Financial Management · November 2025

a) Calculation of NPV (₦000) Years 0 1 - 5 Machine (25,000) - Factory rental - (800) Manager’s salary (W4) - (700) Variable production costs (W5) -___ (12,000) Total outflows (25,000) (13,300) Sales revenue -___ 22,000 NCF (25,000) 8,700 PVF at 5% 1 4.329 PV (25,000) 37,662 NPV = ₦12,667,000 The NPV of the project is positive and if all other factors are held constant, it should be accepted. Working Notes

1. Machine depreciation: is irrelevant, being a non-cash item. 2. Head office costs: These are non-incremental costs and therefore irrelevant 3. Feasibility study: The amount spent on feasibility study is a sunk cost and therefore irrelevant. 4. Only the extra salary payable to the manager is relevant. ₦000 Salary 700 Pension saved (200) Incremental salary 500

5. Variable costs The only relevant costs per unit are: ₦ Direct labour 500 Material 450 Variable overheads 250 1,200 Total per annum = 1,200 × 10,000 units = ₦12,000,000.

b) Sensitivity analysis

i) Life of project: The breakeven life of the project can be calculated using discounted payback period (DPBP). Year NCF PVF at 5% PV CUM PV ₦000 ₦000 ₦000 0 (25,000) 1 (25,000) (25,000) 1 8,700 0.952 8,282 (16,718) 2 8,700 0.909 7,729 (8,810) 3 8,700 0.864 7,517 (1,293) 4 8,700 0.823 7,160 5,867 DPBP = 3 + (1,293/7,160) = 3.18 years The sensitivity margin = (4 – 3.18)/4 = 20.5%. This means that the life of the project can be shortened by 20.5%.

ii) Annual sales volume SM (sales volume) = NPV/PV of contribution PV of contribution = 10,000 units (₦2,200 – 1,200) × 4.329=₦43,290,000 SM = ₦12,662/43,290 = 29.25% This means that the current sales volume of 10,000 units can fall by maximum of 29.25%. Thus, the minimum sales volume is 10,000 × (100 – 29.25) % = 7075 units.

iii) Material price SM = NPV/PV of material cost PV of material cost = 10,000 × ₦450 × 4.329 = ₦19,480,500 SM = ₦12,662/₦19,480.50 = 65% This means that the material price of ₦450 per unit can increase by 65%. Thus the breakeven price per unit is ₦450 × (100 + 65) % = ₦742.50 per unit. Summary and comments The above calculations show that the manufacture of Zinco would still be worthwhile if product life fell to 3.2 years, or if annual sales fell to 7,075 units, or if material costs increased to ₦742.50 per unit of Zinco. These figures represent percentage errors of 36%, 29% and 65%, respectively on the original estimates. If the actual figures were within these percentages of the original estimates, the decision to go ahead would still be valid. These are large percentages and the NPV is therefore remarkably insensitive to errors in the three factors.

c) Introduction In capital budgeting, decisions are made under conditions of uncertainty. Future cash inflows, costs, and discount rates are often subject to change, and managers need techniques to evaluate how such uncertainty affects project viability. Sensitivity analysis and simulation are two widely used approaches. While sensitivity analysis provides a straightforward way of identifying the effect of changes in individual variables, it has important limitations. Simulation techniques, particularly Monte Carlo simulation, offer a more comprehensive approach by modelling uncertainty in a probabilistic manner. Strengths of sensitivity analysis i. Simplicity and clarity - The technique is easy to understand and implement. Managers can see directly how project outcomes (e.g., NPV, IRR) respond to changes in assumptions such as sales volume, costs, or discount rate.

