Chartered Global Management Accountant (CGMA) Corporate Finance, Treasury, and Financial Strategy Syllabus

What is a tax (depreciation) shield and how is its annual value calculated?

It is the reduction in tax payable due to deductible capital allowances/depreciation. Annual value $= \text{Capital allowance} \times \text{tax rate}$, i.e. $D \times T_{c}$.

In relevant cash flow analysis, how are sunk costs and opportunity costs treated?

Sunk costs (already incurred, unrecoverable) are excluded as irrelevant. Opportunity costs (benefits forgone from the next best use of a resource) are included as relevant cash flows.

Distinguish between risk and uncertainty in investment appraisal.

Risk: outcomes are unknown but probabilities can be assigned (quantifiable). Uncertainty: outcomes are unknown and probabilities cannot be reliably assigned (unquantifiable).

What is sensitivity analysis, and how is the sensitivity margin computed?

It examines how much a single input variable can change before the NPV becomes zero. $$\text{Sensitivity} = \frac{NPV}{\text{PV of the variable}} \times 100\%$$ A smaller percentage indicates a more critical/risky variable.

How is the expected value (EV) of a project's outcome calculated?

$$EV = \sum p_{i} x_{i}$$ the probability-weighted average of possible outcomes, where $p_{i}$ is the probability and $x_{i}$ the outcome value.

What is the certainty equivalent approach to risk in appraisal?

Risky future cash flows are converted into smaller equivalent 'certain' amounts using certainty-equivalent factors, and these are then discounted at the risk-free rate rather than a risk-adjusted rate.

Give the dividend growth model formula for the cost of equity.

$$K_{e} = \frac{D_{0}(1+g)}{P_{0}} + g$$ where $D_{0}$ is the current dividend, $g$ the constant growth rate, and $P_{0}$ the current ex-dividend share price.

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

$$K_{e} = R_{f} + \beta(R_{m} - R_{f})$$ where $R_{f}$ is the risk-free rate, $\beta$ the systematic risk of the share, and $(R_{m} - R_{f})$ the equity market risk premium.

What does beta ($\beta$) measure in the CAPM?

Beta measures systematic (non-diversifiable, market) risk — the sensitivity of a security's returns to movements in the overall market. $\beta = 1$ moves with the market; $\beta > 1$ is more volatile; $\beta < 1$ less volatile.

How is the post-tax cost of irredeemable debt calculated?

$$K_{d} = \frac{I(1 - T)}{P_{0}}$$ where $I$ is the annual interest (coupon), $T$ the corporate tax rate, and $P_{0}$ the current market price of the debt.

How is the cost of redeemable debt estimated?

It is the IRR (yield to maturity) of the after-tax cash flows: the market price as outflow, the after-tax interest each period, and the redemption value at maturity, all discounted to equal the current market price.

How is the cost of preference shares calculated?

$$K_{p} = \frac{D_{p}}{P_{0}}$$ where $D_{p}$ is the fixed annual preference dividend and $P_{0}$ is the current ex-dividend market price. No tax adjustment is made, as preference dividends are not tax-deductible.

State the formula for the Weighted Average Cost of Capital (WACC).

$$WACC = \frac{E}{E+D}K_{e} + \frac{D}{E+D}K_{d}(1-T)$$ where $E$ and $D$ are the market values of equity and debt, $K_{e}$ and $K_{d}$ their costs, and $T$ the tax rate.

What three key assumptions must hold for WACC to be a valid project discount rate?

The project has the same business risk as the existing firm, the project does not materially change the firm's financial risk/capital structure, and the project is marginal (small relative to the firm).

State Modigliani and Miller's Proposition I in a world without taxes.

In a perfect market with no taxes, a firm's total value is independent of its capital structure; WACC remains constant. As gearing rises, the increasing cost of equity exactly offsets the cheaper debt.

State the Modigliani-Miller view with corporate taxes.

With corporate tax, debt creates a tax shield, so firm value rises with gearing: $$V_{g} = V_{u} + T_{c}D$$ Geared firm value equals ungeared value plus the present value of the debt tax shield. WACC falls as gearing increases.

What is the traditional view of capital structure?

There exists an optimal capital structure where WACC is minimized and firm value maximized. Moderate gearing lowers WACC, but beyond the optimum, rising costs of equity and debt (from financial distress risk) push WACC back up.

What is financial gearing/leverage and how does it affect financial risk?

Gearing is the proportion of debt in the capital structure, e.g. $\frac{D}{E}$ or $\frac{D}{D+E}$. Higher gearing increases financial risk because fixed interest commitments increase the volatility of returns to equity holders.

Explain pecking order theory of financing.

Firms prefer financing in order of least information asymmetry/signaling cost: first internal funds (retained earnings), then debt, and finally new equity as a last resort. It implies no clearly defined target capital structure.

State the dividend irrelevancy theory of Modigliani and Miller.

In a perfect market, dividend policy does not affect shareholder wealth; investors are indifferent because they can create 'home-made dividends' by selling shares. Value depends on investment/earnings, not the split between dividends and retentions.

What is the signaling effect of dividends?

In imperfect markets with information asymmetry, dividend changes convey management's view of future prospects. A dividend increase signals confidence (raising the share price); a cut signals trouble (depressing it).

What is the clientele effect in dividend policy?

