CB1 April 2024 Exam Paper-Merged

INSTITUTE AND FACULTY OF ACTUARIES
EXAMINATION
22 April 2024 (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 A2024 © Institute and Faculty of Actuaries

1 The shareholders of Company F, a quoted media company, are concerned that their
directors lack the ability to manage the company effectively. How might the capital
market support Company F’s shareholders if their concerns are valid?
A Company F’s market listing will be suspended

B Governance regulations will be enforced
C Quoted company share prices will be compared
D Rival companies will acquire Company F at a premium.
[2]
2 Company S wishes to remunerate its executive directors in a manner that aligns their
interests with those of the shareholders. Which form of remuneration will achieve that
objective?
A A generous annual salary

B A percentage of reported profit
C An annual allocation of shares
D The use of a company car.
[2]
3 An individual has served as a lending officer for K Bank for the past year. During that
time the lending officer has become increasingly concerned that K Bank is making
loans recklessly to borrowers who cannot afford to repay those loans.
Which of the following reflects the lending officer’s ethical responsibility?
A The lending officer should ask K Bank’s board to resign

B The lending officer should ignore the matter
C The lending officer should report the problem to the press
D The lending officer should resign from K Bank.
[2]
4 Which of the following explains the purpose of Double Taxation Relief (DTR)?
A DTR enables countries to receive more tax

B DTR prevents profit from being taxed twice
C DTR safeguards countries’ economic interests
D DTR simplifies the calculation of tax liabilities.
[2]
CB1 A2024–2
5 Which of the following would explain why an investor would invest in a company
that had a negative beta coefficient?
A The investor does not wish to diversify upside risk

B The investor does not wish to invest in a portfolio
C The investor wishes to limit exposure to systematic risks
D The investor wishes to pay less because of the negative beta.
[2]
6 An actuary is considering purchasing a pocket calculator costing $80. The Internal

Rate of Return (IRR) of this investment is 800%.
Which of the following statements is a logical interpretation of this IRR?
A Several calculators should be purchased

B The actuary has calculated the IRR incorrectly
C The small initial investment has driven the high IRR
D There must be multiple IRRs for this investment.
[2]
7 Company R plans to make an investment in a project with a positive Net Present

Value (NPV). Confidential briefings of investment analysts who specialise in
Company R’s industry indicate that the analysts do not believe that the project will
succeed.
How does the shareholder value approach suggest that the project will affect
Company R’s share price?
A The share price will decrease because of the analysts’ opinions

B The share price will increase because of the positive NPV
C The share price will increase because shareholders will trust Company R’s
directors
D The share price will remain unchanged because of the uncertainty.
[2]
8 Which of the following is true of opportunity costs in a project appraisal?
A Opportunity costs are irrelevant to project evaluation

B Opportunity costs arise only when capital is rationed
C Opportunity costs exist only when there are alternatives
D Opportunity costs should be reflected in project cash flows.
[2]
CB1 A2024–3
9 G plans to use their savings to open a holiday resort specialising in beach holidays in
their hometown. The business will be G’s only investment and their only significant
asset. The weather in G’s hometown can be very variable and unpredictable.
Which of the following is true of the risk faced by G because of the weather?
A G cannot mitigate the risk associated with bad weather

B G should ignore the risk because it is unsystematic
C G should not distinguish systematic and specific risks
D G should not invest in this business because it is risky.
[2]
10 Company T’s earnings per share is £3.00 and its dividends per share is £1.20.
What is the company’s dividend cover?
A 0.4
B 0.6
C 1.5
D 2.5.
[2]
11 Explain the implications of information asymmetries for sound corporate governance.

[5]
12 H is a software designer who is working on a program that has a large potential

market. H requires a large injection of funding to complete the development and fund
the marketing of their program. They are considering offering convertible loan stock
to potential investors.
Explain the advantages and disadvantages to H of issuing convertible loan stock. [5]
13 Explain the role of shadow banks. [5]
14 An airline is planning to acquire four new aircraft, financing the acquisition using a
finance lease.
Explain the advantages of leasing an asset compared to taking out a loan in order to
purchase the asset outright. [5]
15 A retailer operates as a sole trader. The retailer is considering incorporating the

business as a limited company.
Explain the advantages and disadvantages of incorporating this business. [5]
CB1 A2024–4
16 Company M, a manufacturer, intends to build a new factory in which skilled staff will
operate complex and dangerous machinery.
Recommend, with reasons, a suitable means of mitigating the risk of injury to staff
and the resulting risks to Company M. [5]
17 Explain why parent companies are required to publish consolidated financial

statements rather than focusing on the financial statements of the parent company
itself. [5]
18 Company G’s return on capital employed is significantly higher when calculated as

profit before tax divided by equity than when it is calculated as profit before tax and
interest divided by the total of equity and long-term debt.
Explain the implications of that difference for the analysis of Company G’s
performance. [5]
CB1 A2024–5
19 The information provided below was obtained from Company V’s bookkeeping
records on 31 March 2024.
Company V
Trial balance as at 31 March 2024
$000 $000
Administrative expenses 8,120
Bank 1,720
Cost of goods sold 28,800
Directors’ salaries 5,100
Dividends paid 2,000
Inventory 6,250
Loan interest 260
Loans (repayable 2030) 2,400
Property, plant and equipment – accumulated depreciation 7,000
Property, plant and equipment – cost 43,000
Retained earnings 9,250
Revenue 90,860
Selling expenses 26,100
Share capital 10,000
Share premium 14,000
Software licence – cost 6,000
Trade payables 980
Trade receivables 7,140
134,490 134,490
The software licence was purchased for $6 million on 1 April 2023. No entries have
been made in the bookkeeping records other than the purchase. The software is used
to analyse sales and to enhance Company V’s marketing activities. The useful life of
the software has been estimated at 10 years.
The tax charge on the year’s profits has been estimated at $5 million.
An error has been discovered in the inventory figure. The value according to the trial
balance has been overstated by $70,000.
(i) Prepare the following financial statements for Company V, in a form suitable
for publication:
(a) Statement of profit or loss. [6]
(b) Statement of changes in equity. [2]
(c) Statement of financial position. [7]
(ii) Explain your treatment of the information relating to the software licence. [5]
[Total 20]
CB1 A2024–6
20 Q is a quoted airline company that operates a network of intercontinental flights.
Q has 100 million shares in issue and the company has a market capitalisation of
$1.1 billion.
Q’s board plans to acquire 100% of L, a quoted hotel company. L owns hotels in
many of the countries that are served by Q’s flights. Q’s directors believe that doing
so will enable Q to offer holiday packages as well as flights and so will be more
profitable.
L has 50 million shares in issue and the company has a market capitalisation of
$0.5 billion. Q’s board plans to issue 50 million new shares and exchange one new
share for each of L’s existing shares.
Each of Q’s directors is remunerated with a salary and a percentage of Q’s annual
profit.
(i) Evaluate the planned acquisition of L as a means of creating growth

for Q. [7]
(ii) Evaluate the agency implications for Q’s shareholders of the proposal by
Q’s directors to acquire L. [7]
(iii) Discuss the possibility that L’s directors will advise L’s shareholders to
reject Q’s proposal once it has been announced. [6]
[Total 20]
END OF PAPER
CB1 A2024–7
EXAMINERS’ REPORT
CB1- Business Finance
Core Principles
April 2024
CB1 ‑ Business Finance ‑ Core Principles - April 2024 - Examiners’ report
Introduction
The Examiners’ Report is written by the Chief Examiner with the aim of helping candidates,
both those who are sitting the examination for the first time and using past papers as a
revision aid and also those who have previously failed the subject.
The Examiners are charged by Council with examining the published syllabus. The
Examiners have access to the Core Reading, which is designed to interpret the syllabus, and
will generally base questions around it but are not required to examine the content of Core
Reading specifically or exclusively.
For numerical questions the Examiners’ preferred approach to the solution is reproduced in
this report; other valid approaches are given appropriate credit. For essay-style questions,
particularly the open-ended questions in the later subjects, the report may contain more points
than the Examiners will expect from a solution that scores full marks.
For some candidates, this may be their first attempt at answering an examination using open
books and online. The Examiners expect all candidates to have a good level of knowledge
and understanding of the topics and therefore candidates should not be overly dependent on
open book materials. In our experience, candidates that spend too long researching answers
in their materials will not be successful either because of time management issues or because
they do not properly answer the questions.
Many candidates rely on past exam papers and examiner reports. Great caution must be
exercised in doing so because each exam question is unique. As with all professional
examinations, it is insufficient to repeat points of principle, formula or other text book
works. The examinations are designed to test “higher order” thinking including candidates’
ability to apply their knowledge to the facts presented in detail, synthesise and analyse their
findings, and present conclusions or advice. Successful candidates concentrate on answering
the questions asked rather than repeating their knowledge without application.
The report is written based on the legislative and regulatory context pertaining to the date that
the examination was set. Candidates should take into account the possibility that
circumstances may have changed if using these reports for revision.
Sarah Hutchinson
Chair of the Board of Examiners
June 2024
CB1 A2024
© Institute and Faculty of Actuaries
A. General comments on the aims of this subject and how it is marked
The aim of the Finance and Financial Reporting subject is to provide a basic
understanding of corporate finance including a knowledge of the instruments used by
companies to raise finance and manage financial risk, and to provide the ability to
interpret the accounts and financial statements of companies and financial institutions.
This paper examines basic finance including raising funds by a variety of methods,
taxation, basic management accounting, net present value and project appraisal and other
topics, it has both calculations and essay type questions on these topics. The paper also
examines financial reporting including preparation of the main financial statements and
interpretation of financial statements. It also considers the basis of the preparation of
statements and the information needs of a variety of end users of financial statements.
Different numerical answers may be obtained to those shown in these solutions

depending on whether figures obtained from tables or from calculators are used in the
calculations, but candidates are not penalised for this.
B. Comments on candidate performance in this diet of the examination.
Many candidates performed well in this exam. The MCQs were answered very well with
more candidates gaining high marks than the previous few diets. The short response
questions were mostly answered well, however there were obvious differences in
competency between candidates who clearly passed where an application of knowledge to
an unfamiliar scenario was required. Performance in Question 19 was very good.
Question 20 produced mixed responses. This is an area (2024 Syllabus topic 2: How
corporates are financed) where candidates’ performance is often weakest in each diet and
generally shows clear delineation of competency in this subject. Candidates should
ensure a sounds knowledge of finance and be able to apply their knowledge to scenarios.
Either question 19 or 20 will be on this area of the syllabus in every exam.
The pass mark was set at 63 due to several questions being easily answerable from the
core reading alone, along with other indicators that those scoring below this did not
demonstrate the level of competency required in this subject.
C. Pass Mark
The Pass Mark for this exam was 63.

1358 presented themselves and 893 passed.
CB1 A2024
Solutions for Subject CB1 – April 2024
Q1 D [2]
Q2 C [2]
Q3 D [2]
Q4 B [2]
Q5 C [2]
Q6 C [2]
Q7 A [2]
Q8 C [2]
Q9 C [2]
Q10 D [2]
[Total 20]
Commentary:
In general, the marks for questions 1-10 were good. The question which was most often
answered incorrectly was Q1.
Q11
Information asymmetries arise in the context of governance because directors have
access to more information than shareholders. [1]
That can mean that shareholders are less capable of supervising the actions of their
boards and of measuring their performance. [1]
For example, the annual report will give a clear indication of the company’s position
and performance, but it will not provide the shareholders with details of all of the
decisions made by management or of every misjudgement. [1]
The directors can use that asymmetry to justify keeping their jobs or being paid a higher
remuneration. [1]
The response may be that shareholders have to seek greater assurance, such as paying
for a good quality external audit to reassure them of the quality of the information with
which they have been provided. [1]
[Total 5]
Commentary:
This question was answered well by many candidates.
CB1 A2024
Q12
H may find it relatively easy to secure investment using convertible loan stock because
they will give buyers the reassurance associated with debt during the bond phase, along
with the potential for capital gain if the stock is worth converting.
[1]
That makes the loan stock less expensive than traditional debt and so reduces the burden
of that debt while the business is developing its new product. [1]
It may also be unnecessary for H to raise cash to repay the loan stock if the holders
decide to exercise their right to convert and so receive equity instead. [1]
The disadvantage of convertibles is that H may dilute their ownership of the company
if the company prospers. [1]
If the company grows and prospers then loan stock holders will be able to obtain shares
at a discount to their potential value. There could be a significant opportunity cost to H
and to any other potential shareholders [1]
[Total 5]
Commentary:
This question was well answered. The core reading was used by many candidates to answer
this question. It is very important that candidates reference the core reading at the end of their
answer.
Q13
Shadow banks create liquidity for lending by taking out short-term borrowings and
making long-term loans. [1]
Doing so enables borrowers to access funds that would otherwise be unavailable for the
durations that they require for their funding needs. [1]
That also creates opportunities for institutions that are holding short-term cash balances
to lend those out and so generate interest that would otherwise be unavailable. [1]
The ability of shadow banks to operate is constrained by the fact that they are not
regulated in the same manner as banks. [1]
That can enable them to offer better terms and conditions than traditional banks, but
there may be a higher risk associated with doing business with them. [1]
[Total 5]
Commentary:
This question was answered very well by most candidates. This was a knowledge question and
most answers were mainly taken from the core reading. It is important that candidates
reference answers that are taken directly from the core reading.
CB1 A2024
Q14
Finance leases differ from traditional lending because the lessor provides the lessee with
the use of the asset rather than the means to buy the asset outright. [1]
The lessor retains ownership of the asset, which reduces the risk associated with default
on the lease. If the lessee does not pay then the lessor can repossess the asset. [1]
It is reasonable to expect that airliners will have a ready market in the event that the
lessor is forced to take them back and so there should be a reasonably low risk of loss. [1]
That protection will reduce the risk to the lessor and will, hopefully, reduce the cost of
the finance in the process. [1]
The fact that the asset itself will form the security for the arrangement will also mean
that the airline will not be required to pledge any of its other assets as security. [1]
[Total 5]
Commentary:
This question was answered reasonably well by many candidates however fewer candidates
scored full marks than in other questions.
Many candidates attempted to discuss the treatment of the lease in the financial statements
and marks were awarded for this if the answer was correct.
Candidates were unsure about the ownership of the asset.
Q15
The biggest advantage is that the retailer will be protected in the event that the business
fails while leaving unpaid debt. [1]
Creditors will be able to claim the company’s assets, but will have no right to claim those
of the retailer. [1]
There is a disadvantage to incorporating in that potential lenders and creditors will be
aware of the risk of default and may take steps to protect themselves. [1]
The company may be required to enter into onerous contracts, such as debt covenants,
which could complicate future funding activities. [1]
Alternatively, they may demand personal guarantees from the retailer agreeing to be
liable in the case that the company defaults. That could remove the benefit of becoming
a limited company. [1]
[Total 5]
Commentary:
Candidates generally scored well on this question. Many candidates were able to make good
suggestions of the benefits of becoming a limited company.
CB1 A2024
Q16
The most logical means of addressing this risk would be to establish safeguards and
procedures that will enable staff to operate the equipment safely. [1]
Staff should then be trained and monitored to ensure that they are operating the
machinery in accordance with those procedures. [1]
This approach to mitigation would reduce the likelihood of accidents occurring because
operators would be required to take greater care. [1]
It would also reduce the risk of successful legal action because Company M would be
able to demonstrate that it had taken precautions to avoid accidents. [1]
Finally, from both an ethical and reputational perspective, Company M could claim
that it had behaved responsibly, with a view to protecting staff from harm. [1]
[Total 5]
Commentary:
Most candidates made good suggestions of how risk could be mitigated. This question scored
high marks with many achieving full marks.
Q17
The parent company’s financial statements reflect only those transactions and balances
that the parent was directly associated with. [1]
It is possible that the parent will have no direct involvement with group trading
activities and so the financial statements might show little more than investments in
subsidiaries and dividend receipts and payments. [1]
The consolidated financial statements would reflect the group as an economic and
trading entity, which would be far more helpful to the shareholders. [1]
Group accounts show totals for revenues and expenses and reflect the group profit,
adjusted to eliminate intercompany transactions. [1]
The consolidated statement of financial position enables shareholders to understand
the manner in which their equity has been invested. [1]
[Total 5]
Commentary:
This question was answered well by many candidates, but candidates who struggled with the
question tended to score very poorly.
CB1 A2024
Q18
The two formulae calculate both return and capital employed differently. The first
shows profit before tax divided by equity and the second profit before tax and interest
divided by total long-term finance. [1]
One would normally expect the return on equity to be higher than the return paid to
lenders as interest because lenders are taking much less risk. [1]
The fact that there is a significant difference between the results of the two ratios
suggests that the company is highly geared. [1]
The high gearing will be desirable to the shareholders as long as the company remains
profitable. The fact that the return paid to lenders is fixed means that the shareholders
do not have to share any increase in profit with them. [1]
There is, however, a problem in that the shareholders’ return will be far more volatile
in relation to changes in earnings before interest and tax. Any decrease in that figure
will result in a much poorer return to the shareholders because interest will still have
to be paid. [1]
[Total 5]
Commentary:
Performance in this question was weaker than most other questions.
Many candidates did not discuss gearing or debt which was the main point of the question.
V
Statement of Profit or Loss
for the year ended 31 March 2024
$000
Revenue 90,860 [½]
Cost of Sales (28,870)
Gross profit 61,990
Distribution Costs (26,700)
Administrative Expenses (13,220)
Operating profit 22,070
Finance costs (260) [½]
Profit before tax 21,810
Income Tax Expense (5,000) [½]
Profit for the year 16,810
FORMAT [1]
CB1 A2024
V
Statement of Changes in Equity for
the year ended 31 March 2024
Share Share Retained
capital premium Earnings Total
£000 £000 £000 £000
Opening balance 10,000 14,000 9,250 33,250 [½]
Profit for the year 16,810 16,810 [½]
Dividends (2,000) (2,000) [½]
Closing balance 10,000 14,000 24,060 48,060
FORMAT [½]
V
Statement of Financial Position
as at 31 March 2024
Notes £000
Non-current assets
Property, plant and
equipment [1] 36,000
Intangible assets [2] 5,400
41,400
Current Assets
Inventory 6,180
Trade receivables 7,140 [½]
Bank 1,720 [½]
15,040
Total assets 56,440
EQUITY AND
LIABILITIES
Equity
Called-up share capital 10,000
Share premium account 14,000
Total equity 48,060
Non-current liabilities
Loans (repayable 2030) 2,400 [½]
CB1 A2024
Current liabilities
Trade payables 980 [½]
Tax 5,000 [½]
5,980
Total of equity and liabilities 56,440

FORMAT [1]
Notes
1. Property, plant and equipment

£000
Cost 43,000 [½]
Depreciation (7,000) [½]
36,000
2. Intangible assets
Cost 6,000 [½]
Amortisation (600) [½]
5,400
Workings
Cost of sales
Before adjustment 28,800 [½]
Inventory correction 70 [½]
28,870
Inventory
Before adjustment 6,250 [½]
Inventory correction (70) [1]
6,180
Distribution
Selling expenses 26,100 [½]
Amortisation of software 600 [1]
26,700
Administrative expenses
Expenses 8,120 [½]
Directors' salaries 5,100 [½]
13,220
[Total 15]
CB1 A2024
(ii)
The licence will provide service to V for ten years, so it is necessary to account for it
as a non-current asset. [1]
The licence is a legal right, which means that it will be accounted for as an intangible
asset. [1]
The licence has been used for one year of its ten year life, which suggests that
amortisation of £600,000 should be charged as an expense. [1]
That is consistent with the accruals concept, charging expenses in the year in which
they are incurred. [1]
The amortisation reduces the book value of the licence to £5.4 million, which is
consistent with the cost and going concern concepts. [1]
[Total 5]
[Total 20]
Commentary:
Performance in Question 19 was very good. Most candidates achieved a high mark in this
question. Quite a number of candidates scored full marks for this question which was
excellent.
CB1 A2024
Q20
(i)
Q will effectively be diversifying by adding holidays to the provision of flights. As
such, there will be some industrial logic to this expansion. [1]
There is the potential for synergy between the provision of flights and accommodation
in foreign locations. [1]
Customers may find it attractive to be able to book a package holiday with a single
company, simplifying bookings and potentially obtaining a lower price for a package
compared to making separate arrangements for flights and hotels. [1]
Q will have to consider whether its existing flight network would be suitable for
supporting package holidays, otherwise the scope for synergy may be lost. [1]
Package holidays often involve short to medium distance travel, so there may be
limited demand for package holidays designed round a network of intercontinental
flights. [1]
Q’s destinations might be better suited to business travel than vacation travel. In that
case, L might not be able to offer a sufficiently wide range of different hotels to meet
the needs of business travellers. [1]
If there is no synergy then there will be no particular advantage in Q’s acquisition of L
and so shareholder wealth may be impaired. [1]
[Total 7]
(ii)
There could be a conflict of interest here because Q’s directors are more likely to
benefit from the acquisition of L than Q’s shareholders. [1]
The acquisition of a profitable company will increase the Q group’s profits, which will
increase directors’ bonuses. [1]
Q’s directors are almost guaranteed to benefit from higher remuneration if this
acquisition takes place. [1]
There is no guarantee that this will be a positive NPV investment for Q and the
acquisition may even have a negative NPV if too much is paid for L. [1]
Q’s directors will also continue to receive their salaries and may even be able to justify
an increase in those on the grounds that the Q Group has grown because of this
acquisition. [1]
Any problems associated with the acquisition may take some time to emerge, which
means that Q’s directors are likely to benefit from the acquisition before their
shareholders become aware of any problems. [1]
There is very little downside risk to Q’s directors if they proceed with this acquisition,
while there is a significant downside risk to the shareholders. [1]
[Total 7]
CB1 A2024
(iii)
L’s directors may be unwilling to support this acquisition because they will no longer
be directors of an autonomous quoted company. [1]
At best, they will be required to report to Q’s Board on any strategic decisions that
have to be taken. [1]
At worst, Q’s directors may decide to replace L’s board in order to ensure that they
have greater control over their new acquisition. [1]
L’s shareholders are likely to benefit from the proposed acquisition. Their shares have
a market value of $10.00 each. The combined value of the company will be $1.6 billion [1]
and there will be 150 million shares, making each worth $10.66.
In the short term, L’s shareholders could accept this offer and sell their shares in Q to
yield a guaranteed profit. [1]
It is rarely advisable to reject an offer to acquire a company because the bidders are
usually required to pay a premium over the existing share price. [1]
[Total 6]
[Total 20]
Commentary:
This question was answered poorly by many candidates. The topic (2. How corporates are
financed: 2024 Syllabus) is usually assessed at a higher order thinking level and candidates
often fail to provide the required depth of analysis and critical thinking in their answers.
Part (i) was on the whole answered well with many candidates discussing synergies.
Part (ii) was attempted reasonably well by some who answered with some very good points.
However most candidates had difficulty explaining any agency implications.
Part (iii) was not answered well with few candidates able to explain reasons why
shareholders might be asked to reject the proposal by the directors.
[Paper Total 100]
END OF EXAMINERS’ REPORT
CB1 A2024
www.actuaries.org.uk
© 2021 Institute and Faculty of Actuaries
EXAMINATION
21 September 2023 (am)

Core Principles
T. 0044 (0) 1865 268 873.
CB1 S2023 © Institute and Faculty of Actuaries

1 A project has an internal rate of return (IRR) of 18%. The required rate of return is
12%. Which of the following statements is correct?
A The IRR criterion yields an absolute measure of project performance.

B The project has a negative net present value (NPV).
C The project’s acceptance will increase shareholder wealth.
D The project’s NPV is required before making any decision.
[2]
2 A limited liability partnership (LLP) is facing bankruptcy because its managing

partner had recklessly taken a loan to invest in a new IT system for the LLP. The LLP
is now struggling to service this loan. The LLP has three other partners who work in
client-facing roles and take no active part in the LLP’s management. Which of the
following statements is correct?
A Creditors have no further rights once the LLP’s assets have been exhausted.
B Only the lender who financed the IT system can claim partners’ personal
assets.
C The four partners are jointly and severally liable for the LLP’s debts.
D The LLP’s creditors have a strong claim against the managing partner’s
personal assets.
[2]
3 Company D, based in Country H, paid taxes in Country L of $2 million on the

$10 million that it earned from its activities in that country. Company D pays tax of
15% in Country H.
What is the maximum offset that Company D can claim in respect of double taxation
relief on taxes incurred in Country L?
A nil
B $0.5 million
C $1.5 million
D $2 million.
[2]
4 Simon has designed a new type of kettle that will enable buyers to boil water very
quickly, using very little energy in the process. The kettle will retail for $25. The
design work has been completed. Simon requires $100,000 to finance the manufacture
of an initial batch of 10,000 kettles.
Which of the following would be the most suitable means of raising this finance?
A Donation-based crowdfunding
B Investment-based crowdfunding
C Loan-based crowdfunding
D Pre-payment crowdfunding.
[2]
CB1 S2023–2
5 An airline requires the use of an aircraft for the next 3 years. The aircraft’s purchase
price is $60 million. H Bank has agreed to lease the aircraft to the airline for 3 years.
The airline will have exclusive use of the aircraft for 3 years, after which it will be
returned to H Bank. The lease payments have a present value of $20 million.
What type of finance is the airline using?
A Bank loan
B Credit sale
C Finance lease
D Operating lease.
[2]
6 A company’s authorised share capital is 500,000,000 $1 shares, of which 300,000,000

have been issued at a premium of $0.10 per share. The issued shares are $0.45 paid.
If the company should fail, what is the maximum amount that the company’s lenders
could claim directly from its shareholders?
A nil
B $165 million
C $195 million
D $275 million.
[2]
7 Company V is a quoted jewellery retailer. The company is evaluating an opportunity

to invest in the manufacture and sale of luxury clothes that will carry the Company V
brand name and logo. Which of the following beta coefficients would be the most
appropriate basis to determine the required rate of return on this investment?
A Company V’s beta coefficient.

B The average beta coefficient for all quoted companies in Company V’s home
country.
C The average beta coefficient for luxury retailers.
D The beta coefficient of Company B, a luxury clothing retailer.
[2]
8 Company E’s ungeared beta is 1.2. The company’s debt is $4 million, and equity is
$8 million. The tax rate is 20%. What is Company E’s geared beta?
A 1.35
B 1.5
C 1.65
D 1.8.
[2]
CB1 S2023–3
9 A parent company has a 100% owned subsidiary and a 90% owned subsidiary. The
three companies have property, plant and equipment with book values of $100, $250
and $300 respectively. What value will be attributed to property, plant and equipment
in the consolidated financial statements?
A $100
B $350
C $620
D $650.
[2]
10 A company has revalued its non-current assets during the year. Where will the gain on
revaluation appear in the company’s financial statements?
A Statement of changes in equity, statement of comprehensive income and

statement of financial position.
B Statement of changes in equity, statement of financial position and statement
of profit or loss.
C Statement of changes in equity, statement of comprehensive income and
statement of profit or loss.
D Statement of comprehensive income, statement of financial position and
statement of profit or loss.
[2]
11 Discuss why the nature of the business undertaken by insurance companies can
complicate the reporting of profit in their financial statements. [5]
12 F is a holiday company that owns hotels in various holiday locations and uses its own
aircraft to operate flights to and from those locations. F has won several prestigious
awards for the high quality of its sustainability reporting.
Explain how F may benefit from the voluntary disclosure of its environmental impact.
[5]
13 Company Z is a quoted company that saw its share price fall after the announcement
of each of the last two major investment projects. As a result, Company Z’s directors
are considering adopting the shareholder value approach to evaluating future projects.
Explain the potential advantages of the shareholder value approach to Company Z.

