Important information

Please read this information carefully before

you begin your exam.

Starting the exam

Click on the right-hand arrow in the header to

begin the exam. The exam timer will begin to
PROFESSIONAL count down.

LEVEL Preparing your answers

Answer all questions.

WEDNESDAY 11 SEPTEMBER 2024
Respond directly to the exam question
2.5 HOURS requirements. Do not include any content of a
personal nature, such as your name.

Only your answer in the word processing

FINANCIAL area will be marked. You must copy over any
data for marking from the spreadsheet area to
MANAGEMENT the word processing area.

This exam consists of three questions (100 Issues during the exam
marks).
If you encounter any issues during the exam
Marks breakdown you should tell the invigilator (centre) or online
chat support (RI) as they may be able to
Question 1 35 marks resolve the issue at the time. Neither the
Question 2 35 marks invigilator nor the online chat support can
Question 3 30 marks advise you on how to use the software.

Ending the exam

The Formulae and Discount Tables are
available as a resource in each question. When the exam timer reaches zero, the exam
will end. To end the exam earlier, go to the last
question and click the right-hand arrow button,
then click the Submit button to close the exam.

For Remotely Invigilated exams, after clicking

the Submit button you should close the
Assessment Master browser tab, and click
End Exam on the Proctor Exam tab if this
option appears for you.

After the exam

We will invite you to complete a student survey

after the exam.

If you believe that your performance was

affected by issues which you raised during the
exam, you should submit an exam disruption
appeal to ICAEW within 7 days of the exam,
as per ICAEW’s published policy. To be eligible
for an exam disruption appeal, you must raise
the issue immediately with either the invigilator
or if sitting remotely, via the online chat agent.
Question 1

Assume the date is 30 September 2024.

You are a finance assistant working for Fistral Water plc (Fistral) which provides water and
sewage services to households in the south-west of England. You have been asked to assist
Fistral’s finance director in calculating the company’s weighted average cost of capital
(WACC) at 30 September 2024.

Company background

In September 2019, Fistral invested £50 million in a major project to reduce the amount of
sewage that it releases into rivers. This investment was funded from the following sources of
green finance:

7% irredeemable green bonds Fistral issued £20 million nominal of 7% irredeemable

green bonds at par of £100 per bond.

On 30 September 2024, these bonds have a market

value of £96% (ex-interest).

Sustainability-linked bank loan Fistral obtained a £30 million sustainability-linked bank

loan which is due to be repaid on 30 September 2029.

If Fistral meets all of the ESG targets set by the bank,

the interest rate on this loan is 6.75% pa.

If Fistral does not meet all of the ESG targets set by the
bank, the interest rate on this loan increases to 9.25%
pa.

In August 2024, environmental campaigners criticised Fistral for the amount of sewage
released into its rivers. The campaigners argued that Fistral paid too much money to ordinary
shareholders in dividends during the last two years and that this money should have been
spent reducing sewage levels.

In response to this criticism, Fistral’s directors made a public statement on 25 September

2024 that Fistral would reinvest future profits in filtration technology to reduce sewage levels.
They also stated that the dividend on 30 September 2024 will be paid to shareholders as
normal but after this there will be no dividends for the next three years.

Dividends and other information

Fistral’s dividend per share from 30 September 2018 to 30 September 2024 is available in
the pre-populated spreadsheet.

Other information as at 30 September 2024 is as follows:

• Fistral has in issue 10 million ordinary shares with a market value of 460 pence per share
(ex-div).
• Fistral has an equity beta of 0.64.

• The risk-free rate is expected to be 4.5% pa.

• The market return is expected to be 11% pa.

• Fistral pays corporation tax at a rate of 25% pa.

Potential failure to meet sewage target

Fistral’s directors are concerned that Fistral may not meet its ESG target for sewage levels
when they are measured on 1 October 2024. The directors want to know what impact this
may have on Fistral’s WACC.

If the sewage target is not met, Fistral’s finance director expects the following:

• The interest rate on the sustainability-linked bank loan will increase to 9.25% pa.

• The market value of Fistral’s irredeemable green bonds will fall to £90% (ex-interest).

• The market value of Fistral’s ordinary shares will fall to 400 pence per share (ex-div).

