Acca F9 Key Point Notes

ACCA F9 Financial Management Key Point Notes
June 2011
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ACCA
F9
Financial Management
Key Point
Notes
June 2011
These notes are not intended to cover the whole syllabus, but target key examinable areas.
Tutor:
Sunil Bhandari
Tutor Contact Details

Mobile: +44 (0)7833 438771
E-mail: via
www.IntelligentAccountancyTutorsLtd.co.uk
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Bhandari
IAT
Ltd
Copyright
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Accountancy
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Use of these Key Point Notes

These notes have been written as an aid to assist students
preparing for the ACCA F9 June 2011 Exam. They accrue for
the topics tested in the past exams.
It is of paramount importance that they are used with an up
to date Revision Kit. A combination of using the notes and
question practice is the best way to prepare for the
forthcoming exams.
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Sunil Bhandari IAT Ltd
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Index
Chapter Number Chapter Name
Preliminaries
Page Numbers
4-12
Chapter One
Financial Objectives
Chapter Two
Dividend policy
Chapter Three
Cost of Capital
Chapter Four
Chapter Five
Bonds-Yields & Market

Value
Risk Adjusted WACC
Chapter Six
CAPM
Chapter Seven
Capital Structure
Chapter Eight
Project Appraisal
Chapter Nine
Business Valuations
Chapter Ten
Sources of Finance
Chapter Eleven
Ratios
Chapter Twelve
Working Capital
Chapter Thirteen
Inventory Control
85-88
Chapter Fourteen
Receivables& Payables
89-92
Chapter Fifteen
Cash Management
Chapter Sixteen
Foreign Currency Risk
Chapter Seventeen
Interest Rate Risk
Appendix
Islamic Finance
13-20
21-24
25-30
31-32
33-36
37-46
47-50
51-66
67-70
71-78
79-82
83-84
93-98
99-106
107-112
113-116
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Exam Technique
First 15 minutes
Read the questions carefully
Recognise the topic being tested (eg NPV, Rights Issue
etc)
Rank the questions according to your strongest to
weakest
Next 180 minutes

Attempt the questions in your ranked order.
Stay within your time allocation both on each part of
the question and on the question itself.
If the written elements are unrelated to the
computations-try front load as they represent easier
marks.
Try to attempt all parts to all the questions.
If in doubt about how to compute a value-make a
reasonable estimate and move on.
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General
Numerical Questions
State formula
Show method
Explain as you go
Make assumptions if in doubt
Written Questions
Check format report / essay/ listed points
Headings / subheadings / columnar
Simple short paragraphs-essays and reports
Use numbered points for most questions-simple
sentence approach.
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Tips
These will be available via my website. Please download
from there.
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Chapter One
Financial Objectives
1
Primary Financial Objective
1.1 For profit making business Maximise Shareholder(S/H)

Wealth
1.2 To Measure S/H wealth
Value of Equity (Ve) =Number of issued Equity/Ordinary
Shares X Current Market Price (Po)
1.3 To find Po:

Given in the Question if it is a listed company(see
below)
Compute Using: Dividend Valuation Model(DVM)
Earnings Based Models(PE)
1.4 Check the question very carefully for the size of the
company is it: Listed
Private Company
Make your comments relevant to the size and

nature of the company stated within the
question.
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Indicators
2.1 Financial indicators pointing towards maximising S/H

wealth include:
Earning per share(EPS)

Dividend per share(DPS)
Return on Capital Employed(ROCE)
Return on Shareholder Capital(ROSC)
Profit after tax
Revenue
2.2 Non-Financial Indicators include:

Market Share
Customer Satisfaction
Quality Measures
The above are all Key Performance Indicators (KPIs)
that need to be measured and reviewed on a regular
basis by the board of directors. (Board)
3. External Factor Affecting Ve & Po
3.1 The Board cannot control all aspects that effect
Ve and/or Po. One of the major factors is macroeconomic
variables.
3.2 Economic Variables -what are they and how may
directional changes effect the share price?
3.2.1 Interest Rates- If they fall: Stimulate demand and revenue
Lower the cost of debt and improve profits
Investors switch to share market for better
returns
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3.2.2
Inflation Rates- If it rises: Costs rise causing a drop in profits

Cause interest rates to rise.
Devalues the home currency
3.2.3
Foreign Exchange Rate(FOREX)- If it rises: Reduce cash receipts for exporters

Lowers the cost for importers
Discourage exporting
3.2.4
Gross Domestic Product- If it falls: Reduce demand and revenue

Cause interest rates to fall to stimulate demand
3.2.5 General Taxation If it rises: Damage company profits

Not encourage investment by companies
More savings from tax effect of tax allowable
depreciation.
Important to relate your comments to the effect upon
Po & Ve .
3.3 Agency Problem
3.3.1 S/H are the owners of the company and expect
their directors (agents) to take decisions to maximise
S/H wealth. The agency problem occurs when directors
take decisions that DO NOT lead to maximising S/H
wealth.
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3.3.2 Examples of decisions that may damage S/H wealth:
Directors pay
Taking high risk business decisions
Non-payment of dividends
Using debt finance (against the wishes of the
S/H)
3.3.3 Solutions to this problem include:

Company Law
Corporate Governance (eg UK Combined Code)
Share Options (ESOPS)
3.3.4 ESOPS
This provides a way of rewarding Directors by
granting them options to buy shares in their company
at a fixed price. They can buy the shares in future
(normally 1 year) at the fixed price which usually is
todays price.Hence, directors are encouraged to take
decisions to maximise future share prices. This
benefits both the directors and the shareholders.
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4 The Three Key Decisions

4.1 To maximize S/H wealth the board must take
Investment
Finance
Dividend
4.2 Investment
4.2.1 Allocate cash for: Organic Growth (Projects)
Acquisitions
4.2.2 Must always consider how investments
impact upon: Company Liquidity
Future Profits and Asset values
Business Risk Profile i.e. effect upon
variability of the cash flows and profits.
4.3 Finance
4.3.1 To finance investments the board have to
decide the best balance of equity and debt.
4.3.2 They will consider: Cash available within the company
Access to new sources of finance
Impact on KPIs like gearing
ratio(Debt:Equity)
Cost of Finance (WACC)
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4.4 Dividends
4.4.1 The Board needs to establish a dividend policy
see Chapter 2
4.5 The three decisions are interlinked.
Example: New projects need new finance but must
generate cash to service the finance providers
including paying dividends to the shareholders.
5
Objectives of Not-For-Profit- Organisations (NFP)

