• Working capital management section, current asset and the aim is the minimize current asset and maximize current liabilities. Because current assets like A/R and inventory use up our cash, so minimize to improve cash flow position. Same rationale for the maximization of current liabilities in order to increase cash position.
• Short term financing & working capital management, p.32 Exercise 9. 2/98 is the implicit interest charge for loan, which means the implicit interest for the early discount, as you pay $2 less for a $98 cash flow. Then the result of 2.04% is the implict interest for the 2 months of early payment, so to find the annual interest we have to adjust by x 12/2 for the annual rate.
• EOQ p.35 Exercise 10, the EOQ is in the syllabus, but exercise 10 is doing it the long way to confirm that the EOQ formula works.
• Short term financing p.7, Exercise 2 (b), interest cover safe or not depends on many factors and there is no hard and fast way to fix a coverage ratio. The listed items are variables that might make a difference. There are many possibilities, those are just examples. #6 stage of company developing - if high growth company, then more risky because uses cash to grow; for a mature and safe company with steady cash flow, a lower cover is ok.
• Short term financing p.10, Exercise 3, ROCE is the same whether geared or ungeared because it is calculated with both equity and debt so effect of leverage does not change ROCE. But for ROE, it is equity only so level of debt or leverage will affect the level of ROE because it is after debt.
• CLP 11-24 Wing Processing cost of goods sold are the incremental only.
• CLP 6-18 Keep or Drop Example 6, for short term decision, divisions should be kept as long as they can cover their variable cost, because any extra amount of contribution can be used to cover some of the fixed cost (even though it is not enough to cover ALL the fixed costs, but covering some is better than nothing).
• There are several questions on the use of hi-low method to find the fixed and variable costs. That is just using variable cost to back out the fixed costs so that contribution analysis can be performed.
• For call options, you have a right to buy something when the price go up in the future, but you do not need to buy it now, so this is similar to a futures contract. Since you keep the cash in your bank account, you would benefit when the interest rate goes up, and hence the call value is higher when interest rate goes up. For put, it is the opposite because you are not receiving the cash proceeds from sale until the put is exercised, so you are delaying receipt of cash and so higher interest rate will reduce the value of a put.
• Essay short question 50 - will not execute transaction in the cash market - that means the manufacturer will go back to the original forward contract counterparty to do the trade directly with him instead of going to do a market rate and then ask him for a payment of difference in cash.
• Essay short question 51 - USD0.0066/Euro that is the price of the call option, delivery of Euro125,000 meaning the contract term is to sell the Euro and receive the USD. In the answer key, the USD0.0102 is the price of each option so the total premium cost use this to find total cost. The put is used because the dividends to be received is in Euro so I need to sell the Euro and exchange for USD, hence the put is used instead of the calls. In this question, the question itself does not ask for advantages or disadvantages, but it ask you to contrast the risk and cost, so that is almost the same as the disadvantages for each strategy.

There is a question on the FX rate selection in Question 4 of the mock exam that we did last Sunday. The way the rate is quoted is by using the mid-point of the bid ask. So for the quotation of 1.7820 +/- 0.0002, the lower exchange rate would be 1.7818 and the higher rate would be 1.7822. The next step would be to divide the amount of USD100,000 with both the 1.7818 and 1.7822. Here we are dividing because USD100,000 will result in a small number of GBP. And we get GBP56,123 when using 1.7818 and GBP56,110 when using 1.7822. Then you have to decide what your action is and you get the worse of the two amounts. So if you are buying USD (or selling GBP), you will have to pay GBP56,123 so you pay more between the two; if you are selling USD (or buying GBP) the you get the lesser amount of GBP of GBP56,110. This line of reasoning can be applied to all currency once you know their relationships (eg GBP1 = USD1.78) and what you are doing (buying or selling which currency).

In your CLP binder, in the diagram on page 14-42 for the currency swap, there is an error. On Day 1 part of the diagram, the Americo should enter into a loan agreement to pay "Interest payments 3% quarterly," not 6% quarterly (on the right side of the flow chart).

