Advanced Financial

Management (AFM)
Sept / Dec 2020
Examiner’s report
The examining team share their observations from the
marking process to highlight strengths and
weaknesses in candidates’ performance, and to offer
constructive advice for those sitting the exam in the
future.

Contents
General comments .............................................................. 2
Question 1 – Kingtim Co ...................................................... 2
Requirement (a) – 7 marks .............................................. 3
Requirement (b) – 35 marks ............................................ 4
Requirement (c) – 8 marks .............................................. 7
Question 2 – Colvin Co ........................................................ 8
Requirement (a) – 15 marks ............................................ 9
Requirement (b) – 4 marks ............................................ 11
Requirement (c) – 6 marks ............................................ 11
Question 3 – Fitzharris Co ................................................. 12
Requirement (a) – 13 marks .......................................... 13
Requirement (b) – 8 marks ............................................ 14
Requirement (c) – 4 marks ............................................ 14
Conclusion ......................................................................... 14

Examiner’s report – AFM September/December 2020 1

General comments

This examiner’s report should be used in conjunction with the published

September/December 2020 sample exam which can be found on the ACCA Practice
Platform.
In this report, the examining team provide constructive guidance on how to answer
the questions whilst sharing their observations from the marking process,
highlighting the strengths and weaknesses of candidates who attempted these
questions. Future candidates can use this examiner’s report as part of their exam
preparation, attempting question practice on the ACCA Practice Platform, reviewing
the published answers alongside this report.

Question 1 – Kingtim Co

Kingtim Co shares similarities with previous case study questions, which typically set
out a complex business scenario and require candidates to demonstrate their ability
to understand, deal with and communicate the type of strategic issues that a senior
financial manager or advisor may be expected to encounter in his or her career. As
an illustration, this question tests a candidate’s ability to assess the strategic and
financial impact associated with an investment proposal, supported by relevant
computations where applicable, brought together in a coherent business report.
Business reports are expected to be succinct, professionally written, and easy to
read with clear headings and conclusions. A candidate who does not demonstrate
this approach will fail to earn the full professional marks available for this question.
The hallmark of a good piece of written work is evidenced by a reasoned structure,
narrative discussions that are relevant and in sufficient detail, and clear and easy to
follow numerical workings supported where appropriate by brief notes.
Kingtim Co focuses on the defence of a potential takeover bid, including an
investment proposal to establish a new chain of retail outlets. The investment is to

Examiner’s report – AFM September/December 2020 2

be financed by a new bond issue and would lead to a change in business and
financial risk. In addition to the technical calculations, including the impact of the
proposal on the company’s forecast earnings, the question also tests candidates’
ability to discuss the impact of the proposal on the company’s cost of capital and to
assess the reaction of the existing equity and bond holders. The information
provided in the scenario also includes an ethical dimension relating to a potential
conflict between stakeholders.
With more detailed discussion below, Kingtim Co was not a highly technical question
although candidates often struggled to gain high marks across all the requirements.
Some candidates ignored the need for a balanced approach, focusing on the
discussion sections at the expense of the detailed calculations or vice versa. In
order to pass, candidates are strongly advised that a balance between undertaking
calculations and providing discursive narrative is necessary.
In other cases, candidates seemed to struggle due to a lack of detailed knowledge of
the parts of the syllabus areas being tested combined with poor exam technique,
including inadequate time management. Case study questions test a range of
syllabus areas and candidates need to be able to apply the knowledge and skills
learnt and to be able to plan their time carefully. The focus for this advice will be on
addressing the issue encountered in this question.

Requirement (a) – 7 marks

For seven marks, it is important to give approximately equal weighting to both

defence strategies mentioned in the requirement. Some candidates allocated
significantly more time to one strategy compared to the other and in a small number
of cases, candidates wasted time on alternative defence strategies that were not
specifically asked for or referred to in the scenario.
Overall, this requirement was generally well answered. Many candidates discussed
the long-term consequences of the defence strategies and how these might deter a
takeover bid. However, very few questioned the use of the sale proceeds or
identified the risk that a smaller cash-rich company may attract new predators when
discussing the proposal to sell off individual garden centres. Many candidates
correctly identified the agency issues and self-interest motivation behind the
directors’ proposal to increase their remuneration but few expanded their discussion
to incorporate the corporate governance aspects of such a strategy or the role of the
remuneration committee.
Questions are designed to test the application of knowledge and the ability to
exercise judgement so candidates who try to answer questions with knowledge they
have rote learned will always perform less well than candidates who take time to
think and apply their knowledge to the actual scenario.
Examiner’s report – AFM September/December 2020 3
Requirement (b) – 35 marks

Many candidates scored high marks in this section although the market value of debt
was often incorrectly calculated. The information provided states that each 6.5%
bond has a $100 nominal value and is trading at $104 per $100 but most candidates
treated each bond as if it had a $1 nominal value. It is important to allocate sufficient
time to reading and understanding the information provided in the scenario so that
candidates are able to answer the question correctly.
Another common, although less frequent, mistake was to misinterpret the market risk
premium as the market return when using the capital asset pricing model to calculate
the cost of equity.