[5]
CB1 S2023–4
14 Company C is a leisure company that owns and operates three theme parks in its
home country. The parks are labour-intensive and cost a great deal to operate. Many
of the parks’ visitors are tourists from Country R, although the numbers visiting are
affected by exchange rates. Country R’s currency is volatile and when the currency is
weak it is more expensive to travel abroad. Therefore Company C’s Board is
considering developing a theme park in Country R.
Describe the approach that Company C’s Board could take to applying Monte Carlo
simulation to the evaluation of the construction of a theme park in Country R. [5]
15 An actuarial consulting firm, X, wishes to expand rapidly and is considering the

acquisition of a slightly smaller actuarial consulting firm, Y, in order to do so.
Explain the issues that should be considered with respect to the target firm before
proceeding with the acquisition. [5]
16 Explain the purpose of the Stock Exchange rule that requires companies to offer new
shares to existing shareholders. [5]
17 Company W is a quoted company. Company W’s Board has offered shareholders a

scrip dividend as an alternative to a cash dividend.
Explain how Company W’s shareholders should decide whether to accept the scrip as
an alternative to cash. [5]
18 Company Y wishes to build a windfarm in a location that is ideally suited to the

generation of electricity using wind power. The proposed development will generate a
substantial positive NPV. Unfortunately, the windfarm will also interfere with the
migration patterns of birds including some rare species.
Describe the ethical implications of proceeding with this development. [5]
CB1 S2023–5
19 The following information has been extracted from Q’s financial statements as
published during the last 6 years to 31 March:
Average for
2018 2019 2020 2021 2022 2023
2018–2023
($000) ($000) ($000) ($000) ($000) ($000) ($000)
Profit/(loss) for the year 1,900 1,600 1,300 (200) (400) (900) 550
Equity 15,480 16,760 17,800 17,600 17,200 16,300 16,857
Loans 6,000 8,000 8,000 11,000 11,000 12,000 9,333
Interest (included in
calculation of profit for the 840 1,120 1,120 1,540 1,540 1,680 1,307
year)
% % % % %
Return on equity 12.3 9.5 7.3 (1.1) (2.3)
Return on capital employed 12.8 11.0 9.4 4.7 4.0
Gearing 27.9 32.3 31.0 38.5 39.0
(i) Calculate Q’s return on equity, return on capital employed, and gearing for:
 2023
 average for 2018 to 2023.
[6]
(ii) Evaluate Q’s performance over the period from 2018 to 2023 and explain how
this pattern of results may have arisen. [10]
(iii) Explain why Q’s pattern of performance makes it important for the directors to
keep the company’s gearing ratio under review. [4]
[Total 20]
CB1 S2023–6
20 Company K is a quoted chemical manufacturing company that complies with the UK
Corporate Governance Code. Company K has four executive directors: the Chief
Executive, the Finance Director, the Marketing Director and the Production Director.
The executive directors have a collective responsibility for Company K’s strategic
management.
The executive directors are remunerated by a combination of salaries, profit-related

bonuses and shares in Company K.
Company K also has four non-executive directors: the Chair and three independent
non-executives. The Chair convenes Board meetings and the other three participate in
all Board meetings. The non-executives have a collective responsibility for oversight
of all governance matters including liaison between the Board and external auditors,
and setting the executive directors’ remuneration including deciding on salaries,
bonuses and share allocations.
Company K’s non-executive directors have all previously held senior positions in
business or government. They are paid fixed salaries for their participation on
Company K’s Board, with no adjustments for the company’s performance.
(i) Discuss the agency implications of having Company K’s Board comprise
equal numbers of executive and non-executive directors. [7]
(ii) Evaluate the difficulties associated with setting remuneration for executive
directors in a manner that supports Company K’s strategy and promotes its
long-term success. [7]
(iii) Discuss the implications for the independence of the external audit of having
liaison meetings between Company K’s non-executive directors and the
auditor. [6]
[Total 20]
END OF PAPER
CB1 S2023–7
EXAMINERS’ REPORT
CB1 - Business Finance
Core Principles
September 2023
CB1 - Business Finance - Core Principles - September 2023 - Examiners’ report
Introduction
Sarah Hutchinson
November 2023

understanding of corporate finance, including a knowledge of the instruments used by
companies to raise finance and manage financial risk and to provide the ability to
topics. It has both calculations and essay type questions on these topics. The paper also
examines financial reporting, including preparation of the main financial statements and

calculations, but candidates are not penalised for this.
Many candidates performed well in this exam. The MCQs were answered reasonably well
and many candidates scored high marks.
The short response questions were also generally well answered. Usually where
application was required, candidates did not perform well. Performance in some of the
short response questions in this diet was excellent. Performance in Questions 19 and 20
was rather mixed, where well prepared candidates provided very good answers.
Candidates’ performance was slightly lower in the area of finance. Candidates should
ensure a sound knowledge of finance and be able to apply their knowledge to scenarios.
Either Question 19 or 20 will be on this area of the syllabus in every exam.
C. Pass Mark


Solutions for Subject CB1 - September 2023
Q1 C [2]
Q2 D [2]
Q3 C [2]
Q4 D [2]
Q5 D [2]
Q6 B [2]
Q7 D [2]
Q8 C [2]
Q9 D [2]
Q10 A [2]
Q3 workings
C - correct - the lower of the charges that would be applied by both countries.
15% x $10m = $1.5m.
A – nil
B - the higher of the two rates. 20% x $10m = $2.0m.
D - the difference between the two rates. $2.0m - 1.5m = $0.5m.
Q6 workings
B - correct - The premium will be paid at the time of issue.
The shareholders will be liable up to the unpaid amount remaining on the issued shares.
300m x $0.55 = $165m.
A – nil
C - includes share premium. 300m x $0.65 = $195m.
D - uses authorised share capital. 500m x $0.55 = $275m.
Q8 workings
C - correct - 1.2*(1+4/8*.75) = 1.65
A - wrong adjustment for tax - 1.2*(1+4/8*.25)
B - wrong gearing - 1.2*(1+4/12*.75) = 1.5
D - no adjustment for tax - 1.2*(1+4/8)
Q9 workings
D - correct. $100 + 250 + 300 = $650
A - Parent only
B - Parent + 100% sub
C - Parent + 100% sub + (90% x 300) = $620
Many candidates scored well in Questions 1 to 10.
There was an error in Question 8 as the wrong tax rate was used in the calculation.
All candidates were awarded 2 marks for the question even if candidates selected the
incorrect answer or did not attempt the question.

Q11
Insurance companies enter into contracts that create potential liabilities that are
difficult to predict, in terms of size and timing [1]
That creates a need for provisions in the financial statements that must be based on
estimates of likely future outcomes [1]
Those estimates may have a significant impact on the reported earnings and on the
net assets reported in the statement of financial position [1]
Particular care must be taken in reporting insurance company profits because
shareholders may expect dividends to reflect reported earnings [1]
It may be necessary to take a conservative approach to reporting liabilities and
Profits in order to discourage the overpayment of dividends that could subsequently
Leave insurers unable to meet the commitments to policyholders. [1]
This question was answered well by many candidates. Only better prepared
candidates mentioned dividends.
Q12
Holiday companies may suffer reputational damage because of concerns that the
holiday industry is damaging to the environment. Voluntary disclosures may enable
some companies to reassure potential customers [1]
Companies that use more efficient aircraft or accommodation may be able to argue
that they are less damaging than competitors and so may win business [1]
It is also possible that voluntary disclosures will enable holiday companies to
respond to critics who claim that their actions are unsustainable. The information
that is released will, hopefully, demonstrate that critics are presenting an exaggerated
message [1]
Voluntary disclosures may also benefit stakeholders and interested parties such as
governments [1]
Some economies rely heavily on tourism and so politicians will be concerned that
protests will disrupt the operation of the local holiday industry. Voluntary
disclosures may equip politicians to support holiday companies. [1]
This question was generally well answered by candidates. Only well prepared
candidates discussed voluntary disclosures in detail.
Q13
The behaviour of the share price suggests that the capital markets may not have a
great deal of confidence in the Board’s ability to identify suitable projects for Z [1]
Shareholder value would encourage the directors to consider proposals from the
shareholders point of view as well as from a strictly technical analysis of the

projected cash flows from investments [1]

The directors might then be better equipped to announce major projects in a manner
that will seem favourable to the shareholders, taking account of the information
that is available to the capital markets [1]
It may be that the share price has fallen after recent announcements because the
directors have been unable to share details of the expected outcomes of investments
with the markets [1]
In some cases, directors will hold analyst briefings that are intended to reduce the
risk of a negative reaction due to a misunderstanding on the market’s part,
Particularly if key information has been withheld from the market because of the
need for commercial secrecy [1]
In time, the directors will develop a better understanding of the market’s reaction to
new projects and the manner in which shareholders evaluate projects on the basis of
the limited information that is provided [1]
That might avoid the stresses and distractions associated with declining share prices
implying that the directors have invested in negative NPV projects [1]
[Marks available 7, maximum 5]
This question was not very well answered by many candidates. Only well-prepared
candidates knew what the shareholder value approach is. Many candidates just
discussed NPV and said it was a more advanced approach. More detail and depth
were required to gain a high mark.
Q14
The starting point would be to develop a detailed model of the performance of the
proposed theme park, taking full account of the economic impact of the strength and
weakness of Country R’s currency [1]
Movements in currency can have an impact on local living costs and so they might
affect customers’ ability to spend money on holidays [1]
The model should then be loaded with a realistic set of data concerning the variables
that might affect performance, including expected exchange rates and the likely
visitor numbers under different economic conditions [1]
The data should be credible and, ideally, obtained from independent experts [1]
The model should allow for the possible loss of revenue in the home country [1]
Finally, the model should be run many times, randomising the inputs from the data
sets of independent variables and the likely responses of dependent variables based
On those inputs [1]
The result should provide the Board with a realistic distribution of the expected
returns from this investment. [1]
This question was answered well by most candidates. Candidates generally gave good
clear descriptions of what was entailed in carrying out Monte Carlo simulations.

Q15
The Board should consider whether there would be exploitable synergies between
The two companies. Synergies could include adding new skills and expertise to the
bidding company, which would create the possibility of additional clients [1]
If the target would add little to the group then the bidding company might be better to
aim for organic growth through the recruitment of additional staff [1]
The cultures of the two companies will have to be compared. The acquisition could
fail if the companies are not found to be compatible [1]
Ideally, the actuaries working for the target company will have very similar attitudes
and will be willing to work alongside their new colleagues as part of a larger group [1]
If staff will feel unhappy or insecure then they might resign and leave the bidder for
relatively little to show for its investment [1]
This question was not answered particularly well. Only well prepared candidates
discussed the different cultures of the companies or the attitudes of management and
staff of both companies. Synergy was discussed well.
Q16
Giving shareholders the right to participate in any issue protects them against the loss
that might be incurred if their company issues new shares at a discount [1]
The company could benefit from an injection of equity, but the existing shareholders
might still be left worse off because of the need to offer new shares at a discount to
the existing market price. There would be no point in paying more than the current
market price for new shares [1]
Allowing shareholders to participate if they wish protects them from dysfunctional
behaviour by the directors, who might expend at the expanse of the existing
shareholders [1]
Some shareholders may be wary of losing influence over companies that they have
invested in [1]
A shareholder with, say a 20% stake may be unwilling to see that percentage decrease
because of a new issue, unless it is possible to participate in the issue and retain the
same overall level of ownership [1]
This question was answered well by most of the candidates. The majority of
candidates understood what a rights issue is and could discuss the problems
reasonably well.
Q17

The shareholders should regard this as a choice between dividend income and making
an additional investment in the company. Clearly, if they need the income for personal
consumption then the scrip would not be suitable for them [1]
There could be cash flow issues because the shareholder will be required to pay
income tax on the value of the shares received, but will have no cash income from
which to fund the tax payment [1]
The scrip would also be unsuitable if their investment portfolio would be thrown out
of balance, with too large a proportion of funds in a single investment [1]
The pricing implied by the terms of the scrip dividend is worth considering.
The share price implied by the offer may be lower than the open market price and so
the scrip may offer a good value investment [1]
The scrip dividend may also offer an opportunity to acquire additional shares without
paying significant transaction costs, which would benefit shareholders who planned to
increase their investments [1]
This question was generally well answered by many candidates. Only well-prepared
candidates were clear about whether shareholders would be keen to accept a scrip
dividend.
Q18
Some might argue that company Y has a duty to maximise its shareholders’ wealth.
The company will be in breach of that duty if the directors do not take the opportunity
to make this investment [1]
It could be argued that the responsibility to protect wildlife habitats and migration
routes is a matter for government and that the absence of legislation to the contrary
means that Company Y is free to build its windfarm [1]
If the proposal is rejected on the basis of conscience, then the shareholders may argue
that the directors are acting in accordance with their personal beliefs, at a significant
cost to the shareholders [1]
The nature of the project creates further ethical considerations. The windfarm will,
presumably, reduce the need for traditional power generation and so will create a net
reduction in emissions [1]
There is an ethical dilemma associated with balancing the needs to protect wildlife
against society’s needs for safe and clean electricity. The evaluation of that dilemma
may depend, in part, on the extent of the harm that will be inflicted on migrating
Birds and the risk of extinction of rare species [1]
This question was not answered as well as some others. Only well-prepared
candidates thought there was an ethical issue and discussed this issue from all sides
and gave a balanced answer.

Q19
(i)
2023 Average
Working for 2018 Working
to 2023
% %
Return
on (5.5) (900)/16,300 3.3 550/16,857
Equity
ROCE 2.8 ((900)+1,680)/(16,300+12,000) 7.1 (550+1,307)/(16,857+9,333)
Gearing 42.4 12,000/(12,000+16,300) 35.6 9,333/(9,333+16,857)
(1 Mark for each ratio)
[6]
(ii)
The biggest concern is that Q’s profit has declined significantly, year by year, since
2018, with losses being reported in the past three years. That pattern is unsustainable
in the medium term because shareholder wealth is being eroded [1]
The only positive indication is that the company is still reporting a positive ROCE,
which suggests that it is generating operating profits [1]
Q’s borrowings have doubled over the past six years, with additional loans being
Taken out in 2019, 2021 and 2023 [1]
That raises concerns about the reasons for taking out those loans. It would be a
concern if the company was borrowing in order to maintain a positive cash flow
because it cannot sustain itself on the basis of its operations [1]
There is the related concern that operating profits cannot cover the cost of Q’s debt
and so the additional borrowing is a major contributor to the loss [1]
This pattern of results could be due to the nature of Q’s products and the markets that
it operates in. Q made good profits for the first three years of this period, admittedly
with a decline in return on equity and ROCE [1]
That was followed by a sudden slide from profit into loss. It may be that Q
manufactures products that have a limited lifecycle [1]
Profits could be declining because of declining demand for Q’s existing product range.
The significant decrease in 2021 could be due to need to spend heavily on the
development of new products [1]
That would be consistent with the decision to borrow $3m in 2021 and a further $1m
in 2023. The additional debt could be required to finance development activities [1]
The fact that lenders are prepared to make these loans despite the poor performance
and increasing gearing suggests that Q has a clear and credible plan that enables it to
offer lenders a realistic assurance that they will be repaid [1]
(iii)
It is clear from the figures that highly geared companies have greater volatility in the
returns that they can offer to their shareholders because of the impact of the fixed cost
of borrowing on the profit attributable to the shareholders [1]
Q’s operating profit has declined across the six years, but the rate of decline is not
nearly as marked as the decline in profit for the year [1]

Q’s gearing will also give the company an insight into its ability to maintain existing
loans. The declining equity and increasing borrowing could leave the company faced
with foreclosure if it is in breach of loan covenants [1]
Q will also have to consider whether its high gearing could make it difficult to raise
further loan capital in the event that the company runs into cash flow problems and
needs to borrow [1]
[Total 20]
Part (i) was answered very well by most candidates.
Part (ii) was also answered well with many candidates achieving full marks in this
part.
Part (iii) was also answered well but not as well as part (ii). Some candidates had
already discussed gearing on part (ii) and been awarded marks for those comments.
Q20 (i)
The relationship between non-executives and the shareholders is less open to agency
problems than the relationship with executive directors. Non-executives are usually
paid a fixed salary, which reduces the potential incentive to manipulate reported profit
or share prices [1]
The creates less of an incentive to manipulate reported profits and share prices
because the rewards available to non-executives will not be affected by any
misbehaviour [1]
The non-executives have established significant reputations from their earlier careers.
It appears that they have more to lose from reputational damage than their executive
counterparts [1]
The non-executives are less likely to tolerate any concerns about the governance
issues arising at K because they could risk being discredited, with no upside risk to
compensate [1]
Having equal numbers will give the non-executives the ability to support one another
in the event of any dispute with the executives [1]
It will be more difficult to coerce all four non-executives into tolerating misbehaviour
that leads to agency problems [1]
The parity of numbers will also increase the likelihood that non-executives will resign
in the event that they agree that there is an unacceptable situation that the executive
directors refuse to resolve [1]
(ii)
The key to a successful remuneration system is that it will align the interests of the
executive directors with those of the shareholders. Ideally, the system will reward
the directors for any decisions that will increase shareholder wealth [1]
It can, however, be difficult to isolate the contribution of individual directors towards
the company’s overall success. There could be a free-rider problem if rewards are
granted to the Board as a whole [1]
There may also be a time lag between a decision and the associated benefit to the
shareholders to manifest itself. For example, it may take years for a new strategy to

increase the share price and directors may be concerned that they could leave before
their contributions are recognised [1]
Remuneration schemes could encourage dysfunctional behaviour and misreporting
of performance in order to enhance payments from profit-related rewards [1]
For example, bonus payments that are linked to profits could be increased by
overstating profits through creative accounting [1]
Directors may be discouraged by remuneration schemes that have the effect of
penalising them for costs and losses that could not have been foreseen [1]
For example, a profit-related bonus might decrease because of an unexpected change
in legislation that requires a product to be withdrawn and compensation paid to
consumers [1]
(iii)
The most likely point of contact between the auditor and the executive directors will
be through the Finance Director, who is in overall charge of preparing the financial
statements [1]
The Finance Director may be under pressure to manipulate the impression created by
the financial statements in order to avoid disappointing fellow Board members and in
order to keep the shareholders happy [1]
The Finance Director may be able to put the external auditor under pressure by
threatening to have the Board seek a replacement firm and by threatening to discredit
the auditor’s reputation in the event of any public debate about the financial
statements [1]
Meeting with non-executives will give the audit partner an alternative means of
communicating with the Board. Non-executives have a greater incentive to reject
any misleading or creative accounting schemes [1]
If the auditor persuades the non-executives that the financial statements are
misleading, then the non-executives may report those concerns to the whole Board [1]
In an extreme case, the non-executives might threaten to resign rather than be
implicated in an accounting scandal, thereby providing the auditor with the ability to
ensure that the financial statements present fairly [1]
[Total 20]
Part (i) was answered well, as most candidates could discuss why equal numbers of
executive and non-executive directors is important. They were aware it was a
corporate governance issue and important for decision making.
Part (ii) was answered quite well by many candidates, again candidates were aware
of the importance of setting directors’ remuneration and how it affected the
shareholders.
Part (iii) was not answered as well as the previous two parts. Only well-prepared
candidates knew the auditors and the non- executive directors could liase. Many said
this was unfair and unreasonable which is incorrect.
[Paper Total 100]


Beijing
14F China World Office 1 · 1 Jianwai Avenue · Beijing · China 100004
Tel: +86 (10) 6535 0248
Edinburgh
Level 2 · Exchange Crescent · 7 Conference Square · Edinburgh · EH3 8RA
Tel: +44 (0) 131 240 1300
Hong Kong
1803 Tower One · Lippo Centre · 89 Queensway · Hong Kong
Tel: +852 2147 9418
London (registered office)

7th Floor · Holborn Gate · 326-330 High Holborn · London · WC1V 7PP
Tel: +44 (0) 20 7632 2100
Oxford
1st Floor · Belsyre Court · 57 Woodstock Road · Oxford · OX2 6HJ
Tel: +44 (0) 1865 268 200
Singapore
5 Shenton Way · UIC Building · #10-01 · Singapore 068808
Tel: +65 8778 1784
EXAMINATION
20 April 2023 (am)

Core Principles
T. 0044 (0) 1865 268 873.

1 Which of the following explains why companies have systems of internal control?
A External auditors recommend controls.

B Internal controls prevent board fraud.
C Staff might make errors or commit fraud.
D Stock exchange rules require controls.
[2]
2 In what sense does the stock market serve as a performance monitor of a quoted
company?
A A stock market quotation requires compliance with rules.

B Economic variables can have an impact on share prices.
C The share price responds to management decisions.
D The stock market requires detailed financial statements.
[2]
3 Who should be responsible for the recruitment and appointment of a replacement if a

quoted company’s finance director resigns?
A a committee of executive directors

B a committee of non-executive directors
C the chief executive officer
D the non-executive chair
[2]
4 A quoted company has appointed the same individual to serve as both chief executive
officer and chair. Why is such an appointment often regarded as undesirable?
A No one will be in charge of the board.

B One person will have too much power.
C The individual will be paid too much.
D There will be insufficient illness cover.
[2]
5 Peer-to-peer lending enables individuals to make loans through a peer-to-peer lending

platform.
How are lenders’ advances protected against default?
A Lenders can take legal action in the event of default.

B Lenders’ investments are spread across multiple loans.
C Peer-to-peer platforms guarantee against default.
D Peer-to-peer platforms require security from borrowers.
[2]
CB1 A2023–2
6 Which of the following explains why tax law often makes a taxpayer’s main private
residence free from capital gains tax?
A taxpayers would refuse to pay

B in order to encourage home ownership
C not all taxpayers are homeowners
D the tax could easily be avoided by renting
[2]
7 A company undertaking a major construction project has insured against the risk of
accidental injury to construction workers. Which type of risk management does the
insurance policy involve?
A risk acceptance
B risk avoidance
C risk reduction
D risk transfer
[2]
8 Insurance company financial statements require premiums received in respect of

future liabilities to be identified and held until the liabilities have expired. Which
accounting concept does this reflect?
A dual aspect
B going concern
C matching
D money measurement
[2]
9 The net asset value per share is calculated using the formula:
Ordinary shareholders' equity – intangible assets

Number of issued ordinary shares
Which of the following explains why intangible assets are subtracted in the
numerator?
A Intangible assets are generally funded by debt and not equity.

B Intangible assets are not physical and cannot be touched.
C Intangible assets are not used to generate operating profit.
D Intangible assets are unlikely to have value if the company fails.
[2]
CB1 A2023–3
10 Which of the following describes creative accounting?
A Figures are biased without breaking the rules.

B Financial statements are based on lies.
C Innovative accounting rules clarify performance.
D New rules are created by lobbying regulators.
[2]
11 The board of a company has asked an actuary to estimate the value of a liability that
will appear in the company’s financial statements. The actuary has been asked to
ensure that the liability remains below $80 million, otherwise the company will suffer
severe penalties.
Explain the ethical issues arising from this assignment. [5]
12 M is an unquoted company with 20 shareholders, none of whom take an active

interest in its management. M usually pays an annual dividend that increases in
response to inflation. M’s board is concerned that the company cannot afford to pay
the expected dividend this year because an important piece of manufacturing
equipment is due for replacement.
Explain the impact of suspending the dividend in order to fund the replacement,
paying particular attention to the fact that M is unquoted. [5]
13 A quoted company, Q, has identified a takeover target in a completely different

industry. Q’s board believes that the market has under-priced the target company’s
shares.
Explain whether it would make sense for Q to proceed with this acquisition. [5]
14 Explain why it is necessary for the Global Reporting Initiative to set standards for
sustainability reporting. [5]
15 An insurance company must account for a substantial estimated liability associated

with a recent claim.
Describe the respective responsibilities of the company’s directors and its external
auditor with regard to accounting for this liability. [5]
16 Describe the importance to the shareholders of the notes to the financial statements in
a quoted company’s annual report. [5]
CB1 A2023–4
17 An investment analyst wishes to compare the profitability of two airlines that have
very different returns on capital employed (ROCE).
Explain why it would be helpful for the analyst to evaluate the components of the
ratio as follows:
ROCE = asset utilisation ratio × profit margin.

[5]
18 An actuarial consultancy has a budgetary control system that its managing partner
claims combines the best aspects of both the top down and bottom up approaches.
Explain why a consultancy would wish to combine these two approaches to setting
budgets. [5]
19 The information provided below has been obtained from R’s draft financial
statements, which have not yet been finalised.
R
Statement of changes in equity
for the year ended 30 June 2022
Share Retained
Total
capital earnings
$000 $000 $000
Opening balance 1,000 480 1,480
Loss for year (211) (211)
Closing balance 1,000 269 1,269
R
Statement of financial position
as at 30 June 2022 2021
$000 $000
Property, plant and
1,864 2,078
equipment
Current assets 60 49
1,924 2,127
Share capital 1,000 1,000

Retained earnings 269 480
Total equity 1,269 1,480
Non-current liability 600 600
Current liabilities 55 47
1,924 2,127
CB1 A2023–5
R is an unquoted company.
The non-current liability is a loan that falls due in seven years. However, there is a
restrictive covenant on the loan entitling the lender to seek immediate repayment if
the gearing ratio, calculated as debt/(debt + equity), ever exceeds 30%. R’s board is
concerned because this ratio has increased from 29% last year to 32%, which breaches
the covenant.
R’s property, plant and equipment include a large office building in the business
district of a major city. The building was purchased 12 years ago for $1,100,000 and
has never been revalued. The building has been depreciated at 2% of cost each year
since its acquisition. The board is considering revaluing the office in order to reduce
the gearing ratio.
(i) Calculate the value that would have to be attached to the office building to
reduce R’s gearing to 30% as at 30 June 2022. [4]
(ii) Explain whether it would be acceptable to revalue the office building in order
to reduce the gearing ratio to less than 30%. [5]
(iii) Explain how R’s board should manage the breached debt covenant, assuming
that the office building is not revalued. [6]
(iv) Explain the implications for R’s shareholders of continuing reported losses.
[5]
[Total 20]
CB1 A2023–6
20 T is a truck manufacturer whose board is considering the development of an
electrically powered delivery truck for use in cities. The truck will be designed to
operate quietly and efficiently on city streets, with none of the emissions associated
with diesel-powered vehicles.
T paid $600 million for the patent rights to use a new type of battery. The
shareholders are aware of that investment because it was capitalised as an intangible
asset in the most recent published financial statements. No other information has been
released.
The next step will be a one-year feasibility study into the remaining technical
challenges of developing and manufacturing the truck and the potential demand from
customers. The feasibility study will cost $250 million. If the study’s results are
disappointing, then the development of the truck will be abandoned and the cost of the
patent written off. If the results are satisfactory then T will pay $4 billion to buy and
equip a factory over a four-year period to bring the truck to market at that time. The
net present value of that final stage has been estimated at between minus $2 billion
and plus $10 billion, although that figure is subject to confirmation by the feasibility
study. None of this information has been announced by the board. T’s current market
capitalisation is $40 billion.
T has a substantial cash balance that is presently deposited in a bank account that pays
almost no interest. The board may use some of that balance to pay for the feasibility
study. The $4 billion will require a loan or an injection of equity.
(i) Discuss, with reference to agency theory, the implications of maintaining

secrecy over the feasibility study and prospective investment in launching the
truck. [7]
(ii) Discuss the argument that the decision to proceed with the feasibility study
and the subsequent investment in making and launching the truck should be
evaluated as a single project. [7]
(iii) Evaluate the argument that the cost of funding the feasibility study would be
close to zero because it would use an existing cash balance. [6]
[Total 20]
END OF PAPER
CB1 A2023–7
EXAMINERS’ REPORT
Core Principles
April 2023
CB1 - Business Finance - Core Principles - April 2023 - Examiners’ report
Introduction
Sarah Hutchinson
July 2023

Different numerical answers may be obtained to those shown in these solutions depending
on whether figures obtained from tables or from calculators are used in the calculations,
but candidates are not penalised for this. However, candidates may not be awarded marks
where excessive rounding has been used or where insufficient working is shown.
Many candidates performed well in this exam. The MCQs were done very well and the
short response questions were reasonable, some were answered very well and others,
usually where application was required, were answered less well. Performance in
Questions 19 and 20 were mixed with some very good answers and some weak ones. The
questions on Financial Reporting were a little weak on this occasion.
The area which candidates’ performance was lower was finance, this is often the case
with this exam. Candidates should ensure a sounds knowledge of finance and be able to
apply their knowledge to scenarios. Either question 19 or 20 will be on this area of the
syllabus in every exam.
Candidates were good at questions which mainly tested knowledge but performance was
not so good on the application of knowledge to scenarios.
C. Pass Mark
The Pass Mark for this exam was 57

1080 presented themselves and 671passed.