There are some questions on the September 2007 actual exam Section B question #4 on options. First we have not went through options yet, but we will on our last class. So some of these questions you might not have encounter yet since we are not there yet. The option strategy that Harry uses here is a covered call strategy. He would have the stock in his portfolio, then he will sell out-of-money call options (at $40) in the question so that he would be forced to sell his shares at $40. He will keep the option premium regardless of what happens. The downside for this strategy is that he will not enjoy the gains of the stock if it goes above $40. I will go through this question in class when we are on this topic, but just some information first. In part (c) and (d), Harry will receive the option premium whether the options are exercised or not so the option premium is earned in both (c) and (d). In part (e) the referral to the handsome returns means that if the stock price do not go above $40, he will earn the extra option premium in additions to the dividends received so that is a better return than when no options were sold. In part (f), the breakeven price calculated is different from the normal break-even price in option pricing. In a normal option pricing convention, the breakeven price would mean the price at which Harry will "break-even" on his option and that would be $40 plus the option price. In this case, the breakeven is really his cost meaning that if the stock price go below the $25, then he would start to incur a real loss (after taken into account the dividends and the option premium received). In part (b), the net cost of the premium is deducted from the purchase price of the stock because it is assumed to be an integrated strategy and Harry is having these two positions together as his trading strategy.

• for the calculation of the NPV, I am trying the find the present value of the cash flow from each year.
• For year 1 and 2, the amount of cash flow are different so they have to be performed separately.
• For year 10, there is a redundancy and disposal cost of the HK factory which is to be calculated and discounted separately.
• What we have left to calculate is the actual amount of cash flow from year 3 to 10 in the amount of $50 million each year. There is a long and a short way to do it.
• The long way is just do the present value year by year. So for year 3, I would have PV of 50 / (1.05)(1.05)(1.05) and so on for each year.
• The short way is to calculate the cash flow like an annuity because it is just a $50 million annual cash flow for 8 years continuously starting in year 3. This is what the answer key is showing. The 7.723 is the annuity factor for a 10 year cash flow, and the 1.859 is the annuity factor for a 2 year cash flow. In this case, I take the PV of a 10 year continuous cash flow minus the PV of a 2 year continuous cash flow to get the PV of the cash flow from year 3 to 10. We have to take the 10 year annuity factor and subtract the 2 year annual factor because the cash flow starts in year 3; we cannot just take a 8 year annuity factor because it assumes that we start the cash flow now and not at year 3. If we want to use the 8 year annuity factor, then we have to discount it by 2 years to move it from a year 2 amount to a year 0 amount. To prove that they are the same, the 8 year annuity factor is 6.4632, then discount by 5% for 2 years = 6.4632 / (1.05)(1.05) = 5.8623 which is the same as the one of 10 year annuity minus 2 year annuity.
• For the annuity value, you can use table or financial calculator. For financial calculator, put in $1 as payment amount, discount interest as i, and time as t, then press PV and you will get the annuity factor.

• Workshop 3
• Question 1 - (a) perform numerical analysis with no time limit, (b) 20 minutes, (c) 15 minutes, (d) 15 minutes.
• Question 2 - (a) 20 minutes, (b) 20 minutes, (c) 5 minutes, (d) 20 minutes, (e) 20 minutes.
• Question 3 - this is a calculation only question, and we will go through this in class.
• Question 4 - (a) 15 minutes, (b) calculation part we will do in class, the outline of risk part 15 minutes, (c) calculation only and we will do this part in class, (d) we can do this part in class since you would need the answer from the previous part to advice.
• Workshop 4
• Question 1 - (a), (b) and (c) you can perform the forecast income statement, balance sheet, and cash shortfall calculations with no time limit, (d) 20 minutes.
• Question 2 - (a) and (b) you can perform the impact analysis with no time limit, (c) 30 minutes, (d) 15 minutes.
• Question 3 - (a), (b), and (c) 15 minutes each.
• Question 4 - (a) 15 minutes for the meaning of WACC. the evaluation of WACC no time limit, (b) 15 minutes to explain FCFF, evaluation of FCFF no time limit, (c) and (d) for the comparatives and the recommendation, we will do on Saturday.