Candidates scored well in this section when they demonstrated an ability to

determine the discount rates from the annual yield curve and were able to apply
these discount rates when calculating the expected market value of the new bond.
Many candidates struggled to calculate the spot yield rates but earned full follow
through credit when calculating the value of the new bonds.
The final step in this requirement involved calculating the yield to maturity of the new
bonds, using the internal rate of return (IRR). Many candidates skipped this part of
the requirement and for those who attempted it, the most common error included
leaving out the interest payable in the redemption year or not knowing how the IRR
is calculated. Another common mistake was to ignore tax in the yield to maturity and
to carry this forward into part (iii) when calculating the revised cost of capital
although full follow through credit was awarded when this happened.
Some candidates lost valuable time making multiple attempts at the same
calculations rather than moving on to the next stage. It is crucial that candidates
manage their time well if they are to pass overall. It was also evident from the
answers to this requirement that a significant minority of candidates lacked the
detailed knowledge of the parts of the syllabus area being tested to make a
reasonable attempt at the calculations. Candidates are strongly advised to attempt
plenty of questions as part of their exam preparation to develop their knowledge and
application skills and to cover the full range of the syllabus in their preparations. This
should include plenty of exam standard questions, completed to time and under
exam conditions.

Examiner’s report – AFM September/December 2020 4

Candidates were presented with information about Kingtim Co’s new expansion
plans in the scenario, including information about the asset beta for companies
already competing in the outdoor retail sector. Some candidates scored full marks in
this section as long as they understood how to ungear Kingtim Co’s current equity
beta and calculate and regear the new asset beta, which was weighted according to
the book value of non-current assets in each division.
A significant number of candidates incorrectly regeared the existing asset beta rather
than calculating a weighted asset beta. When calculating the revised cost of capital,
a significant number of candidates incorrectly applied Kingtim Co’s current cost of
debt to the new bond issue rather than the yield to maturity calculated in part (ii).
Both calculations have featured prominently in past exam questions and would be
expected to do so in the future. Candidates are therefore advised to practice
applying their knowledge in similar calculations as part of their preparations for the
exam.

This was the requirement most often omitted by candidates. Even when this
requirement was attempted, most candidates failed to account for the additional
finance cost and/or the tax payable on Kingtim Co’s forecast earnings. Candidates
are therefore advised to plan their time carefully and ensure there is sufficient time to
answer all the requirements, which is a skill that can be developed with additional
question practice.

Before writing the main body of the report, candidates may find it useful to present a
brief summary of their results from the appendices since this may help provide a
structure to their answers. However, many students present detailed results from
the appendices in their report, which is not an efficient use of time, and in some
cases, this was so extensive that there was no time remaining for any meaningful
discussion or analysis.
As the requirement is quite lengthy, it is crucial not to rush as some points might be
missed. For ten marks, a little planning is required, but there is time to think and

Examiner’s report – AFM September/December 2020 5

prepare a suitable structure for the answer if candidates take time to break the
answer down, as there is more than one part to the overall requirement. Using
headings would also help break this requirement down.
Impact on Kingtim Co’s cost of capital
Many students lost valuable exam time by focusing their discussion on generic
comments about capital structure without any application to the scenario. The
candidates who scored well in this section successfully identified the reasons for the
change in Kingtim Co’s cost of capital, with reference to the increased business and
financial risk and the cost advantages of the new bond issue.
As mentioned before, candidates who try to answer questions with knowledge they
have rote learned will always perform less well than candidates who take time to
think and apply their knowledge to the actual scenario and question posed.
Reaction of equity and bond holders
This part of the requirement shares similarities with recent exam questions drawn
from the same area of the syllabus. However, many candidates missed or rushed
this section even though there are up to seven marks available.
Markers looked for any relevant comments relating to the new bond issue and
Kingtim Co’s expansion plans, including the equity and bond holders’ reaction to the
increase in business and financial risk and any concerns they might have had about
the company’s ability to service and repay debt or the impact on the company’s
dividend policy. Within this broad framework, there are many points candidates could
have raised so the majority of the answers to this section of the requirement were
disappointing overall.
Assumptions
Overall, this was the section of the report where candidates demonstrated the most
competence. However, some candidates wasted significant amounts of time, listing
each of the variables in turn and commenting on their accuracy or questioning the
assumption that variables would remain constant without discussing the validity or
reliability of these assumptions in more detail. Such an approach attracted limited
credit. Candidates are advised to identify key variables whilst performing the
calculations and then critique the validity of the assumptions underlying each of
these variables when they attempt the discussion section.

