HKICPA

Qualification Programme

Module B – Corporate Financing

Dec 2020

Mock 1
Answers

https://www.kaplan.com.hk/
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Answer 1
Marks
(a)

When applied to addressing such difficulties, technology can bring benefits in many areas of
treasury management.

General Control

Access controls – resulting in improved security, clear audit trails and tracking of transactions 2

Transactions – speedier settlements, confirmation of deals and timely reporting will result from 2
improved interfaces between trading systems

Liquidity (Working Capital)

Cash and liquidity management – with improved visibility of cash flows around the business, a
greater understanding of pooled cash positions and improved cash flow forecasts can be 2
achieved

Funding (Long Term Finance)

Debt management – understanding of the company's debt position in terms of its outstanding
loans, mortgages and lease finance 2

Financial Risk Management

Greater control over financial risk management – foreign exchange risk, interest rate risk and the
management of specific instruments for associated hedging strategies can be more tightly
controlled 2

General risk management – understanding of exposure limits, credit limits, authorisation levels
and the undertaking of scenario and sensitivity analysis should help to reduce risk exposure and
ensure compliance with company procedures 2

All Other Valid Points

Max 8

Module B (Dec 2020 Session) – Mock Page 1 ©Kaplan Financial 2020

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(b)
The advantages are that

There would be no worry about exchange rate fluctuation of EUR against HKD between now and 1
the receipt date; the exchange rate risk would be hedged; given the lower volatility of the
company cash flow.

The hedge is 100% effective as the forward OTC Contract rate is guaranteed and can be tailored 1
to exact needs.

The disadvantages include

The opportunity cost foregone on the upside gain when EUR moves in a favourable direction to 1
the company.

Counterparty risk may be encountered.

1
Other alternatives include
(i) Do nothing;
(ii) Buy EUR against HKD put options for the payment amount and expire on the receipt 1
date with the bank over the counter; 1
(iii) Sell EUR futures contract on the futures exchange for the 3-month delivery so as to
hedge the downside risk of EUR vs. HKD; 1
(iv) Money Market Hedge
1
All Other Valid Methods
Max 2

Total 14

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Answer 2
Marks

(a)

The following financial ratios could be used to assess the financial health:

- Profitability: Performance ratios e.g. Net profit margin, Return on equity, Return on 0.5
Capital Employed
- Gearing: Risk related ratios e.g. Debt / Equity Ratio, Interest Cover 0.5
- Liquidity: Liquidity ratios e.g. Current Ratio, Quick Ratio 0.5
- Efficiency: Efficiency ratios e.g. Debtor ratios, Inventory ratios, Creditor ratios, Asset 0.5
Turnover

(b) All may indicate Overcapitalization.

Long turnover periods for inventory and accounts receivable 1

High Current ratio 1
Sales/working capital ratio less than similar companies 1

(c)
Residual income is an absolute dollar amount will increase if a new investment is undertaken 2
which earns a profit in excess of the imputed interest charge on the value of the asset acquired.

Residual income will go up even if the investment only just exceeds the imputed interest charge,
and this means that 'marginally profitable' investments are likely to be undertaken by the
2
investment centre manager.

In contrast, when a manager is judged by ROII which is a relative % rate, a marginally profitable
investment would be less likely to be undertaken because it would reduce the average ROI
earned by the centre as a whole. 2

Disincentive to investment centre managers to reinvest in new or replacement assets, because

the centre's ROI would probably fall in short term…But will rise in long term if it is a good
2
investment.

Max 4
(d)
HK'm
Year 1 2 3
Net Profit after tax 1.51 1.65 1.82
Net Asset 3 4.3 5.8
Cost of Capital 14% 14% 14%
Net Asset*Cost of Capital 0.42 0.60 0.81 1

EVA (Rounded) 1.09 1.05 1.01 1

The financial performance from Yr. 1 to Yr. 3 based on EVA is becoming worse although net 1
profit after tax is rising. The deteriorating EVA is mainly due to the more net asset required after 2
Yr1 offsetting increasing net profit

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(e)

EVA uses an economic value of net assets (which is often replacement cost) whereas residual 2
income uses the accounting value of net assets.

EVA measures economic profit and residual income is based on accounting profit. 2

For EVA and RI, the Cost of capital used may differ. 2

EVA treats certain costs as future investments rather than as expenses and so may be better for 2
encouraging new investment. -------
Max 4

Total 18

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Answer 3
Marks
(a)
From the company’s perspective:

Benefits
2
Interest Tax Benefits can be obtained by issuance of bonds

Reduction of Wacc if the loan level is not excessive 2

--------
Max:2
Disadvantages

Same as the borrowings from banks or financial institutions as well as the issuance of bonds, the interest
costs are required to be paid. (Issuance of shares is not). 2

Interest payments that are obligated to pay to the banks or financial institutions or bondholders and there is
financial burden on the company. (Dividends can be distributed to shareholders at the board of directors’ 2
discretion for issuance of shares)

Gearing Ratio may be too high affecting further borrowing with higher interest rate
2
--------
Max:2
From an investors’ perspective:

Benefits

In the event of liquidation, the creditor hierarchy dictates the priority of claims and debt finance is paid 2
off before equity.