ii. Identification of critical variables - Sensitivity analysis highlights which factors exert the greatest influence on project success, guiding management attention and control. iii. Communication tool - Results can be presented graphically (e.g., tornado diagrams), making it easier to convey the project’s vulnerability to stakeholders. iv. Decision support - Provides useful “what-if” scenarios that allow managers to test the robustness of a project under alternative conditions. Weaknesses of sensitivity analysis i. One-variable-at-a-time limitation - In practice, variables are interrelated. For instance, sales volume and price are likely to move together, but sensitivity analysis cannot capture such interactions. ii. No probability information - While it shows how outcomes change if assumptions vary, it does not indicate how likely such variations are. iii. Arbitrary input ranges - The percentage changes used (e.g., ±10%) are subjective and may not reflect real uncertainty. iv. Linear assumption - It often assumes a straight-line relationship between variables and outcomes, overlooking possible non-linear effects. v. Static approach - Sensitivity analysis ignores management’s ability to adapt or revise decisions over the life of a project. How simulation improves on sensitivity analysis Simulation addresses these shortcomings by allowing multiple uncertain variables to vary simultaneously according to assigned probability distributions. In particular:

i. Probabilistic outcomes - Simulation generates a distribution of possible NPVs rather than a single-point estimate, showing the probability of achieving different levels of return. ii. Interdependence of variables - Correlations between inputs (e.g., price and demand, costs and output) can be modelled. iii. Holistic risk assessment - Thousands of iterations can be run to capture the combined effect of uncertainty, providing expected values, standard deviations, and probabilities of loss. iv. Strategic insights - Managers obtain a richer understanding of risk exposure, making it possible to compare projects not only by expected NPV but also by risk profile. Limitations of Simulation must also be acknowledged: it requires large amounts of reliable data, complex modelling, and sophisticated software. Moreover, results depend heavily on the accuracy of the assumed probability distributions. Conclusion Sensitivity analysis remains a useful first step in risk assessment: it is simple, highlights critical variables, and supports communication. However, its weaknesses - especially the inability to incorporate probabilities and multiple variable interactions - limit its effectiveness as a stand-alone tool. Simulation provides a more advanced and realistic means of assessing risk by producing a full probability distribution of project outcomes. Together, both methods can complement each other: sensitivity analysis for preliminary screening, and simulation for deeper, probabilistic evaluation.

Examiner’s Report This compulsory scenario-based question tests: Calculation of Net Present Value (NPV), with emphasis on identifying relevant and irrelevant costs; Sensitivity analysis of NPV in relation to estimation errors; and Evaluation of the strengths and weaknesses of sensitivity analysis and simulation in capital project appraisal. Approximately 99% of candidates attempted this question. Performance was extremely poor. About 95% of candidates scored below average, with fewer than 5% achieving up to half of the allocated marks. Candidates’ commonest pitfalls were that most of the candidates could not identify the relevant costs nor calculate relevant ratios and NPV to evaluate the project. Candidates are advised to master the various financial management techniques and their application to scenarios.

Marking guide Question Number Question Question Requirement Total Marks Allotted Component 1 a Net Present Value of the proposed project – manufacture of Zinco. 16 marks b Sensitivity of NPV to errors of estimation of product life, annual sales volume and material cost per unit of Zinco 6 marks c Assessment of the strengths and weaknesses of sensitivity analysis as a method of evaluating risk and uncertainty in capital project appraisal. Also, how simulation provide an improvement over sensitivity analysis in this regard. 8 marks Total 30 marks

a)i) Last year’s actual: Inventory turnover = Average Credit Purchases Inventory × 365 Inventory turnover = 2,400,000 480,000 × 365 = 73 days Trade receivables turnover = Average Credit Receivables Sales × 365 Trade receivables turnover = 3,600,000 630,000 × 365 = 64 days Trade payables turnover = Average Credit Purchases Payables × 365 Trade payables turnover = 200,000 2,400,000 × 365 = 30 days Working capital cycle = 73 + 64 – 30 =107 days

ii) Director’s hypothetical proposal: Inventory turnover = 73 × 70% = 51 days Trade receivables turnover = 40 days Trade payables turnover = 50 days Working capital cycle = 51 + 40 – 50 = 41 days

b) Two Importance of working capital management from the above computations.

i. Liquidity/cash availability The working capital cycle measures how long cash is tied up in operations. KT’s current cycle is 106.5 days, which means cash invested in inventory and receivables is tied up for over 3 months. This requires either a large cash reserve or external finance. If the company is short on cash, it may miss supplier payments or lose discounts.

ii. Cost of financing and profitability Longer cycles increase the need to borrow, raising interest expense and reducing net profit. For KT, reducing the cycle from 106.5 to 41.1days, which is in line with the director’s target, would shorten the cash conversion time by 65.4days, which will in turn reduce financing needs and interest cost and improve net profit.