Requirements

1. Outline:

• the criteria that Fistral would have met in order to issue green bonds in September
2019; and

• the benefits to Fistral of issuing green bonds. (4 marks)

2. With reference to both dividend policy theory and practical considerations, discuss how
Fistral’s shareholders may have reacted to the announcement on 25 September 2024
that there would be no dividends for the next three years. (7 marks)

3. Assuming Fistral meets all of the ESG targets set by the bank, calculate Fistral’s WACC
on 30 September 2024 using:

• the dividend valuation model (compound dividend growth should be estimated from
the historic dividend information provided in the pre-populated spreadsheet, using the
earliest and latest dividend)

• the CAPM. (10 marks)

4. Using the information provided in the pre-populated spreadsheet, calculate the

correlation coefficient between dividends paid per share and the years of payment for
the period 30 September 2018 to 30 September 2024. Comment on your result. (2
marks)
5. Assess the suitability of using the dividend valuation model to determine Fistral’s cost of
equity at 30 September 2024, referring to your answer to requirement 4 and any other
relevant information available. (3 marks)

6. If the sewage target is not met on 1 October 2024, explain why the finance director
expects the following:

• an increase in the interest rate on the sustainability-linked bank loan

• a fall in the market value of the irredeemable green bonds
• a fall in the market value of the ordinary shares. (3 marks)

7. Using the CAPM, calculate Fistral’s WACC on 1 October 2024 if the sewage target is
not met and comment on your result. (6 marks)

Total: 35 marks
Question 2

Assume the date is 25 September 2024.

You work for a firm of ICAEW Chartered Accountants that advises on mergers and
acquisitions. You have been asked to advise three directors of Buxstar Ltd (Buxstar) who are
considering a management buy-out (MBO) of the company.

Company background

Buxstar was founded in October 2019 by Gurdeep Randall, the company’s chief executive
and only shareholder. Gurdeep developed an online game to help young children improve
their reading skills. Parents and schools pay a monthly subscription to Buxstar to access the
game.

In the last two years, the number of monthly subscribers to Buxstar’s game has fallen due to
competition from other online reading games and a fall in the overall demand for educational
technology (EdTech) products. Buxstar’s IT director believes that additional spending is
required over the next two years to redevelop the game to attract more subscribers.

In June 2024, Gurdeep resigned as chief executive due to long-term health problems.
Buxstar is now managed by the remaining three directors, the IT director, finance director
and marketing director. Gurdeep wishes to sell the company and these three directors (the
MBO team) have been offered the opportunity to acquire all of Gurdeep’s ordinary shares.

You have been asked to help the MBO team determine an appropriate value for Buxstar’s
ordinary shares as at 30 September 2024.

Extracts from Buxstar’s forecast management accounts are shown below:

Income statement for the year ended 30 September 2024

£
Revenue 565,000
Operating costs (Note 1) (350,000)
Profit before interest and tax 215,000
Interest (5,000)
Profit before tax 210,000
Corporation tax @ 25% (Note 2) (52,500)
Profit after tax 157,500
Ordinary dividend (Note 3) (126,000)
Retained profit 31,500

Balance sheet as at 30 September 2024

£
Non-current assets (Note 4) 65,000
Current assets (Note 5) 45,000
110,000

Ordinary share capital (Note 6) 12,000

Retained earnings 45,500
 57,500
10% bank loan (Note 7) 50,000
Current liabilities 2,500
110,000

Notes

(1) Operating costs include a total of £18,000 for depreciation and amortisation.

(2) Corporation tax is expected to be paid at a rate of 25% for the foreseeable future and is
payable at the end of the year to which it relates.

(3) The directors have agreed with Gurdeep that 80% of Buxstar’s profit after tax for the year
ended 30 September 2024 will be paid to Gurdeep as an ordinary dividend on that date.

(4) Non-current assets include £35,000 of digital assets. The finance director has estimated
that the market value of these assets is £225,000. All other non-current assets are
appropriately valued.

(5) Current assets include cash balances which are forecast to be £32,000 on 30 September
2024 (after adjusting for dividend and corporation tax payments due on 30 September 2024)
and short-term investments in cryptocurrency of £8,000. All other current assets are
appropriately valued.

(6) Buxstar’s ordinary shares have a nominal value of 50 pence per share.

(7) The bank loan is due to be repaid on 30 September 2028.

ReadWell acquisition

Buxstar’s finance director has identified another EdTech company called ReadWell Ltd
(ReadWell), which has a similar online reading game to Buxstar.

ReadWell’s game was initially launched in 2008 but had a major redevelopment in 2019,
leading to an increase in the number of users in 2020. ReadWell does not charge a
subscription fee to play its game. Instead, users are encouraged to make in-game purchases
enabling them to access additional content or to customise their online avatar. ReadWell also
earns income from advertising revenue.

In 2020, there was a significant increase in the level of demand for EdTech products.
Subsequently, many private investors and large technology companies tried to acquire
EdTech companies like ReadWell. During this time, the multiples used to value EdTech
companies were over-inflated.

ReadWell was acquired by private investors in November 2020 and the following multiples
were applied to the acquisition:

Price earnings (P/E) ratio 10.5

 Enterprise value 7.5

In the last two years, demand for EdTech products has fallen and competition in the sector
has increased. Recently, acquisitions of EdTech companies have typically been at lower
multiples.