Stable Interest Income will be received. 2

--------
Max:2
Disadvantages
2
(i) They cannot participate and attend the company’s annual general meeting and extraordinary
general meeting.
(ii) They cannot vote on significant company matters, such as, the appointments of directors, changes to 2
authorised shares capital and appointment of auditors. 2
(iii) They cannot participate in the new issue of shares. 2
(iv) They cannot receive dividends as distribution of profit. 2
(v) They cannot enjoy capital appreciation if the share price increases. --------
Max:2

All other valid points are considered.

(b)
Financial covenants: Lists the financial covenants or ratio restrictions the company
must meet during the agreement period. The financial requirements and ratios are
generally defined in a specific manner and may include maintenance of:
(1) A company’s minimum net worth figure 2
(2) Interest coverage ratios 2
(3) Maximum debt, Debt gearing / leverage ratios 2
(4) Minimum cash to hold, Cash flow coverage ratios 2
(5) Working capital to sales ratios 2
(6) Dividend restrictions 2
--------
Max:4

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(c)

2
2
1
1

Total 18

END OF SECTION A

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Answer 4

Marks
(a)

PESTEL is a checklist of six general environmental factors. They are often interlinked and 2
related to each other. For this case, the most significant factor should be TECHNOLOGY

(b)

Financial Controller’s conduct failed to satisfy the following aspects of the ethical
standards for an accounting professional:

Competence
As an accounting / finance professional, he should discharge his duty by applying his
professional knowledge to analysing a problem. Directing his subordinate to use an 2
incorrect discount rate for a FCFF analysis could, at best, overestimate the expected
return or, at worst, result in the company diverting resources to a bad investment.

Confidentiality
Making use of the confidential information acquired through work (investment proposal)
for personal gain is unacceptable by ethical standards. 2

Integrity
He should be aware that there is potential conflict of interest between his personal
investment and the company’s investment plan. Disclosure or communication of such
conflict to the members of the project team is required. Depending on the situation, he 2
may even need to avoid involvement in the decision-making process.

Objectivity
It is inappropriate for him to allow his personal bias to influence an objective analysis of the 2
investment proposal based on facts, reasonable estimates and unbiased professional
judgment. All such information shall be fairly and objectively disclosed to the intended users.

(c) The revised valuation should be most likely Higher as the required return of the equity 2
has been reduced starting from year five as the Discounted back figures would be higher 2
due to the discount factors after are higher.

(d)

The bond’s yield-to-maturity (YTM) is determined by the following:

The term of the bond - as the longer the term, the greater the remaining coupon payments,
1
the higher the yield.
The coupon rate and coupon payment - as the higher the rate and coupon payment, the
higher the yield to maturity. 1
The number of coupon payments per year – as the frequency increases from annual, semi-
annual to quarterly, the higher the yield to maturity. 1
The redemption value - as the higher the redemption value, the higher the yield to maturity.
The bond’s market price - as the higher the price, the lower the yield to maturity. 1
The bonds market price can be affected by changes in the HIBOR market interest rate and 1
credit risk of the issuer. 1
--------
Max:4

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(e)

Reduce inventory

-Practice Just-in-time (“JIT”) procurement. To link up to suppliers computerized system in 2

order to take advantage of the enhanced inventory management practice which are
expected to reduce inventory level and lead time. Practice of JIT is also particularly
beneficial for high value parts.

-Should review to reduce holding inventory of older models that are not in high demand
2
anymore. The reduction can be offset by carrying more popular models instead. This will
speed up the inventory turnover.

Speed up collection and develop credit policy

-Establish a collection policy to speed up payment particularly to its large customers such as 2
sending out reminders promptly, phone calls, offer early settlement discounts, factoring.

-Establish a tighter credit policy to assess creditworthiness of new customers. 2

Delay payment to suppliers:

Delay payment to suppliers:

-it is possible to delay payment without affecting substantially the relationship with such 2
suppliers.

-Ask for better terms of payment from the supplier 2

--------
Max:4
All Other Valid Methods

Total 22

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Answer 5

Marks

1
1

Total 16

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Answer 6
Marks

(a) No.

ESG Guide included that issuers are now required to state in their annual reports or ESG 1
reports whether they have complied with the 'comply or explain' requirement, and if not, to
give reasons. 2

(b) Yes, it will affect the firm's value in the long run. 1

A bad reputation can affect the firm's value in the following ways:

Could not attract ethical customers and investors.

Customers may be attracted by 'green' products whose production and use do not cause 2
damage to the environment. Some investors may choose to invest in companies with
sustainable business development
policies.

Decreased staff loyalty and morale.

Employees may demonstrate greater loyalty to an employer that has enlightened social and
environmental policies and practices. 2

Downgrade of reputation.
Companies that demonstrate enlightened social and environmental policies are more likely
to benefit from a favourable reputation with the general public and government, as well as 2
customers, investors and employees.

Commercial losses
For many companies, the potential commercial benefits are the main reason for CSR
policies. 2
e.g. Energy saving _______
Max 4
(c)

Environmental
Emissions 1
Use of resources 1
The environment and natural resources 1
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Max 2
Social
Employment
Labour standards
Supply chain management 1
Anti-corruption 1
Health and safety 1
Development and training 1
Product responsibility 1
Community investment 1
1
All other valid points are considered. 1
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Max 2
Total 12

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