iii. Appropriate length of working capital cycle The directors must also make sure that the working capital cycle is long enough to ensure that the company has sufficient liquid assets to meet the overall business objectives. The company must have sufficient inventories and trade receivables to provide customers with an adequate service and cannot take excessive advantage of trade payables without losing all credibility.

c) New inventory level = ₦336,000 = ₦144,000 released New trade receivables level = × ₦3,600,000 = ₦394,521 = ₦235,479 released New trade payables level = × ₦2,400,000 = ₦328,767 = ₦128,767 released Total cash inflow = ₦508,246

d) The difficulties to overcome to implement the directors’ new policies Customer relations and risk of lost sales Tightening credit terms to reduce receivables days to 40 may anger customers or push them to competitors, causing lost sales. Some customers may truly need longer credit, which is restricted by the new policy. Credit control systems and administration Achieving 40 days needs robust credit checks, invoicing, collection procedures, and probably additional staff/training or software, this may increase administration costs. Inventory control/stock out risk Reducing inventory by 30% risks stock outs and lost sales, if forecasting is poor. KT must improve demand forecasting, adopt just-in-time ordering, ensure supplier reliability, and possibly invest in inventory management systems. Supplier negotiation/relationship risk Extending payables to 50 days depends on suppliers’ willingness. Suppliers may refuse, demand earlier payment, or withdraw discounts. Negotiation may require demonstrating consistent ordering, improved forecasting, or a willingness to accept other terms. Operational change management & costs Implementing all changes requires management time, staff training, possible system upgrades (accounting/inventory systems), and an implementation plan. There may be short-term costs (consultancy, software, and training) and internal resistance to new procedures. Supplier negotiation Extending payables to 50 days needs supplier agreement; suppliers may demand higher prices/shorter terms or forfeiture of early payment discounts. Systems and processes Need better IT, credit scoring, inventory management (e.g., JIT, EOQ), and staff training - time and cost to implement.

Examiner’s Report This question tests knowledge of Working Capital Management. About 80% of the candidates attempted this question. Approximately 80% of the candidates scored less than 50% of the marks allocated. Performance was poor due to inability of many candidates to apply their theoretical knowledge to practical situations, as required by the question. Candidates should practise the application of their knowledge to practical situations.

Marking guide Question Number

a) i) Asset beta of coffee shop sector β = (V + V V (1 − T))β + (V V + (1 V − (1 T) − T))β Where:

• βE = 1.50

• (1 - T) = 1 - 0.30 = 0.70

• D/E = 0.4 β = 100 100 + 40(1 × 1.50 − 0.30) + 0 = 1.17 Question Component Question Requirement Total Marks Allotted 2 Ai To calculate Working capital cycle in days. 4 marks Ii To calculate working capital cycle in days based on the director’s hypothetical figures 4 marks B To write two importance of working capital cycle to companies using the figures calculated in part (a) above 4 marks C To calculate the amount of cash that would be released if KT implemented the new inventory control and credit management policy. 3 marks D To describe the main difficulties to be overcome in order to put the Directors’ new policies into practice. 5 marks Total 20 marks

ii) Re-lever asset beta for project capital structure β = β + (β − β ) V V (1 − t) = 1.17 + (1.17 - 0)(0.6) (1-0.3)=1.66

iii) Project cost of equity (CAPM) KE = Rf + βE × MRP KE = 8 + (1.66 × 6) = 17.96 or (say) 18%

iv) Project WACC Weights:

• D/E = 0.6 → Let E = 1 → D = 0.6 → Total = 1.6

• Weight of equity (We) = 1 / 1.6 = 0.625

• Weight of debt (Wd) = 0.6 / 1.6 = 0.375 After-tax cost of debt: Kd(after tax) = 12% × (1 - 0.30) = 8.4% WACC = (We × KE) + (Wd × Kd after tax) = (0.625 × 17.96%) + (0.375 × 8.4%) = 14.38%

v) Reasons why coffee shop sector’s asset beta might differ from bottled water/juice business Reason Explanation