Solutions for Subject CB1 - April 2023
Q1 C [2]
Q2 C [2]
Q3 B [2]
Q4 B [2]
Q5 B [2]
Q6 B [2]
Q7 D [2]
Q8 C [2]
Q9 D [2]
Q10 A [2]
Performance in Questions 1-10 was very good. More candidates than usual scored
full marks.
Q11
The actuary has a personal duty to tell the truth regardless of the incentives and
pressures that would encourage lying [1]
The actuary also has a professional duty that is associated with representing a
professional body whose members are entrusted with important responsibilities [1]
The actuary should refuse this assignment unless it can be established that the
liability will be determined in accordance with best professional practice and that the
result will be reported honestly [1]
Failure to enforce such a condition will threaten the credibility of the actuarial
profession [1]
It could be argued that the people who commissioned the valuation on that basis
have acted unprofessionally [1]
Rather than seeking an objective assessment of the value of the liability, they have
asked the actuary to justify a predetermined valuation in the hope of escaping a penalty.
Presumably that would lead to a stakeholder being misled and abused [1]
This question was not answered very well. There were some very good answers but,
overall, this was not answered very well. A number of candidates just blamed the
valuer and the company when the actuary must shoulder some responsibility as well.
Q12
M’s shareholders are likely to be concerned by this change in the dividend policy [1]
The annual dividend has been sending a clear signal of stability and prosperity and
that will have created confidence in the directors [1]

It is possible that the shareholders will consider meeting and replacing the Board,
although that would simply mean replacing a known management team that has
delivered consistent performance in the past with unknown replacements [1]
The Board should ensure that the shareholders are fully briefed on the reasons for
the suspension of the dividend and that it is made clear that the alternative would
have been to have raised debt [1]
The fact that the company is unquoted means that it would be difficult for the
shareholders to respond by selling their shares and there is no observable share price
in any case to signal that disquiet [1]
It may be that some shareholders who can afford to will be prepared to buy from
other shareholders who misunderstand the situation or who were relying on the
dividend [1]
This question received mixed answers. Many candidates did not realise that
unquoted companies do not have an easily available market for their shares. Well
prepared candidates delivered very good answers.
Q13
The fact that the potential bidder regards the target as undervalued is a concern
because that is unlikely to persist once the bid is announced [1]
The bid will draw attention to the target and might encourage other market
participants to buy shares in the event that it becomes obvious that they are
undervalued [1]
In all probability, the market will correct any undervaluation very quickly and will
eliminate the bidder’s motive for buying [1]
There is also the fact that share prices always increase when it is rumoured that there
is a potential takeover bid because market participants will have good reason to
believe that the bidder will be prepared to pay a premium in order to acquire a
controlling interest [1]
The fact that the companies are in different industries suggests that there is no logical
commercial reason for the acquisition [1]
If the bidder is unable to acquire the target for less than the company is worth then there
is unlikely to be any synergy to justify the acquisition and so the shareholders will lose
value [1]
This question was not as well answered as most other questions, with several
candidates not attempting the question. Only well prepare candidates mentioned that
the undervaluation could be a problem and many saw it as a positive and discussed
it as if it was a bargain.
Q14

Sustainability reporting shares many of the traits associated with conventional

financial reporting, in particular that the content of reports and the definitions of the
matters being reported are open to interpretation and manipulation [1]
Companies require the active support of customers to buy goods and regulators to
provide a licence to operate [1]
Offering credible sustainability reports reduces the likelihood that key stakeholders
will withdraw their support. That aspect creates an incentive to publish incomplete or
misleading reports [1]
GRI standards provide a benchmark against which to evaluate sustainability reports,
thereby enabling stakeholders to be confident in them [1]
Recommending broad disclosure requirements will make any omissions stand out
and so highlight the fact that a company may have been guilty of excluding damaging
information from the report [1]
Setting out definitions and the characteristics of sound sustainability reporting
provides auditors and other reviewers to measure the quality of the disclosures in the
sustainability reports [1]
This question was done well by many candidates.
Q15
The directors are responsible for ensuring that the financial statements present fairly
(or give a true and fair view) [1]
In this case, that will require the directors to ensure that the estimated liability is
calculated as accurately as possible, using all relevant information and applying
relevant models to the calculation [1]
The Board should report the uncertainty concerning this estimate in the notes to the
financial statements so that the shareholders can fully understand the possibility of a
material misstatement [1]
The external auditor’s responsibility relates to the financial statements as a whole
and not to the specific figures within the statements. The auditor must form an
opinion on fair presentation [1]
The auditor should evaluate whether the potential misstatement of the liability
could be material, in which case there will be uncertainty about the fair presentation
of the statements [1]
The auditor could almost certainly deal with the matter by means of an emphasis of
matter paragraph that draws the shareholders’ attention to the note concerning the
uncertainty [1]
This question was answered well by most candidates.
Q16
The notes to the financial statements provide the shareholders with additional

information that can be used to supplement the figures in the financial statements
themselves [1]
For example, the note relating to property, plant and equipment will enable the
shareholders to obtain a better understanding of the book value figure provided in the
statement of financial position [1]
The notes also provide disclosures that might not appear in the financial statements,
such as disclosures of contingent liabilities or the directors’ remuneration [1]
The notes also provide detailed insights into the manner in which the figures in
the financial statements have been prepared [1]
The statement of accounting policies and the detailed calculation in other notes
enables the shareholders to develop a better insight into the approach being taken and
whether the figures might be regarded as conservative or optimistic [1]
Such insights help with comparisons between companies even if they are in the same
industries [1]
Answers to this question were mixed. Some candidates chose to write about one or two
notes to the accounts and others discussed notes in general which was the best
approach. Many candidates scored high marks. A few candidates did not know what
notes to the accounts which was worrying.
Q17
Return on capital employed is an important profitability ratio, but it is particularly
important in analysing capital-intensive businesses, such as airlines [1]
The asset utilisation ratio enables shareholders and other interested parties to
consider the possibility that the airline with the higher ROCE could be better at
using assets efficiently and effectively in order to generate revenue [1]
That could be due to better scheduling of flights so that aircraft can spend more time
in the air or can be used on more popular routes that yield higher fares [1]
Alternatively, the profit margin offers an insight into whether revenues and
operating costs are being managed so that a higher percentage of revenue is being
preserved and reported as profit [1]
Airlines can differ in that regard, with some offering “low-cost” services that are sold
more cheaply while others offer greater comfort in return for higher fares [1]
Candidates answered this question well which was very good to see.
Q18
Realistic targets are the key to effective budgeting. Too slack and the budget holders
will have little incentive to perform well, but they will be demotivated if the budgets
are too demanding [1]

Generally, top down budgets are likely to be demanding, which minimises the risk of
budget slack but could create the risk that senior management is asking for too much,
which bottom up budgeting can have the opposite effect [1]
One possible solution to the challenge of setting motivating but achievable budgets
would be to offer some interaction between the senior management team and the
budget holders [1]
The starting point would for senior management to set some initial targets, that could
be broken down between departments and communicated to junior management [1]
Junior management could then offer their opinions and advice on whether the
Budgets are achievable and whether there might be some alternatives that would be
more efficient [1]
Ideally, there could be a meaningful dialogue that would enhance the overall
effectiveness of the budgets. The danger is that it could be even more demotivating if
the feedback from junior management is disregarded [1]
There were some very good answers to this question. On the whole candidates
scored well.
Q19
(i)
debt/(debt + equity) = 30%
600/(600 + equity) = 30%
600 = 180 + 30% equity
Equity = 1,400 [1]
The revaluation reserve will have to increase equity from 1,269 to 1,400, so the
revaluation adjustment will have to be 131 [1]
The book value is presently 1,100 - (12 x 22) = 836 [1]
The revalued amount will be 836 + 131 = 967 [1]
(ii)
The question of whether the office building should be shown at cost less depreciation
or its revalued amount is really an accounting choice [1]
The Board is free to choose whichever method is most appropriate, although the
motive should be to ensure that the financial statements present fairly [1]
If the Board wishes to revalue the office building, then it should do so on the basis
that the valuation will reflect the fair value of the building, basically its expected
selling price [1]
It would be unacceptable to determine the valuation using the arithmetic in (i) above
because that is unlikely to be an accurate estimate of the market value of the asset [1]
The Board should start by seeking expert advice on the value of the building, using
property experts with local knowledge of that market [1]
If the value happens to exceed $967,000 then the financial statements will present
fairly and the debt covenant will be satisfied if that figure is used [1]

(iii)
R’s Board should start by establishing whether the company is in financial difficulties
that will result in it being unable to service the loan [1]
If R is in serious financial difficulties, then the responsible thing to do would be to
act in accordance with the debt covenant and inform the lender, with a view to having
the company wound up [1]
The alternative would be to carry on trading which would be unethical because the
lender’s funds would be put at risk [1]
The directors could also damage their own personal reputations by behaving in a
manner that is clearly unethical [1]
If the Board can see an effective response to the problems that R is facing then the
first priority would be to develop that planned response quickly so that it can be shared
with the lender [1]
The Board should then approach the lender as a matter of urgency and should explain
that the company will be in a technical breach of its covenant when the financial
statements are published [1]
The Board should then negotiate with the lender so that it has the necessary time and
freedom to implement its survival plan. Such a response would be desirable to the
lender because it would avoid the need to incur the cost and inconvenience of a
foreclosure action [1]
(iv)
R’s retained earnings figure will decrease every time the company reports losses.
That will restrict the company’s ability to pay dividends because it cannot pay
dividends that exceed retained earnings [1]
The problem with the continuing losses will lead to a recurrence of the difficulties
arising from the debt covenant [1]
The value of R’s equity will decline because of these continuing losses, which will
reduce shareholder wealth [1]
The share price is not visible because the company is unquoted, but that does not
alter the fact that potential buyers will be unwilling to pay a great deal for shares in a
company that is reporting losses [1]
Ultimately, the accounting losses will bleed the company of cash and it will be
forced out of business [1]
The losses mean that costs exceed revenues. Even though costs are not always
reflected by cash payments, higher costs will generally mean higher cash outflows [1]
[Total 20]

The calculation should have been straightforward, and many candidates scored well
on part i.
Part ii seemed to cause some candidates problems and answers were very varied as
to whether the company should revalue the buildings or not. Marks were awarded
for a discussion of the issue and many candidates managed to gain reasonable
marks. Questions on Financial Reporting are in every exam and are often not
answered well so it is worth revising this area of the syllabus.
Part iii was answered well by most candidates with candidates giving good
responses as to the approach the company could make to its lender. Candidates
demonstrated a good understanding of debt covenants.
Part iv was also answered quite well. Most candidates gave good answers on why
making losses for a long period would cause serious problems.
Q20
(i)
The shareholders are being asked to place a great deal of trust in T’s Board [1]
The initial and unexplained investment of $600 million seems likely to stretch the
shareholders’ patience, especially when it will soon be followed by a further $250
million investment [1]
The shareholders might not be convinced that the Board’s is withholding information
in order to protect commercial secrecy and so the share price might start to decline [1]
That could put the Board in a position where the directors decide to breach
confidence in order to protect their jobs and their reputations [1]
Past governance scandals have generally involved shareholders being misled by
boards and transparency has emerged as one of the ways in which the markets can
be protected from dishonest directors [1]
From an agency point of view, T’s Board should ensure that the shareholders have
an adequate understanding of the strategy that is being pursued and the manner in
which their wealth in being invested [1]
It is unacceptable to withhold information concerning investments on this scale and
with this level of impact on the product range [1]
The Board should recognise that competitors will be aware that a major investment
has been made and so the shareholders will not necessarily benefit from withholding
any information [1]
(ii)
The feasibility study and the subsequent investment should be considered together
in the first instance because there will be little or no point in proceeding with the
feasibility study unless the truck will go into production [1]
This is complicated by the fact that the best estimate of the investment in production
covers a range of possible outcomes, including losses [1]

The Board cannot necessarily tell whether it will proceed with the launch of the
product even if the $250 million is spent, which raises doubts about the benefits
from the feasibility study [1]
At this stage of the project, the Board was sufficiently confident to invest $600
million in a patent, which suggests that there is reasonable confidence in a
successful outcome overall [1]
Arguably, the Board should view the feasibility study as a separate investment
that is being undertaken to reduce the risk of a failed investment at the
implementation stage [1]
Knowing that the truck can be manufactured and that there will be sufficient
demand will enable the Board to make a better informed decision concerning the
production of the vehicle [1]
The feasibility study would appear to be a potential investment in the acquisition of
knowledge and that knowledge may enable the creation of a substantial new product
line [1]
Once the study has been completed, it will be a sunk cost that has no further
relevance to the decision to manufacture and so that will become a separate decision [1]
(iii)
The fact that the company has a large cash balance available does not mean that the
cost of using that cash is zero [1]
The cash is an asset and, like all assets, its acquisition was funded by equity, debt
or a combination of the two [1]
It could be argued that the cost of capital associated with using the cash should be
based on T’s WACC unless it can be shown to have been raised specifically from
either debt or equity [1]
Alternatively, if the cash would otherwise be used to repay debt then the financing
cost associated with that cash would be the cost of debt [1]
The shareholders might also view the cash as being funded through their investment
in equity and so might expect the Board to put the funds to good use and to seek a
return based on the cost of equity [1]
There will also be opportunity costs associated with spending that cash on the
feasibility study because it might be used to finance alternative investment projects [1]
Presumably there are other ways in which the $250 million could be invested and
those opportunities will be lost to the company [1]
[Total 20]
This question was problematic for several candidates. However, some candidates made
a very good attempt at all three parts of this question.
The first part was problematic as some candidates found difficult to think whether it was
acceptable for a Board to keep secrets from shareholders.
Part ii also caused some problems; marks were awarded for good arguments, and it
would not matter whether a candidate said the study should be treated separately or not
they would still gain marks.

Part iii was also not answered very well, many candidates agreed that the cost of cash
was zero which is incorrect. There is a cost to using cash for the investment, some
candidates gave good answers by discussing opportunity cost which was very good.
[Paper Total 100]

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Oxford
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EXAMINATION
14 April 2022 (am)

Core Principles
In addition to this paper you should have available the 2002 edition of the
Formulae and Tables and your own electronic calculator.
T. 0044 (0) 1865 268 873.

1 Which of the following is most likely to seek a microloan?
A A charity that is attempting to raise the cost of a minibus to transport

volunteers
B A qualified actuary who requires funding in order to rent an office and start a
consultancy
C A subsidiary in a group of companies that requires finance to replace
equipment
D An unemployed carpenter who wishes to buy basic tools in order to start a
small business.
[2]
2 Which of the following statements is true of an interest rate swap?
A The need to use swaps implies poor financial management by the parties.
B The parties to the swap become responsible for one another's liabilities.
C The parties to the swap effectively make offsetting payments to one another
for the swap's duration.
D There are no credit risks associated with swap arrangements.
[2]
3 A quoted company is making a rights issue.
Which of the following statements is correct?
A Shareholders are required to exercise their rights.

B The new shares could be issued at a premium to the present market price.
C The new shares could be issued at a price that is less than their nominal value.
D The share price could increase after the issue.
[2]
4 A company is obtaining a stock exchange quotation through an offer for sale by

tender.
A All applicants will receive shares.

B All shares will be issued at the same price.
C Applicants making low tenders will depress the share price.
D The size of the issue will be decided after the tender process.
[2]
CB1 A2022–2
5 A company offers an automatic dividend reinvestment plan.
Which of the following statements is true with regard to the shareholders who are
enrolled in this plan?
A No tax will be paid.

B Shareholders will receive free shares.
C The new shares will be acquired at a discount.
D There is no benefit to the company.
[2]
6 The purpose of an ‘emphasis of matter’ paragraph in an external auditor’s report is to:
A draw attention to a note to the financial statements.

B explain a problem that arose during the audit.
C highlight a major change to corporate strategy.
D summarise the limitations of an external audit.
[2]
7 Which of the following reflects the accruals concept in the preparation of an insurer’s
financial statements?
A accounting for claim costs and premiums in the same period

B determining costs based on pessimistic assumptions
C excluding potential claims that cannot be measured objectively
D recognising estimated costs of settling recent claims as expenses
[2]
8 A parent company owns a single subsidiary that was purchased for cash 10 years ago.
Which of the following best explains the need to include the goodwill on acquisition
of this subsidiary in the consolidated statement of financial position?
A Goodwill always appears in the consolidated financial statements.

B Shareholders need to be reminded of the value of loyal customers and similar
intangibles.
C The goodwill was paid for and must be included or the statement would not
balance.
D The shareholders would otherwise be misled because the group's assets would
otherwise be understated.
[2]
9 Which of the following best describes ‘other comprehensive income’?
A dividends receivable
B gains that are taken directly to reserves
C income from financial assets
D income from operations
[2]
CB1 A2022–3
10 Which of the following best describes the attitude that a company should have
towards meeting its competitors’ information needs when preparing its financial
statements?
A Competitors are legitimate users of financial statements.

B Competitors have no means of obtaining the financial statements, so their
interest is irrelevant.
C Information that is of value to the shareholders is likely to be useful to
competitors.
D Information that would assist the competitors should be withheld.
[2]
11 Describe the challenges of identifying and evaluating the opportunity costs of an

investment project. [5]
12 Outline the advantages of setting a standard hurdle rate of, for example, 15% p.a. for
all investment projects undertaken by a large company. [5]
13 A film studio is about to start production of an action film. The film stars a major
actor who wishes to perform their own stunts. The studio is concerned that the actor
will be injured during filming.
Outline, with reasons, a suitable approach to mitigating the risks associated with the
actor performing stunts. [5]
14 Describe the implications of agency theory for the regulation of corporate governance.
[5]
15 Outline why requiring large oil companies to publish sustainability reports will
encourage them to behave in a manner that is socially responsible. [5]
16 A quoted company’s board wishes to treat a large payment as an investment in an

intangible asset, but the company’s external auditor insists that the payment should be
treated as an expense. The board’s proposed treatment will result in a significantly
higher reported profit and a stronger statement of financial position.
Explain the governance mechanisms that are in place to ensure that the board cannot
pressurise the external auditor into agreeing to a potentially misleading accounting
treatment. [5]
CB1 A2022–4
17 An engineer has invented a new electric motor that can be fitted to bicycles. She
believes that her invention has significant commercial potential because it will retail
for $600 per unit, which is substantially cheaper than existing products, all of which
are technically inferior.
The engineer has a working prototype, but she cannot afford to launch it unless she
can raise the $400,000 that it will cost to have an initial batch of motors manufactured
and to cover initial marketing.
Explain whether crowdfunding will be a suitable means for the engineer to raise the
$400,000 that she requires. [5]
18 The directors of an actuarial consultancy are working on next year’s annual budget.
The manager in charge of staff development has requested an increase in the staff
training budget for next year.
Describe the challenges associated with determining an appropriate level of

expenditure on the consultancy’s staff training. [5]
19 A quoted manufacturing company has recently appointed a new Chief Executive

Officer (CEO). It is close to the year end and the newly appointed CEO is working
with the Finance Director on plans for the preparation of the company’s annual
financial statements.
The CEO has noted that the company’s land and buildings have always been shown at
cost less depreciation. The company owns a large plot of land that holds a factory that
was built 15 years ago and an office block that was built 12 years ago. The land is
shown in the financial statements at cost and the buildings are shown at cost less
depreciation, with depreciation charged at 2% of cost each year.
The CEO believes that the land and buildings are worth far more than their
depreciated cost and that the financial statements should use a revalued figure. They
have asked the Finance Director to make the necessary arrangements with a
professional valuer and also with the company’s external auditor.
(i) Describe the effects of the revaluation on the relevance and reliability of the
company’s financial statements. [7]
(ii) Outline the effect of the revaluation on the company’s return on capital
employed ratio and its likely impact on the share price. [6]
(iii) Explain why the external auditor should be consulted on the revaluation. [7]
[Total 20]
CB1 A2022–5
20 S is a major quoted transportation company that operates 2,500 Heavy Goods
Vehicles (HGVs), delivering goods on behalf of several hundred customers, including
manufacturers and supermarkets. In addition to 5,000 drivers, S employs 300
administrative staff, most of whom are based in the company’s operations centre. The
operations centre uses sophisticated computer software to track the navigation
systems in S’s HGVs, and to schedule collections and deliveries, to maximise
operating efficiencies.
S’s board is considering the acquisition of G, a competing quoted transportation

company that operates 1,200 HGVs and employs 2,600 drivers and 170 administrative
staff. G also has a computerised operations centre that tracks HGVs and schedules
collections and deliveries. G’s market capitalisation is currently roughly half that of S.
Confidential meetings have taken place with G’s directors, who have agreed to
support the bid. S will issue new shares worth 15% more than G’s present market
capitalisation and will exchange those for 100% of G’s equity. S’s board is confident
that synergies will bring about a significant increase in the overall value of the merged
group.
G’s directors will step down after the merger, in return for a generous financial
settlement. The merged group will be managed by S’s existing board, whose
remuneration will increase in line with the increase in the size of the merged entity.
(i) Discuss the expectation by S’s board that this merger will bring about
significant synergies. [10]
(ii) Evaluate the proposal that G’s directors should receive a generous financial
settlement when they step down. [5]
(iii) Evaluate the proposal that S’s directors should be paid more in recognition of
the increase in the size of the merged entity. [5]
[Total 20]
END OF PAPER
CB1 A2022–6
EXAMINERS’ REPORT
April 2022

Core Principles
Introduction
particularly the open-ended questions in the Specialist Advanced (SA) and Specialist
Principles (SP) subjects, the report may contain more points than the Examiners will expect
from a solution that scores full marks.
Sarah Hutchinson
July 2022

The aim of the Finance and Financial Reporting subject is to provide a basic understanding of
corporate finance including a knowledge of the instruments used by companies to raise
finance and manage financial risk and to provide the ability to interpret the accounts and
financial statements of companies and financial institutions.
This paper examines basic finance including raising funds by a variety of methods, taxation,
net present value and project appraisal and other topics, it has both calculations and essay
type questions on these topics. The paper also examines financial reporting including
preparation of the main financial statements and interpretation of financial statements. It also
considers the basis of the preparation of statements and the information needs of a variety of
end users of financial statements. There is now some management accounting in the syllabus
so there are questions on topics such as budgeting and performance management.
Different numerical answers may be obtained to those shown in these solutions depending on
whether figures obtained from tables or from calculators are used in the calculations but
candidates are not penalised for this. However, candidates may not be awarded full marks
where excessive rounding has been used and where insufficient working is shown.
Performance was reasonable for many candidates. Many of the questions were answered very
well but a number of candidates appeared to be inadequately prepared, in terms of not having
covered sufficiently the entire breadth of the subject. The MCQ questions were answered
very well with high marks being achieved by many candidates. Some of the short questions
were answered well but some candidates did not answer what was asked, most notably in
Question 19 parts (i) and (iii) and Question 16.
C. Pass Mark


Q1 D [2]
Q2 C [2]
Q3 D [2]
Q4 B [2]
Q5 C [2]
Q6 A [2]
Q7 D [2]
Q8 C [2]
Q9 B [2]
Q10 C [2]
Questions 1-10 were generally well answered by most candidates.
Q11
It will not always be clear what projects will have to be sacrificed in the event that a
particular project proceeds [1]
It may be that the directors only have a fixed amount budgeted for new investments,
but that does not necessarily mean that using those funds for one project will stop
others going ahead [1]
Positive net present value projects can generally be financed on the basis that their
cash flows will cover the finance costs and so there is only a genuine opportunity cost
if the choice is being made between projects that are genuinely mutually exclusive [1]
Realistically, managers who identify and promote projects may not be aware of the
alternative approaches that could be used instead [1]
Identifying the missed opportunities could require considerable research in order to
identify alternatives that could be considered instead [1]
It can be difficult to predict cash flows with any certainty and so determining the
opportunity costs could require a significant amount of time and effort and may not
lead to an optimal decision [1]
This question was answered well by many candidates. Most candidates understood
opportunity cost very well and were able to discuss it in the context of project appraisal.
Q12
The net present value criterion is the only method of investment appraisal that is
entirely consistent with the concept of maximising shareholder wealth [1]
One of the problems associated with applying that concept is that each project should
be evaluated at an appropriate discount rate that takes account of the risks associated
with future cash flows [1]
Determining a suitable discount rate can be complicated, so setting a blanket rate across
the whole company will have the effect of simplifying the application of NPV analysis [1]

Setting a blanket rate will avoid the pressures associated with managers arguing for
reduced discount rates to justify projects that they are keen to promote [1]
The rate may not be perfectly suited to all projects, but it has been decided by the board
and so they can be satisfied that projects are achieving an acceptable benchmark rate [1]
The company can also track the success rate of projects to determine whether the 15%
threshold is leading to the acceptance of too many projects or too few [1]
This question was answered very well by candidates. Most candidates are very good at
discussing NPV. Most candidates managed to score well and discussed discount rates and
hurdle rates in some depth.
Q13
The most logical response would be to reduce the risks by assessing each stunt in
terms of the likelihood of injury and insisting that the actor is replaced with a stunt
double if the risks are too high [1]
If agreement cannot be reached over that then the risk might be reduced by filming all
major stunts at the conclusion of shooting [1]
That would not reduce the risk of injury, but it would mean that the actor would have
completed all other filming before the risk of being injured, at which point a stunt
double could take over [1]
There will also be the risk that the studio will be held responsible for any injury to the
actor and it might be possible to transfer that risk [1]
One possibility would be to take out insurance for the cost of settling any legal claims in
the event that the actor is injured while working for the company. That could be difficult
to arrange because insurers might regard the likelihood of a claim as being too high [1]
An alternative would be to transfer the risk to the actor by insisting that she signs a
waiver, accepting any and all risks of injury arising from stunt work [1]
This question was answered well by most candidates. Candidates gave lots of ideas about
the risks. The question was a little different from usual but candidates made very good
attempts at thinking of all possible risks and mitigations.
Q14
The organisations that are responsible for the management of corporate governance,
such as the UK’s FRC need to understand the pressures faced by company directors [1]
Board members are free to manage their companies in any way that they see fit
because the shareholders have little or no direct oversight beyond the annual report [1]
It follows that directors may not always seek the shareholders’ best interests when
they are making decisions if there is a conflict between their interests as agents and
those of the shareholders as principals [1]
It could be argued that the need to regulate corporate governance has emerged
because of scandals in which directors have misbehaved and have drawn attention
to agency problems [1]

Regulators are faced with the difficult task of regulating boards whose duties require
them to be free to make strategic decisions without necessarily seeking explicit approval [1]
Regulators face criticism if they do not prevent scandals that occur because of the abuse
of that lack of oversight and that would have been difficult to have regulated [1]
This question was answered reasonably well however, some candidates were unsure about
agency theory.
Q15
It could be argued that their very nature means that oil companies are viewed as
behaving in a manner that is unsustainable and that does not discourage them from
their ongoing operations [1]
For example, oil corporations are an extractive industry that it clearly consuming
finite resources and customers who buy oil-based products must be aware of that fact [1]
It is possible that the publication of sustainability reports will encourage some
reflection on the part of directors and stakeholders as to the extent to which socially
irresponsible behaviour might be addressed [1]
It is unlikely that oil companies would wish to be associated with social responsibility
reports that admitted to misbehaviour [1]
They might, for example, seek ways to offset the damage that they do, such as
encouraging carbon offset arrangements [1]
They are likely to be unwilling to be associated with misleading or distorted reports
that made them appear defensive and unwilling to acknowledge their responsibility [1]
This question was done reasonably well by many candidates. Candidates were able to
offer good ideas on sustainability reports and apply them to the oil industry. Many
discussed that the reports could be used to improve an oil company's reputation and may
not always be accurate.
Q16
The governance mechanisms relating to financial reporting are generally delegated to
the accountancy profession of the company in question. In the UK that role is managed
by the FRC [1]
The starting point for dealing with accounting issues is the requirement that quoted
companies prepare their financial statements in accordance with formal accounting
standards [1]
In this case, it would be possible to seek some resolution by applying the requirements
of relevant International Financial Reporting Standards (IFRS). Amongst other things,
the IFRS would set out benchmarks that can be used to establish whether this payment
satisfies the criteria for recognition as an asset [1]
The governance rules also lay considerable emphasis on the role of the external auditor
and in safeguarding the auditor’s independence [1]

The auditor will be protected by the need to comply with IFRS, which will go some
way towards offering an objective basis for resolving the disagreement between the
auditor and the directors [1]
The auditor’s independence is also a major element of governance regulations and so
any attempt to coerce the auditor into accepting a misleading accounting treatment
should fail because the auditor would simply refuse [1]
This question was not answered very well. Many candidates discussed the role of the
auditor and not the governance mechanisms that stop the company pressurising the
auditor.
Q17
This might be a suitable project for pre-payment crowdfunding, which would involve
the engineer demonstrating her prototype online and seeking to interest possible buyers [1]
She could then ask interested viewers to commit themselves to buying one of the first
batch of motors, perhaps offering a discount against her anticipated retail price [1]
Cyclists might be prepared to pay, say, $500 now in the expectation of receiving an
exciting new product as soon as it becomes available [1]
This is an exciting product that should appeal to potential buyers and that could be
advertised online at relatively little cost, simply by filming a demonstration and adding
a voice track [1]
From the engineer’s point of view, this could prove an expensive source of finance
because the discount will have to be large enough to motivate potential buyers [1]
It will also be inconvenient if the amount raised is insufficient because it will then be
necessary to reimburse customers, which will lead to delays in any progress with the
product [1]
This is a reasonably new section of the syllabus and most candidates did very well in this
question.
Q18
The training budget is complicated by the fact that it is difficult to determine the
benefits associated with a given level of expenditure [1]
Clients will be more likely to commission work from an organisation that has
well-trained and capable staff, but that will be difficult to quantify [1]
Excessive training will not just be a waste of fees, there will also be the question of
loss of chargeable hours for staff who are engaged in training [1]
There is also a tendency for managers to seek to justify additional expenditure in
their areas of interest [1]
The manager in charge of staff development will enjoy greater status if more time
and money is invested in training [1]
It will also make this area easier to manage because any shortcomings in staff
capability can be addressed by arranging a training course [1]

This question was answered fairly well by many candidates, however, some candidates
discussed budgets and did not always discuss training budgets. There were some marks
available for general discussion but those who specifically discussed training budgets
scored high marks.
Q19
(i)
It could be argued that showing property at its book value of cost less depreciation is
lacking in relevance [1]
The property is 12 years old and is being written off at one fiftieth of that amount
every year. The book value is 38/50 of the original cost 12 years ago [1]
That figure will be of very little relevance to most decision-makers. Arguably, it is
just a balancing figure that has to be inserted for bookkeeping purposes [1]
Showing the property at its valuation will give the shareholders a much clearer
understanding of the value of the resources that have been entrusted to the directors [1]
That will enable them to form a better idea of performance and also of whether they
should allow the company to continue as a going concern [1]
The value will also be relevant to any funding decisions because potential lenders
will prefer to have a clearer understanding of the value of any assets that are pledged
as security [1]
Reliability implies that the figure cannot be challenged as incorrect. It could be argued
that a book value of cost less depreciation is utterly reliable because the original cost
is an objective figure and the annual depreciation rate is known [1]
It could be argued that the book value has little real relevance, but there is no doubt
that it is a factual statement of the asset’s worth [1]
The problem with valuations is that they are inherently subjective. Buildings vary in
many ways, including in terms of location [1]
The property markets can give a rough guide as to the price at which land and buildings
are bought and sold, but there are significant differences between individual properties [1]
There is no guarantee that a potential buyer would be prepared to pay the estimated
market value of a building [1]
(ii)
Return on capital employed will decrease for two reasons. Firstly, the annual
depreciation charge on the buildings will increase because the revalued amount will
have to be depreciated over the remaining 38 years of the building lives [1]
That will increase the annual depreciation charge and so reduce operating profit [1]
The gain on revaluation will also be taken to the revaluation reserve, which will
increase equity [1]
The denominator will therefore be increased, meaning that a smaller figure will be
divided by a larger one [1]
The share price is unlikely to be affected because the capital markets would have been
aware of the basis on which the assets were valued [1]

It will be unlikely that publishing the estimated market value will take the markets by
surprise because any necessary adjustments will have been made in any case when
studying, say, the gearing ratio [1]
The share price is also a reflection of the future cash flows from the business and so
the markets may not be greatly interested in the market value of the property [1]
If we assume that the company is unlikely to sell its property then it could be argued
that the market price is irrelevant and so will not constitute significant information [1]
(iii)
The external auditor is required to form an opinion on the truth and fairness of the
financial statements and to publish that opinion in the audit report attached to the
annual report [1]
Any change in accounting choice will have to be discussed with the external auditor
in order to ensure that the treatment follows accepted accounting principles and so does
not threaten the truth and fairness of the financial statements [1]
The auditor has to gather evidence as part of the process of forming an opinion [1]
In this case, the auditor will have to be satisfied that the adjustments being made are
credible and that the basis being used by the valuer is acceptable [1]
Ideally, the person providing the valuation will be an expert who can provide a credible
figure without any concerns about manipulating the value to meet the directors’ needs [1]
The auditor would also wish to review any evidence collected by the valuer such as
comparable properties that have been sold and any calculations [1]
If the auditor is dissatisfied with the information provided by the company then it will
not be possible to attach a clean audit opinion to the financial statements [1]
The auditor would have to describe the uncertainties associated with the property
and state that the financial statements gave a true and fair view, except for those
uncertainties [1]
[Total 20]
Part (i) was not answered very well by a number of candidates. The difference between
relevance and reliability was not really covered well in many answers. In part (ii) only
well prepared candidates discussed the possible effect of the revaluation on the share
price. Part (iii) many candidates were unclear about why the auditor should be involved
in the revaluation.
Q20
(i)
There are two obvious sources of synergy in this case. The first is the merger of the two
fleets of HGVs and the second is the savings in combining the administrative functions
of the two companies [1]
Synergy will be obtained if the merged entity can operate at a reduced cost compared
with the total running costs for the two separate entities [1]
Combining the two HGV fleets will create synergy if there are savings in running costs,
which might be created in several ways. The combined fleet is larger, so the merged
entity will have greater bargaining power when it needs to replace vehicles and so its
unit costs will be reduced [1]

That would only be possible if the merged entity can use a single supplier for
vehicles, otherwise the potential increase in bargaining power will not exist [1]
The larger fleet and the increased number of customers might also enable savings in
operating costs if journeys could be optimised to reduce the distances being travelled
and the number of empty vehicles [1]
With a larger entity, it may be easier to combine loads so that there is less wasted
capacity. It may also be more likely that a vehicle that has just made a delivery will be
able to take on a fresh load from nearby [1]
That synergy is probably quite realistic
The closure of the smaller of the two operations centres would be viable, but only if
the systems were compatible. If the vehicles are fitted with different satnav systems,
then it may be impossible to merge the operations centres [1]
If the centres cannot be merged then any hoped for synergies in operations may also
be lost because it will be difficult for the collection and delivery schedules to be
optimised across the merged entity [1]
The two administrative functions could also be merged so that efficiencies can be
created in those areas [1]
That will depend on the compatibility of the two systems. If they are not compatible,
then it may cost more to convert files than the savings that were hoped for [1]
The optimisation of resources could also create some significant problems with
morale and the willingness of staff to cooperate [1]
If the target company loses too many staff then those who remain may start to
become nervous and to assert themselves. Industrial action could discourage the
company from implementing plans to reduce costs [1]
(ii)
The financial settlement will reduce the threat of the directors blocking the merger in
order to keep their jobs [1]
Clearly, the company will require only one board and it is unlikely that the directors
of the larger entity will be willing to step down even if their counterparts in the other
company are better qualified [1]
Making this arrangement clear from the outset will reduce the uncertainty for the
outgoing board members because they would otherwise have to negotiate redundancy
terms after the merger [1]
There is a risk that the financial settlement will create a conflict of interest when
negotiating the terms of the merger [1]
The directors should be focussed on taking care of their shareholders’ interests, but
they could be side-tracked by a desire to protect their severance package [1]
The shareholders might also resent the decision to pay a substantial redundancy
payment to outgoing directors [1]
(iii)
One of the foundations of corporate governance is that company directors should be
paid a realistic reward for the work that they do [1]
They should receive sufficient to attract and retain suitably qualified directors, but
they should not be overpaid [1]
Their rewards should be aligned to the shareholders’ interests [1]

The directors are essentially responsible for the company’s strategic management [1]
It is debateable whether it will be more difficult or harder work to manage the merged
entity just because it is 50% bigger [1]
If the shareholders agree to that then they may be creating pressure for the directors
to expand further by acquisition so that their salaries increase by even more [1]
[Total 20]
Candidates generally scored well at part (i) with most coming up with good ideas of
synergies, Part (ii) was less well answered with many candidates discussing director's
remuneration rather than severance. Part (iii) was generally well answered with most
candidates discussing the points on remuneration well.
[Paper Total 100]

EXAMINATION

Core Principles
T. 0044 (0) 1865 268 873.