• Question 61 part (ii) the question stated that 80% of the customers will chose to take advantage of the discount and pay in the first month. In the answer key, it assumes that the remaining 20% of the customers will pay in the 2nd month (although the question did not state when the remaining 20% will pay). However, given that in the original case the customers do not pay until the last month, it should be a reasonable assumption that the remaining 20% of the customer still pay at the end of the 3 months. Just to be safe in situations like this, you can wite in your assumptions of their payment date, then you should still get marks for it.
• on p. 14 to 15 of the reading material distributed on risk management, interest rate cap and collar was discussed. We will do more details in class but I have received a few questions on this, so some pre-explanation. Starting on p.14, an interest rate cap and then collars were discussed. This is the situation: a company had borrowed money or had taken out a loan so it is paying floating interest rate. For certain reason (cash flow, covenants, etc) the company wants a maximum percentage of interest that it pays and not more. Given this situation, the company can buy a cap (or buy an interest rate put option) so that whenever rates go above 10% (as in the example) then the company can exercise the put option and have the put option seller buy the higher interest rates to be paid. In the end, the company will only pay interest at 10% or less, hence the company is protected from an increase of rates to above 10%. One thing can be confirmed at this stage, this is a cap on the upper interest rate range so that company is protected from an interest in the market interest rate; at the same time, the company can benefit from a decrease in the market rate. So this is the basic cap structure.
• continuing on p.14 and 15 of using an interest rate cap from above, the company thinks that it is too expensive, meaning that the company do not want to pay a lot for the put option protection. This is where the collar structure comes in. The company can buy the put option as above, but at the same time sell the lower interest benefits, meaning the company can sell an option on the lower interest scenario so that the company do not need to pay for the full price of the put option. As a result, the company give up some of the potential benefits from interest going lower but gain a lower price to buy its interest rate protection when the rates go higher.

• The background of the question is that the finance director wants to find out the effect of having different levels of debt. The current ratio is 60% equity and 40% debt. Part (a) ask for two scenario, one at 20% debt and another at 60% debt. So first step is to change the total debt level to 20% and 60%. Then it is an iterative process and we have to plug in some interest rates to calculate the interest coverage ratio, then go back to determine if the interest rates used are correct given the coverage ratio.
• If I use the 20% debt level as an example, I know the current debt of $305 million is 40%, so a 20% debt level will mean debt level of 305 * 0.5 = 152.5. Next step is to determine what cost of long term debt will apply. So I will assume that cost of debt is 11% as given in the question; so interest expense will be 152.5 * 11% = 16.78. Since EBIT is 90, the interest coverage is 90 / 16.78 which is 5.37 times. But at cost of long term debt of 11% is for interest coverage of 1.0 to 4.0 times, while we are getting 5.37 times, so we have over-estimated the cost of debt. We try 9% now and find the actual interest coverage to still be higher than the 4.0 to 6.5. So we will check 8.0% and found that given the lower debt level of 152.5, our interest expense can satisfy an interest coverage ratio of having a AA credit rating and a cost of long term debt of 8%. You can try the same process for the 60% debt level scenario.

• Question 33. The question states that the projects are divisible, meaning that I do not need to do the full project and I can do part of a project. If this is the case, then the selection project is more simple. We just calculate the profitability index for each project, then select the highest PI project. If there is money left over after the highest PI project, then I put those into the project with the second highest PI, and so on. Since I can do part of a project, I can just select base on PI alone. Another clarification for Question 33's answer: as stated, I put away 272,727 (PV of 300,000 in a year) for project D in a year, remaining 227,273 I put into the project with the second highest PI which is project A. The last sentence of the answer key states "The cash inflow from Project A at the end of Year 1 will be available for investment in Project D." Here it is just emphasizing that there will be extra cash inflow from Project A in Year 1 in case Project D needs extra money; however, this is not a requirement because the full amount of 300,000 for Project D will be available in Year 1. Or put it in another way, Project D does not need the financial assistance of Project A in Year 1, but there is some extra cash inflow if needed.

