top stories

Diploma in Financial Management

Financial strategy and risk management – DB2

December 2007

Introduction

The general standard achieved by candidates was satisfactory, which was reflected in the pass rate. Although some candidates managed to achieve a very high standard there was evidence that many failed to adopt a thoughtful approach to issues raised. It has been mentioned in several previous reports that candidates need to pay more attention to the particular circumstances described in the project. Thus, points raised should be set in context, giving emphasis to particular issues mentioned, rather than simply relying on broad general points. Unless a more focused approach is taken, high marks cannot be achieved.

A fair amount of computational work was needed in order to answer the first part of the requirements. This was generally done well. Whilst it was pleasing to see that most candidates showed key workings, it was not always easy to trace the workings undertaken to the summary statements. Clear cross referencing and numbering of workings will help markers to follow the reasoning of candidates and thereby avoid the risk that credit is not given for valid points.

Specific comments

The case study, upon which the questions were based, concerns a recently-formed mining company, Balkan Nickel, which is planning to mine for nickel in the Balkan mountain range. The directors of the company are considering various financing options and the company faces various risks when undertaking the venture.

Part (a) carried 45 marks out of 100 marks for the whole project and required candidates to evaluate each of the financing options available. Forecast net present value (NPV), discounted payback and annual profits after tax were required for each of the financing options.

Most candidates made a reasonable attempt at this part and some managed to achieve a very high mark for their efforts. NPV calculations provided a challenge for some candidates. A particular problem concerned the calculation of working capital. It is only the incremental changes in working capital that need to be taken into consideration when calculating the incremental cash flows. Depreciation adjustments and tax calculations also proved to be difficult. In the latter case, a fairly common problem was that operating cash flows were used as the basis for the calculation rather than operating profits (as mentioned in the notes to the case study).

The calculation of profits proved to be less of a challenge for candidates, although basic errors, such as the deduction of working capital and capital expenditure from revenues, marred some efforts. Virtually all candidates were able to calculate the discounted payback and so, for this element, marks were high.

The second option to be evaluated was a joint venture, which involved an equal division of capital input and profits between Balkan Nickel and the other party, Zagros Mining. Undertaking the calculations necessary to reflect the division of profits proved rather too tricky for many. Although operating profits are divided equally, interest arising from the debt remains the sole responsibility of Balkan Nickel, which should be deducted from the fifty per cent share of operating profits received. The net figure derived should then form the basis for Balkan Nickel’s tax liability. 

Part (b) carried 6 out of 100 marks and required candidates to derive a share value for Balkan Nickel based on each of the options being considered.

Generally, this part was not well answered and high marks were rarely awarded. The most appropriate way to value the shares was to use the NPV for each option, as calculated in Part (a). Although many candidates used this approach, they often failed to deduct the value of debt in arriving at the amounts available to equity. Many also failed to correctly calculate the number of issued shares associated with each option and so miscalculated the value of each share.

Part (c) carried 21 marks out of 100 marks and required an evaluation of the benefits and problems associated with each of the options available to Balkan Nickel.

Most candidates managed to gain reasonable marks from this part, although there were few very good answers. The main problem was excessive reliance on general points and failure to tailor the answer to the particulars of the case study. There was also a failure to evaluate the options from the perspective of the founders in a detailed manner. Calculations showing the financial benefits accruing to the founders under each option were really required, which should have shown the combined effect of the share price and the $5 million payment made to each founder under the joint venture option.  Some candidates made points concerning the problems of mining in the Balkans that were common to each of the options under consideration, yet were only mentioned in the context of a particular option.

Part (d) carried 28 marks out of 100 marks and required a report on the key risks facing the company and the ways in which these risks may be managed.

Once again, many candidates would have achieved higher marks if they had used the information in the case study to frame their answers. The identification and management of risks were often considered in a rather mechanical manner without any real evidence that candidates had considered the issues carefully. However, some candidates produced some excellent answers that demonstrated considerable background research on the political and economic condition of Bulgaria and the problems facing a nickel mining company in the Balkans.