Examiner’s report – AFM September/December 2020 6

Professional marks

Candidates were asked to prepare answers in a report format for which the
professional marks were awarded. While many candidates did use a report format
and therefore gained the majority or all of the professional marks, a substantial
minority did not address this requirement fully or at all and hence failed to earn some
relatively easy marks. Too many reports ignored the need for a conclusion, which
restricted the number of professional marks that could be awarded. A small number
of candidates wasted significant amounts of time writing lengthy introductory
paragraphs that add very little to the report and in some cases so much time is spent
on the introduction, there is no time left for any meaningful discussion or analysis.

Requirement (c) – 8 marks

The time constraint was obvious in some scripts since a significant minority of
candidates missed this requirement. Poor time management meant these candidates
spent too much time on relatively straightforward calculations in requirement (b) or
discussed one area repeatedly in other requirements without considering the need to
allow sufficient time for all the requirements.
The time management issues are particularly disappointing because the candidates
who had planned their time adequately generally scored high marks for this
requirement and there were some outstanding answers overall. This was not a highly
technical requirement so it might have been useful to attempt this before the report in
requirement (b). Overall, many candidates discussed the approach taken and
associated issues at length and demonstrated good application of knowledge to the
scenario.

Examiner’s report – AFM September/December 2020 7

Question 2 – Colvin Co

Colvin Co is broadly similar to recent exam questions drawn from the international
investment appraisal section of the syllabus (Section B). The scenario presents
information about a potential investment opportunity as well as other details
regarding the business and candidates are expected to demonstrate a combination
of computational and analytical competence in evaluating the proposal and
discussing wider business issues. If Colvin Co departs at all from the standard
format of previous exam questions on this topic, it should have reduced the scope
and complexity of the calculations although, as can be seen from the more detailed
discussion below, this was not always clear from some of the candidates’ responses.
In addition to an international investment appraisal evaluation, candidates are also
asked to explain strategies that would avoid a block on dividend remittances and
then discuss the validity of a country risk premium that they were asked to
incorporate into the project’s discount rate. With the possible exception of the latter,
i.e. requirement (c), it can be seen that Colvin Co was not highly technical. However,
many candidates struggled to gain high marks. In summary, the reasons for this
include candidates not allocating sufficient time to understand the scenario and/or
requirements clearly as well as poor time management, which meant candidates ran
out of time and in some cases missed one or more requirements entirely. The focus
for this advice will be on addressing these problems, as discussed in more detail
below.

Examiner’s report – AFM September/December 2020 8

Requirement (a) – 15 marks

Candidates were presented with brief background information about Colvin Co, a
company based in the eurozone, and then more detailed information about an
international investment opportunity in a developing economy in which the currency
is the Canvian lira. For 15 marks, candidates were expected to evaluate the
proposal by working through each of the components of an international investment
appraisal calculation and then, as is typical with any investment appraisal, briefly
discuss the impact on shareholder wealth.
Overall, there were some excellent answers to this requirement although many
candidates struggled to achieve high marks. As can be seen from the following
discussion, the reasons for this seem to be insufficient time spent reading the
scenario in the case of the lira cash flows and poor time management when
calculating the euro cash flows. Furthermore, a significant number of candidates fell
short in terms of providing a full discursive evaluation at the end of the NPV
calculations. Each of these problems have been grouped under the following
headings.
Lira cash flows
The numerical information provided to candidates included a financial forecast,
summarising the project’s pre-tax contribution and fixed costs. These cash flows had
already been adjusted for inflation, which meant candidates did not need to spend
any valuable exam time on this. Inflation rates were also made available but only so
that candidates could forecast exchange rates and the working capital requirements
over the project’s expected life, rather than make further adjustments to the
contribution and/or fixed costs.
However, a minority of candidates lost significant amounts of time inflating cash
flows that had already been adjusted for inflation. A small number of candidates lost
even more time, erroneously multiplying the project’s total contribution by the
number of units. Even though the scenario states that the cost of acquiring a
component that was to be manufactured in the eurozone was already included in the
pre-tax contribution, some candidates spent significant amounts of time making
unnecessary adjustments to the cash flows provided.
All of these errors could have been avoided with a more careful understanding of the
details provided in the scenario. Candidates must read the scenario carefully and
understand what is being asked of them before attempting the requirements. This is
a skill that question practice will help develop.
It is also possible that candidates struggled to gain high marks because Colvin Co
makes a minor departure from the format of other exam questions on this topic. It is
worth emphasising the point that exam questions are designed to test the application
of knowledge and candidates who try to answer questions by applying a technique