5.1 These include:
government funded functions(Public Sector)
charities
trade unions
5.2 With no shareholders it is important to ascertain.
a) who are the main stakeholders?
b) what are there objectives?
5.3 It is widely recognised that NFP entities should
demonstrate the principles of Value for
money(VFM)
The indicators are:1) Economy - lowest cost of input resources
2) Efficiency - ratio of input to output measures
3) Effectiveness - how outputs are measured.
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5.4 For example, in a government funded school

measures could be:Economy - cost of teachers
- cost of admin
Efficiency - cost/pupil
- Number of pupils/teacher
Effectiveness - pass rates
- number of pupils moving to higher
education
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Chapter Two
Dividend Policy
1 Introduction
To maximise S/H wealth the Board should establish a
dividend policy-the payment pattern to the equity investors.
2 Theories
Several theories have been put forward to assist:2.1 Residual If spare cash exists at the end of the year pay
dividend.
2.2 Pattern Be consistent with dividend payments. Either
a) Pay the same dividend per share (DPS) each year.
b) Maintain the payout ratio (DPS/EPS)
c) Maintain the same year-on-year growth rate in
dividends. The latter links into the Po via the
dividend valuation model (DVM)
Po= Do (1+g)
(re-g)
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2.3 Irrelevancy
In a perfect capital market providing the directors can
invest in projects with a positive NPV no dividends
are required. The Ve will rise and the S/H can sell shares
to create the cash the need(Manufacture Dividends).
3 Practical Considerations
There are many to consider:
Availability of Cash
What dividends to S/H want (clientele effect)?
Signalling effect payment of dividends indicates a
healthy company
Retaining cash is a key source of Finance.
Dividend growth should be greater than inflation
Tax impact upon S/H
Effect
the
dividend
will
have
on
dividend
cover(EPS/DPS)
Number of investment opportunities will restrict
dividend payments.
Risk-paying now is safer than promising to pay next
year
Is the dividend within the company law regulations?
4 Alternatives to Cash Dividends
4.1 Scrip Dividends
4.1.1 The S/H will receive extra shares instead of cash on a
pro rata basis.
4.1.2 This will allow the S/H to sell extra shares for cash and
the gain will be subject to CGT.
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4.1.3 The effect will:a) Increase the issued equity capital

b) Dilute EPS and Po values
c) Create pressure for the board to pay more total
dividends in the future as more shares are in issue
4.2 Share Buy Back
4.2.1 If the board has one off period of excess cash, they
could consider a share buy back.
i.e. Buy back shares at Po and cancel them.
4.2.2 Considerations:a) Allowable under company law.
b) Increase gearing as Ve may fall.
c) Tax implications for the S/H(CGT)
d) Reduced number of shares will cut supply for
trading purposes and may cause Po to rise.
e) Less dividend pressure on the board in future.
f) Criticism-is this the best use of company cash.
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Chapter Three
Cost of Capital
1 Weighted Average Cost of Capital (WACC)
Ke=Cost of Equity
Kd=Should be Kd(1-t)=Cost of Debt
Ve=Market Value of Equity
Vd=Market Value of Debt
2 Market Values
2.1 Ve=Total Number of Issued Shares X Po
2.2 Vd=Total Book value of the Debt X
Po
$100
2.3 Alternative Presentations

a) Ratio (Vd:Ve) e.g. 1:4
b) Gearing Percentage e.g. 35% hence, Vd=35,Ve=65
for WACC equation
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3 Cost of Equity (Ke)

3.1 The minimum return required by the S/H to compensate
for the risks they face from the equity investment.
3.2 CAPM
Ke=Rf+ (Rm-Rf)e
where Rf=Risk free return
Rm=Return on the market portfolio
(Rm-Rf)=Equity Risk Premium
e=Measure of the risks being
faced by the S/H
3.3 DVM
Where Po=Ex Dividend Share Price

d1=The DPS at Time 1
do=The DPS at Time 0
g =Constant annual future growth rate
in the DPS
4 Cost of Debt (Kd (1-t))
Depends upon the type of Debt
Also note:a) Kd=Called Yield(the minimum return of the lender)or
pre tax cost of debt
b) Kd (1-t)=Cost of Debt* or post tax cost of debt
* This is part of the cost of capital computation.
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4.1 Non traded debt (Bank Loans)

Kd is the Interest rate on the loan
Kd (1-t)=Interest Rate X (1-t)
4.2 Traded Bonds
4.2.1 These are issued and traded in blocks of $100
or 100.Do all computations per block of 100.
4.2.2 Undated Bonds-the process is:a) Kd (1-t) = Ints x (1-t)
PO
b) Exam Tricks :
i.
If there is no taxation
Kd (1-t) = Ints
PO
ii.
If the Kd is given by the examiner in the

question
Kd (1-t)=Given Kd% x (1-t)
4.3.3 Redeemable Bonds-the process is via IRR computation

Time
To
Po
T1-Tn Ints x (1-t)
Tn Capital Repayment*
$
(X)
Take two guesses at

the Kd(1-t) like
10% & 1% and
Perform IRR computation
X
X
* can be replaced by equity value for convertible bonds if

higher than capital repayment.
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5 Uses of the WACC

5.1 The WACC is the money or nominal cost of capital to use
in project DCF approaches. It can be used:a. To compute the NPV as the discount rate.
b. Compare with the project IRR.
IRR>WACC-Accept
5.2 The WACC is useable if the new project under
consideration:a) Is a core activity same as the companys
normal activities
b) Does not alter the capital structure of the
company (Vd:Ve)
5.3 In all the past F9 exam questions, it has been very clear
within the question details that the conditions exist to
use the WACC. If the WACC cant be used then the Risk
Adjusted Cost of Equity per Chapter 5 may be used.
6 What ifs?
6.1 Extend the WACC formula for all extra methods of
company finance. So you could have a WACC with:
Equity
Preference Capital
Bank loans
Traded Bonds
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6.2 For Preference Capital

> Kp=D.P.S
Po
> Vp= No of issued
Preference shares
X Market price per

share (PO)
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Chapter Four
Bonds Yields and Market Values
1 Bonds
Debt which is issued in blocks of 100 and trades on the
stock exchange.
2 Market Value
2.1 The market value is Po/$100 and can be established via
the DVM
The present value of future cash flows received by the
investor and discounted at the yield(Kd)
2.2 Undated Debt
Po =
Ints
Yield
2.3 Redeemable Bonds

Time
Yield%
Ti-Tn Ints
Tn Capital
Repayment*
X
Po
PV
XX
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2.4 Convertible Bonds

Replace the * Capital repayment with the share value if
higher than the cash repayment.
2.5 Bank loans market value is the book value.
3 Yield (the minimum return required by the lender) OR
Pre-tax cost of Debt
3.1 Yield is the minimum return of a lender. Practically we
would expect:RF<Inter-Bank rate(LIBOR)<Yield required by the lender
3.2 Undated Bonds
Yield =
Ints
Po
3.3 Redeemable Bonds

Time
To
Po
$
(X)
T1-Tn Ints
Tn Capital Repayment
Take two guesses at

the yield say 10% &
1% and perform IRR
computation
3.4 Bank Loans

Yield=Interest Rate on the loan
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Chapter Five
Risk Adjusted Cost of Equity
1 Uses
When the company wants to assess a project that is noncore.
2 Process
a. Take the Proxy Company Beta equity and degear via
b. Repeat the above for other Proxy Company Betas.

