ACCA Pakistan Financial Management (FM) Syllabus

What are the three motives for holding cash identified by Keynes?

The transactions motive (to meet day-to-day payments), the precautionary motive (a buffer for unexpected needs), and the speculative motive (to take advantage of opportunities).

What does the Baumol cash management model determine, and what is its formula?

It determines the optimal amount of cash to transfer from investments each time cash is needed. Q = square root of (2 x Co x D / Ci), where Co = cost per transaction, D = annual cash demand, Ci = interest cost of holding cash.

What does the Miller-Orr cash management model do?

It sets an upper limit, lower limit, and return point for a cash balance that fluctuates randomly. Spread = 3 x [ (3/4 x transaction cost x variance of cash flows) / interest rate ]^(1/3); Return point = lower limit + spread/3.

Distinguish between permanent and fluctuating (temporary) current assets.

Permanent current assets are the minimum core level of current assets needed at all times; fluctuating current assets vary with seasonal or cyclical demand above that base level.

Describe an aggressive working capital funding strategy.

Using short-term finance to fund all fluctuating current assets and part of the permanent current assets. It is cheaper but riskier (higher liquidity/refinancing risk).

Describe a conservative working capital funding strategy.

Using long-term finance to fund all permanent current assets and part (or all) of the fluctuating current assets. It is lower risk but more expensive, with surplus cash at times.

What is the matching (moderate) approach to working capital funding?

Funding permanent assets with long-term finance and fluctuating current assets with short-term finance, so the maturity of funding matches the life of the asset it finances.

What is the payback period and its main decision rule?

The time taken for a project's cumulative cash inflows to recover the initial investment. Rule: accept projects with a payback within the company's target period; choose the shortest payback.

State two advantages and two disadvantages of the payback method.

Advantages: simple to calculate and understand; focuses on liquidity/early cash flows reducing risk. Disadvantages: ignores cash flows after payback; ignores the time value of money (in simple form).

What is the Accounting Rate of Return (ARR) and how is it commonly calculated?

ARR = (Average annual accounting profit / Average investment) x 100%. Average investment = (initial investment + scrap value) / 2. Accept if ARR exceeds a target rate.

What is the key weakness of ARR as an investment appraisal method?

It uses accounting profit rather than cash flows and ignores the time value of money.

What is Net Present Value (NPV) and its decision rule?

NPV is the sum of the present values of a project's future cash flows less the initial investment, discounted at the cost of capital. Rule: accept projects with a positive NPV; it maximises shareholder wealth.

What is the Internal Rate of Return (IRR)?

The discount rate at which a project's NPV equals zero. Decision rule: accept the project if the IRR exceeds the company's cost of capital.

State the formula used to estimate IRR by interpolation.

IRR = L + [ NPV_L / (NPV_L - NPV_H) ] x (H - L), where L and H are the lower and higher discount rates and NPV_L, NPV_H are their net present values.

What is the present value formula for a single future cash flow?

PV = Future cash flow x 1/(1+r)^n, where r is the discount rate and n is the number of periods (the discount factor).

What is the formula for the present value of an annuity?

Annuity factor = [1 - (1+r)^-n] / r. PV of annuity = annual cash flow x annuity factor.

What is the formula for the present value of a perpetuity?

PV of a perpetuity = cash flow / r. For a growing perpetuity, PV = cash flow / (r - g), where g is the growth rate.

What is the difference between the money (nominal) and real methods of dealing with inflation in DCF?

The money method discounts money (inflated) cash flows at the money cost of capital; the real method discounts real cash flows at the real cost of capital. Both give the same NPV.

State the Fisher equation linking real and nominal rates.

(1 + money/nominal rate) = (1 + real rate) x (1 + inflation rate).

How are tax-allowable depreciation (capital allowances) treated in NPV calculations?

They are not cash flows themselves but generate tax savings (tax relief). The tax saved = allowance x tax rate, and these savings are included as cash inflows, timed according to when tax is paid.

What is sensitivity analysis in investment appraisal?

A technique measuring how much an input variable can change before the NPV becomes zero (the decision changes). Sensitivity = NPV / PV of the cash flow affected, expressed as a percentage.

What is the difference between risk and uncertainty in investment appraisal?

Risk means future outcomes and their probabilities can be quantified/estimated; uncertainty means probabilities cannot be assigned because there is too little information.

What is the expected value (EV) and how is it calculated?

A weighted average of possible outcomes: EV = sum of (each outcome x its probability). It is used to assess risky investments but ignores the decision-maker's risk attitude and the spread of outcomes.

Distinguish between debt and equity as sources of finance.

Equity (ordinary shares) gives ownership, voting rights and variable dividends, ranking last on liquidation; debt (loans/bonds) carries a fixed interest obligation, no ownership, is often secured, and ranks ahead of equity. Debt interest is tax deductible.

List three sources of short-term finance.

Bank overdraft, short-term bank loans, and trade credit. (Also factoring/invoice discounting.)

What is a rights issue?

An offer of new shares to existing shareholders in proportion to their current holdings, usually at a discount to the market price, allowing them to maintain their percentage ownership.

State the formula for the Cost of Equity using the Dividend Growth Model.

Ke = [D0(1+g) / P0] + g, where D0 = current dividend, g = growth rate, P0 = current ex-dividend share price. (D0(1+g) is the next expected dividend D1.)

State the Capital Asset Pricing Model (CAPM) formula for the cost of equity.

Ke = Rf + beta x (Rm - Rf), where Rf = risk-free rate, Rm = market return, (Rm - Rf) = equity risk premium, and beta = systematic risk of the share.

What is the Weighted Average Cost of Capital (WACC) and its formula?

WACC = [Ke x E/(E+D)] + [Kd(1-T) x D/(E+D)], where Ke = cost of equity, Kd(1-T) = after-tax cost of debt, E = market value of equity, D = market value of debt, T = tax rate.

What does Modigliani and Miller's capital structure theory with tax conclude?

Because debt interest is tax deductible, increasing gearing increases the value of the firm through the tax shield, so the optimal capital structure is theoretically 100% (or near-100%) debt; WACC falls as gearing rises.

What is the traditional view of capital structure?

There is an optimal level of gearing at which WACC is minimised and firm value maximised; beyond that point, rising financial risk increases both Ke and Kd, raising WACC again.