1. Cyclicality of demand Coffee shop sales are more discretionary, depending heavily on consumer incomes and urban lifestyle spending, making them more sensitive to economic cycles. 2. Operating leverage Coffee shops have high fixed overheads (rent, staff), increasing earnings volatility compared to bottled water production. 3. Input cost exposure Coffee beans and dairy are often imported, exposing coffee shop global commodity price and exchange rate risk, bottled water uses mainly local inputs. 4. Customer behaviour and brand sensitivity Coffee shops rely on brand loyalty and foot traffic; consumer preferences can shift quickly due to trends, increasing volatility compared to more stable water/juice demand.

b) Challenges associated with using proxy companies to determine the beta factor of a new project include: i. Differences in business risk profile

• A proxy company may not engage in exactly the same activities as the project under appraisal.

• Even within the same industry, variations in product mix, technology, customer base, or competitive positioning can lead to differences in systematic risk.

• This makes the proxy’s beta an imperfect measure of the project’s true risk.

ii. Differences in financial structure

• Beta reflects both business risk and financial (gearing) risk.

• If the proxy company’s capital structure differs significantly from that intended for the project, the derived beta will be biased.

• Adjustments must be made (e.g., ungearing and re-gearing), but these rely on assumptions about debt levels and costs that may not hold in practice.

iii. Data limitations and estimation errors

• Proxy betas are usually estimated from historical share price data.

• For smaller or less liquid companies, the data may be thin, noisy, or subject to non-trading biases, which distorts the beta.

• As a result, the reliability of the proxy beta is questionable, especially if few suitable listed proxies exist.

iv. Impact of non-comparable diversification

• Many listed companies are diversified across several sectors, whereas the project may be narrowly focused.

• The proxy company’s beta may therefore reflect risks irrelevant to the project.

• Isolating the relevant part of the beta is difficult and can lead to underestimation or over estimation of the project’s risk.

v. Changing market conditions and risk profiles

• Proxy betas are backward-looking, based on historical relationships between the company’s returns and the market.

• If industry risk, regulation, technology, or macroeconomic conditions change, the proxy’s past beta may no longer be valid for the new project’s future.

• This temporal mismatch reduces the usefulness of the proxy.

Examiner’s Report This question tests capital structure as it relates to investment and cost of capital. About 75% of the candidates attempted this question. Performance was poor, with less than 25% of the candidates scoring above 50%. Most candidates did not understand the computation and the context of the application of the beta factors. Candidates should endeavour to master the theories, techniques and applications covered in Financial Management, as they will be required in Strategic Financial Management at the Professional level of the examination.

Marking guide Question Number Question Component Question Requirement Total Marks Allotted 3 Ai To calculate the asset beta for the coffee shop business using the comparator company’s data. 1½ marks Ii To re-lever the asset beta to reflect the project’s capital structure. 1½ marks Iii To calculate the project’s cost of equity using CAPM. 1½ marks Iv To calculate the project’s WACC. 2½ marks V To identify and discuss four reasons why the coffee shop business’ asset beta might differ from NigerGold’s existing bottled water and fruit juice business. 5 marks 3b To identify and discuss five challenges associated with the use of proxy companies in determining the beta factor of a new project. 8 marks Total 20 marks

(a) i. Presumed advantages of entering forward contracts

• Locks the exchange rate for each receipt so the merchant knows exactly how many pounds it will receive - removes FX uncertainty.

• Protects profit margins and cash-flow planning (helpful for budgeting, pricing, dividend/capital planning).

• No initial cash outlay (for typical non-premium forwards) and straightforward to arrange through the bank.

• Avoids adverse currency moves between shipment and later receipts.

