INSTITUTE AND FACULTY OF ACTUARIES

EXAMINATION

21 September 2022 (am)

Subject CB1 – Business Finance

Core Principles
Time allowed: Three hours and twenty minutes

In addition to this paper you should have available the 2002 edition of
the Formulae and Tables and your own electronic calculator.

If you encounter any issues during the examination please contact the Assessment Team on
T. 0044 (0) 1865 268 873.

CB1 S2022 © Institute and Faculty of Actuaries

1 The difference between executive and non-executive directors is that non-executives:

A are not board members.

B are permitted to hold shares.
C are senior to executives.
D do not manage the company.
[2]

2 A sole trader’s current account has a balance of $200 and an overdraft facility of
$1,000. What is the maximum that the account holder can withdraw from this
account?

A $200
B $800
C $1,000
D $1,200
[2]

3 Which of the following explains why depreciation is not an allowable expense for tax
purposes in many countries?

A Depreciation cannot be determined objectively.

B Depreciation does not involve a cash flow.
C Governments do not wish to encourage loss of value.
D Tax relief is already granted on asset operating costs.
[2]

4 A company has 100% ownership of an overseas subsidiary that consistently earns

profit. The effect of Double Taxation Relief (DTR) on this group means that it will be
taxed:

A at the higher of the two countries’ tax rates.

B at the lower of the two countries’ tax rates.
C in whichever country it chooses.
D on the net income received from the subsidiary.
[2]

CB1 S2022–2
5 A quoted company has 100 million $1.00 shares in issue that have a market price of
$11.00 per share. The board plans to raise $270 million through a $9.00 rights issue in
order to finance a project that has an estimated net present value of $140 million.

What is the company’s expected share price after the rights issue?

A $10.54
B $11.62
C $13.70
D $15.10
[2]

6 Which of the following explains why preference shares are usually classified as debt
when analysing a company’s financial position?

A Preference dividends are tax deductible.

B Preference shares affect the risk on ordinary shares.
C Preference shares are legally debt.
D Preference shares carry the same rights as debt.
[2]

7 The directors of a company are considering an investment project that they have
evaluated as having a positive net present value. However, they believe that the
shareholders will regard it as a negative net present value project.

Assuming that the directors make the investment and are correct in their beliefs,
which of the following is most likely to occur?

A The share price will decrease immediately and will not recover.
B The share price will decrease immediately but will increase over time.
C The share price will increase immediately and will remain high.
D The share price will remain unaffected in the short term but will subsequently
increase.
[2]

8 Which of the following is the most likely result if a company provides its shareholders
with a return that is lower than the cost of equity?

A Higher dividends will be paid.

B The company will replace equity with debt.
C The cost of equity will be recalculated.
D The share price will decrease.
[2]

CB1 S2022–3
9 A quoted company wishes to apply the shareholder value approach to the evaluation
of a major project. Which of the following would be a practical way to apply that
method?

A Brief investment analysts in confidence and seek their advice.

B Publish news of the proposal and check movements in the share price.
C Seek advice from a random sample of shareholders.
D Use a range of assumptions for outcomes and variables.
[2]

10 A quoted company has recently introduced a strict policy of requiring a hurdle rate of
14% per annum on all capital projects. The company’s weighted average cost of
capital is 12%. How can the company evaluate its choice of hurdle rate in a year’s
time?

A If all proposals are rejected, then 14% is too high.

B If competing companies use 16%, then 14% is too low.
C If managers overstate the internal rate of return on proposals, then 14% is
too high.
D If the share price increases, then 14% is satisfactory.
[2]

11 Explain the advantages and disadvantages of a quoted company remunerating its

directors on a performance-related basis. [5]

12 A company has been making losses for the past three years and those losses are likely
to continue. The board has identified an opportunity to modernise production, which
will require the company to take out a large loan. If the modernisation succeeds, the
company is expected to return to profit in two years’ time.

Explain the impact of these losses on the company’s cost of debt. [5]

13 Three engineers wish to establish a new business. Their savings are sufficient to
provide 60% of the necessary funding and the remaining 40% will be raised from a
bank loan. They plan to incorporate the business as a limited company, sharing equity
equally and each with a seat on the board.

Explain why the bank would require personal guarantees from each of the engineers
before granting a loan. [5]

14 There is a rumour on the stock exchange that a quoted food manufacturer is planning
to bid to acquire a competing brand through an exchange of shares.

