Sample Question Paper

Level 5 Effective Financial Management

Total marks: 100

Examination duration: 2h

Section A – 20 marks
(Short answer questions: 4 x 5 marks each = 20 marks total)

Answer all questions

1 (5 marks)
Discuss the potential disadvantages of the use of the weighted average cost of capital WACC to measure the
cost of capital.

2 (5 marks)
Explain two factors that contribute to the existence of the ‘agency problem’.

3 (5 marks)
You are a financial manager at Montreal plc. The business intends to launch one new product. This new
product will be either Product A or Product B. Your colleagues have prepared the following forecast of cash
flows arising from the manufacture and sale of the two new products.
Product A Product B
$ $
Revenue 130,000 150,000
Variable expenses 40,000 50,000
Fixed expenses 70,000 70,000
Net operating income 20,000 30,000

i. Calculate the operating gearing for Product A and Product B. (4 marks)

ii. Recommend which of the two products should be manufactured by Montreal plc. (1 mark)

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4 (5 marks)
Financial management is inherently forward looking (Watson and Head, 2016). The cash flows that occur as a
result of financing and investment decisions may arise over many years. Therefore, financial management
must be integrated into the business planning process.
The four key stages of financial management in the business planning process are:
1. Setting of objectives
2. Identifying options
3. Evaluating options and making a selection
4. Developing plans for activities and processes
Analyse the role of financial management in each stage of the business planning process.

Section B – 30 marks
(Short answer questions: 3 x 10 marks each = 30 marks total)

Answer all questions

5 (10 marks)
Clutterbuck plc is evaluating two possible investment projects. Each project has an expected life of five years.
Sufficient funding is available to finance only one of the projects. Clutterbuck plc has a cost of capital of 16%.

Project A Project B
$ $
Initial cost (year 0) 250,000 260,000
Scrap value (year 5) 10,000 25,000
Forecast net cash inflows
Year 1 90,000 120,000
Year 2 80,000 90,000
Year 3 75,000 80,000
Year 4 60,000 50,000
Year 5 55,000 50,000

Required:
a. Calculate the payback period for project A and project B, assuming that all cash flows occur at the end
of the respective year. (2 marks)
b. Calculate the accounting rate of return (ARR) for project A and project B, assuming that the only
difference between cash flow and profit is the depreciation charge. (4 marks)
c. Calculate the net present value (NPV) for project A and project B, using Clutterbuck plc’s cost of capital
as the discount rate. (4 marks)

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6 (10 marks)
Financing decisions can be critical to business success. The mix of debt and equity financing in a business is
referred to as its capital or financing structure. Financial gearing occurs as a result of the use of debt as a
source of finance.
You are planning to purchase some ordinary shares in either Business A or Business B.
The following figures have been taken from the most recent statements of financial position of Business A
and Business B:
Business A Business B
$ $
Debt
5% Debentures 2,000,000 15,000,000
5% Preference shares of $1 1,000,000 1,000,000
Equity
Ordinary shares of $1 5,500,000 20,000,000
Share premium 200,000 3,500,000
Retained profit 650,000 1,200,000

Required:
a. Calculate financial gearing for Business A and for Business B. (4 marks)
b. As a potential ordinary shareholder, critically discuss the levels of financial gearing in Business A and in
Business B. (6 marks)

7 (10 marks)
Cash is an important element of working capital. The amount of cash held by a business needs to be
considered with great care:
a. Explain three reasons an organisation might hold cash balances. (3 marks)
b. Explain three potential responses that a business might make to a forecast shortage of cash. (7 marks)

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 Section C – 50 marks
(Essay questions: 2 out of 3 x 25 marks each = 50 marks total)

Answer TWO questions only

8 (25 marks)
The process of selling shares to the public for the first time is called an initial public offering (IPO).
a. Discuss the typical stages in the IPO process. (6 marks)
b. Critically evaluate the use of IPOs as a method of raising equity finance. (19 marks)

9 (25 marks)
Capital investments can involve substantial cash flows (both outflows and inflows). Often, the initial
investment that is needed to finance the acquisition of an asset that is needed to undertake a project can be
significant. Inappropriate investments can lead to disaster for the business.
Critically evaluate the following capital investment appraisal techniques:
i. Payback
ii. Accounting rate of return
iii. Net present value

10 (25 marks)
The range and complexity of the different types of risk and the impact that they could have on business can
seem overwhelming. A financial decision can have major implications for the success or even survival of a
business.
a. Analyse the financial management techniques that could be used to support the management risk in:
i. Financing decisions (3 marks)
ii. Investment decisions (3 marks)

b. Analyse the use of the following financial risk management techniques:

i. Sensitivity analysis (9 marks)
ii. Simulations (10 marks)

End of question paper

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