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
Revenue 45,628
Sales staff salaries 8,300
Selling expenses 1,778
Share capital 5,000
Share premium 2,200
Trade payables 600
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
EXAMINERS’ REPORT
Core Principles
September 2022
Introduction
Sarah Hutchinson
December 2022

The subject also includes a basic knowledge of Corporate Governance. Some of the topics
will involve subjective judgement when answering questions this is taken into account by
the marking team.
Different numerical answers may be obtained to those shown in these solutions depending
on whether figures obtained from tables or from calculators are used in the calculations
but candidates are not penalised for this. However, candidates may lose marks where
insufficient working is shown.
Many candidates performed very well in this exam. Performance was reasonable for
many candidates. The MCQs questions were answered very well with high marks being
achieved by many candidates. Some of the short questions were answered well, but some
candidates did not answer what was asked, most notably in Question 20 parts (i), (ii) and
(iii) and questions 16.
Candidates were good at questions which mainly tested knowledge but were a little weak
on application of knowledge to scenarios.
C. Pass Mark


Q1 D [2]
Q2 D [2]
Q3 A [2]
Q4 A [2]
Q5 B [2]
Original market cap 1100

Cash injected 270
NPV 140
1510
Shares
In issue 100
new shares = (270/9) 30
130
New share price = (1510/130) 11.62
Q6 B [2]
Q7 B [2]
Q8 D [2]
Q9 A [2]
Q10 A [2]
Questions 1-10 were well answered by most candidates; however, the performance was
lower at questions 5, 9 and 10.
In Question 5 a common mistake was to say A was correct. The correct answer adjusted
the original market capitalisation to allow for the cash injected through the rights issue
and the net present value of the proposed investment, making B correct.
Q11
The most immediate advantage of performance-related remuneration is that it gives
the directors an incentive to work harder and to seek to enhance shareholder wealth. [1]
That will reassure the shareholders, who may otherwise be reluctant to trust the
directors to do discharge their duties correctly [1]
For example, the directors may become less risk averse because they have a monetary
incentive to seek better performance even if there is a risk associated with doing so. [1]
Performance related remuneration could tend to create an unhealthy focus on the
factors that determine “performance” [1]

For example, there could be an undesirable focus on short-term profitability if the

board receives a profit-related bonus, which could be suboptimal for the company in
the longer term [1]
There could also be a temptation to mislead the shareholders through, say, creative
accounting in order to overstate the board’s entitlement to rewards. [1]
This question received mixed answers. Many candidates stated that performance related
pay was good for the company and shareholders but failed to note that there are issues
that arise which mean it is not always good. Candidates who looked at both positive and
negative views on performance related pay scored very well.
Q12
Losses will mean that there is no taxable profit against which to offset the cost of
interest [1]
Tax relief on the cost of servicing loans is a significant part of the cost of debt and
so that cost will increase [1]
Lenders will not have a direct interest in the question of whether the company is
making profits or losses, provided the company is generating sufficient cash to
service the loan [1]
In the long term, cash flows will fall into line with profits and so the lender might
seek a higher interest rate [1]
Continuing losses could lead to the business being wound up, which could result in
assets being sold for less than their true worth [1]
That could create the possibility of a loss for the lenders, which could be reflected
in an increased cost of debt [1]
This question was not answered well and was missed out by some candidates. Candidates
did not generally describe the factors that would increase the cost of debt.
Q13
A personal guarantee will give the bank some protection in the event that the company
fails and defaults on its loan [1]
Legally, the loan is due from the company and the three owners could leave the bank
with part or even all of the loan unpaid [1]
The fact that the engineers are investing heavily with their own personal assets suggests
that they will be unlikely to have a great deal left to pay the bank in the event of a
collapse [1]
The bank will, however, benefit from the fact that the engineers have a clear
disincentive to permit the company to fail and to leave the bank unpaid [1]
The guarantee means that the owners have an incentive to wind the company up if it is
at risk of failure so that there are some funds and assets that can be realised to repay
the bank as much as possible [1]

The guarantee also put the engineers under greater pressure to manage risk because
at present they will only be subject to the loss of 60% of their investment, but the
guarantee will increase that to 100% [1]
This question received mixed answers, many candidates scored well. Generally, if
candidates understood limited liability they scored well. Some candidates confused limited
companies with partnerships.
Q14
The motives of the bidder’s directors are potentially unclear because this acquisition
could be motivated by a desire to grow and to obtain synergies that will boost the
shareholders’ wealth [1]
Unfortunately, the directors could just as easily be keen to make their company grow
in order to boost their remuneration and also to have the management of a larger
company on their CVs [1]
The bid will also create agency issues with respect to the target company’s board
because that company’s directors may be reluctant to support the takeover [1]
Bidders usually offer to overpay for the target in order to encourage a good uptake,
but the target company’s directors are often keen to keep their jobs and seniority [1]
There is also an agency issue associated with the target company’s shareholders and the
actions of the bidding company’s directors because this is a share for share exchange. [1]
The target company’s shareholders must consider whether they wish to exchange their
present investment for a share in a larger group that will be managed by a board of
directors with whom they have not had any prior dealings [1]
This question was not answered well by candidates. Candidates found it difficult to think
of examples of agency issues in the context of the question. Those that did, scored good
marks.
Q15
Arguably, the most important question for shareholders is whether their company is
making a profit, but profit can be misleading in certain situations. In particular a
growing company can run into cash flow problems very quickly [1]
The cash flow statement highlights issues such as the company’s ability to generate
cash from operations, in addition to making a profit [1]
The statement will also highlight the outflows associated with investing in any
non-current assets required to support that investment [1]
Arguably, the shareholders could work out a lot of the information associated with
cash for themselves, using the statement of profit or loss and the statement of financial
position [1]

For example, an increase in trade receivables will reflect an outflow of cash

Similarly, the details in the non-current asset note will give an insight into the
investment being made in property, plant and equipment [1]
The cash flow statement will make it quicker and easier to develop an understanding
of cash management [1]
This question was answered reasonably well by most candidates. Candidates knew that
the cash flow is vital to any business and knowing how money is spent is very important.
Most candidates understood that this information was not readily available in the
statement of profit or loss or the statement of financial position.
Q16
This argument appears to be based on the fallacy that the price / earning ratio will
remain fixed and that inflating the earnings figure will have the effect of increasing
the share price [1]
In the short term that may be true. The publication of an annual report with an
encouraging increase in the earnings per share figure might boost the share price [1]
That increase is, however, unlikely to be sustained in the event that an accounting
technique has been used to justify the publication of a misleading profit figure [1]
The capital markets set the share price on the basis of expected future cash flows and
so a distorted accounting policy would be regarded as irrelevant [1]
The share price would possibly increase while analysts take the time required to study
the financial statements in detail, including the notes to the accounts [1]
Manipulating profit will simply undermine the market’s confidence in the integrity of
the board [1]
Candidates did not answer this question very well, with many having misconceptions
about the P/E ratio. This topic is often an area that is problematic for candidates.
The difficulty candidates have is the belief that the ratio will stay fixed so an increase in
earnings will therefore increase the share price, which is untrue.
Q17
The problem with this discount is that the company will be paying 2% to speed up
cash flows by 35 days [1]
That is equivalent to 365/35 = 10.4 cycles per year or 1.02^10.4 = 23% interest, which
is a significant rate [1]
It would almost certainly be cheaper to pay for a factoring arrangement to achieve the
same improvement in cash flows, or better [1]
The other big problem with this recommendation is that many customers will pay after
the 30 day limit, but will take the 2% discount even though they are not entitled to it [1]

They will be aware that the consultancy might automatically apply the discount because
it will be built into its system. [1]
The firm will also be reluctant to risk the loss of client goodwill over a 2% withheld
payment [1]
In any case, the consultancy will be giving the discount to clients who would have paid
on time anyway [1]
This question was answered well by most candidates. Candidates had a good
understanding of this topic and understood the effects of offering a discount. It was good
to see candidates noted the positive and negative sides of offering the discount.
Q18
An adverse opinion means that the external auditor is warning readers that the financial
statements are so misleading that they should not be relied upon for any purpose [1]
The auditor’s role is to add credibility to the financial statements through the expression
of an opinion on whether the statements present fairly, but in this case the auditor is
quite deliberately refraining from adding credibility [1]
The shareholders will be able to read the audit report in its entirety and so decide
whether they ca adjust the financial statements to correct for the misstatement that is
concerning the auditor, but they may lack confidence in the resulting adjusted figures [1]
The directors’ credibility will be at risk because adverse opinions are very rare and so
the shareholders will be concerned that the accounts have been deliberately manipulated [1]
The fact that the directors are believed to have done so will send a very worrying signal
that the company is in difficulty or that the board lacks confidence in its management
of the business [1]
The directors will also face challenges in dealing with other stakeholders who rely on
accounting information, such as banks and other lenders [1]
This question was also answered well by many candidates. Most candidates were aware of
the effects of an adverse opinion and managed to produce a good answer.
Q19
(i)

Q
$000
Revenue 45,628 [½]
Gross profit 36,308
FORMAT [1]
Q
Statement of Changes in Equity
$000 $000 $000 $000
Opening balance 5,000 2,200 4,950 12,150 [½]
Dividends (300) (300) [½]
Closing balance 5,000 2,200 17,460 24,660
FORMAT [½]

Q
as at 30 June 2022
Notes $000
Non-current assets
Property, plant and equipment [1] 16,086

Intangible assets [2] 6,764
22,850
Current Assets
Inventory 1,890 [½]
Bank 450 [½]
7,540
Total assets 30,390
EQUITY AND LIABILITIES

Equity
Share premium account 2,200
Total equity 24,660
Borrowings 1,030 [½]
Current liabilities
Tax 4,100 [½]
4,700

FORMAT [1]

Notes
1. Property, plant and equipment
$000
Cost 21,230 [½]
Depreciation (5,144) [½]
16,086
2. Intangible assets
Cost 7,120 [½]
Amortisation (356) [½]
6,764
Workings
Cost of sales
Cost of goods sold 8,200 [½]
Manufacturing wages 1,120 [½]
9,320
Distribution
Advertising costs 2,300 [½]
Sales staff salaries 8,300 [½]
Selling expenses 1,778 [½]
12,378
Clerical staff salaries 4,200 [½]
Directors' remuneration 1,700 [½]
6,900
(ii)(a)
Even if the board intends to continue to use the patented product to manufacture the
product, there may be changes in technology or in the product that make it uneconomic
to continue to do so [1]
If the product life is overstated, then the cost of the patent will be written off at the rate
of one twentieth of its cost each year. [1]
When it becomes apparent that the lifespan was unrealistic then the company will have
to make an adjustment, perhaps writing off the remaining asset balance in a single
lump sum [1]
That could be a shock to the shareholders because the understatement of the annual
amortisation charge will have overstated their reported profits [1]
(b)
The useful life of the patent right is difficult to estimate because it is potentially unclear
how long Q will use this process for [1]

In theory, the patent has a life of 20 years, but an improved process could be
developed long before that period has elapsed [1]
There is also the possibility that the process will fall out of use because the product
range changes within that 20-year period [1]

[Total 20]
Part (i) was answered very well by most candidates. It was good to see most candidates
able to produce a set of financial statements with most items in the correct place.
Part (ii) was less well answered but many candidates scored well. Candidates could
usually come up with one or two reasons why it was so difficult to decide on the useful life
of an intangible asset.
Q20
(i)
Unsystematic risk can be reduced or even eliminated through holding a suitably
diversified portfolio of investments [1]
Unsystematic risk arises because of specific risks associated with the investment itself,
such as geological problems associated with the mine [1]
Systematic risks arise because of factors that affect all businesses, usually linked to the
economy or to markets [1]
Systematic risks cannot be completely eliminated, even through diversification,
because most if not all investments will be affected by movements in factors such as
interest rates [1]
The distinction between the risks is important because the directors should be able to
assume that the shareholders’ interests are diversified [1]
That suggests that it would be appropriate to evaluate the project on the basis of risk
as measured by its beta coefficient [1]
The determination of an appropriate required rate of return will be complicated
because it will almost certainly require the directors to identify a suitable proxy measure,
such as a mining company that operates in that same geographical region or that mines
the same ore [1]
The board might base its decision on total risk for the sake of simplicity, but that could
lead to an overstated rate that leads to the project being rejected unnecessarily [1]
(ii)
The biggest agency concern could be the fact that the directors are effectively exposed
to the total risk of the project, whereas the shareholders are exposed only to the
systematic risks, which are likely to be lower [1]
From an agency point of view, the board may be unwilling to proceed because they
could be adversely affected by risks that the shareholders have managed through
diversification [1]

For example, the cost of completing the project could be affected by changes in the
exchange rate between the currencies of the home and host countries [1]
Such a currency movement will not matter to the shareholders if they are diversified
because they will combine investments that benefit from strengthening home currency
with investments that benefit from the currency weakening [1]
The directors may be concerned that the shareholders will accuse them of recklessness
in the event of an investment and that could undermine the board’s credibility [1]
The project clearly has high total risks and there must be a significant risk that it
might fail. The board could be accused of gambling with the shareholders’ wealth [1]
From an agency point of view, the board may be concerned that their decision to
invest will be evaluated on the basis of the project’s outcome [1]
If the project is a failure, then the shareholders may accuse the board of poor judgement,
even if the information that was available at the time of the investment was analysed
logically and took account of risk [1]
(iii)
The project will have a significant impact on the local environment, with digging on
the edge of a wildlife park and the construction of a railway line through the park. [1]
The mine itself will harm the wildlife park, which could endanger habitats and affect
the viability of different animal species [1]
The approach that is being taken to mining this ore also seems to be very destructive,
with the creation of a large and ugly hole in the ground. Initially getting access to the
ore will require the excavation of a large quantity of spoil, which will have to be
dumped [1]
The company appears to have no intention of reinstating the site, which could be a
problem with regard to any tourist industry that is associated with the wildlife park. [1]
It could be argued that the responsibility for the management of the environment really
lies with the host country’s government. If M is fully compliant with the law, then it
could be argued that it is behaving ethically [1]
The investment that is being made will benefit the national economy, potentially
creating jobs for miners and paying tax on profits earned locally [1]
The railway line could also have other benefits, including access to the wildlife park for
tourists, who could further support the national economy [1]
[Total 20]
Part (i) was answered quite well. Candidates find questions of this type difficult, but it was
good to see many candidates demonstrate a good understanding of systematic and
unsystematic risk. It was common for candidates to score 4 marks for giving an example
of each and saying whether the company could diversify the risk. The other marks were a
little harder to come by, but some candidates achieved a high score.
Part (ii) was not answered very well. Candidates found it difficult to think of examples of
agency problems. Some candidates missed this question out and others gave brief

answers. There were many different agency issues that could have arisen from this project
where two parties have different views.
Part (iii) was much better answered with candidates coming up with many ethical
problems. The most common were issues with damaging the ecosystem of the park and
labour issues. Many candidates scored well in this section.
[Paper Total 100]

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EXAMINATION

Core Principles
In addition to this paper you should have available the 2002 edition of the
Formulae and Tables and your own electronic calculator.
T. 0044 (0) 1865 268 873.

1 Which of the following best explains a ‘comply or explain’ approach to codifying the
principles of sound corporate governance?
A Directors who do not comply will be fined.

B Market forces can encourage compliance.
C Stakeholders do not care about compliance.
D There is no agreement on the principles.
[2]
2 Which of the following would be a valid justification for paying the directors of a
quoted company a percentage of reported profits rather than fixed salaries?
A It would encourage better performance by the directors.

B It would encourage more accurate financial reporting.
C It would ensure that the directors are well paid.
D It would punish the directors for their mistakes.
[2]
3 Which of the following would be a suitable succession plan for the membership of a
quoted company’s board?
A A committee of non-executive directors should recruit replacement board

members.
B Non-executive directors should be promoted to vacant executive positions.
C Outgoing directors should recommend their successors.
D The Chief Executive should select a replacement.
[2]
4 A quoted company has had a policy of reinvesting profits in ongoing expansion and
has paid relatively small dividends. The company is now entering a phase where it no
longer requires funds for expansion. The directors therefore intend to start paying out
a larger proportion of profits as dividends.
Which of the following would be the most suitable approach to implementing this
new policy?
A Announce the policy change at the time of the next dividend announcement.
B Announce the policy change well before the next dividend announcement.
C Continue with the present dividend policy and allow cash to accumulate.
D Increase dividend payments without announcing a change in policy.
[2]
CB1 S2021–2
5 A private company was established 5 years ago. A family friend of the founder
contributed 10% of the initial equity. The company is now successful and solvent and
no longer needs the friend’s equity. The company's board has agreed that it will help
the friend to liquidate their investment.
Which of the following would be the most suitable means of assisting the family
friend?
A The company could pay a large dividend.

B The company could repurchase the shares from the friend.
C The company could seek a stock market quotation.
D The friend could sell their shares on the open market.
[2]
6 Jane has invented an innovative and exciting new device that will enable its wearers
to monitor their calorie intake more efficiently. She requires $200,000 to develop this
device into a marketable consumer product. To raise funds, she is considering a
crowdfunding arrangement in which potential buyers of the device will prepay for
their device in return for a 30% discount against the projected retail price.
Which of the following is an advantage of this arrangement to Jane?
A Jane is guaranteed the funding that she requires.

B Jane will receive free finance.
C There is no need to invest time and effort in raising finance.
D Traditional loans will be more complicated to arrange.
[2]
7 A quoted company has a significant loan secured against valuable land and buildings.
The company has been making losses for several years, but it is not yet in danger of
closure.
Which of the following best describes the reason for the company’s cost of debt being
high?
A The company cannot obtain tax relief on interest payments.

B The company cannot pay dividends.
C The lenders are likely to lose their principal.
D The lenders will request an increase in the rate of interest.
[2]
CB1 S2021–3
8 Which of the following best explains why the UK does not tax income from certain
types of investment, such as an Individual Savings Account (ISA)?
A Income from investments such as ISAs is difficult to measure and so tax.

B Returns paid on investments such as ISAs are too low to tax.
C Taxpayers would otherwise transfer their savings offshore.
D The UK Government wishes to encourage citizens to save.
[2]
9 Which of the following could explain a significant difference between a company’s

basic earnings per share and diluted earnings per share?
A The company has convertible debt in issue.

B The company has fixed interest bonds in issue.
C The company plans to pay a substantial dividend.
D The company has recently made a large rights issue.
[2]
10 Which of the following would NOT be disclosed in a company’s statement of

changes in equity?
A An increase in the revaluation reserve

B The payment of a dividend
C The profit for the year
D The repayment of a significant loan.
[2]
11 Explain the relevance of a decrease in a quoted company’s share price for its board of
directors. [5]
12 The directors of a quoted company plan to make a major investment in a factory that
will be used to manufacture a new product that is in development. This will be
financed by a rights issue. The company’s Finance Director believes that the share
price will fall below the theoretical ex-rights weighted average price and has warned
the board of this.
Explain the factors that would determine the share price after the rights issue. [5]
13 A quoted company merged with a slightly smaller competitor as part of an expansion

strategy, but the acquisition has failed to deliver the planned synergies.
Outline possible reasons that would explain the problems associated with this merger.
[5]
CB1 S2021–4
14 Describe the usefulness of the Earnings Before Interest, Tax, Depreciation and
Amortisation (EBITDA) figure to financial analysts. [5]
15 Explain why imposing a requirement on a company to report on its sustainability will

make little real change, unless the board wishes to behave in a socially responsible
manner. [5]
16 A major company exploited a loophole in an International Financial Reporting

Standard (IFRS) that permitted it to publish financial statements that complied with
the IFRS, but which were nonetheless misleading.
Describe the implications for the International Accounting Standards Board (IASB).
[5]
17 Explain whether businesses should aim to keep their working capital cycles as short
as possible. [5]
18 A company sells bicycles through a chain of 30 shops. Unit selling prices are set
centrally across the company. Shop managers are expected to motivate their sales
assistants and to ensure that sales revenue is maximised. They must achieve monthly
sales targets set by head office.
The company’s directors are considering a new system for encouraging shop
managers. The monthly sales targets will be withdrawn and replaced with the
publication of a monthly table that ranks the shops in terms of sales revenue. Any
shop manager who is in the bottom five places twice in a row will face dismissal.
Discuss the suitability of the proposed new system. [5]
CB1 S2021–5
19 T is an actuarial consultancy that was established 11 months ago. T is an unquoted
limited company. The company’s shares are held equally by the six founders, each of
whom is a director in the company.
T employs 50 staff in addition to the directors.
The company owns a large office building in the business district of Capital City. This
cost $2 million when it was acquired 11 months ago, but the building has recently
been valued at $2.4 million by a local property expert.
T’s directors have engaged an accounting firm to conduct the external audit of the
company’s first set of financial statements. These will cover the company’s first full
year of operation and so they have not yet been prepared. However, T’s Chief
Accountant has been gathering information and has been briefing the directors on
some of the accounting issues that have to be decided.
T’s directors have instructed the Chief Accountant NOT to depreciate the company’s
buildings because they wish the first year’s reported profits to be as high as possible.
The Chief Accountant has refused to agree to this, arguing that the building must be
depreciated if the financial statements are to comply with International Financial
Reporting Standards and pointing out that the external auditor will also refuse to agree
to this treatment.
T’s Chief Executive has asked for an explanation of the logic behind charging
depreciation on an asset that is increasing in value. They have also asked whether
recognising the building at its valuation would enhance the company’s reported
performance.
(i) Give an appropriate response, with reasons, to the Chief Executive’s request
for an explanation of the logic behind charging depreciation on T’s office
building even though it is increasing in value. [7]
(ii) Describe, with reasons, possible actions that T’s external auditor will take in
response to any refusal to depreciate the building. [7]
(iii) Describe the likely impact that revaluation of the property will have on T’s
reported performance. [6]
[Total 20]
CB1 S2021–6
20 G is a quoted company that manufactures mobile phones. The company’s directors
are considering expanding by investing in a new factory that will be designed to
manufacture gym equipment. This will incorporate smart sensors that can track users’
exercise routines.
G’s beta coefficient is 1.3, based on historical observations. The directors believe that
the proposed investment in the new factory will make G’s future cash flows more
volatile, but will have the effect of reducing beta to 1.1, ignoring the effects of
funding the investment.
The funding of the proposed investment has yet to be decided. It may be in the form
of debt or equity.
(i) Discuss the significance of the fact that the calculation of G’s present beta
coefficient was based on historical observations. [7]
(ii) Suggest possible reasons why the investment in the new factory could have the
effect of increasing the volatility of G’s cash flows while reducing its beta. [7]
(iii) Evaluate the likely effect of the choice between debt and equity for the
funding of this investment for G’s beta. [6]
[Total 20]
END OF PAPER
CB1 S2021–7
EXAMINERS’ REPORT
September 2021

Core Principles
Introduction
Sarah Hutchinson
December 2021

The aim of the Business Finance subject is to provide a basic understanding of corporate
finance including a knowledge of the instruments used by companies to raise finance and
manage financial risk and to provide the ability to interpret the accounts and financial
statements of companies and financial institutions.
taxation, net present value and project appraisal and other topics, it has both calculations
and essay type questions on these topics. The paper also examines financial reporting
including preparation of the main financial statements and interpretation of financial
statements. It also considers the basis of the preparation of statements and the information
needs of a variety of end users of financial statements. There is now some management
accounting in the syllabus so there are questions on topics such as budgeting and
performance management.

calculations but candidates are not penalised for this. However, candidates may lose
marks where excessive rounding has been used or where insufficient working is shown.
B. Comments on candidate performance i n this diet of the examination.
Performance was reasonable for many candidates. Many of the questions were answered
very well but a number of candidates appeared to be inadequately prepared, in terms of
not having covered sufficiently the entire breadth of the subject. The MCQ questions
were answered very well with high marks being achieved by many candidates. Some of
the short questions were answered well but some candidates did not answer what was
asked, most notably in Question 12, Question 19 and Question 20.
Questions corresponding to parts of the syllabus that are not frequently examined were
generally poorly answered (e.g. Q19 and part (ii) and (iii) of Q20). This highlights the
need for candidates to cover the whole syllabus when they revise for the exam and not
only rely on themes appearing in past papers.
C. Pass Mark

Q1 B [2]
Q2 A [2]
Q3 A [2]
Q4 B [2]
Q5 B [2]
Q6 D [2]
Q7 A [2]

Q8 D [2]
Q9 A [2]
Q10 D [2]
Questions 1-10 were answered well by many candidates.
Q11
The share price reflects shareholder wealth. If the share price decreases then the
shareholders suffer a loss of value [1]
The shareholders could view the decrease as a sign that the directors have failed in their
duty to maximise shareholder wealth [1]
The directors cannot necessarily be expected to maintain the share price in all
circumstances and so they may not be responsible for any decrease [1]
Companies can suffer because changing consumer tastes affect demand or economic
events affect cash flows, none of which could be prevented [1]
The directors are unlikely to hold significant amounts of shares, so there will be no
direct loss if the share price decreases [1]
They could, however, be rewarded with share options or other forms of remuneration
that reflect share prices [1]
This question was answered well by many candidates, however some candidates did not
address the question of the directors and only discussed share price.
Q12
If the directors plan to make a rights issue then there will be a dilution effect that will
reduce the share price in line with the increase in shares, offset by the injection of funds [1]
The theoretical weighted average price can be calculated on the basis of the present
share price, adjusted for the effects of the rights issue itself [1]
The theoretical price assumes that the dilution effect is the only factor that will affect
share prices after the rights issue [1]
The share price reflects the market’s expectations of future cash flows. A rights issue
usually involves raising funds for a purpose, such as raising equity finance for a project [1]
If the market believes that the investment has a negative net present value then there will
be a loss of value that will further reduce the share price [1]
Presumably, the directors believe that the project has a positive net present value, but
that does not mean that the market will necessarily agree with that view and so the
share price could decrease [1]
This question was not answered well by candidates. Many candidates used information from
the study text and other sources to answer this question and did not answer what was asked.