Then average all the a
c. Re-gear a to find the project e
d. Put the Project e into CAPM
Project Ke =Rf + (Rm-Rf) Project e
Note:(Rm-Rf) is the Equity Risk Premium.
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3 Concerns
Will the project finance truly have no effect upon the
companys gearing?
Proxy company e:a) Does it exist?
b) Does the proxy company specialise in the noncore field or does it have many different business
activities
c) If we are not listed-how do we gear up the a
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4 Examiners Article
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Chapter Six
CAPM
1 CAPM Equation
Minimum return = Rf+ (Rm-Rf)
There are several uses of the CAPM equation: To find the companys Ke(Chapter 3)
Risk Adjusted Ke (Chapter 5)
Assist a stock market investor to buy or sell equities
2 CAPM & Buy/Sell Equities
2.1 Single Equity
Take/Find e
Put into CAPM
Minimum Return = Rf+(Rm-Rf)e
Forecast a return for the investment (could use
past returns)
Forecast exceeds/equals
minimum return-Buy or Keep the share
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2.2 Combining Equities (portfolio)

a) Created a weighted average portfolio Beta
i.e (Cash in Share (1)/Total Cash in Equities X 1) + (Cash
In Share (2)/Total Cash in Equities X 2 )
b) Put into CAPM

Minimum Return = Rf+(Rm-Rf)Weighted Average
c) Forecast exceeds/equals
minimum return-Buy or keep the portfolio.
3 Meaning of a e
3.1 A e is the measure of risk being faced by equity
shareholders
3.2 e can be split into: Systematic Business Risk-measured by asset
Financial Risk(e-a)
3.3 Systematic risk is how market factors effect that

investment. Market factors are: Macroeconomic variables
Political factors
The measure is relative to the benchmark of the
market portfolio which has a eta factor of 1.
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3.4
CAPM assumes that the investor has eliminated the

unsystematic risk.
TOTAL RISK
Unsystematic risk
Systematic risk
Company specific factors

Can be eliminated by
diversification
General economic factors

Cannot be eliminated
By holding a portfolio, the unsystematic risk is

diversified away but the systematic risk is not and will
be present in all portfolios.
If we were to enlarge our portfolio to include
approximately 25 shares we would expect the
unsystematic risk to be reduced to close to zero, the
implication being that we may eliminate the
unsystematic portion of overall risk by spreading
investment over a sufficiently diversified portfolio.
Total
Risk
Unsystematic
Risk
.
Systematic
Risk
No of different business
Shares in the portfolio
Approx 25
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Criticisms of CAPM
1) CAPM is a single period model. This means that
the values calculated are only valid for a finite
period of time and will need to be recalculated or
updated at regular intervals.
2) CAPM assumes no transaction costs associated
with trading securities.
3) Any beta value calculated will be based on
historic data which may be not appropriate
currently. This is particularly so if the company
has changed the capital structure of the business
or the type of business it is trading in.
4) The market return may change considerably over
short periods of time.
5) CAPM assumes an efficient investment market
where it is possible to diversify away risk. This is
not necessarily the case, meaning that some
unsystematic risk may remain.
6) Additionally, the idea that all unsystematic risk is
diversified away will not hold true if stocks
change in terms of volatility. As stocks change
over time it is very likely that the portfolio
becomes less than optimal.
7) CAPM assumes all stocks relate to going
concerns, this may not be the case.
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5 Examiners Articles
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Chapter Seven
Capital Structure
1 Introduction
How should the company decide the mix of
equity and debt capital?
2 Practical Issues
If the company uses Debt capital funding it should
consider:
Credit Rating of the company

Rate of interest it will pay
Market conditions- access to Debt capital
Forecast Cash Flows-to service and repay the debt.
Level of Tangible Assets on which secure the loans.
Interest will lead to tax savings i.e Tax Shield
Constraints on the level of debt from
a) Articles Of Association
b) Loan Agreements.
Effect upon the company gearing ratio

Debt/Equity+Debt OR Debt/Equity
Will the debt providers exercise influence over the

company?
The chance of bankruptcy.
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5 Theories of Optimal Capital Structure

3.1
Common Ground-both major views accept two facts:a) Yield<Ke

b) Gearing causes Ke to rise
3.2
Traditional View
%
Cost
Of
capital
Ke
WACC
Kd
Gearing
Key Points:1) Ke rises due to financial risk caused by gearing.

2) Kd is initially uneffected by gearing but rises at high
gearing levels due to the perception of the possibility of
bankruptcy.
3) WACC-trade off of Ke and Kd. Point X is the optimum
gearing level where WACC is lowest.
4) Once point X is reached via trial and error it must be
maintained.
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3.3 MM and Tax

%
Cost of
Capital
Ke
WACC
Kd
Gearing
Key points:1) Assumption behind the model:All debt is risk free

Only corporation tax exists
Debt is issued to replace Equity
All types of debt carry one yield, the risk free
rate
Full distribution of profits
Perfect Capital Market
2) MM concluded companies should gear up to the

maximum levels.
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4 Pecking Order Theory

In this approach, there is no search for an optimal capital
structure through a theorised process. Instead it is argued
that firms will raise new funds as follows: Internally-generated funds
Debt
New issue of equity
Firms simply use all their internally generated funds first
then move down the pecking order to debt and the finally to
issuing new equity. Firms follow a line of least resistance
that establishes the capital structure.
Internally generated funds-i.e. retained earnings.
Already have funds.
Do not have to spend any time persuading outside
investors of the merits of the project.
No issue costs.
Debt
The degree of questioning and publicity associated with
debt is usually significantly less than that associated
with a share issue.
Moderate issue costs.
New issue of equity
Perception by stock markets that it is possible sign of
problems. Extensive questioning and publicity
associated with a share issue.
Expensive issue costs.
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Chapter Eight
Project Appraisal
1 Accounting Rate of Return (ARR)
1.1 Average Annual Post Depreciation Profit
Investment
X 100
1.2 Investment is:a) Initial Investment

b) (Initial Investment +Scrap Value)
2
1.3 Decision rule is:ARR> Target return-accept the project
OR
Take the project with the highest ARR
1.4 Limitations and Strengths
Limitations
Figures are easily manipulated e.g. by changing the
method of depreciation or the estimate of disposal
value.
Ignores the actual/incremental cash flows associated
with the project, and the effect of the timing of those
cash flows on the real return.
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Double counting-depreciation is deducted from the

profit figure in full, but the use of the average assets
means that part of this is also included in the
denominator. The effect is to depress the calculated
return.
Strengths
Expressed in terms familiar to managers-profit and
capital employed.
Easy to calculate the likely effect of the project on the
reported profit and loss account / balance sheet.
Managers are frequently rewarded in relation to
performance against these variables.
Business is judged by ROI by financial markets.
2 Payback
2.1 Time it takes the project to payback its initial
investment.
2.2 General Approach:Time
To
T1
T2
T3
T4
T5
Cash Flows
(X)
X
X
X
X
X
Cumulative Cash flows

(X)
(X)
(X)
X
-
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2.3 Annuity and Perpetuity cash flows