Describe the agency issues that such an acquisition would involve. [5]

CB1 S2022–4
15 Discuss the usefulness of a company’s cash flow statement to the shareholders. [5]

16 A quoted company reported an earnings per share figure of $0.80 in last year’s annual
report. The company’s share price has been close to $4.00 for most of the past year,
giving a price/earnings ratio of 5.0.

The directors are drafting the latest year’s financial statements. If the previous year’s
accounting policies are used, then the earnings per share will be $0.82, but a loophole
has been discovered in an International Financial Reporting Standard (IFRS) that
would enable the company to increase reported profits, raising the earnings per share
to $0.90.

The directors believe that using the accounting loophole will result in a higher share
price of 5 × $0.90 = $4.50, compared to a share price of 5 × $0.82 = $4.10 otherwise.

Discuss the merits of the directors’ assertion. [5]

17 An actuarial consultancy has been suffering cash flow problems because of slow
payments by clients. The consultancy’s terms of trade require payment within 30 days
of the invoice date, but the average payment takes 65 days. The consultancy’s credit
controller has recommended offering clients a 2% discount for prompt payment, i.e.
within 30 days.

Discuss the problems that may arise from implementing the credit controller’s
recommendation. [5]

18 A quoted company’s external auditors disagree with a material accounting treatment

that the company’s board insists on. The external auditor has warned that this
disagreement is so serious that it will be necessary to state an adverse opinion in the
audit report, in which case the auditor’s opinion will be that the financial statements
do not present fairly.

Describe the implications of this form of audit opinion for the shareholders and for the
board. [5]

CB1 S2022–5
19 The information provided below was obtained from Q’s bookkeeping records on
30 June 2022.

(i) Prepare the following financial statements for Q, in a form suitable for
publication:

 Statement of profit or loss [6]

 Statement of changes in equity [2]
 Statement of financial position. [6]

(ii) Discuss:

(a) the difficulties associated with determining the estimated useful life of
the patent rights.
(b) the implications of any error in the assumed life of 20 years.
[6]
[Total 20]

Q
Trial balance as at 30 June 2022
$000 $000
Advertising costs 2,300
Bank 450
Clerical staff salaries 4,200
Cost of goods sold 8,200
Directors’ remuneration 2,700
Dividends paid 300
Interest on long-term loans 120
Inventory 1,890
Long-term loans 1,030
Manufacturing wages 1,120
Patent rights – accumulated amortisation 356
Patent rights – cost 7,120
Property, plant and equipment – accumulated depreciation 5,144
Property, plant and equipment – cost 21,230
Retained earnings 4,950
Revenue 45,628
Sales staff salaries 8,300
Selling expenses 1,778
Share capital 5,000
Share premium 2,200
Trade payables 600
Trade receivables 5,200
64,908 64,908

The tax bill for the year has been estimated at $4,100,000.

CB1 S2022–6
 The patent rights were purchased at the start of the financial year. Q manufactures
electronics and the company paid $7,120,000 for the right to use a patented
manufacturing process for 20 years. The cost of that investment is being written off
(or amortised) on the assumption that the intangible asset will have a useful life of
20 years.

20 M is a quoted mining company that owns the rights to mine for ore in a developing
country. The company has discovered a large deposit in a remote area that is close to
a vast government-owned wildlife park. M’s directors are considering building a mine
to extract this deposit.

Opening up the ore deposit will cost $900 million and will require many thousands of
tonnes of soil and rock to be dumped nearby. If the ore is found to be of good quality
then it will be extracted by digging out a strip of land covering an area of 400 hectares
and reaching a depth of hundreds of metres.

M will build a railway link from the mine to the nearest seaport 120 kilometres away
so that it can export the ore by ship for processing into metal. The government has
given permission for the railway to pass through the wildlife park.

The total investment in the mine will be $4.5 billion, including the initial opening up
of the land, the heavy equipment that will be required and the railway line,
locomotives and wagons.

(i) Discuss the distinction between systematic and unsystematic risk and the
relevance to M’s share price of that distinction in evaluating the company’s
prospective investment in this mine. [7]

(ii) Evaluate the agency issues associated with M’s directors’ decision to proceed
with this project to extract the ore. [7]

(iii) Discuss the ethical implications of M’s decision to proceed with this mine.
[6]
[Total 20]

END OF PAPER

CB1 S2022–7