• Counterparty certainty (contractual with the bank) - unlike leaving exposure to spot market volatility. (Please note minor downsides: opportunity loss if spot moves favorably, bank credit/counterparty risk, and forward amounts/dates must match receipts exactly or leave basis/exposure).

ii. Calculation of sterling amount the merchant would receive (using the bank’s quotes $/£ when the merchant is selling $ to buy £) Given quotes ($ per £) and logic used

• When the merchant sells USD to receive GBP, the bank sells £ to the merchant at its ask (the higher $/£). So we divide USD by the bank’s ask rate to get £. Rates used:

• Spot ask = 1.692 ($/£)

• 1-month forward ask = 1.690

• 3-month forward ask = 1.684 Receipts: 1. Immediate (on shipment) — $60,000 at spot 1.692 £ = 60,000 ÷ 1.692 = £35,460.99 2. One month after shipment — $45,000 at 1-month forward 1.690 £ = 45,000 ÷ 1.690 = £26,627.22 3. Three months after shipment — $45,000 at 3-month forward 1.684 £ = 45,000 ÷ 1.684 = £26,722.09 Total sterling received (hedged) = £35,460.99 + £26,627.22 + £26,722.09 = £88,810.30 (Amounts rounded to 2 decimal places)

iii) Hindsight comment - was hedging wise? Assuming that the actual spot quotes at the times the two $45,000 instalments arrived were:

• First instalment spot quote: 1.694 – 1.696 → merchant would have bought £ at the bank’s ask 1.696 if unhedged.

• Second instalment spot quote: 1.700 – 1.704 → bank’s ask 1.704. If the merchant had left those receipts unhedged, conversion would give:

• First instalment unhedged: 45,000 ÷ 1.696 = £26,533.02

• Second instalment unhedged: 45,000 ÷ 1.704 = £26,408.45

• (Spot - immediate receipt still remains £35,460.99 as above.) Total sterling unhedged = £35,460.99 + £26,533.02 + £26,408.45 = £88,402.46. Comparison: Hedged total = £88,810.30 Unhedged total = £88,402.46 Hedging gained ≈ £407.84 (i.e. merchant received ~£408 more by hedging) Conclusion: Given the actual spot movements (spot ask rates turned out higher than the forward rates the merchant locked in), hedging was wise in this instance - it produced a modest but real improvement in pound receipts of £407.84 and removed the risk of further adverse moves.

b) How using foreign-exchange (FX) futures would differ from the forward assumed above Key differences the merchant would face, if it uses FX futures instead of bank forwards:

i. Standardisation vs customisation

• Futures are exchange-traded, standardised contract sizes and set delivery months; forwards are OTC and can be tailored to exact amounts and dates.

• Practical effect: the merchant might have to use several futures contracts (or over/under hedge), if contract sizes/delivery months do not match the $60k/45k/45k schedule exactly - basis risk.

ii. Daily marking-to-market and margins

• Futures are marked-to-market daily with margin requirements (initial margin + variation margin). Gains/losses are settled daily in cash. Forwards settle only at maturity (no daily cash flows).

• This means potential margin calls (cash flow requirement) even though the ultimate economic exposure is similar.

iii. Credit risk / clearinghouse

• Futures have lower counterparty credit risk because the exchange’s clearinghouse guarantees performance. Forwards expose the merchant to bank counterparty risk.

iv. Liquidity and transparency

• Futures are typically more liquid and have transparent pricing; forwards depend on bank quotes and may have larger bid-ask spreads for nonstandard sizes/dates.

v. Settlement and delivery

• Many FX futures are closed out before delivery (cash settled); physical delivery is possible, but less common. Forwards commonly result in actual currency conversion at maturity.

vi. Accounting and regulatory differences

• Margining and daily gains/losses can affect balance-sheet/working capital and accounting. Futures may trigger different hedge accounting treatments against forwards.

vii. Transaction costs and flexibility

• Futures exchange fees and margin opportunity cost versus bank spread and any forward commission - total cost profile differs and depends on contract availability and bank terms. Implication for the merchant: Futures could be attractive for credit and price transparency, but may not match the exact amounts and timing of the three receipts, and would introduce daily margin cash flows. For a merchant needing precise, date-specific cover for $60k/45k/45k, tailored forwards through the bank are usually more convenient despite the OTC counterparty exposure.

Examiner’s Report This question tests foreign exchange transactions and derivatives, specifically forward contracts. About 60% of the candidates attempted this question. Less than 30% of the candidates scored 50% of the marks allotted. Candidates showed vague understanding of the core concepts of foreign exchange transactions. Many failed to differentiate between foreign exchange futures and forward contracts. Improved preparation is necessary to master these concepts, which are essential for a chartered accountant.