Payback period=Initial Outflow
Annual Inflows
3 Net Present Value (NPV)
3.1 NPV is the increase in S/H wealth arising from the
project.
3.2 Two formats to consider
Format (A)
Year
Receipts
Payments:
Wages
Materials
Variables/Fixed Overheads
Administration/Distribution
Expenses
Taxable Operating Cash
Flows
Tax: Corporation Tax on
operating cash flows
Initial Outlay
Net Realisable Value
Tax saved on TAD
Working Capital
Net Cash Flows
Discount Rate (e.g. 12%)
Present Value
Net Present Value(NPV)
0
1
2
3
4
5
$000 $000 $000 $000 $000 $000
X
X
X
X
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
(X)
X
(X)
X
X
X
X
X
X
X
X
X
(X)
(X)
(X)
1
(X)
X
(X)
(X)
X
X
X
(X)
X
X
X
$XXX
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X
(X)
X
(X)
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Format B
Time
CF
To
T1-Tn
T2-Tn
12% (SAY)
(X)
X
X
NPV
1.0
X
X
PV$000
(X)
X
X
$XXX
3.3 Incremental Cash Flows

Result from/caused by the project
Include opportunity cash flows
Ignore: Non-Cash Flows
Sunk Costs
Interest /Dividend payments
3.4 Financial Maths Required:1) Compounding
Eg: Inflation is 5% pa
Real cash flow at time 7 is $250
Money cash flow =$250 x 1.057= $352
2) Discounting (tables)
Eg: Cash flow at T5 is $390.
r=10%pa
PV=$390 x 0.621 =$242
3) Annuity (tables)
Eg: Cash flow from T1-T9 is $400 pa r=5%
PV =$400 x 7.108 = $2843
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4) Delayed Annuity
Eg: Cash flow T3-T5 =$300 pa
r=10%
PV=$300 x (AF1-5 AF1-2)
=$300 x (3.791-1.736)
=$617
5) Perpetuity
Eg:Cash flow is $500 pa from T1 each year forever.
r= 4%
PV= $500 x 1
r
=$500 x 1 = $12,500
0.04
6) Delayed Perpetuity
Eg: Cash flow is $600 from T4-Tperp
r= 5%
PV=$600 x (1/r AF1-3)
=$600 x (1/0.05-2.723)= $10,366
7) Perpetuity with Growth
Eg: Cash Flow at time 1 will be $120 and then it
will grow at 3% pa.
r=12%
PV= $120 x 1
(r-g)
PV=$120 x
1
= $1,333
(0.12-0.03)
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8) Delayed Perpetuity with Growth

Eg: As for (7) above but $120 is cash flow at T5.
PV= $120 x Effective Discount Rate.
Effective Discount Rate=
1 x DF4 at 12%
(r-g)
1
x 0.636
(0.12-0.03)
= 7.067
PV =$120 x 7.067 = $848
3.5 Inflation- Factors to consider:
a) h is symbol for inflation
b) r is symbol for real excludes inflation
c) i is symbol for money/nominal includes inflation
d) Two approaches are possible
3.6 Include Inflation
Money cash flows can be: Given in the question
Computed via
Real CF x (1+h)n
Money cost of Capital can be
Given in the question
WACC (see earlier chapter)
Computed via
(1+i)= (1+r) (1+h)
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Exclude Inflation
Not yet tested by the examiner at F9
Cash flows are REAL i.e. exclude inflation
Discounted at REAL Cost of Capital i.e. exclude
inflation
3.7 Working capital-think of as a project bank account:i.
ii.
iii.
Invest at To
Adjust each year
Close at end of the project.
Eg: Project needs WC at end of each year as follows:
Relevant
CFs
T0
(300)
T1
300
(50)
T2
350
(25)
T3
375
375
3.8 Taxation-relevant cash flows to be included in the NPV

computation. (RTQ re timings of tax flows!!!)
1) Operating Flows x Tax rate
2) Tax saved on Capital allowances or Tax Allowable
Depreciation(TAD):a) TAD-straight line.
eg: CAPEX is $1m.Scrap value at T4=$200K.TAD
is 4 years and tax rate is 30% (No delay)
Tax saved= [($1000-$200)] x 30% =$60 pa
T1-T4
4
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b) TAD-Reducing Balance
eg: Asset is bought at T0 (1/1/10)cost
$1m.Sold at T4 for $200k.TAD is 25% reducing
balance. Tax is 30% (1 year delay).
Time
Tax saved
$000
75
56
42
67
240
T2 $1000 x 25% x 30%

T3 75 x (100% -25%)
T4 56 x75%
T5 Bal Figure
30% x (1000-200)
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4 Internal Rate of Return (IRR)

4.1 The cost of capital that gives an NPV=Nil
4.2 Approach-Take the following example:
NPV@ 10% =$200K
NPV@ 20% = ($15K)
IRR= 10+ (200/200-(-15)) x (20-10) =19.30%
4.3 Decision Rule
IRR>Project Cost of Capital-Accept
4.4
PROS
CONS
*Easier to explain
*Simple decision rule
*Will mislead if comparing

projects
* If cash flows are nonregular (-, +, +, +,-)
IRR computed above is
incorrect as there will be
multiple IRRs
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5 Capital Rationing
5.1 A restriction of cash preventing the company from
accepting all projects with a positive NPV
5.2 Causes:
Hard
Soft
External constraint on
Raising cash.Eg:- Credit
Crunch Crisis
Internal within the

Company
Eg:- Capex Budget
5.3 Period only single period is examinable i.e. cash may

Be restricted at T0 or T1.
5.4 Divisible projects can invest in proportions of a project
from 0% to 100% maximum.
Approach:1) Compute Project NPVs
2) Compute Profitability Index(PI) =
NPV
Cash Invested at critical period
3) Rank-High to Low PI
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5.5 Non-Divisible take all or none of any project.

Approach:1) Compute Project NPVS
2) Take best combination of projects that
maximise the total NPV but spend less than or
equal to cash available in the critical period.
6 Asset Replacement
6.1 If assets have to be replaced on a periodic basis,
Equivalent Annual NPV is the method to use.
6.2 Process
a) Compute the NPV for each replacement cycle.
b) E.A.NPV =
NPV
Annuity Factor for life of the project @cost of capital
c) As (b) will give negative values, take the least

expensive.
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7 Accruing for Risk or Uncertainty within NPV

Several methods, the best are:7.1 Probabilities One project cash flow may be
uncertain.
Example Sales in year 1
$000
2000
1000
P
0.70
0.30
1.0
Sales in T1 for NPV=

(2000 X 0.70)+ (1000 X 0.30) =$1700K
7.2 Decision Trees
Used when dependent probabilities exist. This can best
be demonstrated by an example.
Year 1 Sales
$10,000
0.3
$20,000
0.7
Year 2 Sales
$15,000 0.6
$ 5,000 0.4
$30,000 0.8
$ 15,000 0.2
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As a decision tree:P
10,000
15,000
P
0.3 x 0.6 = 0.18
5,000
0.3 x 0.4 = 0.12
0.3
20,000
30,000
0.7 x 0.80 =0.56
0.7
15,000
1.00
0.7 x 0.20 = 0.14

1.00
7.3 Risk adjusted Cost of Equity See Chapter 5

7.4 Sensitivity Analysis-What if?
Change one variable that will cause the NPV to go nil.
Quickest way is to:
NPV
X 100% For Cash flows
PV of the cash flow
that is uncertain
IRR-Cost of Capital X 100% For the Cost of capital

