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ACCA Passcards
Paper P4
Advanced Financial Management
Passcards for exams
up to June 2015

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Professional Paper P4
Advanced Financial Management


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First edition 2007, Eighth edition June 2014
ISBN 9781 4727 1132 8
e ISBN 9781 4727 1188 5
British Library Cataloguing-in-Publication Data
A catalogue record for this book is available from the
British Library
Published by
BPP Learning Media Ltd
BPP House, Aldine Place
142-144 Uxbridge Road
London W12 8AA
www.bpp.com/learningmedia

Printed in the UK by
RICOH UK Limited
Unit 2
Wells Place
Merstham
RH1 3LG

Your learning materials, published by BPP Learning
Media Ltd, are printed on paper obtained from traceable
sustainable sources.

Page ii

All rights reserved. No part of this publication may be
reproduced, stored in a retrieval system or transmitted, in
any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior

written permission of BPP Learning Media.
©
BPP Learning Media Ltd
2014


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Preface

Contents

Welcome to BPP Learning Media’s ACCA Passcards for Professional Paper P4 Advanced Financial
Management.
 They focus on your exam and save you time.
 They incorporate diagrams to kickstart your memory.
 They follow the overall structure of BPP Learning Media’s Study Texts, but BPP Learning Media’s ACCA
Passcards are not just a condensed book. Each card has been separately designed for clear presentation.
Topics are self contained and can be grasped visually.
 ACCA Passcards are still just the right size for pockets, briefcases and bags.
Run through the Passcards as often as you can during your final revision period. The day before the exam, try
to go through the Passcards again! You will then be well on your way to passing your exams.
Good luck!

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Preface

Page
1
2
3a
3b
3c
4
5
6
7a
7b
8

The role and responsibility of senior
financial executive
Financial strategy formulation
Conflicting stakeholder interests

Ethical issues in financial management
Environmental issues
Trading and planning in a multinational
environment
DCF
Application of option pricing theory in
investment decisions
Impact of financing and APV method
Valuation and free cash flows
International investment decisions

1
7
17
23
25
31
41
47
51
65
73

Contents

Page
9
Acquisitions and mergers vs growth
81
10

Valuation for acquisitions and mergers 87
11
Regulatory framework and processes
99
12
Financing mergers and acquisitions
105
13–14 Reconstruction and reorganisation
111
15
The treasury function in multinationals 119
16
Hedging forex risk
123
17
Hedging interest rate risk
135
18
Dividend policy in multinationals and
transfer pricing
143
19
Recent developments
149


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Page 1

1: The role and responsibility
of senior financial executive

Topic List
Financial management
Financial planning

Senior financial executives are required to make crucial
decisions, including those related to investment,
distribution and retention.


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Financial
management

Financial
planning

Financial objectives

Non-financial objectives

The prime financial objective is to maximise the
market value of the company’s shares. Primary
targets are profits and dividend growth. Other targets
may be the level of gearing, profit retentions, operating
profitability and shareholder value indicators.

Non-financial objectives do not negate financial
objectives, but they do mean that the primary
financial objectives may be modified. They take
account of ethical considerations.

Why profit maximisation is not a
sufficient objecture
Risk and incertainty
Profit manipulation
Sacrifice of future profits?
Dividend policy

Examples
Employee welfare
Management welfare
Society’s welfare
Service provision
Responsibilities towards customers/suppliers

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Investment
decisions
Investment decisions include:
New projects
Takeovers
Mergers
Sell-off/Divestment
The financial manager must:
Identify decisions
Evaluate them
Decide optimal fund allocation

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Page 3

Financing
decisions

Dividend
decisions

Financial decisions include:
Long-term capital structure

Need to determine source, cost
and risk of long-term finance.
Short-term working capital
management
Balance between profitability and
liquidity is crucial.

Dividend decisions may affect
views of the company’s long-term
prospects, and thus the shares’
market values.
Payment of dividends limits the
amount of retained earnings
available for re-investment.

1: The role and responsibility of senior financial executive


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Page 4

Financial
management

Strategic planning

The formulation, evaluation and selection of
strategies to prepare a long-term plan of action to
attain objectives. Strategic decisions should be
suitable, feasible and acceptable.
Long-term direction
Matching activities to environment/resources
Strategic analysis means analysing the
organisation in its environment, its resources,
competences, mission and objectives.
Strategic choice involves generating and evaluating
strategic options and selecting strategy.