Marking guide Question Number Question Component Question Requirement Total Marks Allotted 4 4ai To state the advantages of forward exchange contracts. 3 marks aii To calculate in pound sterling, the amount that the merchant would receive. 6 marks aiii To Comment with hindsight on the wisdom of hedging in this instance, assuming that the spot rates at the dates of receipt of the two instalments of $45,000 were as follows: First installment 1.694 – 1.696 Second installment 1.700 – 1.704 5 marks 4b To describe how foreign exchange transactions (using futures) would differ from those assumed in part (a) above. 6 marks Total 20 marks

Companies operating in the same industry face broadly similar economic conditions and competitive pressures, yet they often adopt different levels of financial gearing (debt vs. equity). This can be explained by differences in company-specific circumstances, strategic choices, and external pressures.

i. Differences in business risk and earnings volatility Firms with more stable revenues can tolerate higher gearing, while those with volatile earnings prefer lower gearing to avoid financial distress. For example, within the airline industry, a budget airline with diversified routes may carry more debt than a smaller regional airline dependent on one route. Thus, even within the same sector, cash flow predictability shapes capital structure decisions.

ii. Asset structure and collateral availability Companies with more tangible, asset-backed collateral (e.g., real estate, machinery) can borrow more easily than firms reliant on intangibles (brands, technology). For example, in Nigerian cement production, Dangote Cement (with significant fixed assets) can sustain higher gearing than a smaller cement distributor relying on leased facilities. This means that the nature of assets differentiates debt capacity, even among peers.

iii. Growth opportunities and investment strategy High-growth firms often rely on equity to preserve flexibility and avoid the burden of debt servicing, while mature firms with steady cash flows may gear up to enhance returns. For example, a new fintech company in Nigeria may prefer low gearing to remain agile, while a long-established bank may use higher gearing to exploit tax shields. This means that the stage of business life cycle affects gearing choices within the same sector.

iv. Management risk appetite and strategic philosophy Some management teams are conservative and prefer stability, while others adopt aggressive strategies, accepting higher gearing to boost returns on equity. For example, two construction firms bidding for government contracts may adopt very different gearing policies depending on the management’s appetite for risk. Thus, corporate culture and leadership strongly influence capital structure.

v. Ownership structure and control considerations Family-controlled or closely held firms may avoid equity issuance to preserve control, leading to higher gearing. Widely held public firms may be more willing to issue equity. For example, in Nigeria, many family-owned manufacturing companies rely heavily on bank loans rather than share issues to avoid dilution of family control. This means that ownership concerns drive gearing choices even among similar firms.

vi. Tax position and profitability Debt provides a tax shield, but this benefit depends on the firm’s profitability. Loss-making companies cannot exploit tax deductions, so they may prefer equity. For example, a profitable telecoms operator might use high gearing to reduce its tax bill, while a struggling competitor avoids debt due to inability to claim tax shields. Tax efficiency differs across firms, leading to different gearing strategies.

vii. Access to capital markets and banking relationships Larger or more reputable companies often find it easier to borrow at lower interest rates, while smaller or riskier firms face higher costs of debt. For example, Nestlé Nigeria can secure favourable syndicated loans, whereas a smaller food processor may find equity financing cheaper than expensive bank debt. Thus, market credibility influences gearing choices within the same industry.

viii. Macroeconomic and country-specific factors Firms within the same industry but exposed to different international markets or currencies may adopt different gearing levels. For example, an oil servicing company with contracts paid in USD may be comfortable with USD- denominated loans, while a domestic-focused rival avoids debt exposure to exchange rate risks. The implication of this is that the currency exposure and geopolitical risks affect gearing tolerance.

ix. Agency costs and bankruptcy costs High debt increases bankruptcy/financial distress probability and may lead to agency conflicts - managers may prefer low debt to reduce distress risk.

x. Regulatory and industry norms Some industries (banks, utilities) have standard leverage norms driven by regulation or practice; deviation may signal risk or mismanagement.

Examiner’s Report This question tests financial gearing and capital structure of companies. About 80% of the candidates attempted this question. Approximately 50% of the candidates scored above 50% of the allocated marks. Candidates’ Commonest Pitfalls was that candidates who performed poorly demonstrated inadequate understanding of the requirements of the question. Candidates should endeavour to cover the syllabus effectively.