Q13
It may be difficult to evaluate post acquisition synergies because the bidding company
will have limited access to the target company’s records, if any [1]
The directors of the target company may wish to resist the acquisition and could refuse
to grant any access to information that would assist the bidders [1]
For example, integrating IT systems can prove difficult and it may be difficult to tell
whether there will be a problem without first having access to the target’s IT staff [1]
Synergies may prove difficult to obtain in practice if the managers at the target company
choose to resist, even after acquisition [1]
For example, the synergies might require a reduction in staffing, but the target company
staff might act to keep as many jobs as possible [1]
Even though the target company is owned and controlled, its staff may be able to
undermine any attempts to introduce operating efficiencies [1]
Q14
The EBITDA figure is a reasonable approximation to the figure for cash from operations [1]
That figure will be of value in helping analysts track historical cash flows with a view to
understanding past volatility [1]
It could be argued, though, that there is very little need to calculate EBITDA because
the cash flow statement will give a more detailed breakdown of cash flows, including
cash from operations [1]
The EBITDA figure has the advantage of reflecting operating profit without any
allowance for subjective estimates such as depreciation and amortisation [1]
The figure comprises operating activities that are reflected by transactions and so they
are less subject to distortion by manipulation of estimates and should be more readily
comparable between companies in the same industry [1]
EBITDA does, however, ignore important costs, such as depreciation, and so it could
overstate performance [1]
In general this question was answered well.
Q15
If companies are required to report on their social responsibility then they may respond
by modifying their behaviour in response in order to maintain and enhance their
reputations [1]
The directors will be aware that customers might be reluctant to buy products made and
sold by companies that behave in an unsustainable manner [1]
The shareholders may also be reluctant to own shares in companies that are operating
in a manner that is harmful to the environment [1]
Any such pressure will, however, be offset by the fact that the board’s primary duty is
to maximise shareholder wealth [1]

The shareholders may wish to encourage companies to avoid major excesses in terms
of irresponsible behaviour, but there is a limit to the extent to which they will tolerate
reduced dividends in order to achieve that [1]
Social responsibility cannot be measured and evaluated to the same extent as cash flows
from operations and so there is a limit to how much impact this will have on behaviour [1]
This question was not answered very well. Most candidates scored some marks for discussing
sustainability but few answered the question asked. Some candidates were able to show
understanding of the problems of sustainability and the link to share price.
Q16
There have been cases such as this in the past and they have been labelled “accounting
scandals” [1]
In general, they have had a significant impact on the credibility of financial reporting
and the regulators who are responsible for it [1]
The fact that the misleading financial statements do not breach the rules suggests
incompetence on the part of standard setters [1]
These cases also highlight the extent to which the subjects of accounting regulation are
prepared to go in order to manipulate their reported results [1]
The fact that accounting standards are studied closely with a view to finding loopholes
indicates that standard setters must think ahead and take much greater care in setting
standards that leave very little scope for interpretation [1]
Paradoxically, the need to prevent such behaviour could lead to standards that are more
prescriptive and that leave less room for the application of professional judgement [1]
Some candidates answered this quite well, others found this question difficult.
Q17
A short working capital cycle generally implies that fewer net assets are tied up in
working capital [1]
That is desirable because working capital does not offer any return, so funds are being
invested in a manner that generates no reward [1]
The working capital cycle can be shortened in two basic ways, by speeding up the
liquidation of current assets and the slowing down of settlement of trade payables [1]
Cash management generally requires that attention should be paid to those balances in
any case [1]
There can be risks attached to a very short working capital cycle because companies
can lose business if they press receivables too hard for faster payment or lose sales if
they have insufficient inventory to meet demand [1]
They can also lose trade credit if they delay payments to suppliers for too long [1]

This question was answered very well by most candidates.
Q18
This approach to budgeting avoids the dilemma that setting specific targets can lead to
dysfunctional behaviour [1]
The new system will overcome the natural resistance of shop managers to agree to work
towards targets that are perceived as testing and so there could be a need to invest senior
management time in imposing the targets [1]
There will also be less scope for the manipulation of revenues, such as putting less
effort into sales once the target has been met because the target could be increased even
further if a shop has a good period [1]
The new system will effectively put the different shops and their managers in
competition with one another [1]
There will be no incentive to slack or to debate performance because the targets are
essentially being set by other shops in the chain [1]
This could, however, put the shop managers under a great deal of stress, which might
damage efficiency if they are struggling to break out of the bottom part of the table [1]
This question was answered well with many candidates discussing "beyond budgeting".
Q19
(i)
The purpose of depreciation is to recognise that items of property, plant and equipment
have finite useful lives [1]
It is, therefore, appropriate to write off their book values by depreciating them in order
to recognise that their lives have been partly consumed [1]
Depreciation is about recognising an expense in the statement of profit or loss rather
than correcting the value in the statement of financial position [1]
The increase in the value of the buildings is a medium term phenomenon that will
reverse eventually when the buildings reach the ends of their useful lives [1]
The buildings will eventually deteriorate and will have a value of zero regardless of
how the property market moves in the shorter term [1]
Buildings are generally depreciated at a low rate, possibly 2% of cost, to reflect the
fact that they may have lives of up to 50 years [1]
The need to depreciate buildings has been debated and resolved by the accountancy
profession [1]
There is an accounting standard that requires all tangible non-current assets with finite
lives to be depreciated [1]
The directors cannot, therefore, decide independently that they disagree with that logic
because there are rules in place to ensure consistency [1]
(ii)

The external auditor is required to form an opinion on the truth and fairness of the
financial statements and to express that opinion in the audit report that is attached to
the financial statements [1]
As part of that duty, the auditor must review the accounting policies being applied by
the directors to ensure that they are consistent with standards and with good
accounting practice [1]
In this case, the depreciation policy is unacceptable and the auditor will have to decide
whether that leads to a material misstatement of the reported figures [1]
If the failure to depreciate does lead to a material misstatement then the first thing
that the external auditor should do is meet with the directors to explain that there is
a problem [1]
Ideally, the auditor will be able to persuade the directors to change their decision, in
which case the buildings will be depreciated and the problem will be resolved [1]
If the auditor cannot persuade the directors to change then the next step would be to
warn them that the auditor will have both a legal and professional duty to bring these
problems to the attention of the shareholders [1]
The auditor will have to insist on a modified audit opinion [1]
The failure to depreciate the buildings will overstate profit and asset values by a
material amount and so the auditor will have to make it clear that there is a
disagreement over the accounting treatment [1]
The audit report will state that the financial statements give a true and fair view
“except for” the omission of depreciation [1]
(iii)
The revaluation will increase the book value of the buildings, which will increase the
amount that has to be written off over their useful lives [1]
The annual depreciation charge is likely to increase, thereby reducing profit [1]
The only way to avoid that would be to review the estimated useful lives of the
buildings with a view to extending the life and so offsetting some of the increase in
depreciation by dividing a larger book value by a larger life [1]
The performance will also be impacted by the fact that the revaluation will increase the
revaluation reserve balance [1]
That means that capital employed is larger and so return on capital employed will be
reduced [1]
Thus, the profit figure is likely to be smaller in absolute terms and will almost
certainly be smaller in relation to the resources that have been invested [1]
[Total 20]
This question was not answered well. Candidates struggled with part (i) and few candidates
were able to say in any depth why buildings should be depreciated.
Part (ii) was not answered well, many candidates wrote everything from the study text and
other sources on different types of audit reports which did not answer the question asked.
Many candidates relied on rote learning and did not apply their knowledge to the question
asked. Some candidates gave excellent answers to this question.
Answers to part (iii) represented an improvement relative to part (ii), but few candidates

answered well, again this was mainly due to a reliance on rote learning which meant
candidates did not answer what was asked.
Those who answered well understood that depreciation would increase after the revaluation
and were able to discuss the changes in return on capital employed very well.
Q20
(i)
Beta is calculated on the basis of the apparent sensitivity of returns on this company’s
shares to changes in returns on the market portfolio [1]
That ensures that the beta calculation is based on objective observations and can be
taken over a significant period of time [1]
The basis on which beta is calculated is well established [1]
The drawback with the use of historical data is that there is no reason to believe that
beta will remain unchanged over time [1]
The economic factors that drive the capital markets might change. The company
itself might also be managed differently or be affected by a change in circumstances [1]
For example, oil prices might become less volatile, which could have an impact on the
market portfolio, but could also have a significant impact on the relative volatility of,
say, an airline that uses a great deal of oil [1]
The danger is that beta is generally used in forward-looking decisions about investing
or retaining investments [1]
If the beta coefficient is based on outdated observations then the decisions will be badly
informed and so the wrong decision may be made [1]
In this case, the decision that is being made is a long-term investment in a factory, so
the cost of unwinding an incorrect decision will be significant [1]
(ii)
The new factory would increase absolute volatility if the underlying business is highly
volatile and risky [1]
The company presently manufactures mobile phones, which are a relatively well
established and mature product and so demand should be relatively steady [1]
The new factory will make a completely new product range that may have extremely
volatile demand [1]
This is a product that has not yet been proven and so demand could fluctuate
significantly, perhaps being affected by reviews or concerns about product safety [1]
It is also possible that competing products will emerge that will rob the product of
revenue, so the greater volatility may not be entirely within the company’s control [1]
The risks associated with the new product may be largely unsystematic risks, which
means that they can be diversified away [1]
If that leaves only a small residue of systematic risk then the investment will have a
small beta [1]
The overall beta for the expanded company will be the weighted average of the betas
for the existing company plus that of the new business [1]
That means that the overall beta will decrease provided the gym equipment business
has a beta of less than 1.3 [1]

(iii)
Gearing generally increases systematic risk, which means that the use of debt will
increase beta [1]
That can be demonstrated by calculating the geared and ungeared betas for the company
[1]
The ungeared beta is basically the beta arising from the systematic risks associated with
the business activities [1]
The geared beta increases that figure to take the effect of gearing for systematic risk into
account [1]
The geared beta is calculated by multiplying the ungeared beta by the figure
(1 + debt:equity*(1-tax rate)) [1]
That value is greater than 1, so the geared beta will always be greater than the ungeared
[1]
One way to think about geared beta is that the borrowing will make the company’s
exposure to changes in economic variables even greater and so it should increase beta [1]
[Total 20]
Candidates found all parts of this question difficult. Candidates dealt with part (i) best but
most answers were very generic. A number of candidates demonstrated a very good
understanding of Beta.
Part (ii) candidates did not apply their knowledge to the scenario. Many candidates could not
apply their knowledge of beta to a scenario however, some candidates did show they
understood diversification and Beta very well which was good to see.
Part (iii) was also weak, candidates did gain some marks for discussing geared beta but in
general the answers did not score well. Some candidates were excellent and were able to
discuss geared beta well and apply it to the question asked.
[Paper Total 100]

EXAMINATION
21 April 2021 (am)

Core Principles
Time allowed: Three hours and fifteen minutes
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.

1 Why are quoted companies required to have non-executive directors on their boards?
A Executive directors are corrupt and incompetent.

B Executive directors are often inexperienced.
C Non-executive directors can fulfil a supervisory role.
D Non-executive directors require lower salaries than executives.
[2]
2 Which of the following is an agency cost?
A Board meetings
B Directors’ salaries
C External audit of a company’s financial statements
D Interest on corporate debt.
[2]
3 A parent company has a foreign subsidiary located in a host country that does not
have a double tax arrangement with the parent’s home country. The foreign subsidiary
pays regular dividends to the parent company. Which of the following will apply?
A The subsidiary will not be taxed on profits earned in its host country and the
parent will pay tax on dividends in its home country.
B The subsidiary will pay tax on profits earned in its host country and the parent
will not be required to declare the dividends as taxable income in its home
country.
C The subsidiary will pay tax on profits earned in its host country and the parent
will pay tax on dividends received in its home country.
D The subsidiary will pay tax on profits earned in its host country and the parent
will pay tax on dividends received in the subsidiary’s host country.
[2]
4 A company has issued subordinated debt securities. Which of the following reflects
the priority that would apply in the event of default?
A Mortgage loans first, followed by preference shares, then equity shares, then
subordinated debt.
B Mortgage loans first, followed by preference shares, then subordinated debt,
then equity shares.
C Mortgage loans first, followed by subordinated debt, then preference shares,
then equity shares.
D Subordinated debt first, followed by mortgage loans, then preference shares,
then equity shares.
[2]
CB1 A2021–2
5 A company with floating rate debt has entered into a swap arrangement with a
counterparty that has fixed rate debt.
What are the implications to the company of a default by the counterparty?
A Nothing will change.

B The company will be forced to pay interest on both loans.
C The company will be left with floating rate debt.
D The company’s loan will be written off.
[2]
6 A holiday company takes bookings for holidays up to a year before customers travel.
The company recognises revenue from those bookings in the same accounting period
as the costs associated with providing the holidays is incurred.
Which accounting concept is the holiday company applying?
A Accruals
B Dual aspect
C Matching
D Prudence.
[2]
7 Why do analysts disregard intangible assets when calculating net asset value per
share?
A Intangible assets have no value to the shareholders.

B Intangible assets may prove difficult to sell if the company fails.
C It is unrealistic to expect company directors to use intangible assets to create
value.
D Only tangible assets can be controlled.
[2]
8 Which of the following is a valid formula for Return on Capital Employed (ROCE)?
D
[2]
CB1 A2021–3
9 A company’s factory cost $50 million. Depreciation to date on the building is $12
million. The factory was recently valued at $55 million. What amount will appear in
the company’s revaluation reserve in respect of this revaluation?
A $5 million
B $17 million
C $38 million
D $55 million.
[2]
10 J is a quoted company that owns 5% of K, an unquoted company. J has contracts in

place that gives it the right to be involved in any decisions made by K’s directors. J
also has the right to replace K’s directors at any time. How should K be accounted for
in the J Group’s consolidated financial statements?
A As an associate
B As an investment
C As a non-controlling interest
D As a subsidiary.
[2]
11 Directors are duty-bound to maximise shareholder wealth.
Discuss the impact on this duty if they must also consider the needs of a wider range
of stakeholders. [5]
12 Describe the difficulties in deciding whether a particular quoted company is a suitable

acquisition target for a larger quoted company. [5]
13 A change in safety regulations will require a train company to fit new equipment to all
trains. The company does not believe that the equipment will reduce the risk of
accidents and it will be expensive.
Explain the usefulness of the Net Present Value (NPV) criterion in planning the
company’s response to this change. [5]
14 A quoted company has a policy of seeking an internal rate of return of at least

14% p.a. on all investments of more than €5 million. This rate was set 5 years ago.
Describe the company’s approach to capital project appraisal. [5]
CB1 A2021–4
15 A quoted company’s directors have drafted their financial statements in a manner that
they claim is realistic, despite the fact that it does not comply with International
Financial Reporting Standards (IFRS). Changing the figures to comply with IFRS
would lead to the recognition of a loss instead of the profit shown in the draft
statements.
Explain how the company’s external auditor would respond to this. [5]
16 Describe the purpose of integrated reporting. [5]
17 An actuarial consultancy invoices its clients on a monthly basis, based on the time
spent on each client. The consultancy has four major clients who often take as long as
3 months to settle any given invoice.
Explain the implications of slow payment by these clients for the consultancy. [5]
18 An actuarial consultancy has a budgetary system in place to monitor costs and

revenues. During the year ended 31 March 2021, hours charged to clients exceeded
the budget by 8%. Profit was 3% over budget, after taking account of adverse
variances on staff overtime and on office heat and light. The consultancy’s Board is
considering reducing the office manager’s bonus because of the two adverse
variances.
Describe the implications of holding the office manager responsible for the adverse
variances under these circumstances. [5]
CB1 A2021–5
19 The information provided below was obtained from Hopplo plc’s financial statements
for the year ended 31 March 2021.
(i) Calculate the following ratios for the two accounting years:
(a) Return on Capital Employed (ROCE) [2]
(b) Gross profit percentage [2]
(c) Distribution costs as a percentage of revenue. [2]
(ii) Assess Hopplo’s performance for the year ended 31 March 2021. [9]
(iii) Discuss the difficulties in assessing Hopplo’s performance on the basis of the
information provided. [5]
[Total 20]
Hopplo plc

for the year ended 31 March
2021 2020
$000 $000
Revenue 22,427 19,502
Cost of sales (7,177) (7,411)
Gross profit 15,250 12,091
Distribution costs (2,467) (1,365)
Administrative expenses (1,121) (1,170)
Operating profit 11,662 9,556
Finance costs (6,080) (3,360)
Profit before tax 5,582 6,196
Income tax expense (1,228) (1,363)
Profit for the year 4,354 4,833
CB1 A2021–6
Hopplo plc
as at 31 March
2021 2020
$000 $000
ASSETS
Non-current assets
Property, plant and equipment 181,000 146,000
Current Assets
Inventory 658 680
Trade receivables 1,869 1,625
Cash at bank 43 340
2,570 2,645
Total assets 183,570 148,645

Equity
Called-up share capital 70,000 70,000
Share premium account 20,000 20,000
Retained earnings 15,792 14,706
Total equity 105,792 104,706
Borrowings 76,000 42,000
Current liabilities
Trade payables 598 618
Tax 1,180 1,321
1,778 1,939
Total of equity and liabilities 183,570 148,645
CB1 A2021–7
20 Drentel is a quoted company that manufactures bicycles and was established many
years ago. It has been making losses for the past 5 years because its products have not
kept up with consumer tastes and sales have been declining.
Despite the losses, Drentel has continued to pay a steady dividend each year.
Drentel’s Board is considering a proposal to sell a range of battery-powered electric

bicycles, which is a major growth area in the bicycle market. Drentel’s current range
of bicycles is suitable for modification to carry an electric motor. This would require a
significant investment in order to acquire the rights to use patented manufacturing
processes and also to acquire the specialised machinery that would have to be built to
Drentel’s specifications. The investment required is equivalent to approximately 25%
of the company’s market capitalisation.
Drentel’s beta is currently 1.8. The Board believes that the beta will fall to 1.6 if the
company proceeds with the electric bicycle project.
(i) Evaluate the relevance of the decline in Drentel’s beta for the decision to
invest in electric bicycles. [10]
(ii) Discuss Drentel’s policy of maintaining its dividend payments despite losses.
[10]
[Total 20]
END OF PAPER
CB1 A2021–8
EXAMINERS’ REPORT
April 2021
Subject CB1 - Business Finance

Core Principles
Introduction
Paul Nicholas
July 2021
 Institute and Faculty of Actuaries

1. The aim of the Business Finance subject is to provide a basic understanding of corporate
finance including a knowledge of the instruments used by companies to raise finance and
manage financial risk and to provide the ability to interpret the accounts and financial
statements of companies and financial institutions.
2. This paper examines basic finance including raising funds by a variety of methods,
taxation, net present value and project appraisal and other topics. It has both calculations
and essay type questions on these topics. The paper also examines financial reporting
including preparation of the main financial statements and interpretation of financial
statements. It also considers the basis of the preparation of statements and the information
needs of a variety of end users of financial statements. There is now some management
accounting in the syllabus so there are questions on topics such as budgeting and
performance management.
3. Different numerical answers may be obtained to those shown in these solutions depending
on whether figures obtained from tables or from calculators are used in the calculations
but candidates are not penalised for this. However, candidates may lose marks where
excessive rounding has been used or where insufficient working is shown.
1. Performance was good for many candidates. Many of the questions were answered
very well. The MCQ were answered very well with high marks being achieved by
many candidates. Some of the short questions were answered well but others were
answered poorly. There were two questions where poor performance was most
noticeable, question 20 part (i) and question 12.
C. Pass Mark
1,213 presented themselves and 744 passed.

Q1 C [2]
Q2 C [2]
Q3 C [2]
Q4 C [2]
Q5 C [2]
Q6 C [2]
Q7 B [2]
Q8 C [2]
Q9 B [2]
A = 55 - 50
B = 55 - (50 - 12)
C = 50 - 12
D = 55
Q10 D [2]
Performance was very good in the MCQ; many candidates scored more than 16 marks
which was excellent.
Q11
Directors’ primary duty is to the shareholders, specifically the maximisation of shareholder
wealth [1]
That is a suitable duty because it can be readily understood and easily communicated to
stakeholders [1]
It also enables the shareholders to be confident that their wealth is being managed in a
manner that is to their financial advantage [1]
It is, however, accepted that companies should also be managed in a manner that meets the
needs of a wider range of stakeholders, including employees and society [1]
Those duties need not prevent the maximisation of wealth because they can be discharged by
complying with the spirit of rules and laws and taking account of reputational matters. It is
not, for example, in the shareholders’ interests to profit from lax health and safety that reduce
short-term costs [1]
Performance was very good in this question with a number of candidates scoring full
marks.
Q12
The biggest difficulty is that the buyer may be unable to obtain any detailed information,
beyond that which is available in the public domain [1]
The directors of the target company may be unwilling to encourage potential buyers because
their jobs and, indeed, their careers may be put at risk and so may be reluctant to provide
them with advice or support [1]
Takeovers are often motivated by the prospect of synergies between the buyer and the target,
but those can be difficult to realise [1]

Potential synergies identified before acquisition may disappear because of issues such as the
loss of expertise if the target company’s staff are unhappy and choose to resign rather than
remain with the company [1]
A further concern is that the predator’s shareholders may not understand the business case for
the takeover and so the share price might fall in the aftermath of the announcement that the
takeover is planned [1]
This question was one of the least well answered. Many candidates discussed how
goodwill was calculated which was not required and others discussed how a
subsidiary could be shown in the financial statements which was again not required.
Q13
It seems likely that the investment in the new equipment will reduce the train company’s
market capitalisation because it involves an outflow with no positive result in the form of
additional future inflows [1]
In that sense, the investment fails the NPV criterion because it appears to be a negative NPV
investment and so it should not be selected [1]
If challenged, the board could argue that the need to comply with the safety regulations
means that the revenues from the sale of tickets will become a relevant cash flow in terms of
the decision to proceed [1]
Once the regulations come into effect, the company would be forced to take its trains out of
service unless the equipment has been fitted, which almost certainly makes this a positive
NPV investment [1]
The NPV criterion would suggest that the implementation of the investment should minimise
the present value of the cash outflow. The company should delay the investment for as long
as possible, ideally allowing the modifications to be scheduled to coincide with scheduled
maintenance and servicing [1]
This was reasonably answered, however, many candidates failed to discuss that the
company was forced to invest for health and safety reasons. Many candidates wrote
generic answers on NPV.
Q14
The 14% rate is not necessarily relevant to every investment opportunity. Ideally, the
company should set a rate that takes proper account of the cost of capital and the risks
associated with the investment [1]
Having said that, the 14% rate can be justified on the basis of the outcomes of projects that
have been accepted and rejected in the past. If the company has been accepting too many
projects, or projects that have failed then the policy is not working [1]
Setting specific rates for projects would still require subjective judgements that could be
viewed as invalid with the benefit of hindsight [1]
The 14% threshold requires the company to prepare a formal statement of relevant cash flows
in order to determine an IRR, which would require detailed consideration of the assumptions
underlying the decision [1]

The 14% criterion would be relatively easy to communicate to shareholders and other
stakeholders, who would be able to consider whether that seems like a realistic target for a
company in this industry [1]
Q15
The external auditor’s duty is to evaluate and report on whether the financial statements
present fairly, so that the shareholders can establish whether the financial statements can be
trusted for decision making purposes [1]
The auditor is expected to base the evaluation on professional judgement, but that judgement
will be informed by the company’s compliance with relevant accounting regulations,
including IFRS [1]
The stakeholders who will be relying on the auditor’s opinion are likely to take it for granted
that the financial statements comply with IFRS because those form a basis for determining
whether the statements give a fair presentation [1]
The auditor will undoubtedly attempt to persuade the directors to revise the draft financial
statements so that they comply with the rules [1]
If they are unable to do so then they will be required to issue a modified audit report that will
state that the financial statements present fairly “except for” the figures that are deemed to be
misstated because of the failure to comply with IFRS [1]
This question was answered reasonably well by many candidates.
Q16
Integrated reporting aims to provide stakeholders with a broader understanding than can be
obtained from traditional financial statements [1]
It supplements the usual accounting statements and notes with non-financial information that
deals with issues that will be of interest to shareholders and also to a wider range of
stakeholder [1]
For example, the statements will give an insight into the approach taken to risk management,
which will interest shareholders primarily because of the financial impacts but will also be
relevant to the employees and customers who may be the subject of some of those risks [1]
Integrated reporting encourages company boards to consider the wider social responsibilities
that all companies have [1]
Integrated reporting requires some consideration of environmental performance as well as
wealth creation. That enables the shareholders to be better informed about the overall impact
of their companies and enables shareholders to be satisfied that they are not profiting from
harm caused to people or the environment [1]
This question was answered very well.

Q17
Slow payment by clients will disrupt cash flows and will reduce available cash. The
consultancy may have to bear additional overdraft fees and interest in order to finance its
investment in receivables [1]
Cash will have to be released from elsewhere in order to ensure that the consultancy can meet
its own commitments, which may divert funds from activities that would otherwise generate
profits [1]
Managing cash flows will distract management from the business issues associated with
running the consultancy [1]
The slow payments will also require the consultancy to waste time and effort in chasing
clients for payment [1]
Clients may decide not to make payment until they are forced to pay, so that they can benefit
from retaining cash within their own businesses [1]
This question was done reasonably well with many candidates discussing the
detrimental effects on cash flow in detail.
Q18
The issue here is that the consultancy has exceeded budgeted activity by charging more
billable hours than had been budgeted, which has also led to additional profit [1]
While those variances are to be welcomed, it appears that there have been corresponding
adverse variances in the form of overtime payments and office running costs. The manager is
likely to be very demotivated if those additional costs are regarded as inefficiencies because
the company would not have earned the extra profit without them [1]
There could be an argument that the costs should have been flexed to take account of the
additional (and welcome) activity [1]
There could be a counter-argument that the adverse variances should be at least investigated
to ensure that they were unavoidable in the context of the additional billings [1]
If adverse variances are simply disregarded then the danger is that the budgets will no longer
be viewed as the basis for spending decisions [1]
This question was answered badly. This is a fairly new topic for CB1.
Q19
(i)
2021 2020
ROCE 11,662/(105,792+76,000)= 6% 9,556/(104,706+42,000)= 7% [2]
Alternatively:
5,582/105,792= 5% 6,196/104,706= 6%
GP% 15,250/22,427 = 68% 12,091/19,502 = 62% [2]
Dist/revenue 2,467/22,427= 11% 1,365/19,502= 7% [2]

(ii)
The most important point is that the company’s ROCE declined slightly from last year,
admittedly, by only one percentage point [1]
That suggests that the directors have earned a poorer return in the resources that were made
available to them, which is a significant concern with regard to their performance [1]
Having said that, the company appears to be in a transition and so the results may require
further investigation before offering a final judgement [1]
The investment in property, plant and equipment increased significantly. Hopefully, that
investment is expected to generate further profits in the future and will lead to an increase in
ROCE [1]
In the short term, it may be that the investment in investment has depressed ROCE because
the assets have not had a full year in which to yield savings or generate revenues [1]
The ratios provided above could understate the overall performance of the company and its
board [1]
The company also appears to have modified the business model. Revenue has increase from
19,502 to 22,427, an increase of 15% [1]
That appears to coincide with an increase in distribution costs, both in absolute terms and as a
percentage of revenues [1]
The additional spend appears to have enabled the company to inflate its mark-up on sales [1]
(iii)
The financial statements do not indicate when the new assets were purchased. The
assumption is that they were acquired during the year, but they could have been purchased on
the first day of the financial year [1]
It would give a clearer indication of the capital employed if there was an indication of when
the assets were purchased and made fully operational [1]
There are no details of any changes to Hopplo’s business model [1]
If the company has changed the nature of the products that it makes and sells then the
increased gross profit % may be misleading. The increase could simply be due to the
company moving to a different market segment or even a totally new market [1]
There is no information about the industry, so we cannot obtain details about the performance
of similar businesses in the same industry for the sake of comparison [1]
[Total 20]
This question was answered reasonably well by many candidates, however, there were
also some weak answers especially in part (iii).
Q20
(i)
The beta reflects the sensitivity of returns on equity to changes in the return on the market as
a whole [1]
Generally, a lower beta equates to a lower risk for shareholders and so the decrease will be
welcomed and may lead to an increase in the share price [1]
The reduction suggests that the required rate of return on the electric bicycles is relatively
low compared to the rest of the business and so Drentel will find it easier to justify the
investment [1]
The reduction in beta suggests that the project is more likely to have a positive NPV [1]

The shareholders could, however, derive the same benefit from investing in any other
company that is investing in electric bicycles and Drentel’s Board need not necessarily invest
in this new product in order to create this benefit [1]
Beta measures risk from the perspective of the shareholders, whose investment is regarded as
a part of a diversified portfolio [1]
The decrease in beta does not mean that the project will be a low-risk investment for Drentel
itself because the company will be exposed to total risk [1]
That could leave stakeholders who cannot diversify, such as employees, exposed to the risk
of significant loss [1]
Total risk could be very high even if beta is low because a low beta simply means that the
returns on an asset are not well correlated with the returns on the market as a whole [1]
The directors could be taking a significant risk with their own careers if they make this
investment and it proves unsuccessful [1]
(ii)
If a company is making losses then dividends have to be funded from profits earned in
previous years [1]
Those retained earnings could be viewed as a long-term source of funding that was set aside
to finance future growth, but is now being used to finance dividend payments [1]
Paying dividends from retained earnings is not sustainable in the long term. It erodes the
funds available for investment [1]
It also implies that the directors have no strategies in place to put those funds to use in order
to address the losses [1]
The company will, eventually, run out of distributable reserves. More worryingly, it may run
out of cash before the distributable reserves have been exhausted [1]
The fact that the directors are maintaining the dividend could, however, be viewed as a signal
of confidence [1]
The fact that the ongoing payments can only be sustained if the company returns to profit
implies that they have an idea of how they are going to address the predicament that they find
themselves in [1]
The fact that this signal is costly because it could cost their reputations if they cause the
company’s collapse through such a strategy makes the signal all the more credible [1]
The existing shareholders may be willing to retain their shares, and so reduce downward
pressure on the share price, because they are willing to speculate on the continuing dividend
stream [1]
If the directors can, indeed, maintain those payments then the shares will have value for that
alone [1]
[Total 20]
In general part (i) was weak; this part was missed out by some candidates and many
did not achieve a high mark. Finance questions are often answered badly.
There was a general lack of understanding of beta.
Part (ii) was answered very well by most candidates.
[Paper Total 100]

EXAMINATION
01 October 2020 (am)

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

1 Which of the following best summarises the attitude that the directors of a quoted
company should take towards social responsibility?
A Social responsibility can and should constrain the creation of wealth.

B Social responsibility is just as important as the maximisation of shareholder
wealth.
C The directors should place social responsibility before their own interests.
D The directors should take care to ensure that they are seen to be socially
responsible, even if they are not.
[2]
2 How should the directors of a quoted company view agency problems?
A Agency problems are inevitable and so they should be ignored.

B Agency problems are perceived, but do not exist in reality.
C Agency problems concern the shareholders and not the directors.
D Agency problems may be reduced through transparency and accountability.
[2]
3 In many countries, capital gains are not taxed until the assets on which the gain
has arisen are sold. Which of the following is the most logical explanation of this
practice?
A It assists taxpayers in their tax planning.

B It ensures the maximum possible revenue into government funds.
C It is easier to determine an objective tax expense.
D It is unfair to tax capital gains.
[2]
4 Which of the following best explains why many countries do not allow depreciation to
be treated as an expense for tax purposes?
A Depreciation is not a real expense.

B The calculation of depreciation allows too much discretion.
C The tax treatment of depreciation maximises the revenue from corporate tax.
D There is no relationship between depreciation and cash flows.
[2]
5 Why might a manufacturing company’s return on capital employed be overstated

during times of inflation?
A Competitors will increase selling prices.

B Depreciation on property, plant and equipment may be understated.
C Employee wages will decline in spending power.
D Sales revenue will be overstated.
[2]
CB1 S2020–2
6 A wholesaling company has “prebooked” sales by recording revenues that will not be
earned until the first month of the following financial year. Which of the following
statements best describes the impact that this will have on the analysis of the
company’s financial statements for this year?
A Both sales and cost of sales will be overstated, so the accounting ratios will not
be affected.
B Inventory will be understated and trade receivables overstated.
C Profit and cash will be overstated.
D Profit will be overstated, but return on capital employed will be unaffected.
[2]
7 An insurance company’s financial statements show a conservatively high valuation of

liabilities in respect of insured risks. Which of the following best explains this?
A The directors wish to manipulate future profits.