Firms attract investors (clienteles) whose income/tax preferences match the firm's dividend policy. Sudden policy changes are costly because they disrupt the existing shareholder base, encouraging stable, consistent dividends.

What is a scrip (stock) dividend and a share buyback?

A scrip dividend issues new shares to shareholders instead of cash, conserving cash. A share buyback (repurchase) uses cash to buy back and cancel shares, returning surplus cash and increasing earnings per share and gearing.

Distinguish equity, debt, and hybrid/mezzanine sources of finance.

Equity (ordinary/preference shares) confers ownership and variable returns. Debt (loans, bonds) is a contractual fixed-return obligation, ranking ahead of equity. Hybrids (e.g. convertible bonds, warrants) combine features of both.

What is a rights issue, and how is the theoretical ex-rights price (TERP) calculated?

A rights issue offers new shares to existing shareholders pro rata, usually at a discount. $$TERP = \frac{(\text{No. old shares} \times \text{old price}) + (\text{No. new shares} \times \text{issue price})}{\text{Total shares after issue}}$$

What are the four elements of working capital, and what is the working capital cycle?

Elements: inventory, receivables, cash, and payables. The cash operating cycle is: $$\text{Inventory days} + \text{Receivables days} - \text{Payables days}$$ representing the time between paying suppliers and collecting from customers.

Explain the trade-off between profitability and liquidity in working capital, and the aggressive vs. conservative policies.

Holding more working capital reduces risk of illiquidity but lowers profitability (idle assets). An aggressive policy holds low working capital (higher return, higher risk); a conservative policy holds high working capital (lower return, lower risk).

State the Economic Order Quantity (EOQ) formula for inventory management.

$$EOQ = \sqrt{\frac{2 C_{o} D}{C_{h}}}$$ where $C_{o}$ is the cost per order, $D$ the annual demand, and $C_{h}$ the holding cost per unit per year.

State the Miller-Orr model for cash management.

It sets an upper limit, lower limit, and return point for cash balances. $$\text{Spread} = 3\left(\frac{3 \times \text{transaction cost} \times \text{variance of cash flows}}{4 \times \text{interest rate}}\right)^{1/3}$$ and the return point $= \text{lower limit} + \frac{\text{spread}}{3}$.

What are the main roles/functions of a corporate treasury department?

Liquidity and cash management, funding and capital markets (raising finance), banking relationships, and financial risk management (managing interest rate, foreign exchange, and commodity exposures).

State two methods of valuing a business and their formulas.

Net asset (book/realizable) value: total assets minus total liabilities. Dividend valuation model: $$P_{0} = \frac{D_{0}(1+g)}{K_{e} - g}$$ Other methods include P/E ratio valuation ($\text{EPS} \times \text{P/E}$) and discounted free cash flow.

What is the Price/Earnings (P/E) ratio method of valuation?

$$\text{Equity value} = \text{Earnings} \times \text{P/E ratio}$$ A suitable (often quoted-company) P/E multiple is applied to the target's earnings, typically discounted for an unquoted firm's lack of marketability.

Distinguish a horizontal, vertical, and conglomerate merger.

Horizontal: firms at the same stage in the same industry. Vertical: firms at different stages of the same supply chain (e.g. supplier and customer). Conglomerate: firms in unrelated business activities.

What are common sources of synergy in mergers and acquisitions?

Revenue synergy (cross-selling, market power), cost synergy (economies of scale, eliminating duplication), financial synergy (lower cost of capital, debt capacity, tax benefits), and managerial synergy (better management of underperforming assets).

Distinguish transaction, translation, and economic foreign exchange risk.

Transaction risk: cash flow effect of exchange-rate changes on contracted future foreign currency transactions. Translation risk: accounting effect of restating foreign assets/liabilities. Economic risk: long-term effect of exchange-rate movements on the firm's competitive position and value.

State interest rate parity (IRP) and what it predicts.

$$F_{0} = S_{0} \times \frac{1 + i_{c}}{1 + i_{b}}$$ The forward rate $F_{0}$ adjusts the spot rate $S_{0}$ by the ratio of the two countries' interest rates (counter currency $i_c$ over base $i_b$); it predicts the forward exchange rate.

State purchasing power parity (PPP) and what it predicts.

$$F_{0} = S_{0} \times \frac{1 + h_{c}}{1 + h_{b}}$$ The future spot rate adjusts the current spot by the ratio of the two countries' inflation rates; the higher-inflation currency is expected to depreciate.

What are the main internal and external techniques for hedging foreign exchange transaction risk?

Internal: matching, netting, leading and lagging, and invoicing in home currency. External: forward contracts, money market hedges, currency futures, currency options, and currency swaps.

How does a money market hedge work for a future foreign currency payment?

Borrow domestic currency now, convert to the foreign currency at spot, and deposit it so it grows to the exact amount needed at the payment date — locking in the cost today and avoiding the future spot rate.

What instruments are used to manage interest rate risk?

Forward rate agreements (FRAs), interest rate futures, interest rate options/guarantees (caps, floors, collars), and interest rate swaps. They fix or limit the effective interest rate on borrowing or lending.

What is an interest rate swap, and why might two firms enter one?

A contract to exchange interest payment streams (typically fixed for floating) on a notional principal. Firms swap to obtain a preferred interest basis more cheaply, exploiting comparative advantage in different markets and sharing the gain.