Marking guide Question Number Question Component Question Requirement Total Marks Allotted 5 5 To critically discuss why different companies might choose to adopt different levels of financial gearing, even within the same industry. 15 marks

a) Major government activities that influence financial management

i. Monetary policy

• Controlled by the Central Bank through interest rates, money supply, and credit regulation.

• Affects cost of borrowing, availability of credit, and investment decisions.

ii. Fiscal policy

• Government spending and taxation policies shape overall demand in the economy.

• Influences company sales, profitability, and cash flow.

iii. Regulations and legislations

• Company law, securities regulation, labour law, and environmental standards all affect financial management.

• Determine reporting obligations, capital structure choices, and compliance costs.

vi. Taxation policy

• Corporate income tax, capital gains tax, and value-added tax directly influence net profits and dividend policy.

• Tax incentives may encourage investment in specific sectors.

v. Foreign exchange and trade policy

• Exchange rate controls, tariffs, import restrictions, and export promotion measures affect cost structures and international competitiveness.

vi. Government borrowing and debt management

• High government borrowing can crowd out private investment and push up interest rates.

• The issuance of government securities competes with corporate securities for investor funds.

vii. Industrial and investment policies

• Incentives, subsidies, and infrastructure development influence capital budgeting and location of projects.

• Special schemes (e.g., free trade zones, pioneer status) may reduce costs and improve returns.

viii. Stability and governance

• Political stability, anti-corruption efforts, and enforcement of property rights create an enabling environment for financial decision-making. Illustrations of how government activities affect companies i. Monetary policy example

• If the Central Bank raises interest rates, bank lending becomes costlier. A company may defer expansion financed by debt, slowing growth and affecting its objective of maximising shareholder wealth.

ii. Fiscal policy example

• Increased government capital spending on infrastructure (e.g., roads, power) reduces operating costs for manufacturing firms, improving profitability.

iii. Taxation example

• A reduction in corporate income tax leaves more retained earnings available, supporting dividend payment or reinvestment into growth projects.

vi. Foreign exchange control example

• If the government restricts access to foreign exchange, an importing company may face higher costs and supply shortages, frustrating its cost minimisation and profitability objectives.

v. Industrial policy example

• A company producing solar panels may benefit from tax holidays and subsidies for renewable energy, helping achieve long-term investment returns.

b) Major characteristics of capital project decisions that make them strategic

i. Large capital outlay

• Capital projects usually require substantial financial investment, often stretching the resources of the organisation.

• Wrong decisions can tie up funds in unproductive assets.

ii. Long-term impact

• These projects typically involve long time horizons, with cash flows and benefits extending many years into the future.

• They lock the firm into a chosen course of action for a significant period.

iii. Irreversibility (or High exit costs)

• Once undertaken, capital projects are often difficult or costly to reverse (e.g., specialised machinery, infrastructure).

• Poor choices may lead to sunk costs and under-utilised resources.

iv. Uncertainty and risk

• Because of the long life span, projects are exposed to market, technological, economic, and regulatory risks.

• Forecasting benefits and costs is therefore uncertain.

v. Strategic fit

• Capital projects usually define or alter the future direction of the business, such as entering new markets, adopting new technology, or expanding capacity.

• They must align with the organisation’s overall strategy.

vi. Impact on competitive position

• Successful projects can enhance competitive advantage through cost efficiency, differentiation, or innovation.

• Poorly chosen ones can weaken competitiveness.

vii. Influence on stakeholders

• Decisions affect not just shareholders but also employees, customers, and the community (e.g., environmental impact, job creation).

• This makes them politically and socially significant.

Examiner’s Report This question tests the knowledge of influence of government activities on financial management and the strategic nature of capital projects. About 95% of the candidates attempted this question. About 40% of them scored above 50% of the marks allotted. Candidates’ commonest pitfall was that candidates who performed poorly did not adequately illustrate how government activities influence financial management or did not understand the strategic nature of capital projects. It is essential that candidates fully understand the impact of government activities on financial management and the strategic nature of capital project decisions.