B The external auditor has been negligent.
C The directors wish to manipulate the company’s tax bill.
D The nature of the industry makes such a valuation prudent.
[2]
8 You are reviewing the financial statements of several major retailers. One company
has a relatively high asset utilisation ratio and a relatively low profit margin. How
should this be interpreted?
A The company has a relatively high return on capital employed.

B The company has a relatively low return on capital employed.
C The company sets high prices in order to maximise profit.
D The company sets low prices in order to increase sales volume.
[2]
9 What is implied by a beta of zero on a potential investment?
A The investment is high risk.

B The investment is risk free.
C The investment will make a diversified portfolio less sensitive to movements
on the market.
D The investment will make a diversified portfolio more sensitive to movements
on the market.
[2]
CB1 S2020–3 PLEASE TURN OVER

10 In times of inflation:
A both real and nominal rates required from projects will be increased.
B both real and nominal rates required from projects will be unaffected.
C real rates required from projects will be increased, but nominal rates will be
unaffected.
D real rates required from projects will be unaffected, but nominal rates will be
increased.
[2]
11 Describe how guidance such as that contained in the UK Corporate Governance Code
might reduce concerns arising from agency theory. [5]
12 Describe how a company might determine whether it has the necessary “significant
influence” required to classify another company as an associate. [5]
13 A company has traditionally evaluated projects on the basis of their net present value
(NPV).
Discuss the advantages of extending project evaluation to include strategic fit as an

additional factor in investment appraisal. [5]
14 A commercial bank recently rejected a loan application from a large company. The
loan would have been secured by a specific charge against property that was worth at
least twice the amount borrowed, but the bank rejected the application on the grounds
that the risk of default on the loan was too high.
Discuss the bank’s decision to reject the loan application in these circumstances. [5]
15 A quoted company bases investment decisions on the internal rates of return (IRR)
offered by potential projects. In order to be accepted, a project’s IRR must be greater
than 12% per annum.
Discuss this investment criterion. [5]
CB1 S2020–4
16 Discuss the proposition that the cost of equity is zero for an unquoted company
because there is no observable share price. [5]
17 Discuss the proposition that the needs of all users of financial statements can be
satisfied by a single set of financial statements. [5]
18 Explain the relevance of a qualified audit opinion in which the external audit report
stated that the financial statements gave a true and fair view, except for a specified
disagreement over an accounting choice made by the company’s board. [5]

19 The information provided below was obtained from Dosco plc’s bookkeeping records
on 31 March 2020.
(i) Prepare Dosco plc’s financial statements in a form suitable for publication:
• statement of profit or loss [9]

• statement of changes in equity [2]
• statement of financial position. [4]
(ii) Discuss the implications of the loss on revaluation of property for Dosco’s
shareholders. [5]
[Total 20]
Dosco plc
List of balances as at 31 March 2020
$000
Administrative expenses 939
Cash at bank 155
Borrowings (long term) 361
Directors’ remuneration 1,366
Dividends paid 101
Interest on borrowings 44
Manufacturing costs 1,734
Manufacturing materials – inventory at start of year 614
Manufacturing purchases 4,003
Manufacturing wages 1,120
Plant and equipment – accumulated depreciation 939
Plant and equipment – cost 7,081
Property – accumulated depreciation 1,543
Property – cost 3,251
Revenue 16,927
Sales salaries 890
Selling expenses 888
Share capital 1,626
Share premium 434
Trade payables 184
Further information:
(1) Inventory was counted at 31 March 2020 and was valued at $740,000.
(2) Manufacturing costs exclude $50,000 of compensation that will be paid in

June 2020 to employees who were injured in an industrial accident.
(3) Property was valued at $1,500,000 on 31 March 2020. That valuation is to be

incorporated into the financial statements.
(4) Corporation tax of $1,337,000 is to be provided for the year.
CB1 S2020–6
20 Pantro manufactures laptop computers. The company was established 20 years
ago and has always had its factory in its home country. Pantro exports its products
worldwide.
Pantro’s directors are considering relocating production to a developing country that

has suitable infrastructure, including excellent transport links, but much lower labour
costs than the company’s home country. The potential host country’s government is
prepared to offer generous grants and tax incentives to encourage Pantro to relocate.
Much of Pantro’s production is mechanised, although the final assembly and packing
of laptops is labour-intensive.
(i) Identify the two most significant risks arising from the relocation of
production, giving reasons for their selection and recommending a suitable
mitigation for each. [10]
(ii) Suggest the two most significant problems that will arise in budgeting
for labour costs at the new factory, giving reasons for their selection and
recommending a response to each. [10]
[Total 20]
END OF PAPER
CB1 S2020–7
EXAMINERS’ REPORT
September 2020

Core Principles
Introduction
Mike Hammer
December 2020

Subject CB1 (Business Finance – Core Principles ) – September 2020 – Examiners’ report

1. The aim of the Finance and Financial Reporting subject is to provide a basic
understanding of corporate finance including a knowledge of the instruments used
by companies to raise finance and manage financial risk and to provide the ability
to interpret the accounts and financial statements of companies and financial
institutions.
2. This paper examines basic finance including raising funds by a variety of

methods, taxation, basic management accounting, net present value and project
appraisal and other topics, it has both calculations and essay type questions on
these topics. The paper also examines financial reporting including preparation of
the main financial statements and interpretation of financial statements. It also
considers the basis of the preparation of statements and the information needs of a
variety of end users of financial statements.
3. Different numerical answers may be obtained to those shown in these solutions

depending on whether figures obtained from tables or from calculators are used in
the calculations but candidates are not penalised for this. However, candidates
may lose marks where excessive rounding has been used or where insufficient
working is shown.
B. Comments on candidates’ performance in this diet of the examination.

Many candidates performed very well in this exam. The Multiple Choice
Questions (MCQs) were done reasonably well. The short response questions were
reasonable, some were answered very well and others, usually where application
was required, were answered not that well. Performance in Question 19 was very
good with many candidates scoring a high mark, the question was on preparing
financial statements. Performance in Question 20 was a little weaker than 19. The
question was divided into two parts, part i on risk was done quite well but part ii
was on budgeting for labour for a new venture overseas and was done not that
well by most candidates.
The area in which candidates’ performance was the weakest was finance, this is
often the case with this exam.
Candidates were good at questions which mainly tested knowledge but were a
little weak on application of knowledge to scenarios.
Having said that, the results were in line with previous diets and many candidates
performed very well.
C. Pass Mark
The Pass Mark CB1 was 58.
CB1 S2020 ©Institute and Faculty of Actuaries

Solutions for Subject CB1 September 2020
Q1 A [2]
Q2 D [2]
Q3 C [2]
Q4 B [2]
Q5 B [2]
Q6 B [2]
Q7 D [2]
Q8 D [2]
Q9 C [2]
Q10 D [2]
Questions 1-10 were generally well answered by candidates. Many candidates achieved a
high mark.
Q11
Codified statements demonstrate the commitment of regulators to addressing governance
Issues [1]
Stakeholders should be reassured that agency problems have been identified as a problem and
will be dealt with through regulation [1]
Setting the standard requires a public debate about the extent to which rules should be
imposed. Interested parties can contribute to that debate [1]
The statements also provide an easily understood benchmark against which the quality of
governance can be measured. If a company claims to be compliant then that claim can be
verified [1]
Codified statements set a minimum acceptable standard for behaviour, or require companies
to explain explicitly to shareholders why they are taking a different approach.
[1]
Stakeholders can be reassured that the directors are sufficiently committed to sound
governance to meet, or even exceed, the codified rules [1]
Codified guides can address common areas where agency problems might arise, such as
directors taking excessive remuneration. [1]
This question was generally well answered by many candidates. Some discussed the
governance guidance in detail which was awarded marks. The main problem with some
weaker answers was candidates quoting the governance guidance and not really
answering the question.
Q12
Significant influence can be difficult to identify because, by definition, it is less definite than
control [1]

If an entity is under the control of another then it is a subsidiary [1]

Significant influence implies more than simply having the right to vote at general meetings,
because that relationship would imply a simple investment [1]
In general, significant influence is implied by ownership of between 20% and 50% of
equity [1]
That is not, however, sufficient in itself to determine significant influence. The shareholder
must also be able to demonstrate that it has some influence over strategic decisions [1]
One way to do that would be to have the right to appoint a director, who can speak during
board meetings and can vote, but who does not have outright control [1]
This question was asnwered badly by most candidates. Candidates could not discuss
significant influence in any depth and tended to discuss subsidiaries and consolidations in
general terms and did not really answer what was asked.
Q13
The biggest advantage of adding strategic fit would be that the company would be more open
to projects that could have the potential to increase wealth, even if that cannot be
demonstrated through NPV calculations [1]
For example, a potential investment could have a negative NPV, but it could also create
scope for the entity to exploit potential opportunities that might arise in the future [1]
One example might be the acquisition of a supplier of an important material. If that material
becomes scarce in the future then the company will have a guaranteed supply [1]
Strategic fit would also help with capital rationing decisions [1]
If the company cannot afford to finance all of the positive NPV projects that are available to
it then it might make sense to focus on those that might offer synergies that can have a wider
value across the entity [1]
It will also make it more difficult for managers to seek investments that are intended to use
up capital investment budgets if they have to show that there is a strategic value beyond
NPV [1]
This question was answered very well by many candidates. Candidates demonstrated a
good knowledge of NPV and understood that sometimes strategic fit could also be taken
into account when assessing projects.
Q14
The specific security against the property means that the bank would not be subject to any
risk of the loss of principal [1]
In that case, it could be argued that it would be short-sighted to turn down the lending
opportunity [1]

Having said that, the bank would not wish to be responsible for the foreclosure of a loan that
could put a customer out of business [1]
Doing so would create the impression that the bank is greedy and uncaring [1]
The availability of security cannot ever be the only consideration. Apart from anything else,
if the customer could not be expected to make all payments on time there will be costs
associated with managing the account [1]
Payments will have to be chased and negotiated [1]
The foreclosure itself would also leave the bank holding the asset pledged as security and
having to find a buyer [1]
There is also a risk that the property will decline in value, leaving the bank with insufficient
to recover its loss [1]
[Marks avalabile 8, maximum 5]
This question was not answered as well as other questions. Candidates did not have many
ideas as to what would put a lender off lending to a business.
Q15
The first thing is that IRR does make allowance for the time value of money, which is a key
consideration in terms of linking the investment decision to shareholder wealth [1]
IRR is a valid basis for accepting or rejecting projects provided it can be established that the
IRR is greater than the cost of capital [1]
IRR is not, however, an ideal basis for choosing between mutually exclusive projects [1]
A project with a higher IRR could be limited by a short life or a low initial investment and so
it may not be the one to maximise shareholder wealth [1]
Setting a fixed IRR target of 12% ignores the possibility that different projects have different
risk characteristics [1]
It is possible that 12% is too low a target for some projects and too high for others [1]
That could be taken into account by considering qualitative issues associated with risks and
non-financial criteria such as strategic fit [1]
This question was one of the questions which was answered not very well. Candidates found it
difficult to write much for this question. Candidates often moved on to discuss NPV which was
not required.
Q16
The company’s shares will have a value that will be affected by the returns on offer to the
shareholders, regardless of whether the shares are quoted or not [1]
The directors must offer the shareholders an adequate return on their shares, otherwise the
shareholders will respond adversely [1]
For example, the shareholders may be more open to offers to buy a controlling interest in the
event that the company offers a poor return [1]

With quoted companies, an inadequate rate of return will lead to a decline in the share price
so that the market obtains the rate that it deems appropriate. With unquoted companies, the
shareholders may have to take slightly more extreme measures. For example, they may
penalise the directors for failing to offer an adequate return [1]
They may vote against salary increases or may even vote directors out of office [1]
Overall, the required rate of return is implicit in every company’s equity finance but it is
more difficult to observe it directly in the case of an unquoted company [1]
This question was answered badly by many candidates but very well by others. There were
some reasonable marks for this question as well as some very low marks. Candidates
wrote very short answers which tended to discuss quoted companies rather than small
unquoted companies.
Q17
Different users are interested in different matters relating to the company. For example,
lenders are primarily interested in the security of their loans and so they need to have a clear
understanding of the financial position and the cash flows [1]
Shareholders are in a slightly different position, being interested primarily in profitability and
the ability to pay dividends [1]
The differences between users may be open to exaggeration. For example, the shareholders
are likely to be interested in most of the issues that concern the lenders, even if some of those
issues are less important to them [1]
A set of financial statements that was drafted with the shareholders in mind would probably
offer sufficient information to meet the lenders’ needs too [1]
Many users are also in a position to interact with the company and to supplement the
information that is published [1]
For example, lenders can make the provision of specific information a condition of advancing
a loan, so they will not be affected by setting accounting requirements that are primarily
directed at other users’ needs [1]
This question was answer quite well by many candidates. Most candidates could discuss
the needs of users of financial statements well.
Q18
In itself, this form of audit report suggests that the users of the financial statements, primarily
the shareholders, must decide between two figures [1]
The qualified report will state the nature of the auditor’s disagreement and will quantify its
effects on profit and financial position [1]
Financial reporting is a professional activity that involves subjective judgement and so there
is never a single “correct” set of figures, but the fact that the auditor has offered an alternative
to the directors’ estimates suggests that users should take care in reading the financial
statements [1]

It is unusual for auditors to find it necessary to disagree because they usually resolve any
differences privately through negotiation with the directors [1]
The fact that such an agreement could not be reached suggests that there could be concerns
about the directors’ motivation [1]
For example, the company might have been forced to distort its statement of financial
position in order to avoid breach of a debt covenant [1]
This question was not answered very well with candidates discussing auditing and audit
reports in general rather than the specifics of the question. Many candidates wrote enough
to pass but did not achieve a high mark.
Q19 (i)
Dosco plc
$000
Revenue 16,927 [½]
Gross profit 9,938
[1]
Dosco plc
Statement of Changes in
Equity
£000 £000 £000 £000
Opening balance 1,626 434 1,610 3,670 [½]
Dividends (101) (101) [½]
Closing balance 1,626 434 5,983 8,043
[½]

Dosco plc
as at 31 March 2020
Notes $000
Non-current assets
Property, plant and equipment [1] 7,642
Current Assets
Inventory 740 [½]
Cash at bank 155 [½]
2,333
Total assets 9,975

Equity
Share premium account 434
Total equity 8,043
Borrowings 361 [½]
Current liabilities
Provision for compensation 50 [½]
Tax 1,337 [½]
1,571

[1]

Notes
1. Property, plant and

equipment
Plant and
Property equipment Total
$000 $000 $000
Cost or valuation
At 31 March 2020 1,500 7,081 8,581 [½]
Depreciation
At 31 March 2020 - 939 939 [½]
Net book value
At 31 March 2020 1,500 6,142 7,642
Workings
Cost of sales
Manufacturing costs 1,734 [½]
Opening inventory 614 [½]
Purchases 4,003 [½]
Wages 1,120 [½]
Closing inventory (740) [½]

Compensation 50 [1]
Loss on revaluation 208 [1]
6,989
Property - cost 3,251
Property - depreciation (1,543)

1,708
Valuation 1,500
Loss on valuation 208
Distribution
Sales salaries 890 [½]
Selling expenses 888 [½]
1,778

Expenses 939 [½]
Directors' remuneration 1,366 [½]
2,305
[Total 15]
(ii)
The loss on revaluation reflects a decrease in the fair value of the property. That suggests that
its market value has decreased [1]
It could be argued that this means very little to the shareholders if the company does not
intend to sell the property because it will still retain its ability to generate future cash flows
for Dosco [1]
The only immediate concern is that the decrease will reduce the collateral that is available to
potential lenders and so Dosco’s borrowing capacity may be diminished [1]
The recognition of the loss on revaluation as an expense could confuse the readers of the
financial statements [1]
The profit for the year has diminished in order to complete the bookkeeping entries for the
loss on valuation, even though that loss does not necessarily reflect Dosco’s trading
activities [1]
While the loss will reduce this year’s profits, it will have the effect of reducing depreciation
in future years and so reported profit will increase. That could have the effect of making the
shareholders believe that performance has improved [1]
The loss will also reduce equity, which will increase the gearing ratio, even though the cost of
servicing existing debts will not be any more onerous [1]
[Total marks available 7, maximum 5]
Part i of this question was answered very well by most candidates.

Part ii was done less well and sometimes missed out all together. Usually answers were
too brief.
Q20 (i)
There may be adverse social and political consequences to this move [1]
Pantro will be making its workforce redundant and the company will be viewed as severing a
significant tie to its home country [1]
That could lead to a decrease in future revenues if buyers feel the need to buy their laptops
from an alternative supplier [1]
Pantro might mitigate that risk by focussing on the need to remain competitive, given that
laptops are essentially a commodity product and the market is price sensitive [1]
The fact that the company will remain headquartered in its home country means that it will be
contributing to its home economy through paying tax [1]
It will also be providing employment opportunities in a developing country where
opportunities might otherwise be scarce [1]
There could be concerns about product quality, arising from the fact that a new workforce is
being employed in a newly established factory [1]

That could be due in part to the learning curve in the early stages of production and also to a
lack of staff commitment to the company in the early stages [1]
If Pantro develops a reputation for poor quality then it could lose a great deal of goodwill and
its sales volumes could take a very long time to recover [1]
This risk could be avoided by building up a stockpile of laptops to cover the period
immediately after the transition to the new factory [1]
The new production process could then be subject to the highest possible scrutiny, with
extensive testing of all output [1]
If necessary, sub-standard machines could then be rectified or even scrapped, with feedback
to the production staff [1]
(ii)
The most immediate problem may be in establishing the number of employees who will
actually be required [1]
If they lack the necessary skills to operate at the rates that their predecessors from the home
country achieved then Pantro may require more employees than they had before [1]
There may also be a high staff turnover because other employers may be coming into the
country and offering better rates of pay or terms and conditions and that could require
additional appointments to act as a buffer [1]
The most immediate response to this would be to develop aptitude tests for potential
appointees to ensure that they can master the assembly tasks [1]
Pantro should monitor the markets carefully and should ensure that it matches the rates and
working conditions that are offered by competitors for staff [1]
Minimising staff losses through avoiding dismissal and resignation will give Pantro a clearer
basis for planning and budgeting staff numbers [1]
The hourly rates paid to staff could be difficult to predict because of changes in the local
economy [1]
An influx of new employers, attracted by the government incentives, could create an
unhealthy competition for new starts, forcing up rates [1]
The potential to save employment costs could be undermined, as has happened with many
developing countries in the past [1]
Pantro could start with its own economic forecasts concerning basics such as rates of
unemployment, cost of living, etc [1]
If the host country has large numbers of potential employees so that there is little immediate
prospect of full employment then hourly rates will be easier to predict with some
certainty [1]
If the local economy is likely to see rising living costs because of, say, housing shortages then
rates of pay will almost certainly increase because of a rising cost of living [1]
In part i marks were awarded whatever two risks were discussed as long as they were
reasonable. Candidates did well in this part of the question.
Candidates did not answered very well part ii of this question. Marks were fairly low for
this question. Candidates failed to link the idea of budgets and labour costs convincingly.
This question required application not just knowledge and candidates always find that
difficult.


EXAMINATION
06 May 2020 (am)

Core Principles

1 Why would the directors of a quoted company spend more than necessary on their
external audit?
A Auditors are greedy and will overcharge if they can.

B Company directors do not understand the pricing of audit services.
C Finance directors are frequently recruited from the external audit firm.
D To signal that the financial statements are credible in the face of agency
concerns.
[2]
2 How can the directors of quoted companies deal with the different risk preferences of
the many shareholders who have invested in their companies?
A By aiming to maximise market capitalisation

B By maximising expected returns, regardless of risk
C Through minimising risk as much as possible
D By seeking feedback from shareholders.
[2]
3 Which of the following would be a suitable duty for a non-executive director?
A Development of a business plan to support application for bank funding

B Participation in the selection of executive directors
C Selection between major mutually exclusive projects
D Selection of the principal supplier for key raw materials.
[2]
4 An actuary has prepared a computer model to simulate a complex project’s outcome.

The model’s logic has been reviewed carefully. The following table shows the
simulation results.
Average net
Number of runs
present value
5,000 +$50 million
10,000 –$70 million
20,000 +$2 million
What should be concluded from these results?
A Projects should not be evaluated on the basis of simulations.

B The decision to proceed should be based on the return of +$2 million.
C The required rate of return has been set too high.
D The simulation needs to be run many more times.
[2]
CB1 A2020–2
5 A company has $10 million available for investment. It is considering investing in
three individual investment projects:
Initial investment Net present value

Project One $4 million $9 million
Project Two $2 million $3 million
Project Three $7 million $11 million
What would be the opportunity cost of investing in Project One?
A $2 million
B $5 million
C $11 million
D $14 million.
[2]
6 The directors of a company are considering investing in a machine that will cost
$38 million. The machine will have a useful life of 5 years. The cost of capital is 10%
p.a.
The directors have determined that the annual capital charge of this machine is $10
million. The machine will generate revenues of $14 million and will require annual
running costs of $1.5 million.
A The annual capital charge method indicates that the company should invest in
the machine because it will increase shareholders’ wealth.
B The annual capital charge method indicates that the company should invest in
the machine, but it does not indicate that the investment will increase
shareholders’ wealth.
C The annual capital charge method indicates that the company should not invest
in the machine because doing so will reduce shareholders’ wealth.
D The annual capital charge method indicates that the company should not invest
in the machine, even though the investment will increase shareholders’ wealth.
[2]
CB1 A2020–3 PLEASE TURN OVER

7 Why would the directors of a quoted company pay close attention to the company’s
draft financial statements?
A The directors are unlikely to understand the financial statements.

B The external auditor cannot be trusted to check the draft financial statements
properly.
C The information obtained from the company’s internal management accounts
is unreliable.
D The shareholders will use the financial statements to evaluate the directors’
stewardship.
[2]
8 A quoted company made a significant bond issue. Which of the following statements
is correct?
A The company’s beta coefficient will remain unchanged after the bond issue,
until the passage of time indicates whether beta has increased or decreased.
B The company’s beta coefficient will increase after the bond issue.
C The company’s beta coefficient will decrease after the bond issue.
D The company’s beta coefficient will only change if the company continues to
earn taxable profits after the bond issue.
[2]
9 How should an investor evaluate a security that has a beta value of zero?
A The security has zero risk.

B The security has an extremely high risk.
C The security offers a return that is not affected by movements of the market as
a whole.
D The security offers a zero return.
[2]
10 Which of the following best explains the fact that a consolidated statement of
financial position does not show a figure in respect of non-controlling interest?
A All of the subsidiaries are wholly owned by the parent company.

B None of the subsidiaries were acquired as going concerns.
C The group has no associated undertakings.
D The parent company has a widespread shareholding.
[2]
11 Explain the role of share prices in managing the behaviour of the directors of quoted
companies. [5]
CB1 A2020–4
12 The directors of ABC, a manufacturing company, evaluate projects using the payback
method. The directors are reluctant to switch to the net present value criterion and are
justifying their reluctance on the basis that the company has grown steadily since it
was founded 20 years ago.
Describe the relevance of the payback criterion to ABC. [5]
13 Explain the most appropriate ways of mitigating the reputational risks associated with
manufacturing and selling unhealthy food products, such as sweets. [5]
14 International Accounting Standards identify relevance as a desirable characteristic for

accounting information.
Describe whether accounting for property, plant and equipment at historical cost less
depreciation results in a valuation that lacks relevance. [5]
15 The United Nations defines sustainable development as ‘development that meets the
needs of the present without compromising the ability of future generations to meet
their own needs’.
Describe the difficulties associated with preparing a useful sustainability report for a
quoted company. [5]
16 Describe the relevance of International Financial Reporting Standards (IFRS) to

external auditors. [5]
17 An actuarial consultancy has prepared a cash flow forecast that shows that its bank
overdraft will increase steadily for 6 months, reaching a final figure of $87,000. Fees
from scheduled work will then start to flow in and the overdraft will decrease steadily
for 6 months until it is cleared. Unfortunately, the consultancy’s overdraft limit is
$50,000.
Explain how the consultancy should deal with its expected cash flows. [5]
18 A private company’s directors collectively own 100% of the company’s share capital.
For the past 3 years the company has paid an annual dividend equal to the annual
profit after tax.
Describe the implications of this dividend policy. [5]

19 Parent is a major quoted financial services company. It has a wholly-owned
subsidiary (Sub) that provides actuarial services to the other companies in the group.
Sub employs 94 qualified actuaries, plus 110 support staff. These numbers include 18
senior managers who are responsible for Sub’s management. Sub operates from an
office space within Parent’s head office.
Sub’s annual running costs are approximately $20 million, including an annual
internal charge of $2.5 million made for the use of the office space.
Sub’s senior management team has held an initial meeting with Parent’s Board to
discuss the possibility of a management buyout of the subsidiary by its senior
managers. Parent’s Board has agreed, subject to the following terms:
 The senior management team would pay $4 million for Sub.

 Sub would continue to provide all of Parent’s actuarial services under contract for 4
years, at an annual fee of $16 million. That contract would be renegotiated at the end
of year 4.
 Sub would be permitted to remain in the office space for 18 months without charge
but would be required to vacate the space at the end of that time.
 Sub would retain all the IT equipment and office furniture.
The senior management team could raise $1.8 million by investing $100,000 each
from their personal savings and by remortgaging their homes. They will each take
equal shares in the company and will retain 100% ownership between them.
(i) Discuss the advantages and disadvantages of this management buyout

arrangement to Sub’s senior management team. [8]
(ii) Describe the advantages and disadvantages of this management buyout

arrangement to Parent. [6]
(iii) Discuss whether it would be preferable to permit Sub’s other employees to

buy shares in the company. [6]
[Total 20]
CB1 A2020–6
20 Vonder is a major quoted company that manufactures tyres. The company’s annual
report for the year ended 30 June 2020 was released yesterday. The following
summary was included in the business pages of this morning’s newspapers:
Current year Last year

$ billion $ billion
Operating profit 48 44
Book value of equity 362 351
Market capitalisation of equity 447 427
Non-current liabilities 350 240
The newspaper article referred to the fact that the figures take account of a new
factory that cost Vonder $150 billion when it took possession in May 2020. The
purchase was paid for using debt that was raised on the date of acquisition.
Vonder’s CEO is concerned that the company’s shareholders will misunderstand the
company’s Return On Capital Employed (ROCE) for the year ended 30 June 2020.
(i) Explain the relevance of the book value and the market capitalisation of equity
for the calculation of Vonder’s ROCE. [8]
(ii) Discuss the implications of the investment in the new factory for Vonder’s
ROCE. [7]
(iii) Discuss the implications of a misunderstanding of ROCE for Vonder’s share

price. [5]
[Total 20]
END OF PAPER
CB1 A2020–7
EXAMINERS’ REPORT
April 2020
Subject CB1 - Business Finance - Core Principles
Introduction
Mike Hammer
July 2020


Subject CB1 - Business Finance - Core Principles - April 2020 - Examiners’ report

1. The aim of the Finance and Financial Reporting subject is to provide a basic
institutions.
2. This paper examines basic finance including raising funds by a variety of methods,
taxation, basic management accounting, net present value and project appraisal and
other topics, it has both calculations and essay type questions on these topics. The
paper also examines financial reporting including preparation of the main financial
statements and interpretation of financial statements. It also considers the basis of
the preparation of statements and the information needs of a variety of end users of

the calculations but candidates are not penalised for this. However, candidates may
lose marks where excessive rounding has been used or where insufficient working
is shown.
B. Comments on student performance in this diet of the examination.
Many candidates performed very well in this exam. The MCQs were done quite
well. Some of the short response questions were done very well but some of the
questions were poorly answered. Performance in Question 20 was poor. The
question was divided into three parts and they were all done quite badly. The
question was on company performance and the ROCE ratio in particular.
The area which candidates’ performance was weakest was finance, this is often the
case with this exam.
Candidates were good at questions which mainly tested knowledge but were a little
weak on application of knowledge to scenarios.
Having said that the results were in line with previous diets and many candidates
were very good.
C. Pass Mark
The pass mark for this exam was 57
774 candidates presented themselves and 462 passed
CB1 A2020
Solutions
Q1 D [2]
Q2 A [2]
Q3 B [2]
Q4 D [2]
Q5 C [2]
Q6 A [2]
Q7 D [2]
Q8 B [2]
Q9 C [2]
Q10 A [2]
[Total 20]
Q1-10 were done well by many candidates. A few candidates achieved full marks which
was excellent.
Q11
 Share prices reflect the market’s expectations of future cash flows, which is a
reflection of both the business and the manner in which it is being managed [1]
 If the directors’ management is dishonest or incompetent then the share price will
decrease, which may prompt questions about the quality of management [1]
 Share prices are generally driven by informed and competent investors, but all
shareholders can interpret the decline of the share price as “bad news” and can
consider whether a change of direction might be required [1]
 The ultimate sanction for poor share price performance is that the company will be
regarded as a prime candidate for takeover [1]
 Poorly performing directors could find that a predator believes that it would be
potentially profitable to offer a premium over the share price in order to take control
and to manage the company more efficiently [1]
 Directors may receive shares as part of their remuneration packages. If so, they will
have a direct incentive to act in the shareholders’ interests in order to maximise the
value of their personal shareholdings [1]
[6, Max 5]
Many candidates demonstrated a good understanding of the factors that drive share
prices. Candidates were less aware of the link between share price and directors’
performance. There were, however, some very good answers.
Q12
 The payback criterion does not make a full allowance for the time value of money [1]
 or for risks and rewards associated with cash flows after the payback period has
elapsed [1]
 The criterion is not, therefore, necessarily consistent with the basic criterion of
maximising shareholder wealth [1]
CB1 A2020
 Despite that, it is realistic to suggest that a project that has a short payback period is
likely to have a positive NPV and so it may be a satisfactory basis for identifying
satisfactory projects [1]
 ABC may also operate in a relatively low-risk industry and so have a low required
rate of return on projects, in which case there is less risk of payback being misleading
[1]
 The fact that the criterion has been used for many years does not, in itself, mean that it
has been successful. For example, the company could have invested in a number of
negative NPV projects without that ever being noticed [1]
 The company will also be unaware of the opportunity cost of investing in projects that
had lower NPVs than alternatives that could have been selected instead [1]
[6, Max 5]
There were many excellent answers to this question. A few candidates gave very generic
answers on why payback was poor or why NPV was a better method these answers did not
gain high marks but usually passed.
Q13
 Realistically, the only effective mitigation would be to reduce the risk. The risk can
only be avoided by switching to a completely different range of products that do not
have any health risks [1]
 There are no practical ways to transfer the risk and accepting the risk appears to be
unacceptable [1]
 The main problem is likely to be the reputation risk arising from the sale of a product
that may be harmful if consumed to excess. The manufacturer might attempt to
mitigate that risk by educating consumers and encouraging them to behave
responsibly [1]
 The company can reduce the risk by encouraging buyers to be responsible when
buying and eating sweets [1]
 Promoting the products as treats that are not to be eaten in place of nutritious food or
eaten in excessive quantities will, at least, demonstrate that the company is aware of
the risk and is keen to address it [1]
 It may also be possible to reduce the risk by making portions smaller or adjusting the
recipe so that the sugar content is reduced [1]
[6, Max 5]
This question was done badly. Some candidates spent a lot of time discussing health and
safety issues rather than the problems of sugar content. Candidates did not mention
mitigation in any detail. Few candidates discussed social responsibility.
Q14
 Relevance can only be judged in the context of the decisions that are to be based on
the figures [1]
CB1 A2020
 Cost less depreciation will not necessarily offer even a rough estimate of the market
value of an asset and so it will be little help in, say, informing a lender’s decision
about asset values as collateral [1]
 Similarly, knowing the book value will be of little help in deciding whether to retain
an asset or sell it on the open market or scrap an asset rather than repairing it [1]
 The issues affecting property may differ from those involving plant and equipment
because property tends to have a longer life. Valuing a building at cost less
depreciation could result in a figure that is so badly out of date that it has very little
relevance [1]
 The book value may not reflect the market value or economic value of the assets, but
it does enable some allowance to be made for the availability of assets when
calculating ratios [1]
 Comparing, say, ROCE for two companies in the same industry will be aided by the
inclusion of book values because the figures will, at least, reflect the scale of the
respective companies’ investments [1]
[6, Max 5]
This question was also done badly by many candidates.

