490,000 x (3/52) = 28,269
Debtors: 700,000 x (8/52) = 107,692
Creditors: 140,000 x (4/52) = (10,769)
Working capital required: 154,807

Work-in-progress is assumed to be half complete as regards labour and overheads, but fully
complete as regards raw materials, i.e. all raw material is added at the start of the production.

Assessment Guide:

Learning Outcome
7. Understand the different elements of treasury and working capital and be able to perform
calculations from a given set of data to determine the effect on an element of, or on the entire
working capital of, a business.
 FINAL VERSION: TO BE USED FOR MARKING

Assessment Criterion
7.1. Explain the main areas of treasury and working capital and calculate the working capital cycle
and the cash conversion or operating cycle.

Only answers that demonstrate that the student has achieved the Learning Outcome can be
awarded a pass grade (Grade C or above).
Examiners will agree the expectations for the award of other grades with markers in more detail at
the Standardisation meeting. The general criteria for the awarding of grades are as follows:
Answers awarded Grades A*, A and B will indicate that the candidate has demonstrated additional
knowledge and understanding, application and action, and autonomy and accountability over and
above the threshold required to achieve the Learning Outcome.
Answers awarded Grade C will indicate that the candidate has demonstrated sufficient
knowledge and understanding, application and action, and autonomy and accountability to
achieve the Learning Outcome.
Answers awarded Grades D, E and F will indicate that the candidate has not demonstrated
sufficient knowledge and understanding, application and action, and autonomy and accountability
to achieve the Learning Outcome.