ACCA AFM common mistakes
ACCA AFM · Understand the traps and how to avoid them.
Computing an NPV in real terms but discounting at the nominal (money) cost of capital, or mixing real cash flows with a nominal discount rate in the same appraisal.
Candidates learn the Fisher relationship and the nominal/real distinction as separate facts but do not consciously label each cash flow and each rate as real or nominal before starting the calculation, so the two get combined by default.
What to do instead
Before any discounting, write a one-line 'consistency check' at the top of the answer stating whether cash flows and the discount rate are both nominal or both real. If the question gives inflation per cost/revenue line, inflate each line individually to nominal and discount at the nominal WACC; only deflate to a real rate if the question explicitly requires real-terms analysis.
Discounting at the post-financing WACC when the question asks for an APV or when the project materially changes the firm's gearing, thereby double-counting the tax shield and mis-stating the financing side effects.
WACC is the default tool drilled in earlier papers, and candidates apply it reflexively without checking whether the project's financing differs from the existing capital structure or whether subsidised loans, issue costs or a changed debt capacity are present.
What to do instead
Read the financing details first. If the project has subsidised debt, issue costs, or a different debt capacity from the firm, use APV: discount operating cash flows at the ungeared (asset beta) cost of equity, then add the present value of the tax shield on the actual debt and any subsidised-loan benefit, net of issue costs. State explicitly why WACC is inappropriate.
Ungearing and regearing betas using the wrong formula or the wrong values - e.g. using book values instead of market values for D and E, applying the tax shield to the wrong party, or regearing to the proxy's gearing rather than the target's.
The asset-beta formula has several variants (with and without tax, with debt beta) and candidates memorise one form without checking which assumptions the question supports, and they grab the gearing figures printed in the question rather than the market-value gearing that the formula requires.
What to do instead
Write the formula down explicitly and label each input before substituting. Use market values of equity and debt; if only book values are given, convert or state the assumption. Ungear at the proxy company's gearing, then regear at the acquiring company's or project's target gearing. If debt is stated to be risk-free and the question implies a debt beta, use the version that includes it.
Ignoring or mishandling taxation timing - treating tax as arising in the same year as the cash flow, omitting the tax lag, and forgetting capital allowances/balancing allowances on the investment and its disposal.
Candidates focus on the operating cash flows and treat tax as a single percentage line, missing the convention that tax is paid in arrears and that capital allowances replace depreciation as the tax-deductible amount.
What to do instead
Build a tax computation as a separate working: operating cash flow, less capital allowances (on a reducing-balance or straight-line basis as stated), apply the tax rate, and shift the tax cash flow one year later if the question says tax is paid in arrears. Include a balancing allowance or charge on disposal, and remember the scrap proceeds themselves are a capital cash flow, not taxable income.
Valuing a target by mechanically averaging or selecting a P/E or earnings-yield multiple without adjusting for the target's different growth, risk, or one-off items, and without adding a control premium where an acquisition is involved.
Multiple-based valuation looks quick and candidates reach for it to save time, applying the acquirer's or sector P/E directly to the target's earnings without asking whether the earnings are sustainable or whether the multiple reflects the target's characteristics.
What to do instead
State the basis of the multiple and why it is appropriate. Adjust earnings for non-recurring items and normalize where needed. Use a proxy-company or sector P/E that reflects the target's risk and growth, apply it to sustainable earnings, then separately consider a control premium and synergies. Cross-check against a DCF or asset-based value and comment on the range.
Producing a discussion answer on a restructuring or financing decision that lists generic advantages and disadvantages without applying them to the specific figures, stakeholder positions, or constraints in the scenario.
Under time pressure candidates fall back on textbook lists ('equity dilutes control, debt increases risk') rather than linking each point to the computed numbers and the named parties in the case.
What to do instead
For each discussion point, anchor it to a figure or fact from the scenario: cite the resulting gearing ratio, the EPS impact, the effect on a named shareholder's holding, or the covenant level. Structure the answer as 'issue - evidence from the scenario/calculation - consequence for the specified stakeholder', and cut any point that cannot be tied to the case.
Treating an interest rate or currency hedge as a standalone product recommendation, without quantifying the outcome under alternative rate/rate scenarios or comparing the hedged versus unhedged result.
Candidates describe forward contracts, futures, options and swaps generically and recommend one without demonstrating, with numbers, what happens if rates or exchange rates move up or down, so the recommendation is unsupported.
What to do instead
For each candidate hedge, compute the effective rate or receipt under at least two scenarios (e.g. rate rises and falls), include premiums, basis, margin and transaction costs, and present a comparison table. Then recommend based on the firm's stated risk appetite and the certainty-versus-flexibility trade-off, quantifying the cost of that certainty.
Mis-timing or mis-sizing derivative hedges - using the wrong number of contracts, ignoring the contract size or the maturity mismatch, and forgetting basis risk or the margin/tick value mechanics.
The mechanics of futures and options (contract size, tick value, number of contracts, closing out before expiry, basis convergence) are fiddly and candidates skip the working, guessing the number of contracts or ignoring that a hedge is closed out before the futures expiry.
What to do instead
Show the contract-count working explicitly: exposure divided by (contract size × price), rounded, with a note on over/under-hedge. State the tick value and compute the gain/loss on the futures position using the price movement in ticks. Account for basis at close-out, and reconcile the net effective outcome against the unhedged position.
Confusing the cost of redeemable debt (the IRR/yield to maturity that equates market price to future cash flows) with the coupon rate, and similarly using the dividend growth model's current dividend rather than the next dividend.
Candidates see a coupon percentage and use it directly as the cost of debt, and in the DGM they plug in D0 instead of D0(1+g), because both errors come from pattern-matching to the most visible number rather than identifying the correct cash-flow stream.
What to do instead
For redeemable debt, set up the cash flows (interest net of tax, redemption value) against the market price and solve for the IRR; only use the coupon as the cost when debt is irredeemable and the market price equals par. For the DGM, always use D1 = D0(1+g), and check whether the question gives D0 or D1 explicitly.
Answering the numerical requirement fully but leaving the discursive/advice requirement thin, or vice versa, so the marks for the professional-skills and discussion elements are lost even when the calculations are right.
Candidates allocate time to the calculation because it feels concrete and verifiable, then run out of time for the report, memo or recommendation, and do not appreciate that the discussion and communication marks are a substantial, separately-marked component.
What to do instead
Before starting, split the marks by requirement and allocate time proportionally, including a fixed block for the discussion. Draft the recommendation and key discussion points in bullet form early, then support them with the numbers. Use the required format (report/memo with headings, addressee, and a clear conclusion) and ensure every assumption you made in the numbers is stated and justified in the narrative.