Candidates did not understand relevance and reliability and where they did they failed to
make any link to assets.
This question required some knowledge of financial reporting and few candidates
demonstrated this in their answers.
Q15
 The factors that need to be taken into account in measuring the impact on the
environment are not always fully understood or agreed [1]
 Areas such as the implications of emissions or the need to manage climate change are
often the subject of controversy. That can make it difficult to measure and report on
sustainability [1]
 The question of whether an entity can be viewed as managing resources responsibly
when it is consuming natural resources that may be irreplaceable is complicated [1]
 This is also an area in which companies may feel exposed because they may be
encouraging criticism of their behaviour through admitting to their environmental
impact [1]
 For example, attempts to offset carbon emissions are often viewed as inadequate
because it may take some time for the offset to actually occur in the face of emissions
that are occurring in the short term [1]
 Social and political differences can mean that companies will always face criticisms
that their reports are deliberately misleading [1]
[6, Max 5]
Many candidates passed this question as they managed to think of three points that were
relevant. Few candidates achieved a high score.
CB1 A2020
Q16
 External auditors have a responsibility to report on whether financial statements
present fairly [1]
 In doing so, they must form an opinion on whether the financial statements have been
prepared in a manner that justifies an unmodified opinion. That can require delicate
professional judgement because of the potential for disagreement over accounting
treatments [1]
 The IFRS provide a benchmark against which fair presentation can be measured. It
would certainly be difficult to argue that a fair presentation was being offered if the
accounts did not comply with IFRS [1]
 That can strengthen the auditor’s position in the event of any disagreement with the
directors because any controversial accounting treatments that do not comply with
IFRS can be rejected [1]
 The IFRS also provide the auditor with some justification for an audit opinion. If the
opinion is ever challenged by a user of the financial statements then the auditor can
argue that the financial statements present fairly in terms of the recognised accounting
standards [1]
 The ability to justify an audit opinion in those terms may be sufficient to reduce the
risk of reputational damage to the auditor [1]
[6, Max 5]
This question was not answered very well. A number of candidates did not read the
question properly and wrote about how IFRS help people prepare financial statements
and did not discuss the auditor. The answer should have been about why IFRS are useful
to auditors not generic points about the benefits of IFRS.
Q17
 The neatest response would be to take the forecast to the bank immediately and to
admit that there is a danger that the overdraft will exceed the $50,000 limit. The
consultancy could then seek an increase in the overdraft limit, even on a temporary
basis [1]
 If the bank can see that the company anticipates returning to a positive balance then it
might be prepared to grant this request, avoiding the problem altogether [1]
 If the bank is unwilling to increase the overdraft then the consultancy might find it
easier to take out a short-term loan that would cover the period of the deficit [1]
 Alternatively, the management team should review the forecast carefully to determine
whether there are any payments that might be delayed [1]
 The scheduled purchase of equipment or replacement of company cars might be put
off until after the anticipated return to a positive balance [1]
 That would, at the very least, reduce the overdraft to below the $87,000 maximum
and, hopefully, even keep it below the $50,000 limit [1]
[6, Max 5]
This question was done quite well by candidates.

Many candidates demonstrated a good understanding of cash flows.
Many candidates achieved a passing score and a good number of candidates scored full
marks.
CB1 A2020
Q18
 The most immediate threat is that the company could run out of cash, making this
policy inherently unsustainable [1]
 The fact that profit has been earned does not mean that there is sufficient cash
available to pay the entire amount as a dividend [1]
 The company could, for example, have recognised revenues that are still to be
collected and so the dividend payment could reduce the bank balance. It could also be
necessary to use cash for purposes other than operating costs. Assets could require
replacement [1]
 The lack of retained earnings could mean that the company has insufficient funding to
invest in attractive opportunities that arise. The company will either have to borrow or
seek an injection of equity from the directors, out of their personal wealth [1]
 The fact that the company is wholly owned by its directors reduces the risks of major
problems [1]
 There is no need to maintain the dividend in order to signal confidence because the
directors already have a full understanding of the business and will be able to put any
decrease in dividend into context [1]
[6, Max 5]
This question was in the area of finance which is often the weakest subject area. Few
candidates could write much for this question and many did not achieve a passing score.
Many candidates did not realise the company was quite small and all the shares were
owned by the directors. This made a huge difference to the answer and these candidates
did not pass this question.
Q19 (i)
 The most immediate advantage is that the managers are no longer restricted to their
salaries. They will share the profits made by Sub, which could be significantly greater
[1]
 The deal gives them the security of $16m of revenue every year, which is a good start
for a new business venture because they don’t need to go out and look for business
[1]
 They will be working for a known business and will understand what is being
expected of them [1]
 The directors will have rent-free accommodation for the first 18 months of their
operations on an independent basis, which will reduce the disruption of relocating
staff and will save costs [1]
 The significant personal borrowings will be a serious concern. The failure of the
business could leave them in serious financial difficulties [1]
 They will have to reduce running costs from $20.0m - 2.5m = $17.5m to $16.0m
immediately, which could prove difficult [1]
 They will undoubtedly have to make former colleagues redundant in order to achieve
this, which may be uncomfortable and even distasteful [1]
 It may be more difficult to achieve those savings than they expect because it is
reasonable to imagine that Parent has already considered all practical ways to reduce
costs while maintaining quality [1]
CB1 A2020
 It will also be necessary to start looking for new premises almost immediately in order
to be ready to relocate [1]
[9, Max 8]
(ii)
 The biggest advantage is that the business will receive an inflow of $4m. That will
improve cash flows, even if it is not a huge sum in comparison to the size of the
Group as a whole [1]
 Parent will also benefit from the cost savings associated with the fixed annual fee to
Sub being lower than the operating costs that would otherwise be incurred [1]
 When the contract is set for renewal in four years, the company will have a massive
advantage in terms of bargaining power and may be able to reduce costs even further
[1]
 This arrangement will enable the company to retain the services of its existing
actuarial team, rather than risking the disruption of outsourcing to a third party who
may prove to be incompetent [1]
 There could be disadvantages, though. The MBO team will be under pressure to
reduce costs, which could have an adverse impact on the quality of the service [1]
 The need to keep the contract will also give the actuaries a good reason to avoid
owning up to any errors or omissions, which could prove costly in the long run [1]
 The new entity might also start looking for additional work from third parties, which
could be a further distraction [1]
[7, Max 6]
(iii)
 Restricting shares to the 18 senior managers could have the effect of demotivating
other managers and staff, who would wish to own a stake in the company [1]
 There would be no significant loss of control if the senior staff took, say, 3% each
which would give them 54% in total and so they would retain control [1]
 The additional equity would reduce the need for the founders to find the whole $4m
from their own resources [1]
 It would also reduce the possible need to raise debt finance and so reduce the
problems associated with gearing at this early stage [1]
 Opening up shareholdings could make it more difficult to manage staff in the medium
term. For example, it could prove more difficult to make an employee redundant if
that person is also a shareholder [1]
 The staff might also be unwilling to move on if they are unhappy because they could
feel tied to the company because of their investment [1]
 They may also feel entitled to greater latitude in their performance and in their
behaviour because they own some shares [1]
[7, Max 6]
[Total 20]
This question was answered very well. There were many good passes and many
candidates gave very good answers. The candidates in general showed a good
understanding of management buyouts and gave in depth answers which demonstrated an
understanding of the topic.
CB1 A2020
Q20
(i)
 Accounting performance ratios are generally calculated using book values and that is
an important enough reason to make the book value of equity relevant [1]
 The figure will only change from year to year in the event that Vonder seeks a fresh
injection of share capital or has a significant inflow from retained earnings [1]
 That makes the resulting ROCE ratio consistent from one year to the next, with
changes in capital employed only reflecting increases or decreases because of
investments or withdrawals [1]
 The book value of share capital also reflects the actual cash invested in the company
by the shareholders and so it is a realistic measure of the management team’s
performance [1]
 Basing ROCE on the market value of equity reflects the wealth created for the
shareholders in relation to the opportunity cost of leaving their investment with the
company [1]
 That makes it a more realistic measure of the benefits of investing in the company
from the shareholders’ perspective [1]
 It also holds the directors responsible for the value of the resources that have been
entrusted to them and the associated return that they earn from those resources [1]
 That could make life difficult for the directors because any increase in the share price,
which could be due their sound management of the business, will decrease their
ROCE [1]
 Having said that, it could also motivate the board to ensure that the shareholders are
adequately compensated for the investment that they are making [1]
[9, Max 8]
(ii)
 The investment in the factory will understate ROCE for the year ended 30 June 2020
[1]
 The capital employed will be inflated by $150 billion, despite the fact that the funds
were not invested in any meaningful way until a month before the year end [1]
 The operating profit does not appear to have increased by much in response to this
investment, if at all [1]
 There could have been additional costs that actually reduced operating profit for the
year because they could not be carried forward. For example, the costs of recruiting
staff to work in the factory will have been incurred and written off as a cost [1]
 The company could also have charged a month’s depreciation on the building [1]
 It would be far more realistic to base ROCE on an amount that excludes the fresh
investment. In other words 362 + 350 - 150 = $562 billion [1]
 Doing that would enable the shareholders to compare the ROCE of 48/562 = 9% with
the previous figure of 44/(351+240) = 7% [1]
 The alternative would be 48/(362+350) = 7% [1]
[8, Max 7]
(iii)
 In theory, if the shareholders are disappointed with the profitability and performance
of the company then the share price could decline [1]. ROCE reflects the company’s
ability to generate wealth from the resources that it has available to it and so it is a key
ratio for investors [1]
CB1 A2020
 That would, however, be a potentially naïve assumption which would depend on all
shareholders and potential shareholders being misled [1]
 In the short term, the announcement of misleading information could lead to
offsetting market forces, with the shareholders who are disappointed seeking to sell
pushing the share price down and those who believe that the news is not actually a
problem buying shares and pushing the share price up [1]
 There could be a brief period of turbulence, but that would not necessarily cause any
serious problems in the longer term because the market will be driven by informed
decisions by intelligent participants [1]
 The only real concern would be that the threat of such misunderstandings could lead
to the directors indulging in dysfunctional behaviour, such as not making investments
in case the market misunderstands them [1]
[5]
[Total 20]
[Paper Total 100]
Q20 was done badly. There were many weak answers to all parts of this question.
Candidates did not understand ROCE and could write very little for any parts of the
question. This question was the poorest in terms of numbers of passing candidates.
CB1 A2020
EXAMINATION
27 September 2019 (pm)

Core Principles
INSTRUCTIONS TO THE CANDIDATE
1. Enter all the candidate and examination details as requested on the front of your
answer booklet.
2. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
3. Mark allocations are shown in brackets.
4. Attempt all questions. Answers to questions 1–10 should be indicated on the Multiple
Choice Answer Sheet included in your booklet. From question 11 onwards begin your
answer to each question on a new page.
5. Candidates should show calculations where this is appropriate.
Graph paper is NOT required for this paper.
AT THE END OF THE EXAMINATION
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.

1 Which of the following statements provides the best explanation for why non-financial
factors ought to be considered when evaluating an investment project?
A Non-financial factors can be more easily understood.

B Non-financial factors can give insights into upside risks.
C Non-financial factors are the primary driver of shareholder wealth.
D Only anticipated net cash flows matter.
[2]
2 Which of the following is a valid basis for weighting debt and equity in order to
calculate the weighted average cost of capital (WACC)?
A Book value of debt and book value of equity.

B Book value of debt and market value of equity.
C Market value of debt and book value of equity.
D Market value of debt and market value of equity.
[2]
3 The expected outcome of a project has been estimated using two approaches. The first
approach was to predict the outcomes based on five sets of assumptions with given
probabilities. The second approach was a Monte Carlo simulation that has been run
many thousands of times. The results from both approaches are significantly different.
A The investment decision should be based on the more pessimistic of the two
predicted outcomes.
B The approach based on five sets of assumptions can be more readily reviewed
and checked for reality.
C The Monte Carlo simulation is more sophisticated and is, therefore, more
reliable.
D The project should be abandoned because there is no way to predict the
outcome with any certainty.
[2]
4 What is the strongest argument in favour of setting a common hurdle rate across a
company for all projects?
A All projects in the same industry have the same risk.

B The decision rule is clear and can be applied consistently.
C A common rate will ensure consistency when capital rationing is in effect.
D The hurdle rate is not a material factor in evaluating a project.
[2]
CB1 S2019–2
5 You have been asked to determine the internal rate of return (IRR) of a project that
has an initial cash outflow, followed by seven years of net cash inflows. The project’s
net present value was + $500,000 when determined at 11% and – $500,000 when
determined at 16%.
Which of the following statements concerning the project’s IRR is correct?
A The IRR is approximately 13.5%.

B The IRR is exactly 13.5%.
C The IRR is greater than 16%.
D The IRR is less than 11%.
[2]
6 Which of the following best describes the responsibility of the external auditor?
The external auditor:
A expresses an opinion on the fair presentation of the financial statements.

B prepares the financial statements.
C reassures the directors that the financial statements present fairly.
D reassures the shareholders that the company is a sound investment.
[2]
7 A company owns property that cost $5.0 million and has been depreciated by
$1.5 million. The property has recently been revalued at $8.1 million. What figure
will appear in the revaluation reserve in respect of this asset?
A $1.6 million
B $3.1 million
C $4.6 million
D $6.6 million
[2]
8 A company makes sales on credit of $100,000 every month. Trade receivables

generally take 50 days to pay. What would be the impact on cash of changing the
terms of trade so that receivables were settled after 40 days?
A The bank balance will increase immediately.

B The bank balance will increase over the next 40 days.
C The bank balance will increase over the next 50 days.
D The bank balance will increase within a month.
[2]

9 Why is it generally expensive to grant a cash discount for prompt settlement of trade
receivables?
A Credit customers will be unlikely to take up the cash discount.

B Granting a discount will involve significant and complicated bookkeeping
entries.
C It is not possible to incorporate the cost of cash discounts into selling prices.
D The discount must be compounded, generally revealing a high annualised cost.
[2]
10 Which of the following statements best distinguishes a budget from a forecast?
A budget:
A has a future orientation.

B involves active planning.
C may involve feedback against actual.
D requires an understanding of the entity.
[2]
11 Discuss the need for formal and transparent procedures to determine the policy for
directors’ remuneration in a quoted company. [5]
12 The partners who own an actuarial consultancy are considering moving to a larger and
more prestigious office, despite the fact that doing so has a negative net present value
on the basis of a five-year cash flow projection.
Discuss the possibility that the move might be justified on the basis of strategic fit. [5]
13 Recommend, with reasons, the most appropriate means of mitigating health and
safety risks associated with opening a branch office in another country that has, until
recently, been politically unstable. [5]
14 Discuss the advantages and disadvantages of showing non-current assets in the

statement of financial position at their fair value rather than cost less depreciation. [5]
15 Explain the purpose of integrated reporting as an alternative to traditional financial

reporting.[5]
16 Describe the potential conflict between relevance and reliability in the selection of
accounting policies. [5]
CB1 S2019–4
17 Describe the purpose of the non-controlling interest figure in a consolidated statement
of financial position. [5]
18 The directors of an actuarial consultancy are concerned about the high costs
incurred for administration, including costs of administrative staff, associated office
accommodation costs and other costs such as IT.
Discuss the suitability of zero-based budgeting for managing the consultancy’s

administrative costs. [5]
19 Roundspar, a manufacturing company, needs a new piece of equipment that will cost
$10m. A potential lender has requested the following asset cover ratios:
Total assets less current liabilities less intangible assets

Loan capital plus prior ranking debt
$60m – 2m – 11m
=
$10m + 12m
= 2.1 times
and
Total assets less current liabilities less intangible assets

Total loan capital
$60m – 2m – 11m
=
$44m
= 1.1 times
Both ratios take account of the increased assets and additional debt arising from the
transaction.
Roundspar currently has a $12m mortgage loan that is secured against property valued
at $18m.
The new loan will be secured by a floating charge.
(i) Explain why each ratio would be relevant to the potential lender. [6]
(ii) Discuss the advantages and disadvantages to the lender of excluding intangible
assets from the asset cover ratio. [8]
(iii) Discuss the potential agency conflicts that might arise between the interests of
Roundspar’s shareholders and the providers of debt finance. [6]
[Total 20]

20 Tarvale is a major quoted company that manufactures timber products. The company
has suffered a major setback during the past few months. The company’s largest
supplier was unable to meet Tarvale’s timber requirements because volcanic activity
close to the supplier’s forests caused forest fires which severely disrupted transport
routes. Tarvale was able to purchase timber from alternative sources, but paid
much more than usual because Tarvale receives a substantial discount from its usual
supplier.
Most of Tarvale’s board members are concerned that the shareholders will blame
them for allowing the company to become so heavily dependent on a single supplier.
The Production Director disagrees, though, on the basis that the Capital Asset
Pricing Model (CAPM) suggests that shareholders diversify, which protects them
from unsystematic risks. The volcanic disruption is an unsystematic risk and so the
shareholders were protected. In any case, the Production Director had considered the
risk of disruption due to the volcano and had concluded that the risk of an eruption in
any given year was less than 5%.
Tarvale has a high gearing ratio. The Production Director proposes that the board
should determine the company’s ungeared beta in order to determine whether the
shareholders are earning a satisfactory return on their investment, despite the costs
associated with the volcano.
(i) Discuss the Production Director’s argument that holding diversified portfolios
would have protected Tarvale’s shareholders from the volcanic disruption and
so the shareholders will not blame the board. [8]
(ii) Discuss the Production Director’s proposition that the risk had been evaluated
and so the board should not be criticised. [7]
(iii) Discuss the respective relevance of Tarvale’s geared and ungeared betas to its
shareholders.[5]
[Total 20]
END OF PAPER
CB1 S2019–6
EXAMINERS’ REPORT
September 2019
Subject CB1 - Business Finance:

Core Principles
Introduction
The Examiners’ Report is written by the Principal Examiner with the aim of helping
candidates, both those who are sitting the examination for the first time and using past papers
as a revision aid and also those who have previously failed the subject.
Mike Hammer
December 2019

Subject CB1 (Business Finance - Core Principles - September 2019 - Examiners’ report
1. The aim of CB1 subject is to provide a basic understanding of corporate finance

including a knowledge of the instruments used by companies to raise finance and
manage financial risk and to provide the ability to interpret the accounts and
financial statements of companies and financial institutions.
2. This paper examines basic business finance including raising funds by a variety of
methods, taxation, net present value and project appraisal and other topics, There is
also a section on management accounting including budgeting, it has both
calculations and essay type questions on these topics. The paper also examines
financial reporting including preparation of the main financial statements and
interpretation of financial statements. It also considers the basis of the preparation
of statements and the information needs of a variety of end users of financial
statements.
the calculations but candidates are not penalised for this. However, candidates may
lose marks where excessive rounding has been used or where insufficient working
is shown.
B. Comments on student performance in this diet of the examination.
1. Candidates performed reasonably well in this exam. Question 19 which was on

three areas of accounting was answered reasonably well but not as well as Q19 in
April. Question 20 was on risk and geared and ungeared betas and other finance
issues was done reasonably well and much better than in April.
2. As usual there were some excellent candidates at the top who scored very high
marks.
In general, the multiple choice questions were well done as were many of the short
questions.
3. There were a few areas of this exam where candidates did not perform as well as
expected. These were in the areas of integrated reporting, relevance v reliability,
zero based budgeting and finance.
4. Candidates were good at questions which mainly tested knowledge but were a little
weak on application of knowledge to scenarios
5. Having said that the results were reasonable but the pass mark was lower than in
recent diets of this subject.
C. Pass Mark
CB1 S2019 @Institute and Faculty of Actuaries

1 B [2]
2 D [2]
3 B [2]
4 B [2]
5 A [2]
The residual NPVs are the same, + or -, so the approximate IRR is roughly half way from
11% to 16% (i.e. 13.5%).
Graphing NPV at various points shows a curve, so IRR will not be exactly 13.5%.
6 A [2]
7 C [2]
A - 8.1 - 5.0 - 1.5 = 1.6
B - 8.1 - 5.0 = 3.1
C - Correct answer - 8.1 - (5.0 - 1.5) = 4.6
D - 8.1 - 1.5 = 6.6
8 B [2]
Receivables before change = $1,200,000 x 50/365 = $164,384
Receivables after change = $1,200,000 x 40/365 = $131,507
Decrease = cash inflow = $32,877
The effects of the change will be felt within the first 40-day cycle.
9 D [2]
10 B [2]
[Total 20]
X Questions 1-10 were answered well by many candidates.

11 The directors can negotiate and sign contracts on the company’s behalf without
seeking the shareholders’ permission. [1]
That could enable the directors to abuse their powers by granting one another
excessive salaries and other benefits. [1]
Allegations of greed have undermined shareholder confidence in the directors in the
past, with concerns that board members are paying themselves excessive and
unjustified amounts. [1]
Formal policies set out the basis on which remuneration packages are decided and so
there is, at least, a mechanism for setting remuneration. [1]
The shareholders will also be keen to understand how board remuneration motivates
the directors. [1]
For example, a basic salary may not offer an incentive to excel because the rewards
will be the same regardless of performance. [1]
Performance related rewards can also raise problems if they encourage dysfunctional
behaviour. [1]
For example, directors’ share options can create an incentive to manipulate share
prices so that options are in the money when they are exercised. [1]
The need for disclosure is required in order to comply with the requirements of
codified rules relating to corporate governance. [1]
Transparency will also help to reduce agency conflicts. [1]
[10, Max 5]
This question was answered well. Many candidates scored a high mark for this question.
12 Arguably, all negative NPV projects should be rejected on the basis that they are
expected to reduce the partners’ wealth. [1]
The NPV criterion is, however, restricted to the cash flows that have been identified
and predicted by the decision makers. [1]
It could be argued that moving to a larger office will create scope for expansion that
might be complicated if the partnership does not take the new office. [1]
The additional space will enable the firm to employ additional consulting staff
without undue concern about accommodating them. [1]
A more prestigious office may also help to attract new clients, who may regard the
building as evidence that the firm is professional and successful. [1]
It would be reckless to take such potential revenues into account in a formal NPV
calculation because they cannot be predicted with any certainty. [1]
The new premises create a potential for upside risk that may be lost if the partners do
not proceed. [1]
The justification will depend on the NPV. If it is proportionate to the possible upside
then it could be viewed as an investment in future scope for adding new business. [1]
The five-year timescale may be too short a period to reflect the full potential for such
a long-term project. [1]
[9, Max 5]
X This question was answered well by most candidates.

13 The most suitable response would be to reduce uncertainty as far as possible by

studying the present political climate and taking advice from reliable sources as to the
risk. [1]
The entity will have to establish that any managers and staff who are asked to live and
work in the new host country will not be at risk because of violence or corruption. [1]
It may be possible to seek advice from the home government, assuming that it has an
embassy or consulate in the country. [1]
The risk may be avoided to some extent by engaging local staff to fill as many posts
as possible. [1]
That will reduce the number of home country nationals who will be put at risk. [1]
It will also ensure that the locally hired staff will be available to brief their
counterparts and will be able to offer informed advice. [1]
The company could arrange for practical support, such as arranging accommodation
and transportation between home and office. [1]
That would ensure that staff are based in safe locations and that they are protected
during their commute. [1]
The company might organise suitable insurance cover for all staff. [1]
Insurance would not, of course, mitigate the risk itself, but it would protect the
company from the financial costs. [1]
[10, Max 5]
X Candidates generally scored high marks in this question.
14 Valuations can be far more relevant than cost less depreciation. [1]
The shareholders will be informed of the value of the resources for which the
directors should be accountable. [1]
Lenders will have a much clearer understanding of the value of any assets that have
been offered or pledged as security. [1]
The main disadvantage of reporting values is that they may be difficult to determine
with any reliability. [1]
There are very few assets that have an open and observable market value. For
example, property values may be affected by the precise location of the property and
issues affecting local markets. [1]
Furthermore, values might fluctuate over time, with increases and decreases
introducing volatility into reported results. Such volatility will be distracting if the
entity has no intention of selling the assets concerned. [1]
A credible valuation, using independent experts, would be relatively expensive to
carry out. [1]
Recognising any increase in value will result in a higher depreciation charge, which
will reduce profit. [1]
[8, Max 5]
Answers to this question were mixed some very good and some quite poor.
Candidates quite often came up with points on valuations being subjective and expensive,
which was good.

15 Integrated reporting is intended to give stakeholders a clearer understanding of the

entity and its management. [1]
The company publishes significant amounts of supplementary information on factors
such as strategy, stakeholder relationships and other factors. [1]
The overall effect is to give users of the integrated report a much clearer
understanding of the entity’s direction, so that they can better understand risks and
rewards. [1]
To an extent, many stakeholders would have conducted research into the issues
disclosed in the integrated report for themselves and so some of the information
offered may be a little redundant. [1]
The difference is that the integrated report communicates the directors’
understanding, which may help stakeholders better understand the company’s
direction. [1]
Independent research may still yield benefits, but the board’s understanding of the
company’s position and environment may be difficult to determine without a detailed
report. [1]
Integrated reporting frequently gives a clear insight into the sustainability of the
company’s operations. [1]
Company’s often use the integrated report to highlight their impact on the
environment. [1]
[8, Max 5]
This question was answered badly with most candidates being unsure what integrated
reporting is. Many candidates thought it was something to do with consolidations. This is
a new topic and is covered in the core reading but answers were disappointing.
16 Relevant information tends to be more subjective, partly because it is frequently

future oriented. [1]
For example, shareholders in a small company that makes expensive sports cars may
be keen to know the market value of inventory rather than its cost because that will
give a better idea of the value that has been created during the year. [1]
Predicting the market value will be a subjective process because it will have to take
account of the possibility of disruptions such as the launch of new models by
competitors. [1]
Reliable information is generally backward looking and so it can be validated and
audited. [1]
That does not necessarily mean that it lacks relevance. For example, costs are
historical, but the cost of an asset that has recently been acquired can be relevant to
certain decisions. For example, selling prices should cover the costs of replacing
inventory. [1]
Even subjective estimates can often be verified to some extent, so that users can be
reassured that the information is sufficiently reliable for their purposes.
[1]
[6, Max 5]
This was answered very badly with few candidates demonstrating knowledge of the topic.

17 Non-controlling interest arises in group accounts to recognise the fact that some or all
of the group’s subsidiaries are not wholly owned. [1]
By definition, the parent has control over each subsidiary, but any non-controlling
shareholders who remain have a claim to their portion of the subsidiary’s equity. [1]
The value of that equity reflects the non-controlling shareholders’ claim to the
retained earnings arising since the subsidiary joined the group. [1]
The total reported for non-controlling interest enables the parent company
shareholders to see the extent to which the equity in the group’s subsidiaries is funded
by external shareholders. [1]
The non-controlling shareholders have no specific rights to the group itself or the
parent company and so care has to be taken in interpreting the non-controlling
interest. [1]
It acts as a reminder that one or more subsidiaries have external shareholders who
may have rights that could constrain decisions that might benefit the group at the
subsidiaries’ expense. [1]
[6, Max 5]
This question was answered reasonably well by many candidates. Although many answers
lacked detail and were a little vague many achieved a passing score.
18 If costs seem excessive then zero based budgeting would force the directors to review
them in turn, with a view to establishing whether they might be dispensed with. [1]
Traditional budgets are often incremental, with little questioning of the need to
eliminate costs that may no longer be required. [1]
Working through each cost in turn, perhaps by starting with a list of the administrative
staff posts and discussing whether it remains necessary, will give the directors an
opportunity to eliminate costs. [1]
Zero based budgeting can be difficult to implement in a meaningful way because
certain costs would be difficult to eliminate. For example, eliminating or reducing the
costs of heating the offices may be impractical and it would be a waste of time to
discuss it. [1]
Also, staff may be discouraged by such severe cost cutting, particularly if they fear
that their jobs are at threat. [1]
A full zero based budgeting exercise would be time consuming and expensive in itself
and those costs may not be justified. [1]
[6, Max 5]
This is a reasonably new topic for CB1 and it was not answered very well. Many
candidates said it started with a blank sheet but after that had little to say. Some candidates
did not address what was asked but gave a general answer on zero based budgeting and
did not mention admin costs, heat and light or any other expenses.