Examiner’s report – AFM September/December 2020 9

they have rote learned from previous exam questions will always perform less well
than candidates who take the time to think and apply their knowledge to the actual
scenario. In this case, the contribution had already been calculated and adjusted for
inflation so there was no credit available for any further adjustments.
It was disappointing to see that many candidates still cannot determine the need for
incremental cash flows when calculating the working capital requirement, including
the recovery in the final year. There were also a number of examples of working
capital being included in Colvin Co’s tax payable. Although many candidates
correctly forecasted the exchange rates, there was a sizeable minority who mixed up
the inflation rates or compounded them incorrectly. Most candidates also made a
reasonable attempt at the tax working, although the carried forward loss adjustment
was a clear differentiating factor. Each of these errors suggests a lack of detailed
knowledge of the parts of the syllabus area being tested. This is another problem
that could be remedied with further question practice.
Euro cash flows
Some candidates failed to convert the lira cash flows into euros and many others
ignored the contribution from the component manufactured in the eurozone, even
though this has been a standard feature in previous exam questions on the same
topic.
It is probable this omission is linked to the time management problems experienced
in the first part of the appraisal with many candidates, as discussed previously,
spending too much time carrying out tasks that were not required when calculating
the project’s lira cash flows and then not having sufficient time to spend on the euro
cash flows. Those candidates who planned their time carefully, including taking the
time to understand the information provided, were more successful in this
requirement.
Evaluation
Candidates were asked to evaluate the suitability of the proposal, including the
impact of the country risk premium. At the most basic level, this means providing a
justified recommendation at the end of the net present value (NPV) calculation. This
should have been an opportunity for relatively straightforward credit but was often
missed.
It should also have been clear from the wording of the requirement that candidates
were expected to calculate the project’s net present value using two discount rates,
with and without the country risk premium, and then comment on the results but very
few candidates went this far. Alternatively, it would also have been possible to score
these marks without using two discount rates by concluding, for example, that the
16% discount rate produces a negative NPV (and so the project should be rejected)
but a 13% discount rate may yield a positive NPV and is worth further investigation.
It is important that candidates read the requirements carefully if they are to answer
the question correctly.

Examiner’s report – AFM September/December 2020 10

Requirement (b) – 4 marks

This was the requirement where many candidates scored high marks and it was not
unusual for answers to receive full credit. The scenario explained the potential for a
block on dividend remittances and most candidates recognised that a strategy to avoid
such a block should generate cash for the parent in the parent’s country. Candidates
who made suggestions to achieve this objective and recognised the inevitable conflict
it might generate with the Canvian authorities, scored high marks.

Requirement (c) – 6 marks

The scenario presented the chief executive’s justification for adding a premium to
Colvin Co’s cost of capital in order to compensate investors for country risk.
Candidates were asked to discuss the validity of these reasons. This requirement
was not well answered as candidates rarely recognised that the key driver of
required return is systematic risk, not the particular risks faced by the investor (or
company investing in a project), and particularly not the total risk as measured by
standard deviation. In addition, very few candidates questioned the actual
adjustment, an arbitrary 3% premium, since no justification was provided for this
figure in the scenario.
Candidates did not need to reproduce the model answer to earn full credit. When
candidates questioned whether the political risk or specific product market risk of
Canvia generated non-diversifiable additional systematic risk or made any other
relevant points for or against the country risk premium, they scored high marks.
Many of the candidates’ responses were very brief and in some cases this
requirement was missed entirely. It is possible this stemmed from the problems
encountered with the lira cash flow calculations in requirement (a). It is worth
emphasising the importance of careful time management if candidates are to be
successful in this exam.