Cost of Capital
Lower the sensitivity % the higher the risk
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7.5 Discounted Payback

Payback using discounted cash flows
Format
Time
T0
T1
T2
T3
T4
T5
D.C.F
(X)
X
X
X
X
X
Cumulative D.C.F
(X)
(X)
(X)
X
-
8 Post Completion Audit (PCA)

During the life of a project, an investigation should be
undertaken to examine its profitability and compare it with
the plan. There are three reasons for undertaking these
post-mortems:
To discourage managers from spending money on
doubtful projects, because they may be called to
account at a later date.
It may be possible over a period of years to discern a
trend of reliability in the estimates of various
managers.
A similar project may be undertaken in the future, and
then the recently completed project will provide a
useful basis for estimation.
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9 NPV and S/H wealth

9.1 As stated earlier, NPV represents the change in S/H
wealth arising from the project. It is the only method
that can be directly related to the primary objective of
financial management.
9.2 The NPV is effectively the change in the market
capitalisation of the company and the movement in its
share price. It relies upon markets being efficient
(see chapter 9) to reflect the project data within the new
market price.
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Chapter Nine
Business Valuations
1 Equity
1.1 To value equity /ordinary shares on a per share basis
two primary methods exists.
1.2 DGM/DVM
Po is the present value of future dividends discounted at
the cost of equity(re or Ke)
Po= Do (1+g)
(re-g)
1.3 P/E Model
PO =EPS X P/E Ratio
P/E Ratio may have to come from a proxy company.
2 Others
2.1 Preference shares
PO = D
rp
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2.2 Traded Debt-Undated

PO per $100 = Ints
rd
2.3 Traded debt Redeemable
PO per $100:Time
rd
PV
T1-Tn Ints
X
Tn
Capital Repayment * X
X
X
X
X
PO
*For convertibles, use higher of capital repayment or share

value if converted into equity.
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3 Efficient Market Hypothesis (EMH)

3.1 EMH explains how stock market prices change to reflect
data /information. The market can be efficient at 3
levels: Weak
Semi-Strong
Strong
3.2 Weak the prices reflect only historic/past data.
3.3 Semi-Strong-prices include past data +public
announcements.
3.4 Strong-prices reflect past, public and insider (secret)
data.
3.5 Most of the worlds stock markets are closer to
semi strong.
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Chapter Ten
Sources of Finance
1 Introduction
Where and how do companies raise long term capital.
2 Equity General Factors
2.1 Ordinary shares of the company with voting rights.
2.2 Carry the greatest risk but also the best possible
returns.
2.3 Could be traded on the stock exchange if company is
listed.
2.4 A Stock Exchange Listing
Advantages of a listing on the stock exchange
To existing shareholders:
they can sell some of their shares;
greater marketability raises value;
no valuation problems e.g. for IHT
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To the company
new funds can be obtained;

takeovers can be financed by equity issues;
easier to raise future finance
perceived risk reduction fall in cost of equity;
extra status may generate new business.
Disadvantages of a listing
costs borne by company;

company must comply with SE regulations;
dilution of control;
public scrutiny of profits/results.
3 Equity- Raising New Capital

3.1 Retained Earnings-First source of cash. Hold back the
payment of dividends. Will effect the dividend policy
and can raise a small amount of cash.
3.2 Rights Issue-Pro Rata issue to existing S/H.
3.2.3 From the exam questions will need to obtain or
compute:a) Po just before the rights issue (Cum Rights
price)
b) Issue Price
c) Ex Rights Price-price directly after the share
issue (TERP)
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For Example: 1 for 3 rights issue at 550p and

cum rights is 600p
No
3 at 600p
1 at 550p
4
18.00
5.50
23.50
TERP = 23.50/4 =5.88

d) Value of the right
5.88- 5.50 =38p
3.2.4 Shareholder can sell the rights to another
shareholder at the value of the rights.
3.3 Placing- Sell a large batch of new shares to
institutions.
3.4 Prospectus- Sell shares to investors at a fixed price
after issuing a prospectus.
3.5 Tender- Request investors to tender for the shares
at a price they would want to pay. The board then
establishes final price.
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4 DEBT
4.1 Loans provided to the company on a long term basis.
Debt holders will:a)Interest paid from pre-tax profits
b) Security via
Fixed charged
Floating charge
Securitisation of future income.
c) Covenants-restrict company activity in areas
such as:
Dividend payments
Issues of further debt
4.2 Bank Loans
4.2.1 Funds come from one bank or group of banks.
4.2.2 Terms & Conditions depend upon market
conditions and credit rating.
4.3 Traded Bonds
4.3.1 Loan is split into blocks of $100 and issue on the
market.
4.3.2 Can be undated or redeemable.
4.3.3 Bond has a yield and market value (Chapter 4)
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4.4 Other Types of Debt

a) Convertible Bonds-Debt that can be converted
to shares, normally at redemption.
b) Eurobonds-Rare large foreign currency loan in
the home country. Used by MNCs and minimum
values normally $1m.
c) Mezzanine Loan
Loan Finance that has elements of equity as
part of it. For example
a) Convertible Bonds
b) Loan plus a warrant right to buy a share
in the future at a fixed price.
d)
Grants-Free government finance providing

conditions are met.
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Leases
Leasing is an alternative way of obtaining the use of
items of equipment for companies which for varying
reasons may wish to avoid acquiring them outright.
Terminology
a) Operating lease
Usually for a short period, where substantially all
the risks and rewards of ownership remain with
the lessor.
b) Finance Lease
Usually for long period, where substantially all
the risks and rewards of ownership pass to the
lessee.
The type of lease that we need to consider in
more detail is a finance lease because this is an
alternative to borrowing some money in the long
term in order to purchase an asset.
Reasons for leasing
The full lease rental is allowable against tax.
Interest on debt financing is allowable against
tax but the capital repayment is not.
It is readily available form of finance, especially
for plant and equipment or motor vehicles. It is
therefore very convenient for companies to
enter into such arrangements.
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It removes the need for a significant capital

outlay at the beginning of a projects life i.e. it
avoids the need to find the capital at the outset.
It may be cheaper in financial terms that
conventional debt financing i.e. the effective
interest rate on leasing may be less than the
interest payable on a loan.
5.2 Lease Vs Buy Evaluation
3 Step approach
1. Ascertain the post tax cost of debt
i.e Pretax % X (1-t)
2. NPV of the lease cash flows using (1)
Lease cash flows are:
Payments/Rental
Tax savings caused by rentals.
3. NPV of buy cash flows using (1)
Relevant flows are: Capital Cost
Scrap value
Tax saved on Capital allowances or Tax
allowable depreciation.
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6 The role of Treasury Function

