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Once again, the performance of candidates in the DB2 project was pleasing. The general standard of projects submitted was high and this was reflected in the pass rate.

Projects were generally well-researched and convincingly argued. Many candidates demonstrated a good understanding of the Financial Strategy and Risk Management syllabuses. Projects were also well-structured and well-presented. However, in a few cases, candidates did not clearly state key assumptions or show key workings despite the fact that these requirements were clearly stated. By reading the instructions more carefully, higher marks would have been gained.

Section 1 - Financial Strategy

The case study on which the questions for this section were based concerned a family-owned company, Whinchat Limited. The company had been put up for sale by its owners and the proposed sale had attracted the attention of a large pharmaceutical company, Scaup plc. Candidates were asked to put themselves in the position of a consultant acting on behalf of Scaup plc and to consider various aspects of the possible takeover.

Part (a) carried 50% of the total marks awarded for the question and required candidates to suggest, with reasons:

1. a reserve price per share in Whinchat Limited that would be appropriate for the shareholders of Whinchat Limited
   and
2. a reserve price in Whinchat Limited that would be appropriate for the shareholders of Scaup plc.

On the whole, this part was well answered with some candidates scoring very high marks. However, some candidates would have gained higher marks if they had expanded their analyses and arguments. Although the instructions clearly stated that possible options should be examined and that suggestions (which included suggestions on reserve prices) should be supported by appropriate arguments, this was not always done. Some candidates examined only one method of valuing the shares of Whinchat Limited while others did not provide any real justification for their choice of reserve prices. The calculations that were carried out in arriving at a value per share were generally logical and appropriate. However, many struggled with share valuation calculations based on free cash flows. A large number failed to take account of the free cash flows over the whole life of the business. Where a share valuation method required the use of industry data, many used the available data to derive an average figure. In a few cases, the data concerning a particular company within the industry was used to help arrive at a suitable share value for Whinchat Limited. Although the merits of both approaches may be argued, the reasons for the particular approach taken were not always made clear.

Part (b) carried 30% of the total marks for the section. It required candidates to recommend a systematic approach to the identification, evaluation and management of future company acquisitions to Scaup plc. This part brought a wide range of answers, some of which were very good. The better answers often included points concerning the need for strategic fit, the need for appropriate acquisition criteria, the negotiating and due diligences processes and the need to manage the integration of the company acquired. Weaker answers often considered only a narrow aspect of the takeover process (e.g. the rules for listed companies concerning takeover) or were too brief to do justice to the topic.

Part (c) carried 20% of the total marks for the section and required candidates to set out recommendations concerning a rights issue of shares to finance the takeover deal. This part was usually answered well. However, some candidates did not recognise the need to offer a discount to the market price of shares in Scaup plc.

Section 2 - Risk management

The case study on which the questions for this section were based concerned a company that was currently grappling with two key issues. The first concerned the dividend policy of the company. The company had not paid a dividend for a number of years and the directors were debating whether the company should recommence dividend payments. Within the Board of Directors, there were mixed views as to the desirability of making dividend payments. The second issue concerned directors’ remuneration.

The Chairman was considering the introduction of a performance-based incentive scheme to remunerate the Board of Directors and also the setting up of a Remuneration Committee. Part (a) accounted for 70% of the total marks for this section and concerned the dividend puzzle. Candidates were first asked to comment on the theoretical importance of dividends to share valuation and to discuss the different views expressed by board members. This element was generally well answered. Most candidates spotted that the different directors had taken positions that accorded with theories set out in the literature and managed to score high marks. However, a minority of candidates failed to deal with the relevant theories of dividend valuation and provided no real foundation for the arguments expressed. Candidates were also asked to discuss the major issues to be considered in deciding on dividend policy. This was generally well answered with good answers relating the points made back to the company being considered.

Finally, candidates were asked to consider the likely impact of various dividend levels on share prices in two different situations. Firstly, where the equity beta remained constant. Secondly, where the equity beta changed. This part was less well answered than other parts within this section. A good answer required the calculation of share price at various dividend levels for both situations. This meant calculating the required return to equity using CAPM and then using the dividend growth model to obtain a share price. Many candidates struggled with the calculations required and sometimes an attempt was made to answer this part without recourse to calculations. There were also examples of candidates providing tables of calculations that were appropriate, but then failing to discuss the implications of these calculations.

Part (b) dealt with the remuneration issue and accounted for 30% of the marks for this section. Candidates were required to discuss the purpose, scope and advantages of a Remuneration Committee. This element was usually well answered with many candidates showing their familiarity with the literature including the relevant recommendations set out in the Greenbury and Hampel reports.

Candidates were also required to explain the advantages of an incentive scheme for directors and to discuss the merits and problems of profits-based and share-based schemes. This element was, again, well answered and marks were generally high.

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