P4 Advanced Financial Management (AFM)

It's not numbers-only

P4 is a technical paper with some complex calculations sometimes but DO NOT think of the exam as numbers-only. There are plenty of discursive parts which are usually easier than the calculations and easy marks can be picked up by applying commercial awareness and common sense.

Treat questions Individually

Analyse the individual requirements of the question. If you can do the wordy bits first then do so as you will not get bogged down in them like you will with the calculation elements.

Do not expect to finish everything - Check the clock

Do not expect to finish a question. You must stick to time, especially on the calculations which are very easy to over-run on. The exam is extremely time pressured and the secret to passing is to have a go at every part of every question, not to try and get 100% on every question – to do that you would need about 7 hours!

If you are not sure what to do with a particular figure in a question, ignore it and move on – state assumptions, you haven’t got time to worry about it!

Input variables

If you get a Black-Scholes question, always list out the input variables as your first stage and assign the relevant values to them – there will be about 2-3 marks usually for doing this.

Timing

Practice as many questions as possible but do as many as possible to time. You must get used to doing the questions in the time available and not spending too long on them.

Practice as many questions as possible across the syllabus, and don’t only concentrate on what you consider to be the core areas.

Choose carefully on section B of the paper – it is very limited choice but nonetheless it will be critical.

Do not put down unnecessary workings; because as it will cost you heavily in lost time.

If there is a calculation that you are unable to complete – for e.g. a WACC which prevents you from going on to do the NPV, then just make a reasonable assumption and estimate a WACC which you have been unable to calculate, this will then allow you to progress the calculation and get on to the often more generously rewarded discursive parts of the question.

Look out for examinable articles - two in particular for June 2011:

24 August - The new examiner Shishir Malde gives his approach for the P4 paper

23 September - Another article by the new examiner Shishir Malde on Risk Management

January/February article

FAQs

Q. Having calculated an NPV, if the question then asks you to “advise the Board” what do you talk about to get the marks other than whether the NPV is + or -?

A. Remember the an NPV is only a financial appraisal and there may be a host of other issues to consider such as the following:

Risks – are there any significant risks associated with the project? What could go wrong?

Ethics/Stakeholders - Are there any potential stakeholder conflicts?

Strategy – Is the project a good fit with the organisations present strategy and objectives?

Real options – Are there any choices or flexibility within the project?

Alternatives – Any other uses for the capital?

In addition to the above, consider the numbers:

How certain are the cashflows?

Is the cost of capital suitable? (Risk?)

Q. What are the common topics that always come up?

A. Two key topics are always NPV appraisal and capital structure, particularly CAPM and Betas. You will not pass if that is all you know but you will struggle to pass if you do not know them!

Q. Where do I begin on a NPV question?

A. This area is frequently examined and you will be under extreme time pressure to do as many calculations as possible within the allotted time. Having read the question – you will either start on cash flows or the discount rate (see below). To maximise your mark earning potential group the cash flows under three headings, operating, capital and working capital – and deal with the tax accordingly – impacts on operating / capital flows but not working capital. If the question requires the calculation of an MIRR then when you use a proforma for your cash flows split them between the investment phase and return phase which will then allow you to use the MIRR formula or any other method recognised.

Q. How do I calculate s cost of capital?

A. If it is an NPV calculation and you are required to calculate a risk adjusted WACC then following four steps will be required:

Ungear the equity beta of the proxy company supplied to find the asset beta

Regear the asset beta to reflect the financial gearing of the investment

Use the equity beta to find the Ke(g) using CAPM

Feed Ke(g) into CAPM along with a post tax Kd

Q. How do I approach an APV question?

A. Remember we use APV when we don’t know the post project gearing, typically because the finance has changed.

1. We evaluate the investment decision at an ungeared Ke found be degearing an asset beta of the proxy co / industry we are investing in.

2. We then calculate the present value of the finance flows using the pre tax cost of borrowing / debt - the main finance flows being the cost of raising the finance (tax relief on the debt) and the present value of the tax shield

Q. How do I use currency futures to hedge against an adverse rate of exchange movement?

A. Remember the critical step is to identify the currency of the futures contract, and having established this, then what we do with that currency in the currency market, we do exactly the same in the futures market. So if we have a $ receivable and a $ futures contract, then we would be selling our $ from the customer in the currency market and therefore we would create the hedge by selling $ futures.

Q. I do I use an interest rate futures to hedge against an adverse movement in the rate of interest.

A. It is just a case of remembering that whenever we are concerned about rate rises because we are looking to borrow at some point in the future the we hedge by selling interest rate futures, or if we were looking to invest at some point in the future and we are concerned about rate falls then we hedge by buying interest rate futures.