Financial
planning

Key elements of financial planning
Long-term investment and short-term cash flow
Surplus cash
How finance raised
Profitable

Strategic cash flow management
Planning involves a long horizon, uncertainties and
contingency plans.

Strategic fund management
Consideration of which assets are essential and
how easily assets can be sold.

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Strategic
Tactical

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Investment

Financing

Dividend

Selection of products/markets
Target profits
Purchase of major non-current
assets
Other non-current asset
purchases
Efficient/effective resource
usage
Pricing

Debt/equity mix

Growth v dividend payout

Lease v buy

Scrip v cash dividends

Tactical planning and control
Conflict may arise between strategic planning (need
to invest in more expensive machinery, research and
development) and tactical planning (cost control).
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1: The role and responsibility of senior financial executive


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Financial
management

Financial
planning

Johnson and Scholes separate power groups into 'internal coalitions' and 'external stakeholder groups'.
Stakeholder goals

Shareholders

Providers of risk capital, aim to maximise
wealth

Suppliers

To be paid full amount by date agreed,
and continue relationship (so may accept
later payment)

Long-term
lenders

To receive payments of interest and
capital by due date

Employees

To maximise salaries and benefits; also
prefer continuity in employment

Government

Political objectives such as sustained
economic growth and high employment

Management

Maximising their own rewards

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2: Financial strategy formulation

Topic List
Assessing corporate performance
Financial strategy
Arbitrage
Risk and risk management

Formulating the correct financial strategy is crucial for
business success. The four main areas of financial
strategy are capital structure policy, dividend policy, risk
management and capital investment monitoring.


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Assessing corporate
performance

Profitability and return
Return on capital employed
Profit margin
Asset turnover

Debt and gearing
Debt ratio (Total debts: Assets)
Gearing (Proportion of debt in long-term capital)
Interest cover
Cash flow ratio (Cash inflow: Total debts)

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Financial
strategy

Arbitrage

Risk and risk
management

Liquidity ratios
Current ratio
Inventory turnover
Receivables’ days

Acid test ratio

Payables’ days

Stock market ratios
Dividend yield
Earnings per share
Price/earnings ratio

Interest yield
Dividend cover


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Comparisons with
previous years
% growth in profit
% growth in revenue
Changes in gearing ratio
Changes in current/quick ratios
Changes in inventory/
receivables turnover
Changes in EPS, market price,
dividend
Remember however

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Comparisons with other
companies in same industry
These can put improvements on
previous years into perspective if
other companies are doing better,
and provide further evidence of
effect of general trends.
Growth rates
Retained profits
Non-current asset levels

Comparisons with companies
in different industries
Investors aiming for diversified
portfolios need to know
differences between industrial
sectors.
Sales growth
Profit growth
ROCE
P/E ratios
Dividend yields

Inflation – can make figures
misleading
Results in rest of
industry/environment, or
economic changes
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2: Financial strategy formulation


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Assessing corporate
performance

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Financial
strategy

Arbitrage

Risk and risk
management

Economic Value Added (EVATM)
EVATM = NOPAT – (cost of capital × capital employed)

Adjustments to NOPAT
Add:
Interest on debt
Goodwill written off

Accounting depreciation
Increases in provisions
Net capitalised intangibles

Adjustments to capital employed
Add:
Cumulative goodwill written off
Cumulative depreciation written off
NBV of intangibles
Provisions


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Shares
Ownership stake
Equity (full voting rights)
Preference (prior right to dividends)
All companies can use rights issues
Listed companies can use offer for sale/placing

Debt/Bonds
Fixed or floating rate
Zero coupon (no interest)
Convertible
Bank loans

Security over property may be required

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Comparison of finance sources
When comparing different sources of finance, for
example different categories of debt, the following
factors will generally be important:
Cost
Flexibility
Commitments
Uses
Speed/availability
Certainty of raising amounts
Time period available

2: Financial strategy formulation


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Assessing corporate
performance

Estimating cost of equity
Theoretical valuation models, eg Capital Asset
Pricing Model (CAPM) or Arbitrage Pricing
Theory (APT)
Bond-yield-plus-premium approach: adds a
judgmental risk premium to the interest rate on
the firm’s own long-term debt
Market-implied estimates using discounted cash
flow (DCF) approach (based on an assumption
on the growth rate of earnings of the company)

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Financial
strategy

Arbitrage

Risk and risk
management

Practicalities in issuing new shares
Costs
Income to investors
Tax
Effect on control