6.1 Treasury functions mainly exist in Large MNC.
6.2 Roles include:Managing the groups cash resources
Liaise with the banks.
Advising on Heading strategies for: Forex Risk
Interest Rate Risk
Establishing source of Finance and cost of capital
for the group.
Deciding upon investment policy.
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Chapter Eleven
Ratios
1. Ratios-You must Learn!!!!
1.1 Investor
EPS = PAT less Preference Dividends
No of ordinary shares in issue
P/E = Po
EPS
Dividend Cover= EPS
DPS
Payout Ratio = DPS
EPS
Dividend Yield = DPS
Po
Total Shareholder = Dividend for + Capital Gain
Return(TSR)
the year
for the year
Share Price at start of the
year
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1.2 Gearing
Capital Gearing= Debt or Debt
X 100
Equity
Debt+Equity
NB Preference shares are generally treated as debt.
Interest Cover = Operating Profit
Interest
1.3 Profitability
ROCE = Operating Profit X 100
Equity +Debt
ROE = PAT X 100
Equity
Margin = Operating Profit X 100
Turnover
1.4 Liquidity
Current Ratio= C.Assets
C.Liabilities
Quick/Acid Test = (C.Assets-Inventory)
Ratio
C.Liabilities
Inventory Days=
Inventory
x 365
COS or purchases
Receivables Days= Trade Receivables x 365

Sales
Payables Days = Trade Payables x 365
COS or Purchases
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2 Important
Learn the ratios

State on answer book, substitute the relevant
figures from the question and compute the ratio.
Comment on each ration in a sensible manner.
Be ready to change the ratios around
Eg: C.Ratio is 1.25:1.C.Assets are $260K and
C.Liabilities are made up of bank overdraft and
payables. Payables are $108K.What is the value of
the bank overdraft?
Solution
CA=1.25($260K)
CL=1.00(?)
CL=$260K=$208K
$1.25
Bank O/D=$208K-$108K
=$100K
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Chapter Twelve
Working Capital Management &
Financing
1 General
The level and nature of working capital within any
organisation depends on a variety of factors, such as:
the industry within which the firm operates

the type of products sold
whether products are manufactured or brought in
the level of sales
inventory and receivables policies
the efficiency with which working capital is managed
Ultimately it is the balance of: liquidity

profitability
2 Cash Operating Cycle
Length of cycle =Average inventory + Average
holding
receivables
period
collection period
Period
credit
taken
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Financing of Working Capital
3.1 Current assets can be simply financed by using current

liabilities .The latter is made up of: Trade payables
Bank Overdraft
The latter carries an interest cost while the former does
not.
3.2 However, there is a view that some elements of the
current assets are permanent. Hence they are a kin
to non-current assets. There are financed by long term
sources of funding-WACC.
3.3 For example
$000
Current Assets
Trade payables
Bank overdraft
Bank overdraft Interest = 8% pa
WACC =12%
4,500
2,000
1,000
What is the cost of financing the current assets?

Solution
Short term cost
8% x 1000 =
$80
Long term cost

12% x (4500-2000-1000)=
$180
$260
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Chapter Thirteen
Inventory Control
1
INVENTORY MANAGEMENT
Economic Order Qty(EOQ)

-Optimise stock order quantity
and Re-order level
-Minimises stock associated
costs
No discounts
Just In Time(JIT)
-Nil/minimum
stock
With discounts
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EOQ
Assumptions
Demand is known
Purchase price is
constant
(No discounts)
Lead time is
constant
(No Stock outs)
Re-order level =
demand in lead
time
Graphs
EOQ + DISCOUNTS
Method
1)
Calculate the EOQ

using the formula,
ignoring
any
potential discounts.
This is the starting
point.
2)
If, and only if, the

EOQ calculated in
1) would result in a
discounted
purchase
price,
recalculate the EOQ
using the formula
taking into account
the
relevant
discount.
3)
Finally,
calculate
the
total annual
cost using the EOQ
calculated
in
2)
AND
the
total
annual
cost
ordering
in
quantities
higher
than the EOQ but
where
greater
discounts
are
available.
Q/2
ROL
0
TIME
Co=Fixed cost per

order
D=Annual Demand
Total relevant
costs
Variable
holding
costs
CH=Variable holding
cost per unit.
All costs are known

and constant
Fixed order
costs
EOQ
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Forecast Sales qtys
(2)
Demand Driven
(1)
Close Link
with suppliers
(7)
No or Ltd
Raw material
Inventory(6)
No Finished (3)
Goods inventory
JIT
(Factors)
NO WIP(5)
JIT
Production (4)
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Chapter Fourteen
Receivables and Payables
1 Receivables
1.1 Receivables management is the balance between: liquidity (hold a lower balance)
profitability(offer more credit)
1.2 Factors to consider when offering credit.
Do competitors offer credit?
Industry norms
Check the credit rating of both new and existing
customers
Set realistic credit limits
1.3 To collect cash from receivables efficiently:
Invoice promptly
State terms on the invoice
Send out monthly statements
Call customers to chase payment
Consider legal proceedings as a last resort.
1.4 Factoring companies offer contracted out receivables

management.
Receivables administration/collection of cash.
Advances of cash
Insurance cover for bad debts.
All the above have costs & fees attached.
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1.5 Recourse- Services can be offered with or without

recourse. If without recourse, the factoring company will
suffer any bad debts should they arise.
1.6 Invoice discounting-this is where cash can be raised
using certain receivables balances as security.
Customers are not aware of the transaction. The debt is
paid off when the receivables settle their debt.
1.7 Offering early settlement discounts to customers.
Eg Receivables normally pay in 45 days a settlement
discount of 1.0% is offered for payment within 30
days. Bank overdraft rate is 20%pa
Solution
Assume sale of $100
Discount is $ 1.00 = 0.01
$99.00
Effectively, annual value is:365
(45-30)
= 24.33
(1+0.01)24.33-1 x 100
=27.4%
Discounts costs the company 27.4 % but save
20%.Hence, dont offer these terms.
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1.8 Changes of Policy

Prepare all computations on an annual basis
Show incremental relevant cash costs and savings
when changing from old to new policy.
Proforma Changing Receivables Policy
Annual
$000
xxx
xxx
(xxx)
Bad debts saved

Admin costs saved
Discount given
$000
xxx
Finance cost of
Original receivables
Finance cost of
New receivables
NET SAVINGS
xxx
xxx /(xxx)
xxx
2 Payables
2.1 Again balancing act: Maximise use of free credit
Not to over extend and lead to:a) Costs/Charges
b) Supplier withdrawing supply
c) Supplier going out of business.
2.2 Taking early settlement discount offered by suppliers
same approach as receivables as per 1.7.
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Chapter Fifteen
Cash Management
1 GENERAL
Motives to hold cash
Transactions-Day to Day payments
Precautionary-To cover rainy day
Speculative-Possible investment
opportunities
Business may have

Surpluses
Deficits
Surpluses
Consider: Amount
Time
Access
Return
Risk
Deficits
Uses: 1. Extend trade
payables
finance.
2. Bank facils.
Investments
Deposits
Building society
a/cs
Inter bank
market
Gilts
AIM
London SE
Futures
3. Factoring
companies.
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2 CASH BUDGETS-SHORT TERM MANAGEMENT