• Question 103. The net cash flow for year 1 to 4 is 870,000 (=1,810,000 - 940,000). The net cash flow for year 5 is 1,180 because the company will receive an extra 310,000 from the sale of the machine (salvage value) in year 5.
• There are three ways to calculate IRR. (a) use a financial calculator which is assumed in your CLP binder. (b) without a financial calculator, you can do it by hand with trial and error (manually). Meaning you perform a number of NPV calculations using different discount rates until you find a discount rate which result in a zero NPV. This is an iterative process and not recommended here because you will be there for days just to do this. (c) In the extra notes that I have distributed, on p. 53, there is one section on IRR and an estimation method is provided there. Using this estimation approach, you only need to perform the NPV calculation twice using different discount rates. Then the formula on p.53 will extrapolate an estimated IRR from your two NPV calculation. You can try to work through that formula to see how it works. However, given the three approach, using the financial calculator would be the easiest.

• work on the practice questions that I have provided to you,
• study and review the CLP topics that we have discussed, and
• review workshop 3 and 4 material.

• I have posted the answer key to the following questions which I have distributed on July 17: Mercury Training, GM Co, Tempem, and WACC, please check your answers. Please take note that some parts of these questions (latter parts) are beyond our syllabus, so do not worry too much if there are parts which are not in the CLP syllabus. I will clarify for each question what you should be able to perform for the QP FM and for the Final Exam in the coming class.
• For the coming week, please just make sure that you have read up-to-date on what we done so far (both for the CLP reading and relevant articles that you might need to read posted here).
• For the practice questions posted here or distributed in class, please make sure that you are able to answer similar nature of questions.
• Review reading the material and articles posted for July 31 within the Course Outline and Notes section to prepare for the upcoming class on Saturday July 31. On July 31, we will finish the "degearing and regearing" part in CLP 12, go through CLP 16 on short term financing and working capital management, and will start on CLP 13 and 14, so please review these sections in your CLP binder before class.

• (b) the degear / regear process we have started talking about it last class and we will do actual calculation in next class, but see note below,
• (c) refers to more debt which will increase cost of equity because higher equity risk,

Degear / Regear process:

• we talked about this in the last class, but we will do the actual calculation next class, but here is the reason why that we discuss in the last class,
• I am in an industry but want to invest in another completely new industry,
• I cannot use my own equity beta to calculate my cost equity because now the new industry is different, so what to do?
• find another company in same business with my new proposed business, but debt level is different, how to adjust?
• first degear meaning taking out the effect of debt to find the risk / beta of this industry,
• then regear meaning adding back the level of debt that I expect to put on this new business,
• then finally I can use this adjusted beta to put into the CAPM to estimate the cost of equity for WACC calculation.

• for the share conversion, it was just assumed that the share price will increase by the growth rate and then see if conversion will take place, this is just a starting point to get the process going,
• for the convertible bonds, the yield to maturity is 7.8%, and that was calculated by putting the values into the financial calculator,
• for Burse, it is assumed that the convertible bonds will convert given the information that we were given, so that is based on the best information that we have. IF something change in the course of time, then all the estimates would have been changed and all new calculations would have to be redone again.

• follow the same approach to review each question before answering them,
• skim the text of the question,
• read the actual questions very carefully to make sure that you know the requirements are,
• look at the marks available for each section to determine how many points should be written and their depth,
• observe strict time limit based on the marks available (you have to learn to get all the marks within each question and not to miss out on the easy marks for each question),
• write so that it is easy to read, like using heading and subheading, and short introduction sentence so marker knows what you are about to write,
• for the questions that was distributed last Saturday, you can do some of them in two stages if you are having trouble following the above order - do first time using unlimited time so you get the best answer, then try to do it again given the alloted time for the marks, doing it this way can help you learn to focus your thinking process on the important mark producing content,
• please keep the answers so that I can review later on,
• I will post other questions for you to practice next week,
• ** note that some of the practice questions that you have go past the QP FM syllabus difficulty level, so if you were not able to do the more difficult part of these questions, do not worry too much about it, and lastly,
• I have posted the answer key to several questions that we have went through in class (under Course Assignment and Review section), if there are answer keys that I have missed, please sent me an email.

• read CLP 5, 12, 15, 16, and 17,
• bring your work on all the practice questions that I have posted below, and
• calculator and writing instruments and paper as we will work through several questions during the day.

