ACCA AFM cheat sheet

Agency problem arises when managers (agents) pursue own interests over shareholders (principals); mitigated by performance-related pay, share options, and monitoring.

Stakeholder theory: firm should balance interests of shareholders, employees, customers, suppliers, government, and community, not just maximise shareholder wealth.

Corporate governance codes (e.g., UK Corporate Governance Code) require board independence, audit committees, and transparency to reduce agency costs.

Financial intermediaries (banks, pension funds, insurers) reduce information asymmetry and transaction costs by channelling savings to borrowers.

Efficient market hypothesis (EMH) semi-strong form: prices reflect all publicly available information; strong form: all information including private.

NPV maximisation is the primary financial objective; it is consistent with shareholder wealth maximisation and considers time value of money.

Agency costs include monitoring costs (audit fees), bonding costs (managers committing to constraints), and residual loss.

The senior financial adviser role includes advising on capital structure, dividend policy, risk management, and mergers and acquisitions, while ensuring compliance with regulations.

Regulatory environment: financial reporting standards (IFRS), listing rules, and insider trading laws shape corporate financial decisions.

NPV = PV of cash inflows − PV of cash outflows; accept if NPV > 0, rank mutually exclusive projects by highest NPV.

IRR is the discount rate making NPV = 0; accept if IRR > cost of capital; can give multiple IRRs with non-conventional cash flows.

Modified IRR (MIRR) assumes reinvestment at cost of capital and avoids multiple IRR problem.

Payback period: time to recover initial investment; ignores time value of money and cash flows after payback.

Discounted payback period uses discounted cash flows; still ignores cash flows after payback.

Accounting rate of return (ARR) = average annual profit / average investment; based on accounting profit, not cash flow.

Relevant cash flows are incremental, after-tax, and exclude sunk costs, allocated overheads, and financing costs (captured in discount rate).

Tax-allowable depreciation (capital allowances) creates a tax shield; calculate tax saving = allowance × tax rate, adjust for tax lag.

Inflation: use nominal cash flows with nominal discount rate, or real cash flows with real discount rate; do not mix.

Asset beta (ungeared beta) measures business risk; equity beta (geared beta) includes financial risk; relever using Modigliani-Miller formula: βe = βa [1 + (1−T)(D/E)].

Interest rate risk: measure gap (rate-sensitive assets − liabilities) and duration (weighted average time to cash flows).

Forward rate agreement (FRA) fixes interest rate for a future period; buyer hedges against rate rise.

Interest rate futures: hedge by selling futures to protect against rate rise; basis risk exists between futures and spot rates.

Interest rate swap exchanges fixed for floating interest payments; comparative advantage argument explains gains from swapping.

Interest rate option (cap, floor, collar) gives right but not obligation; cap limits rate rise, floor limits rate fall, collar combines both.

Foreign exchange risk types: transaction (short-term cash flows), translation (accounting consolidation), economic (long-term competitiveness).

Forward contract locks exchange rate for future transaction; money market hedge borrows/invests in two currencies to fix rate.

Currency futures and options are exchange-traded; options give right but not obligation, requiring premium.

Purchasing power parity (PPP) links exchange rates to inflation differentials: forward rate ≈ spot × (1+inflation domestic)/(1+inflation foreign).

Interest rate parity (IRP) links interest differentials to forward premium/discount: forward/spot = (1+interest domestic)/(1+interest foreign).

Merger motives: synergy (operating, financial, managerial), diversification, market power, tax benefits, and undervaluation.

Synergy value = value of combined entity − (value of acquirer + value of target).

Purchase consideration can be cash, shares, or loan stock; cash gives immediate control but may strain liquidity; shares dilute ownership.

Takeover defences: poison pills, staggered boards, white knights, golden parachutes, and share buybacks.

Divestment (sell-off, spin-off, carve-out) can unlock value by focusing on core activities.

Management buyout (MBO) involves existing management purchasing the business, often financed by private equity and debt.

Leveraged buyout (LBO) uses significant debt to finance acquisition; increases financial risk but can improve efficiency.

Business reorganisation includes downsizing, outsourcing, and restructuring of operations to improve profitability.

Valuation of target: use P/E ratio, dividend valuation, discounted cash flow, or asset-based valuation; compare with market price.

Weighted average cost of capital (WACC) = (E/V) × Ke + (D/V) × Kd × (1−T), where V = E + D.

Cost of equity (Ke) using CAPM: Ke = Rf + βe × (Rm − Rf).

Dividend growth model: Ke = (D1/P0) + g, where g = retention ratio × return on equity.

Cost of debt (Kd) is the yield to maturity on debt, adjusted for tax: Kd(1−T).

Modigliani-Miller (MM) with taxes: value of levered firm = value of unlevered firm + T×D; WACC decreases with leverage.

MM without taxes: capital structure irrelevant; WACC constant.

Trade-off theory: optimal capital structure balances tax shield benefits against financial distress costs.

Pecking order theory: firms prefer internal funds, then debt, then equity, due to information asymmetry.

Dividend policy: residual theory, stable dividend, constant payout, and clientele effects.

Rights issue: existing shareholders offered new shares at discount; theoretical ex-rights price (TERP) = (market value before + proceeds)/number of shares after.