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Assessing corporate
performance

Pecking order
Retained earnings
Debt
Equity

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Financial
strategy

Arbitrage

Risk and risk
management

Suitability of capital structure
Company financial position/ stability of earnings
Need for a number of sources
Time period of assets matched with funds
Change in risk-return
Cost and flexibility
Tax relief
Minimisation of cost of capital

Feasibility of capital structure
Acceptability of capital structure
Whether lenders are prepared to lend (security)
Availability of stock market funds
Future trends
Restrictions in loan agreements
Maturity of current debt
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Risk attitudes
Loss of control by directors
Excessive costs
Too heavy commitments
2: Financial strategy formulation


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Assessing corporate
performance

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Financial
strategy

Arbitrage

Risk and risk
management

Dividend policy
Dividend decisions determine the amount of, and
the way in which, a company’s profits are distributed
to its shareholders.

Ways of paying dividends
Cash
Shares (stock)
Share repurchases

Theories of why dividends are paid
Residual theory
Target payout ratio
Dividends as signals
Taxes
Agency theory


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Assessing corporate
performance

CAPM exam formula
E(r i) = Rf + βi (E(rm) – Rf)

Factor analysis
Analysis used to determine factors to which security
returns are sensitive. Research indicates:
Unanticipated inflation
Changes in industrial production levels
Changes in risk premiums on bonds
Unanticipated changes in interest rate term
structure

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Financial
strategy

Arbitrage

Risk and risk
management

Arbitrage pricing theory
The theory assumes that the return on each security
is based on a number of independent factors.

r = E(r j ) + B1F1 + B2F2 ... + e
E (rj ) is expected return on security
B1 is sensitivity to changes in Factor 1
F1 is difference between Factor 1 actual and
expected values
e is a random term

2: Financial strategy formulation


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Assessing corporate
performance

Types of risk
Systematic and unsystematic
Business
Financial
Political
Economic
Fiscal
Regulatory
Operational
Reputational

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Financial
strategy

Arbitrage

Risk and risk
management

Risk management
Overriding reason for managing risk is to maximise
shareholder value.

Risk mitigation
The process of minimising the likelihood of a risk
occurring or the impact of that risk if it does occur.


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3a: Conflicting stakeholder interests

Topic List

Governance of a modern corporation can give rise to
conflicts between the various stakeholders of the firm.

Stakeholders

Be prepared to answer questions on key concepts such
as agency theory or goal congruence, or developments
in corporate governance.

Corporate governance


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Stakeholders

Separation of ownership and management: ordinary
(equity) shareholders are owners of the company, but
the company is managed by its board of directors.
Central source of stakeholder conflict: difference
between the interests of managers and those of owners.
Sources of stakeholder conflict
Short-termism

Sales objective (instead of shareholder value)
Overpriced acquisitions
Resistance to takeovers
Relationships with stakeholders may be difficult

Corporate
governance

Transaction costs economics
The transaction costs economics theory
postulates that the governance structure of a
corporation is determined by transaction costs.

The transactions costs include search and
information costs, bargaining costs and policing
and enforcement costs.


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Stakeholders

Agency theory

Corporate
governance

Goal congruence

Proposes that, whilst individual team members act
in their own self-interest, individual well-being
depends on the well-being of other individuals and
on the performance of the team.

Is accordance between the objectives of agents
acting within an organisation and the objectives of
the organisation as a whole.

Corporations are set of contracts between principals
(suppliers of finance) and agents (management).

Management incentives may enhance congruence:

The agency problem
If managers don’t have significant shareholdings,
what stops them under-performing and overrewarding themselves?

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Profit-related pay
Rights to subscribe at reduced price
Executive share-option plans
BUT management may adopt creative accounting.
Sound corporate governance is another approach.

3a: Conflicting stakeholder interests


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Stakeholders

Corporate
governance

UK Corporate Governance Code
AUDITORS provide external assurance
DIRECTORS responsible for
corporate governance

FINANCIAL REPORTING
SYSTEM links

SHAREHOLDERS

OTHER USERS
Board of directors
Meet regularly

Matters refer to board
Division of responsibilities
Committees – audit, nomination,
remuneration

(employees, creditors)

Executive
directors
Limits on service contracts,
emoluments decided by
remuneration committee
and fully disclosed

Non executive directors
Majority independent
No business/financial links
Don’t participate in options
Appointed for specified term