LAYOUT
January
February
March
Receipts
Cash sales
Receipts from debtors
Sale of assets
Payments
Cash purchases
Payments to creditors
Expenses
Purchase of assets
Tax
Dividends
Interest
Net cash inflow/(outflow)

Balance b/f
Balance c/f
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Exam Technique
Proforma (as above)
Copy in easy figures.
Workings for others e.g. receivables receipts, payables
payments.
Total & tidy!!
3 Cash Flow Forecasts
3.1 Two ways /possible exam questions covering this area: Balancing figure
Cash Flow Statement
3.2 Balancing Figure
Prepare a Forecast statement of Financial position and
use CASH AT BANK as the balancing figure.
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3.3 Cash Flow Statement

Prepare a cash flow statement but not strictly to P7
standards as follows:-
Operating Profit
Add: Depreciation
$000
xxx
xxx
Change in Inventory
Change in Receivables
Change in payables
xxx
xxx
xxx
Cash from operations
xxx
Sale of NCA
Issue of Shares
New Loans
xxx
xxx
xxx
Tax paid
Interest paid
Dividends paid
Purchase of NCA
Loans repaid
(xxx)
(xxx)
(xxx)
(xxx)
(xxx)
Share buyback
(xxx)
Cash generated this year

Balance b/f
Cash Balance C/F
xxx
xxx
$xxx
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4 CASH MODELS
Aim is to optimise the amount of cash held in the longterm.
4.1 Baumol Model
The inventory control model of cash.
Max Bal
Spread
Min Bal
Time
4.2 Spread comes from EOQ formula:
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4.3 Miller Orr

A model to cope with the daily variances in the use of cash.
Max Bal
SPREAD
Return
Point
One third
of spread
Min Bal
Time
Sell Investments and
Replenish cash
Formulae are:
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Chapter Sixteen
Foreign Currency Risk
1. Translation Exposure
This is a Financial Reporting risk. The change in the value
of an asset /liability caused by a change in the spot
exchange rate.
1.1 Example-ABC plc has a US subsidiary worth $10m.
2008 -
at $1.50
6.67m
2009 -
at $1.75
5.71m
Loss to equity
(0.96m)
Funded by a $10m loan.

2008
at $1.50
6.67m
2009
at $1.75
5.71m
Gain to equity
0.96m
1.2 Not a cash risk, only due to financial reporting!!!!

2.
Transaction Exposure
Change in the value of the spot rate over the short term
(less than a year) causing a cash gain or loss.
2.2 Must hedge!!
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3. Economic Exposure
Longterm change in the spot rates effecting project cash
flows .Risk can be reduced by Global Diversification.
4. SPOT and Forward Rates
4.1 Typical presentation of SPOT and Forward Rates.
(Bid)
(Offer)
$1.5000 - $1.5555 /
Reciprocal and
cross over!!!!!
0.6429 - 0.6667 / $
(Bid)
(Offer)
4.2 Picking the correct rate Good Method

Spot and Forward rates presented as FX/Home
currency
If we are Receiving Forex
Use the right hand rate
5. Internal Hedges for Transaction Risk
5.1 Invoice in home currency
All transactions in home currency
Transfer risk to the other party
Only useable rarely-if we have monopoly power.
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5.2 Foreign currency bank account

Held in the main currencies ($, Euro)
Pool all transactions in same FX
Liking have 3 bank accounts with 3 cheque books!!
5.3 Leading and Lagging
Watcher / predictor of spot rate changes
Leading accelerate exchange
Lagging delay the exchange
Used a lot by Importers who have to sell their home
currency
5.4 Netting
Match all FX transactions in the same FX occurring on
the same day
Eg: 30 June we expect
Receive $200K
Pay
($50k)
Net Rec $150k
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6. External Hedges for Transaction Risk

6.1 Forward Market
Fix the rate today that will apply on a set future date
Technique: 1. Net the future transactions in same FX and same
date. Ascertain if buying or selling the .
2. Forward contract, X months, at
Given as a spread
3. Exchange FX at the forward rate(Remember if
receiving FX use the right hand rate)
6.2 Money Market Hedge
The exchange will take place today at the known spot
rate.
Technique
Home
Today
Todays Spot
Answer
Abroad
FX
X
1+ints home
1+ ints foreign
Future Date
Answer
FX
FX
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7. Pros & Cons

Pros
Cons
Forward Market
Fixed Rate, certainty
Inflexible/contract
Easy
Lose out on the
Cheap
upside potential or
Tailored(Any size of
gain
transaction)
Must ensure FX
receipts arrive
MMH
Convert today
Cheap
Tailored
Flexible
Complicated
May not apply for FX
receipt as borrowing
may not be possible
abroad
8. Predicting Future Exchange Rates

Best long term prediction model is PPPT
S0=Spot Today
S1=Spot 1 years time
hc=annual inflation rate foreign
hb=annual inflation rate base/home country
In the short term use IRPT
F0=Forward/future spot rate

i=interest rate
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Practical Factors influencing the Spot Rate

1. Political stability-strengthens home currency value
2. Economic growth-strengthens home currency
value
3. Commodity pricing-oil is priced in dollars
4. Trader activity-buying & selling of currencies
5. Central bank action acting as a trader in FX
6. Changing interest rates-protect the value of the
home currency.
9 Derivatives (written questions only at F9)
9.1 Futures
This is a method of hedging which is trying to fix the
future spot rate at a value approximately equal to the
current spot rate.
Futures exchange rates are always similar to spot
rates and this is a key factor.
Hedge is based upon:1) Find the direction of the change in the spot rate that
would cause a transaction loss.
2) Use the Futures market and effectively spread bet on
the futures rate moving in directions that cause a loss.
3) If:a) Spot rate moves in the direction to cause a
transaction loss, a profit will be made on the
futures market, hence two will cancel out.
b) Spot rate moves in the direction to cause a
transaction profit, a loss will be made on the
futures market, hence two will cancel out.
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Its not a perfect hedge due to basis risk and odd

contract sizes.
9.2 Options
If we could take the current spot rate and use it in
the future, there would be no transaction risk.
With an option:1) Take a contract to give us the option (right)to
exchange in the future at approx current spot
rate.
2) Pay a non-refundable premium
3) Future-use the option rate if spot rate has
move unfavourably. Otherwise the option
lapses.
Think of an insurance policy-very similar
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Chapter Seventeen
Interest Rate Risk
1 ISSUES
There are two issues / type of F9 questions: Term Structure of Interest rates
Risk Management.
2 Term Structure of Interest Rates
2.1 Interest rates on the market generally follow this
relationship:
Return on
Govt Bonds
(RF)
<
LIBOR
(Interbank
Rate)
<
Lenders
Rates
2.2 Hence if the RF was to change it has a direct impact on

all other rates.
2.3 To predict the change in the RF, we use the Theory of
the Yield curve
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The standard of the
yield curve
Years until maturity
The curve is upward due to:a) Liquidity Preference Theory- the longer there is to
maturity the greater the return wanted by the lender.
b) Expectations theory-the yield reflects the expectation of
higher future inflation rates
2.4 Some research has indicated it may not be a curve but a
kinked function.
%
5 years
Years to
Maturity
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2.5 If inflation expectations are in reverse ie deflation, it is