Marking guide Question Number Question Component Question Requirement Total Marks Allotted 6 A To outline the major government activities that influence financial management and illustrate how government activities affect companies in achieving their financial objectives. 10 marks B Major characteristics of capital project decisions that make them so strategic in nature. 5 marks Total 15 marks

a) i) Book values Debt/equity = = 125%

ii) Market values Debt/equity = = 33.75%

b) Evaluate weaknesses and benefits of book verse market gearing Book value gearing - weaknesses i. Outdated valuations: Book values (historic costs) do not reflect current market valuations of debt or equity - may misrepresent true leverage. ii. Ignores market expectations: Book gearing does not capture investor perception/risk which affects cost of capital. Book value gearing - benefits Simplicity and accounting consistency: Easy to compute from financial statements and consistent for regulatory/contractual tests. Market value gearing - benefits Reflects current economic reality: Market values incorporate current investor expectations, current share price and debt trading price - gives a more accurate view of the firm’s economic leverage and cost of capital. Market value gearing - weaknesses i. Volatility: Market prices fluctuate day-to-day and may be driven by temporary sentiment or liquidity effects, giving noisy leverage signals.

ii. Market distortion on small or illiquid stocks: For thinly traded equity, market value can be unrepresentative.

c) Proceeds raised = ₦2.5 × 50 million = ₦125 million Ex rights price = [₦2.5 + (2 × ₦4)] 3 = ₦3.5 Value of equity after rights issue = ₦3.5 × 150 million = ₦525 million Value of debt after rights issue = (₦150 million - ₦125 million) × 0.90 = ₦22.5 million Gearing = 22.5 million 525 million = 4.29%

Examiner’s Report This question tests financial gearing using book values and market values bases and the evaluation of the approaches. About 75% of the candidates attempted this question. About 30% of the candidates scored above 50% of marks allotted. Candidates’ commonest pitfall is the main challenge was part (7c), particularly the calculation of the ex-rights price, which many candidates either avoided or answered incorrectly. Candidates are admonished to study to understand basic concepts in financial management fully. GENERAL COMMENT: Candidates writing this paper are advised to pay particular attention to the details and applications of each concept, technique, approach covered under this subject, as they will be required for good performance in Strategic Financial Management at the Professional level of the examination.

Marking guide Question Number Question Question Requirement Total Marks Component Allotted 7 a. Calculating the gearing (that is, debt/equity) of ZK Plc at 31 March 2025, using both

i. Book values; and

ii. Market values 3 marks

b. i. The weaknesses; and

ii. The benefits Of the two methods used to calculate gearing in requirement (a) above 6 marks

c. To calculate the gearing at ZK Plc in market value terms, immediately after the rights issue and redemption of debts. 5 marks Total 15 marks ICAN/252/Q/B6 Examination No.................... INSTITUTE OF CHARTERED ACCOUNTANTS OF NIGERIA SKILLS LEVEL EXAMINATION – NOVEMBER 2025 PUBLIC SECTOR ACCOUNTING & FINANCE EXAMINATION INSTRUCTIONS PLEASE READ THESE INSTRUCTIONS BEFORE THE COMMENCEMENT OF THE PAPER

1. Check your pockets, purse, mathematical set, etc. to ensure that you do not have prohibited items such as telephone handset, electronic storage device, programmable devices, wristwatches or any form of written material on you in the examination hall. You will be stopped from continuing with the examination and liable to further disciplinary actions including cancellation of examination result if caught.

2. Write your EXAMINATION NUMBER in the space provided above.

3. Do NOT write anything on your question paper EXCEPT your Examination number.

4. Do NOT write anything on your docket.

5. Read all instructions in each section of the question paper carefully before answering the questions.

6. Do NOT answer more than the number of questions required in each section, otherwise, you will be penalised.

7. All solutions should be written in BLUE or BLACK INK. Any solution written in PENCIL or any other COLOUR OF INK will not be marked.

8. Cross out ALL UNUSED SPACES ON ALL PAGES of the Answer Booklet.

9. You are required to attempt Question ONE (Compulsory), TWO Questions in Section B and TWO Questions in Section C.

10. Check that you have collected the correct question paper for the examination you are writing. THURSDAY, NOVEMBER 20, 2025