Examiner’s report – AFM September/December 2020 11

Question 3 – Fitzharris Co

Fitzharris Co was a 25-mark question which relates to the treasury and advanced risk
management techniques section of the syllabus (Section E). The individual question
parts are similar in nature and complexity to requirements that have appeared in recent
examinations and should not have been unexpected. Having said that, the question
does focus on more complex areas of risk management, rather than a relatively more
straightforward futures and/or options question that may have been seen in past
published exams. The scenario presents information about the borrowing that is
required to fund a major construction project. The initial requirement was to perform
hedging calculations using an interest rate swap and a collar given media predictions
of future interest rates. The question then required candidates to comment on the
results of their calculations and discuss the advantages and disadvantages of swaps
compared to traded collars. Finally, candidates were required to explain the
significance of two of the determinants of option valuation.

The requirements in this question were quite technical and candidates must recognise
that to do well in a question of this nature, they must invest the necessary time required
to master the topics. The detailed review below focuses on key problems which were
identified and future candidates would do well to address these.

Examiner’s report – AFM September/December 2020 12

Requirement (a) – 13 marks

This question part considered two of the areas candidates typically find it harder to
deal with. A minority of candidates were able to efficiently perform all the necessary
calculations and quickly earned high marks. However too many candidates struggled
and spent too much time doing incorrect and often unnecessary calculations for which
little credit could be awarded.

The swap was often done well. A common problem was that the comparative
disadvantage of 0.2% which arises when the counterparty borrows at a fixed rate was
treated as an advantage. Furthermore, a significant proportion of candidates could
work through to a correct conclusion but could not calculate suitable swap rates for
the parties to use. Candidates should be encouraged to clearly identify the type of loan
each party initially takes from the bank, prior to the swap, as this was often unclear
and had to be inferred, where this was possible, from a candidate’s other workings.

Candidates were generally less successful with the collar. A significant minority of
candidates did calculations for an options hedge instead, or indeed a futures hedge,
for which they could only receive limited credit.

A key problem in this question was the number of contracts that should be used. As
can be seen in the model answer the calculation of the number of contracts has been
based on the borrowing period of 3 years. In reality a rolling series of hedges would
be used to cover such a long period and hence credit was given for other justifiable
answers. Candidates should note that in future questions the number of contracts will
continue to be calculated based on the period for which the funds will be borrowed or
indeed invested.

The calculation of basis remaining continues to be a problem for many candidates and
it is recommended that candidates do their best to master this as it is fundamental
when dealing with futures, options and collar hedges.

The decision whether to exercise or lapse an option continues to cause problems.

Candidates who adopt a structured and logical approach, as demonstrated in the
model answer, seem to make fewer mistakes even when working at speed and it is
recommended that all candidates try to do likewise.

Candidates should note that as the answer was only required in % terms it was only
necessary to work in %. As can be seen in the model answer this makes the
calculations required much simpler and enables candidates to quickly demonstrate
their knowledge of collars. A similar approach could be used for futures and options.

Examiner’s report – AFM September/December 2020 13

Requirement (b) – 8 marks

Many candidates achieved a satisfactory mark in this question part but few made
sufficient points to earn really good marks.

Candidates must recognise that it is insufficient to simply state the results from their
hedges and that their comment must add value if it is to earn credit. Whilst other
comments could have earned credit the simplest way to achieve this was to make a
justified choice as to which seems to be the better hedge.

Too often the advantages and disadvantages given were the advantages and
disadvantages of each hedge that a candidate had learned and did not compare the
hedges as required here. Candidates must demonstrate that they can apply their
knowledge to the question posed.

Candidates should also avoid repetition unless it is adding value. For instance, stating
that swaps have default risk and that collars don’t will only earn one mark.

Requirement (c) – 4 marks

This question part was generally poorly answered due to a mix of time pressure and
a lack of knowledge. Candidates seemed better able to explain the significance of the
time until expiry than the interest rate. Candidates should recognise that the option
sensitivities will continue to be examined and that it is worth learning the basic
knowledge regarding these sensitivities. Candidates who had done this were able to
achieve a good mark in this question part.

Conclusion

Candidates must be able to identify what is important in scenarios, read and respond
fully to question requirements and question narrative, appreciate what is of key
importance to businesses and financial stakeholders, and produce answers that are
well-structured and presented appropriately in both numerical and discursive
elements.

In summary, applying correct techniques and knowledge to differing and complex

scenarios, adopting an integrative approach, demonstrating sound evaluative skills,
displaying good presentation skills, and making considered judgements and
decisions, are the factors that will lead to success in the Advanced Financial
Management exam.

Examiner’s report – AFM September/December 2020 14