Directors’ bonuses

On 24 September 2024, in a meeting between you and the MBO team, Buxstar’s marketing
director made the following suggestion:

‘I think that each of the three members of the MBO team should be paid a bonus of
£10,000 (gross) on 30 September 2024. If the company has less cash and is making less
profit, we can offer a lower value when we acquire Gurdeep’s shares. Gurdeep is no
longer involved in the management of the company, so will never find out.’

The forecast management accounts for the year to 30 September 2024 do not currently
include any directors’ bonuses.

Requirements

1. Assuming the MBO team are not paid bonuses and using the multiples from the
acquisition of ReadWell in 2020, calculate the amount per share that the MBO team
could offer to acquire Buxstar’s ordinary shares, based on the following methods:

• Net asset basis (historic)

• Net asset basis (revalued)
• P/E ratio
• Enterprise value.

Ignore any adjustments for non-marketability. (9 marks)

2. With regard to the valuation of Buxstar:

(a) Discuss whether it is appropriate to use the multiples from the ReadWell acquisition.
(5 marks)

(b) Outline any other challenges that the MBO team may face when using the valuation
methods in requirement 1 to determine an appropriate value for a technology company.
(5 marks)

3. Assuming bonuses totalling £30,000 are paid on 30 September 2024:

• Revise the forecast income statement to reflect these bonuses.

• Calculate the net impact on total cash balances.
• Calculate the impact on each of the valuations in requirement 1. (9 marks)

4. Identify the ethical issues for you, as an ICAEW Chartered Accountant, of the marketing
director’s suggestion to pay the bonuses to the MBO team. (3 marks)
5. Identify two methods of payment that the MBO team could use to acquire Gurdeep’s
shares, briefly outlining the advantages and disadvantages of each method. (4 marks)

Total: 35 marks
Question 3

Assume the date is 30 September 2024.

You are a treasury assistant working for Totzen Electronics plc (Totzen), a UK manufacturer
of electric car batteries. You have been asked to advise the treasury manager on two tasks.

3.1 Task one: foreign exchange rate (forex) risk

Totzen is due to pay 15 million Brazilian Reals (R$) to a supplier in Brazil on 31 December
2024. The treasury manager is considering hedging techniques to mitigate any forex risk
because sterling is forecast to weaken against the Brazilian Real in the next three months.

The following information is available at the close of business on 30 September 2024:

Exchange rates

Spot rate (R$/£) 6.2430 – 6.2570

Three-month forward contract premium (R$/£) 0.0250 – 0.0242

Annual borrowing and depositing interest rates (%)

Sterling (£) 6.20 – 5.40

Brazilian Real (R$) 4.60 – 3.80

December currency futures price (standard contract size £62,500): R$ 6.2150/£

Over-the-counter (OTC) currency options

December put options to sell Brazilian Reals are available with an exercise price of
R$ 6.2340 per £. The premium is £0.0050 per R$ and is payable on 30 September 2024.

December call options to buy Brazilian Reals are available with an exercise price of
R$ 6.2190 per £. The premium is £0.0020 per R$ and is payable on 30 September 2024.

Totzen currently has a sterling overdraft.

Requirements

a. Calculate Totzen’s sterling payment on 31 December 2024 if it uses the following to

hedge its forex risk:

• a forward contract
• a money market hedge
• currency futures
• an OTC currency option.

Assume that the spot rate on 31 December 2024 will be R$/£ 6.1210 – 6.1350 and that
the December futures price will be R$ 6.1280. (13 marks)
b. Explain interest rate parity and prepare calculations which show whether interest rate
parity is holding, using the average exchange rates and interest rates from the data
provided in 3.1. (5 marks)

c. For each of the four hedging strategies in requirement 3.1a, explain the implications if
sterling strengthens against the Brazilian Real by 31 December 2024. (4 marks)

d. Explain how Totzen could manage forex risk on payments to the Brazilian supplier using
the following:

• a foreign currency bank account

• leading and lagging. (2 marks)

3.2 Task two: FTSE 100 index risk

Totzen has a portfolio of FTSE 100 shares, with a current market value of £3,510,000.

Totzen plans to sell the portfolio of shares on 30 June 2025 to release cash. Totzen’s finance
director is worried that the FTSE 100 index will fall in value over the next nine months.

The FTSE 100 index is 7,800 on 30 September 2024 and you have the following information
available to you regarding FTSE index futures prices:

December 2024 7,850

March 2025 7,920
June 2025 7,960
September 2025 7,980

The face value of a FTSE 100 index futures contract is £10 per index point.

Requirement

Demonstrate how Totzen can use FTSE 100 index futures to hedge its portfolio of shares
against a fall in the FTSE 100 index and calculate the outcome if, on 30 June 2025:

• the portfolio of shares is sold for £3,393,000 and the FTSE 100 index is 7,540;
• the portfolio of shares is sold for £3,627,000 and the FTSE 100 index is 8,060. (6 marks)

Total: 30 marks