19 (i) The first ratio reflects the likelihood that the lender’s principal will be repaid in the
event that the company goes into liquidation. [1]
The numerator shows the assets that will be available for sale in the event that the
company fails and the denominator shows the total that will have to be repaid in order
for the lender to be repaid in full. [1]
If Roundspar fails then $12 million will have to be repaid to other creditors before the
lender receives anything. Overall, that means that Roundspar’s assets cover the
lender’s position 2.1 times. [1]
The alternative ratio is a variation of the gearing ratio. Rather than focussing on the
specific protection for the lender, it indicates whether Roundspar is likely to get into
difficulty. [1]
If Roundspar is highly geared then it will have calls on its cash flow, which could
increase the risk of it running into difficulty. [1]
The lender will not be particularly concerned about the company’s ability to repay the
whole $44m that it owes, but it will be inconvenient and possibly expensive if
Roundspar defaults. [1]
(ii) The most immediate advantage of disregarding intangibles is that they may have little
value in the event that the company fails. [1]
For example, intangibles could include the cost of acquiring the rights to the trading
name “Rounsdspar”. [1]
That trading name will probably lose most of its value in the event that the company
is wound up. [1]
A further advantage of excluding the intangibles is that their values are likely to be
highly subjective and so it is unclear how much of the $11m will be realised in the
event of a failure. [1]
The disadvantage of excluding intangibles is that it could lead to unduly pessimistic
loan evaluations, which could cost the lender the opportunity to make a profitable
loan. [1]
The intangible assets have a value to the shareholders, which will give them an
incentive to support the company in order to maintain their value. [1]
They are also a source of revenue (if they have any value at all), which will reduce the
risk of corporate failure to some extent. [1]
Some intangibles, including licences and patents, can be sold on the open market and
can have considerable value. [1]
(iii) Under normal circumstances, the lenders have very little ability to influence or
manage the company’s decisions. [1]
The loan agreement might give them certain rights if the company is late in making a
loan payment or fails to achieve agreed benchmarks, such as a maximum acceptable
gearing ratio. [1]
Provided the company does not breach any of those conditions, it can continue
without interference from the lenders. [1]
The interests of the shareholders and lenders could conflict in situations where the
shareholders were in danger of losing their investment and were keen for the company
to take risks in the hope of resolving the problem. [1]
If the company faced collapse then the shareholders would be keen to pursue a risky
strategy that offered the possibility of recovery. If the strategy succeeds then the
shareholders will benefit and they will be no worse off if the strategy fail. [1]

The shareholders might also be keen to withhold information from the lenders in the
event that the lenders might be entitled to protect themselves by foreclosing. [1]
For example, a loss on revaluation might be suppressed because it would put the
company in default of a gearing restriction. [1]
[7, Max 6]
[Total 20]
Part (i) was answered very well.

Part (ii) was answered less well and most answers were brief and lacked detail. A number
of candidates seemed unclear what the intangibles were in this case and had difficulty
answering the question.
Part (iii) had some weak answers as candidates were unclear what lenders should be aware
of and what influence they could have.
20 (i) The Production Director’s argument rather misses the point about the purpose of
diversification. Holding a diversified portfolio implies that shareholders can look
forward to a relatively steady return from the portfolio as a whole, with poor
performances from some investments being compensated by stronger returns from
others. [1]
Looking forward, diversification will protect Tarvale’s shareholders from
unsystematic risks. [1]
That would not justify reckless behaviour by the Board because Tarvale’s
shareholders will be adversely affected by this loss, even if they are diversified [1]
Diversification does not mean that the shareholders are guaranteed an offsetting gain
to deal with every loss. [1]
The capital markets will not necessarily perceive the logic underlying the Production
Director’s arguments. It may appear that the company has been mismanaged and that
could cause the share price to fall. [1]
The shareholders may be affected by perceptions that the company is risky, even if
the risks are not as serious as generally believed. [1]
The Board had a responsibility to identify significant risks and to take appropriate
action in response. [1]
Diversification is really a matter for the shareholders to manage. They have a right to
expect that the directors will act responsibly in order to mitigate all risks responsibly.
[1]
(ii) The fact that the risk of a volcanic eruption has been evaluated is a partial defence
because it demonstrates that the Board was aware of the threat and had considered it.
[1]
It could be argued that the Board had determined that the most appropriate response to
the risk was to accept it, perhaps on the basis that a more rigorous mitigation strategy
would have been too expensive. [1]
The fact that the volcano erupted does not, in itself, show that the response to the risk
was inadequate. [1]
It would be more appropriate for the shareholders to consider whether they would
have paid more to source timber from a source that was not threatened by the same

volcano, if they had been aware of the threat when the decision to accept the risk was
taken. [1]
The evaluation does not, in itself, excuse the Board entirely. Firstly, it could have
been argued that the low prices charged by this supplier reflected a high probability of
problems. [1]
If the risk was of the order of 5%, as implied by the Production Director, then that is
quite a high likelihood of a loss on this scale. [1]
There could also be arguments that the Board had misunderstood the threats and that
they had understated the impact that this threat would have. [1]
(iii) The ungeared beta is relevant to the shareholders because it indicates the systematic
risks associated with the company’s business operations. [1]
The beta should be relevant to, say, evaluate the systematic risks associated with any
expansion of the business. [1]
Or it could be helpful as a basis for comparison with a similar company in order to
establish whether systematic risks could be managed more effectively. [1]
The geared beta allows for the effects of borrowing. Gearing increases systematic risk
and so the geared beta reflects the overall systematic risk associated with investing in
the company. [1]
The geared beta will give an idea of the total systematic risk being accepted, both
because of the business and its funding. [1]
The difference between geared and ungeared beta will give an idea of the impact that
any changes to financing might have to the entity’s systematic risk. [1]
[6, Max 5]
[Total 20]
[Paper Total 100]
Part (i) was answered reasonably well although there were some poor answers. This
question was about diversified portfolios, some candidates seemed very unsure about how
to answer this question.
Part (ii) This was answered well by many candidates and was about risk and directors
behaviour.
Part (iii) This was about geared and ungeared betas, this can often be a problem area for
candidates but was answered quite well this time.

EXAMINATION
5 April 2019 (pm)

Core Principles
INSTRUCTIONS TO THE CANDIDATE
1. Enter all the candidate and examination details as requested on the front of your
answer booklet.
2. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
3. Mark allocations are shown in brackets.
4. Attempt all questions. Answers to questions 1–10 should be indicated on the Multiple
Choice Answer Sheet included in your booklet. From question 11 onwards begin your
answer to each question on a new page.
5. Candidates should show calculations where this is appropriate.
Graph paper is NOT required for this paper.
AT THE END OF THE EXAMINATION
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.

1 Which of the following statements best explains the role of the external auditor from
an agency perspective?
A The auditor enables the shareholders to rely on the financial statements

prepared by the directors.
B The auditor ensures that the company is well managed.
C The auditor provides the directors with independent advice on accounting and
financing matters.
D The shareholders can task the external auditor to examine particular areas of
concern.
[2]
2 Which of the following statements best describes the driver of the market price of a
quoted company?
A Expectations of future revenues.

B Expectations of future dividends.
C Historical trends of reported profits.
D Historical trends of dividend payments.
[2]
3 Martin has just been admitted to a long established business partnership. He has
bought 20% of the partnership equity, although he has not paid for this yet. He will
be entitled to 15% of the partnership profit. If the firm incurs any liability, what
proportion of that liability will be Martin’s legal responsibility?
A 0%
B 15%
C 20%
D 100%
[2]
4 When does a bondholder receive the nominal value of a bond?
A At the time of purchase.

B Annually.
C Whenever coupon payments are made.
D At maturity.
[2]
CB1 A2019–2
5 Which of the following statements describes the agency problem?
A
Agents may feel that they cannot trust their principals.
B
Agents may have insufficient authority to manage their principals’ affairs.
C
Principals may feel that they cannot trust their agents.
D
Principals may not have the necessary expertise to manage their own
businesses.
[2]
6 Charlie is a 100% subsidiary of the Corpo Group. Corpo is a major quoted

corporation. Charlie has serious cash flow problems and is struggling to meet its
immediate liabilities. Which of the following statements is correct?
A Corpo has no reason to support Charlie.

B Corpo is forbidden from supporting Charlie unless there is a contractual
reason for doing so.
C Corpo is required by law to support Charlie and settle the liabilities.
D Corpo will make a commercial decision as to whether it will support Charlie.
[2]
7 A parent company’s only asset is an £8 million investment in a 60% subsidiary. The

subsidiary’s assets are valued at £25 million. What value will be attributed to group
assets in the consolidated financial statements?
A £8 million
B £15 million
C £25 million
D £33 million
[2]
8 A newly formed company was funded by an equity injection, in which the

shareholders purchased a total of 10,000 £1 fully-paid shares for £2.50 each. Which
of the following figures will appear in the company’s statement of financial position?
Share capital (£) Share premium (£)

A 10,000 15,000
B 10,000 25,000
C 25,000 0
D 25,000 15,000
[2]

9 Which of the following statements best describes the purpose of the depreciation
charge?
A The depreciation charge creates a reserve for the replacement of assets when
they reach the end of their useful lives.
B The depreciation charge ensures that asset values remain realistic.
C The depreciation charge ensures that businesses obtain tax relief on the
consumption of assets’ values.
D The depreciation charge reflects the consumption of an asset’s value during the
period that benefits from that consumption.
[2]
10 Which of the following statements is a valid interpretation of an unmodified external

auditor’s report?
A The auditor has checked all transactions and balances and found everything to
be in order.
B The auditor has material misgivings about the truth and fairness of the
C The auditor is of the opinion that there are no material breaches of the
applicable accounting reporting standards.
D The directors have properly discharged all of their duties with regard to the
[2]
CB1 A2019–4
11 Discuss the proposition that businesses should take account of social responsibility
when conducting their operations. [5]
12 Describe whether preference shares should be treated as debt rather than equity when
evaluating a company’s gearing. [5]
13 Explain the implications of credit risk for entities which are considering entering into
interest rate swaps. [5]
14 Explain why top-down budgeting might be a more effective basis than

bottom-up for setting a consultancy firm’s annual budget for consultancy staff travel
and accommodation. [5]
15 The chief executive of a large actuarial consultancy has remarked that the head office
stationery cupboard is heavily stocked with basic office supplies such as pens, pencils,
paper clips and staples.
Discuss the implications of introducing a formal inventory management system to

reduce the value of the inventory held in the stationery cupboard. [5]
16 Discuss the proposition that the cash flow statement is a more suitable basis for
understanding a business’ performance than the statement of profit or loss.[5]
17 Discuss the implications of the fact that an actuarial consultancy’s statement of

financial position will typically make no reference to the value of staff. [5]
18 The development and implementation of International Financial Reporting Standards

(IFRS) is sometimes a contentious and prolonged process.
Describe the implications of this. [5]

19 Jill is the chief executive of Gearworks, a small company which manufactures
components for the car industry. Gearworks is a member of a trade association. The
latest issue of the trade association’s journal contains an article that summarises the
averages of the accounting ratios of 20 companies which are members of the trade
association. The article includes the following table of accounting ratios:
Average
Return on capital employed, excluding debt 26%
Return on capital employed, including debt 22%
Gross profit margin % 25%
Current ratio 2.1:1
Inventory turnover 42 days
Receivables turnover 50 days
The latest draft financial statements for Gearworks are summarised below:
Gearworks
Statement of profit or loss for the year ended 31 March 2019
€000
Revenue 1,200
Cost of sales (840)
–––––
Gross profit 360
Administrative expenses (22)
Distribution costs (14)
–––––
Operating profit 324
Finance charges (54)
–––––
Profit for the year 270

–––––
–––––
Gearworks
Statement of financial position as at 31 March 2019
€000
Non-current assets 1,800
Current assets
Inventory 76
Trade receivables 150
Cash at bank 11
–––––
237
–––––
Total assets 2,037

–––––
–––––
Share capital 500
Retained earnings 862
–––––
1,362
Loans 600
Current liabilities
Trade payables 75
–––––
Total equity and liabilities 2,037

–––––
–––––
CB1 A2019–6
(i) Calculate each of the six ratios listed in the magazine article using Gearworks’
financial statements. You can assume that Revenue consists of credit sales. [6]
(ii) Comment on Gearworks’ performance in comparison to the industrial

averages.[9]
The draft financial statements provided above were prepared before the estimated tax
charge for the year had been calculated.
(iii) Explain how the inclusion of tax would have affected your understanding of
Gearworks’ performance. [5]
[Total 20]
20 Central is a major quoted company which manufactures highly specialised equipment

for use in the mining industry. Central has very limited scope for expansion. It
dominates the markets for its equipment and there is no real scope to develop sales in
alternative markets. Central has been highly profitable and it has amassed significant
retained earnings and has a large cash balance.
Central’s board has sought advice about the most efficient use of that cash balance.
Three main options are under consideration:
• The first possibility is that the cash might be retained for the foreseeable future, so
that Central has the necessary funding in place if any new opportunities arise.
• Alternatively, the board could use the funds in order to diversify into a completely
different line of business. Central’s cash reserves are large enough to fund the
creation of a significant business in another industry, such as leisure.
• Finally, Central could implement a share buyback under which Central would buy
shares back using the surplus funds.
(i) Discuss the implications of Central retaining the surplus cash in order to take
advantage of any new opportunity which might arise. [6]
(ii) Discuss the potential advantages and disadvantages of Central using the
surplus funds in order to diversify. [7]
(iii) Discuss the suitability of a share buyback to Central’s circumstances. [7]

[Total 20]
END OF PAPER
CB1 A2019–7
EXAMINERS’ REPORT
April 2019 Examinations
Subject CB1 - Business Finance

Core Principles
Introduction
circumstances may have changed if using these reports for revision
Mike Hammer
July 2019

Subject CB1 - Business Finance Core Principles - April 2019 - Examiners’ report
A General comments on the aims of this subject and how it is marked
1. The aim of the Business Finance Core Principles subject is to provide a basic
institutions.
2. This paper examines basic finance including raising funds by a variety of

methods, taxation, net present value and project appraisal and other topics, it has
both calculations and essay type questions on these topics. The paper also
examines financial reporting including preparation of the main financial
statements and interpretation of financial statements. It also considers the basis of
the preparation of statements and the information needs of a variety of end users
of financial statements. The paper includes a small quantity of management
accounting mainly budgeting.

but candidates are not penalised for this.
B Comments on student performance in this diet of the examination
Performance was very good. Many of the questions were answered very well.
Questions 1-10 in particular were very good with a number of candidates scoring full
marks. There were one or two questions where the performance was poor most
noticeably questions 13, 18, 19 (iii) and question 20.
C Pass Mark
CB1 A2019 @Institute and Faculty of Actuaries

1 A [2]
2 B [2]
3 D [2]
4 D [2]
5 C [2]
6 D [2]
7 C [2]
• A Parent’s investment in sub
• B Parent’s investment + 60% of sub’s assets
• C Correct answer: sub’s assets, with nothing from parent because its only
asset is cancelled on consolidation
• D Parent’s investment + 100% of sub’s assets
8 A [2]
• A Correct answer: equity shares = 10,000 x £1.00 and …
share premium = 10,000 x £1.50
• B - Values share premium at £2.50/share
• C - Values share capital at £2.50
• D - Values share capital at £2.50 and double counts premium
9 D [2]
10 C [2]
[Total 20]
Questions 1-10 were answered very well. Many candidates scored a very high mark which
was excellent.
11 Social responsibility can be discussed from an ethical perspective. Business

operations affect numerous stakeholders in a host of different ways. [1]
For example
• Externalities such as emissions can create health hazards and reduce the
quality of life. [1]
• These externalities often arise because it would cost more to process
Emissions before releasing them into the environment. [1]
• Companies often have to make quite delicate decisions because they may
be operating in jurisdictions in which there is little or no regulation to force
them to behave responsibly. [1]
• Companies should also consider social responsibility from an economic
perspective. [1]
• It may be that companies can reduce costs by taking advantage of lax
legislation, perhaps by establishing factories in countries where low pay is
permitted. [1]
• Such behaviour can affect revenues because customers may be unwilling to
buy a product that has been manufactured in such conditions. [1]
[7, Max 5]

This question was answered well. With many candidates commenting on the increase in
share price for socially responsible companies.
12 Preference shares generally combine characteristics of both debt and equity and
so there can be a debate about their treatment in ratio analysis. [1]
From a practical point of view, they carry a fixed rate of dividend, which has a
similar impact on cash flows to borrowing. [1]
These fixed payments increase the risks borne by equity shareholders in exactly
the same way as the fixed payments associated with debt. [1]
Preference shares may not carry the same degree of compulsion to pay fixed
finance charges as debt. [1]
The directors may be permitted to suspend a preference dividend payment if they feel
that the company cannot afford it, but there will be reputational damage (at least). [1]
The suspension of a preference dividend may also lead to other penalties, such as
the suspension of ordinary dividends. [1]
In some cases, preference shares may be designed so as to carry contractual rights
to dividends and the repayment of the face value on a specified date. [1]
Preference shares have been implicated in creative accounting schemes. [1]
[8, Max 5]
This question was done well with most candidates showing good understanding of the
differences between ordinary and preference shares and discussing debt very well.
13 The essence of an interest rate swap is that two parties agree that they will recreate
the effects of fixed and variable rate liabilities. [1]
In other words, if the variable rates are higher than fixed then the fixed rate
borrower will reimburse the variable rate borrower, and vice versa. [1]
That creates the effect of the fixed rate borrower having a variable rate loan and
the variable rate borrower is now effectively fixed. [1]
The parties to a swap do not actually exchange obligations. [1]
In other words, there is no direct obligation arising from a counterparty falling
behind on its loan payments. [1]
The most immediate problem would be that any unpaid sum due from the
counterparty could be forfeited in the event of a financial collapse. [1]
The long-term risk of a financial problem would be the possibility that the swap
will collapse and will either leave an unwanted fixed/variate rate liability. [1]
That could require a fresh swap to be negotiated with a new counterparty. [1]
Credit risk may be mitigated by conducting detailed credit checks on the
counterparty to the swap. [1]
The intermediary who organises the swap may take deposits or other advance
payments to mitigate credit risk. [1]
[10, Max 5]

This question was poorly answered. Candidates did not demonstrate much knowledge of
interest rate swaps.
14 Top down budgeting involves budgetary targets being set by senior managers
and imposed on more junior managers and staff. [1]
Junior managers can feed back and raise concerns, but the budget is essentially
set by the time that they first see it. [1]
The budget for staff travel and accommodation will have a direct impact on the
comfort and convenience enjoyed by staff when they travel for work. [1]
Under bottom up budgeting, consultancy staff might be inclined to set budgets that
permit them to spend more, so that their trips are more enjoyable. [1]
For example
• they might set budgets with the intention that they will use first class rail
travel and business class when they fly. [1]
Top down budgeting would make it easier for senior management to set an
appropriate standard, allowing for the need to avoid false economies. [1]
There could, for example, be an argument that journeys that exceed a certain length
would be unduly tiring by economy class. [1]
[7, Max 5]
15 The most immediate impact would be that inventory levels would decline,
releasing cash in the process. [1]
Unfortunately, the contents of the stationery cupboard are unlikely to be worth
enough to release a material amount of cash, and so it is debatable whether the
effort would be justified. [1]
Having a formal inventory management system would enable the consultancy to
optimise its inventory of stationery, but that might involve all staff in additional
time and effort because inventory levels would have to be monitored. [1]
Requiring staff to update records to show that they had taken a packet of staples
Or a pen would distract them from their real work. [1]
Holding smaller quantities of stationery would create the risk of shortages. [1]
Running out of basic commodities, even if it happened infrequently, could cost
more than the costs created by holding excessive quantities. [1]
Arguably, the system of maintaining healthy levels of inventory and replenishing
well before they run out is the most efficient way to manage this asset. [1]
Insisting on an improvement could undermine the CEO’s credibility. [1]
[8, Max 5]
Most candidates showed an understanding of cost versus benefit when managing

stationary inventory.

16 The cash flow statement helps readers to understand the cash flows arising from
operations. [1]
Given that shareholder wealth is essentially a function of net cash flows, the
cash flow statement could be linked to shareholder wealth. [1]
Cash flows are also relatively objective measures of performance. [1]
The amount of cash on hand at the beginning and end of each financial year can
be checked against bank statements. [1]
Accruals-based financial statements leave scope for errors and creative
accounting. [1]
Measuring performance in terms of cash flows could, however, create scope
for dysfunctional behaviour. [1]
If the directors do not, for example, invest in new assets then the operating cash
inflows will increase in the short to medium term, although that could then lead to a
shock when the assets finally need replacing. [1]
[7, Max 5]
Candidates demonstrated reasonable understanding of the cash flow statement and why it
is useful.
17 The most obvious implication is that it is unclear what resources are available to the
management team. [1]
The consultancy’s most significant and most valuable asset is its staff. [1]
Anyone considering the strength of the business from the outside will also be left
with the impression that it has little or nothing with which to generate revenue. [1]
This could also mean that there is a tendency for costs incurred in order to improve
the workforce’s capability is written off as a cost rather than capitalised as an asset.
[1]
Money spent on, say, training or staff development will not be added to the asset of
human resources. [1]
There could be wider implications for the credibility of the financial statements of an
entity in this industry. [1]
If stakeholders cannot see key facts such as the value of staff then they may wonder
what other omissions there might be. [1]
That could limit the value of the financial statements in any negotiations that occur.
[1]
[8, Max 5]
This question was done well.
18 The first implication is that the body of IFRS may constantly seem to be incomplete
and in the process of changing. [1]
Accounting standards are necessary to ensure that all companies prepare their
financial statements in a consistent manner so that their results can be compared. [1]

Accounting standards are necessary to ensure that companies can prepare their
financial statements in as consistent a manner as possible from one year to the next,
so that their year-on-year results can be meaningfully compared. [1]
If accounting standards are not updated promptly because of controversies over
accounting then there will never be a settled body of accounting standards. [1]
That will damage the IASB’s reputation which will, in turn, undermine the
credibility of financial statements. [1]
The fact that accounting standards are sometimes disputed could also affect
the accounting treatments themselves. [1]
The need to obtain the support of preparers and other interested parties could
mean that a technically sound accounting practice is set aside in order to reach a
compromise. [1]
[7, Max 5]
The answers to this question were weak. Candidates did not demonstrate clear
understanding of the problems of standard setting.
19 (i)
Gearworks Average
Return on capital employed, 270/1,362 = 20% 26% [1]
excluding debt
Return on capital employed, 324/(1,362+600) = 17% 22% [1]
including debt
Gross profit % 360/1,200 = 30% 25% [1]
Current ratio 237/75 = 3.2:1 2.1:1 [1]
Inventory turnover 76/840 x 365 = 33 days 42 days [1]
Receivables turnover 150/1,200x365 = 46 days 50 days [1]
[Total 6]
(ii) The most important issue is that Gearworks is delivering a less attractive return on
investment, with both ROE and ROCE either 5 or 6 points below the industry
average. [1]
Taking this at face value, the company’s board has been inefficient, although it
could be argued that the company’s size means that it is unable to achieve the
same economies of scale as are available to some other industry members. [1]
Larger companies will be able to invest in more efficient technology or to spread
operating costs over a higher unit output. [1]
Gearworks has a higher gross profit % than average. It is unlikely that this has
been achieved through more effective procurement activities because it is a small
company. [1]
It may be that Gearworks has been forced to charge a higher margin than average in
order to cover costs, which has probably constrained revenue and also ROCE. [1]
Gearworks has a high current ratio, which implies that the company is very solvent.
[1]
This also means that resources are being tied up in current assets that are unlikely to
yield any return and so this will be contributing to the poor ROCE and ROE. [1]

The concerns about the current ratio are contradicted slightly by the fact that
Gearworks turns over both inventory and receivables more rapidly than average. [1]
The high current ratio may, therefore, imply that excessive cash is being held (which
seems unlikely) [1]
or that the company is settling trade payables too quickly, which would require
further ratios to investigate. [1]
[10, Max 9]
(iii) Calculating the tax charge would give profit after tax as a measure of
performance. [1]
That would enable ROCE to be based on pre or post-tax values. [1]
It could be argued that a post-tax statistic could be a more relevant measure of
overall performance because it is part of the board’s responsibility to manage the
tax expense and to use any legal methods available to them to minimise the tax
charge. [1]
The tax charge would also create a liability for Corporation Tax in the statement
of financial position. [1]
That would create a potentially confusing impact on liquidity ratios because the
amount would be payable within months of the year end, but would not be as
urgent as the trade payables. [1]
Liquidity ratios could be less attractive, despite the fact that the company has not yet
taken the necessary steps to raise cash in order to fund the payments. [1]
[6, Max 5]
[Total 20]
Part (i) was done very well with most candidates gaining a high mark. Part (ii) was
reasonable with many candidates understanding what the ratio analysis showed. Part (iii)
was weak with poor understanding of how taxation would change the ratios.
20 (i) The most immediate implication is that the shareholders will start to wonder why
the company has this resource lying idle and not generating any revenue. [1]
This asset has arisen from the company’s past profits and so it has essentially
been funded by equity, which is an expensive form of finance. [1]
Raising equity and leaving the resulting assets lying unproductive could discourage
the shareholders. [1]
The fact that the directors have no plans for this cash surplus suggests that they
cannot justify the balance in any communications with shareholders. [1]
There does not appear to be a realistic prospect of any project getting under way
to put this cash to effective use. [1]
The shareholders’ return on equity will be diluted by this unproductive asset. [1]
There could even be a possibility that the capital markets will discipline the
directors through the market for corporate control. [1]
Any potential bidder could afford to pay a premium over the present share price
in order to obtain control. [1]
That premium could then be recouped using the cash to invest in positive NPV
projects. [1]
[9, Max 6]

(ii) Diversification would reduce the total risk associated with running Central. [1]
That could be desirable to the board members, who may feel nervous about using
the available funding to further increase the company’s investment in the mining
industry. [1]
The board members may be reluctant to invest in existing or related lines of business
because their careers could be at risk if an investment subsequently goes wrong. [1]
Investing in an unrelated line of business will, hopefully, mean that Central can
maintain a steady stream of profits. [1]
The disadvantage of diversification is that the shareholders will derive no benefit
from that. [1]
They can and should already be diversifying for themselves in their wider context
of their personal investment portfolios. [1]
If the shareholders wish to diversify for themselves then they can buy shares in
leisure industry businesses. [1]
There is a danger that Central’s management team will make such an investment
and then mismanage it and so waste the shareholders’ money. [1]
[8, Max 7]
(iii) A share buyback would be a suitable arrangement for returning the cash. The obvious
alternative would be a large dividend payment. [1]
Paying a dividend would risk creating tax problems for those shareholders who
have high taxable incomes. [1]
A share buyback could be structured so that shareholders could opt to be included
and there may be sufficient willing participants to focus the repayment on those
who would benefit from a tax perspective. [1]
The buyback would essentially involve a capital gain in most cases. [1]
There could be further issues associated with market psychology. [1]
Paying out a large dividend could be reported in the press as an example of
corporate and market greed. [1]
A buyback would at least create the impression that the shareholders are sacrificing
part of their investment in order to participate. [1]
There would also be little or no risk of creating an expectation that the dividend
payout has increased and will run at a higher rate going forward. [1]
[8, Max 7]
[Total 20]
[Paper Total 100]
Part (i) was done very well with most candidates gaining a high mark. Part (ii) was a little
weaker, candidates struggled to discuss diversification and apply it to the question. Part
(iii) was also a little weak with candidates demonstrating a poor understanding of share
buybacks.

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INSTITUTE AND FACULTY OF ACTUARIES

22 April 2024 (am)

Subject CB1 – Business Finance

CB1 A2024 © Institute and Faculty of Actuaries

A Company F’s market listing will be suspended

A A generous annual salary

Which of the following reflects the lending officer’s ethical responsibility?

A The lending officer should ask K Bank’s board to resign

A DTR enables countries to receive more tax

A The investor does not wish to diversify upside risk

6 An actuary is considering purchasing a pocket calculator costing $80. The Internal

Which of the following statements is a logical interpretation of this IRR?

A Several calculators should be purchased

7 Company R plans to make an investment in a project with a positive Net Present

A The share price will decrease because of the analysts’ opinions

8 Which of the following is true of opportunity costs in a project appraisal?

A Opportunity costs are irrelevant to project evaluation

A G cannot mitigate the risk associated with bad weather

What is the company’s dividend cover?

11 Explain the implications of information asymmetries for sound corporate governance.

12 H is a software designer who is working on a program that has a large potential

13 Explain the role of shadow banks. [5]

15 A retailer operates as a sole trader. The retailer is considering incorporating the

Explain the advantages and disadvantages of incorporating this business. [5]

17 Explain why parent companies are required to publish consolidated financial

18 Company G’s return on capital employed is significantly higher when calculated as

(a) Statement of profit or loss. [6]

(b) Statement of changes in equity. [2]

(c) Statement of financial position. [7]

(i) Evaluate the planned acquisition of L as a means of creating growth

A. General comments on the aims of this subject and how it is marked

Different numerical answers may be obtained to those shown in these solutions

B. Comments on candidate performance in this diet of the examination.

The Pass Mark for this exam was 63.

Solutions for Subject CB1 – April 2024

Total assets 56,440

Total equity 48,060

Total of equity and liabilities 56,440

1. Property, plant and equipment

[Paper Total 100]

END OF EXAMINERS’ REPORT

21 September 2023 (am)

Subject CB1 – Business Finance

CB1 S2023 © Institute and Faculty of Actuaries

A The IRR criterion yields an absolute measure of project performance.

2 A limited liability partnership (LLP) is facing bankruptcy because its managing

3 Company D, based in Country H, paid taxes in Country L of $2 million on the

What type of finance is the airline using?

6 A company’s authorised share capital is 500,000,000 $1 shares, of which 300,000,000

7 Company V is a quoted jewellery retailer. The company is evaluating an opportunity

A Company V’s beta coefficient.

A Statement of changes in equity, statement of comprehensive income and

Explain the potential advantages of the shareholder value approach to Company Z.

15 An actuarial consulting firm, X, wishes to expand rapidly and is considering the

17 Company W is a quoted company. Company W’s Board has offered shareholders a

18 Company Y wishes to build a windfarm in a location that is ideally suited to the

Describe the ethical implications of proceeding with this development. [5]

The executive directors are remunerated by a combination of salaries, profit-related

CB1 S2023 © Institute and Faculty of Actuaries