It's not numbers-only

P4 is a technical paper with some complex calculations sometimes but DO NOT think of the exam as numbers-only. There are plenty of discursive parts which are usually easier than the calculations and easy marks can be picked up by applying commercial awareness and common sense.

Treat questions Individually

Analyse the individual requirements of the question. If you can do the wordy bits first then do so as you will not get bogged down in them like you will with the calculation elements.

Do not expect to finish everything - Check the clock

Do not expect to finish a question. You must stick to time, especially on the calculations which are very easy to over-run on. The exam is extremely time pressured and the secret to passing is to have a go at every part of every question, not to try and get 100% on every question – to do that you would need about 7 hours!

If you are not sure what to do with a particular figure in a question, ignore it and move on – state assumptions, you haven’t got time to worry about it!

Input variables

If you get a Black-Scholes question, always list out the input variables as your first stage and assign the relevant values to them – there will be about 2-3 marks usually for doing this.

Timing

Practice as many questions as possible but do as many as possible to time. You must get used to doing the questions in the time available and not spending too long on them.

Practice as many questions as possible across the syllabus, and don’t only concentrate on what you consider to be the core areas.

Choose carefully on section B of the paper – it is very limited choice but nonetheless it will be critical.

Do not put down unnecessary workings; because as it will cost you heavily in lost time.

If there is a calculation that you are unable to complete – for e.g. a WACC which prevents you from going on to do the NPV, then just make a reasonable assumption and estimate a WACC which you have been unable to calculate, this will then allow you to progress the calculation and get on to the often more generously rewarded discursive parts of the question.

Look out for examinable articles - two in particular for June 2011:

24 August - The new examiner Shishir Malde gives his approach for the P4 paper

23 September - Another article by the new examiner Shishir Malde on Risk Management

January/February article

FAQs

Q. Having calculated an NPV, if the question then asks you to “advise the Board” what do you talk about to get the marks other than whether the NPV is + or -?

A. Remember the an NPV is only a financial appraisal and there may be a host of other issues to consider such as the following:

Risks – are there any significant risks associated with the project? What could go wrong?

Ethics/Stakeholders - Are there any potential stakeholder conflicts?

Strategy – Is the project a good fit with the organisations present strategy and objectives?

Real options – Are there any choices or flexibility within the project?

Alternatives – Any other uses for the capital?

In addition to the above, consider the numbers:

How certain are the cashflows?

Is the cost of capital suitable? (Risk?)

Q. What are the common topics that always come up?

A. Two key topics are always NPV appraisal and capital structure, particularly CAPM and Betas. You will not pass if that is all you know but you will struggle to pass if you do not know them!

Q. Where do I begin on a NPV question?

A. This area is frequently examined and you will be under extreme time pressure to do as many calculations as possible within the allotted time. Having read the question – you will either start on cash flows or the discount rate (see below). To maximise your mark earning potential group the cash flows under three headings, operating, capital and working capital – and deal with the tax accordingly – impacts on operating / capital flows but not working capital. If the question requires the calculation of an MIRR then when you use a proforma for your cash flows split them between the investment phase and return phase which will then allow you to use the MIRR formula or any other method recognised.

Q. How do I calculate s cost of capital?

A. If it is an NPV calculation and you are required to calculate a risk adjusted WACC then following four steps will be required:

Ungear the equity beta of the proxy company supplied to find the asset beta

Regear the asset beta to reflect the financial gearing of the investment

Use the equity beta to find the Ke(g) using CAPM

Feed Ke(g) into CAPM along with a post tax Kd

Q. How do I approach an APV question?

A. Remember we use APV when we don’t know the post project gearing, typically because the finance has changed.

1. We evaluate the investment decision at an ungeared Ke found be degearing an asset beta of the proxy co / industry we are investing in.

2. We then calculate the present value of the finance flows using the pre tax cost of borrowing / debt - the main finance flows being the cost of raising the finance (tax relief on the debt) and the present value of the tax shield

Q. How do I use currency futures to hedge against an adverse rate of exchange movement?

A. Remember the critical step is to identify the currency of the futures contract, and having established this, then what we do with that currency in the currency market, we do exactly the same in the futures market. So if we have a $ receivable and a $ futures contract, then we would be selling our $ from the customer in the currency market and therefore we would create the hedge by selling $ futures.

Q. I do I use an interest rate futures to hedge against an adverse movement in the rate of interest.

A. It is just a case of remembering that whenever we are concerned about rate rises because we are looking to borrow at some point in the future the we hedge by selling interest rate futures, or if we were looking to invest at some point in the future and we are concerned about rate falls then we hedge by buying interest rate futures.