• the need for management accounting and financial accounting,
• comparison of absorption and activity based accounting on their use, advantages, and when to use them,
• reason for using budgets,
• purposes and benefits of using variance analysis,
• financial and non-financial based performance measurement, how they compare, when to use, and
• relevant costs and irrelevant costs for project evaluation.

• review the articles in Course Outline and Notes for June 13; these are introductory articles only and read them if you are unfamiliar with the topic, otherwise, we will go through these articles very quickly during class and highlight the relevant points,
• read Omega Asia Bank in Section 4 which provides the basic company information for the Workshops,
• prepare for questions in Workshop 1 and 2, these might involve reviewing the binder material on budgeded financial statements (WS1Q2), EVA (WS1Q3), stakeholder theory and balanced scorecard (WS2Q1 and WS2Q2), activity based accounting (WS2Q3), and project appraisal (WS2Q4),
• email to me any questions that you might have at thomaswu@uic.edu.hk,
• check this page frequently as I will post information here.

• an introduction to QP workshop and exam,
• workshop and exam techniques,
• review of guidance answers for Workshop 1 and Workshop 2,
• review of mindmap for an introduction of the FM module topics,
• topic of strategic evaluation using external and internal analysis,
• external analysis using PESTEL, SWOT, 5 forces, and industry / product life cycle,
• internal analysis using SWOT, value chain, CSF,
• strategic choice evaluation using CSF, Porter's generic strategics, product / industry life cycle, Ansoff, BCG, GEM,
• topic of ethics,
• topic of project evaluation using the 5 approaches of ARR, payback, discounted payback, NPV, and IRR,
• discussed the need to adjust for the risk of new or unrelated investment in the WACC calculation,
• reviewed special situations in project evaluation like mutually exclusive projects, multiple project selection using PI, unequal life projects using EAA, capital rationing, and sequencing and real options, and
• practice of presentation skills by going through a 3 minutes and a 1 minute presentation.

• Budgeting, Budgeting answer
• NPV, NPV answer

• NPV, NPV answer

• Cash Budgeting, Cash Budgeting answer
• CVP Analysis, CVP Analysis answer
• Ethics, Ethics answer

• Budgeted Financial Statements, Budgeted Financial Statements answer
• NPV Analysis, NPV Analysis answer
• SWOT Analysis, SWOT Analysis answer

• NPV Analysis, NPV Analysis answer
• WACC 1, WACC 1 answer
• WACC 2, WACC 2 answer

• project evaluation using ARR, discounted payback,
• practice questions on project evaluation,
• practice written questions on strategies,
• project evaluation under special situations like mutually exclusive projects, use of PI, EAC, capital rationing, sequencing, and real options,
• WACC introduction,
• calculation of WACC using CAPM and DDM models for the cost of equity,
• practice questions on WACC,
• review of long term sources of financing including equity, preferred shares, bank debt, bonds, convertible bonds, warrants, and other forms of long term financing, and
• capital structure issues including use of debt, optimal capital structure.

• review of in-class question done in last class,
• a practice short essay question,
• ungearing and regearing of a company's beta to adjust risk level for cost of equity calculation,
• short term financing,
• profitability, gearing, and liquidity ratios,
• working capital ratios,
• use of discount and factoring to reduce account receivable use of cash,
• use of EOQ to reduce inventory use of cash, and
• an introduction to OTC and exchange traded financial instruments.

• interest rate risk,
• interest rate forwards (FRA) and futures (exchange traded interest rate futures),
• foreign exchange risk,
• foreign exchange forwards and futures,
• Workshop 3 and Workshop 4 discussion and preparation.

• overview of risk management (interest and foreign exchange) using forwards, futures, and options,
• option section in CLP 18,
• exam techniques review,
• practice question on strategies,
• review of application of exam techniques on the strategic practice question, and
• mock exam part 1 based on short essay questions.

• review of the section B of the mock exam done last week individually,
• overview of the CLP sections and what each topic entails,
• detailed discussion of the tax benefits of depreciation in project evaluation,
• detailed discussion of derivation and usage of WACC in project evaluation,
• detailed discussion of use of forward, futures, and money market hedge in risk management, and
• detailed discussion of the cost management concepts of absorption and activity based costing and cost volume profit analysis.