feasible to get a reverse yield curve.
No of years of maturity
3 Risk Management
3.1 Normally, this occurs when a company has produced a
short term budget and believe that in the near future
they will run up a cash deficit (possibly a surplus). They
want to hedge against interest change that could damage
their profits.
3.2 For example
1 Jan
Now
31 Mar
(Deficit)
Pay old interest
for 2 months
31 May
Return to
surplus
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3.4 To hedge this risk a company has two basic choices: Lock the Rate
Ceiling/ cap the rate
4
Lock The Rate
4.1 FRA
A company can purchase a FRA that would lock the rate
for a set period in the future.
No fees are payable but minimum size is $1m.
4.3 Futures
This will effectively lock the rate to a value equivalent
to the borrowers current rate. It involves effectively
spread betting on the movement of the interest rate
on the market.
Contract sizes and deposits (margins) complicate this
process.
5
5.1
Ceiling Rate
IRG
An IRG can be purchased at fees that can cap the rate
payable. The company only uses the cap if the
borrowing rate exceeds this value.
Fees effectively increase the value of the cap offered
by the banks.
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5.2
Option
Achieves the same as above but uses the futures
market. The purchase of a PUT Option sets a capped
rate.
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Appendix New Topic

Islamic Finance
1.Introduction
The Islamic economic model has developed over time based
on the rulings of Sharia on commercial and financial
transactions. The Islamic finance framework is based upon:
Equity, such that all parties involved in a transaction can
make informed decisions without being misled or cheated.
To pursue personal economic gain but without entering into
those transactions which are forbidden.(eg, transactions
involving alcohol, pork related products, armaments,
gambling and other socially detrimental activities).

Also, speculation is also prohibited (so options and futures
are ruled out).
The strict prohibition of interest (riba = excess).
2.How can returns are earned?

As stated above, earning interest (riba) is not allowed.
In an Islamic bank, the money provided by depositers is not
lent, but is instead channeled into an underlying investment
activity, which will earn profit. The depositer is rewarded by
a share in that profit, after a management fee is deducted
by the bank.
A typical illustration would be how an Islamic bank may

purchase a property from a seller and re sell it to a buyer at
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a profit. The buyer will be allowed to pay in installments.

Compare this to a typical mortgage where the bank lends
money to the buyer and charges interest.
Hence returns are made from cash returns from a productive
source eg profits from selling assets or allowing the use of
an asset (rent).
3.Islamic Sources of Finance

In Islamic Banking there are broadly 2 categories of
financing techniques:
Fixed Income modes of finance murabaha, ijara, sukuk
Equity modes of finance mudaraba, musharaka
FIXED INCOME MODES
a) Murabaha
Murabaha is a form of trade credit or loan. The key
distinction between a murabaha and a loan is that with a
murabaha, the bank will take actual constructive or physical
ownership of the asset. The asset is then sold onto the
'borrower' or 'buyer' for a profit but they are allowed to pay
the bank over a set number of installments.
The period of the repayments could be extended but no
penalities or additional mark up may be added by the bank.
Early payment discounts are not within the contract.
b) Ijara
Ijara is the equivalent of lease finance; it is defined as when
the use of the underlying asset or service is transferred for
consideration. Under this concept, the Bank makes available
to the customer the use of assets or equipment such as
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plant or motor vehicles for a fixed period and price. Some of

the specifications of an Ijara contact include:
The use of the leased asset must be specified in the
contract.
The lessor (the bank) is responsible for the major
maintenance of the underlying assets (ownership costs)

The lessee is held for maintaining the asset in proper order.
An Islamic lease is more like an operating lease but the

redemption features may be structured to make it similar to
a finance lease.
c) Sukuk
Companies often issue bonds to enable them to raise debt
finance. The bond holder receives interest and this is paid
before dividends.
This is prohibited under Islamic law. Instead, Islamic bonds
(or sukuk) are linked to an underlying asset, such that a
sukukholder is a partial owner in the underlying assets and
profit is linked to the performance of the underlying asset.
So for example a sukukholder will participate in the
ownership of the company issuing the sukuk and has a right
to profits (but will equally bear their share of any losses).
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EQUITY MODES
a) Mudaraba
Mudaraba is a special kind of partnership where one partner
gives money to another for investing it in a commercial
enterpirse. The investment comes from the first partner
(who is called 'rab ul mal'), while the management and work
is an exclusive responsibility of the other (who is called
'mudarib').
The Mudaraba (profit sharing) is a contract, with one party
providing 100% of the capital and the other party providing
its specialist knowledge to invest the capital and manage the
investment project. Profits generated are shared between
the parties according to a pre-agreed ratio. In a Mudaraba
only the lender of the money has to take losses.
This arrangement is therefore most closely aligned with
equity finance.
b) Musharaka
Musharaka is a relationship between two or more parties,
who contribute capital to a business, and divide the net
profit and loss pro rata. It is most closely aligned with the
concept of venture capital. All providers of capital are
entitled to participate in management, but are not required
to do so. The profit is distributed among the partners in
pre-agreed ratios, while the loss is borne by each partner
strictly in proportion to their respective capital
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ACCA F9 Financial Management Key Point Notes

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Use of these Key Point Notes

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Bonds-Yields & Market

Foreign Currency Risk

Interest Rate Risk

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

Next 180 minutes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

Primary Financial Objective

1.1 For profit making business Maximise Shareholder(S/H)

1.3 To find Po:

Make your comments relevant to the size and

ACCA F9 Financial Management Key Point Notes

2.1 Financial indicators pointing towards maximising S/H

Earning per share(EPS)

2.2 Non-Financial Indicators include:

ACCA F9 Financial Management Key Point Notes

Inflation Rates- If it rises: Costs rise causing a drop in profits

Foreign Exchange Rate(FOREX)- If it rises: Reduce cash receipts for exporters

Gross Domestic Product- If it falls: Reduce demand and revenue

3.2.5 General Taxation If it rises: Damage company profits

ACCA F9 Financial Management Key Point Notes

3.3.2 Examples of decisions that may damage S/H wealth:

3.3.3 Solutions to this problem include:

ACCA F9 Financial Management Key Point Notes

4 The Three Key Decisions

ACCA F9 Financial Management Key Point Notes

Objectives of Not-For-Profit- Organisations (NFP)

ACCA F9 Financial Management Key Point Notes

5.4 For example, in a government funded school

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

4.1.3 The effect will:a) Increase the issued equity capital

ACCA F9 Financial Management Key Point Notes

ACCA F9 Financial Management Key Point Notes

2.3 Alternative Presentations

ACCA F9 Financial Management Key Point Notes

3 Cost of Equity (Ke)

Where Po=Ex Dividend Share Price

ACCA F9 Financial Management Key Point Notes

4.1 Non traded debt (Bank Loans)

If the Kd is given by the examiner in the

4.3.3 Redeemable Bonds-the process is via IRR computation

Take two guesses at

* can be replaced by equity value for convertible bonds if

ACCA F9 Financial Management Key Point Notes

5 Uses of the WACC