ACCA FM common mistakes
ACCA FM · Understand the traps and how to avoid them.
Discounts nominal (money) cash flows at a real discount rate, or discounts real cash flows at a nominal rate, and presents the resulting NPV as the decision figure.
Exam questions often supply an inflation rate and a real rate, and candidates grab whichever rate appears first without checking whether the cash-flow forecast is stated in nominal or real terms.
What to do instead
Label every cash-flow figure as nominal or real before discounting. Convert with (1 + nominal rate) = (1 + real rate) × (1 + inflation rate), then discount nominal flows at the nominal rate and real flows at the real rate. Never mix the two.
Computes WACC using the statement of financial position book values of equity and debt as the weights.
Book values are easy to find and ratio analysis earlier in the syllabus uses them, so candidates default to them even when share prices and debt market values are available.
What to do instead
Use market values: equity = ex-dividend share price × number of shares; debt = market price per bond × number of bonds (or present value of future cash flows). Use these market-value weights, or target weights if the question states a target capital structure.
Calculates payable days using year-end trade payables divided by cost of sales, while calculating receivable days using average receivables.
Purchases are rarely given directly and cost of sales is the nearest available figure, so candidates mix bases without noticing the inconsistency.
What to do instead
Use average balances consistently for receivables, inventory and payables. Derive purchases as cost of sales + closing inventory − opening inventory. If the data are unavailable, state the assumption explicitly and keep the same basis across the whole operating cycle.
Values a target by applying a P/E multiple to combined post-acquisition earnings and then adds the target's debt to arrive at equity value.
Candidates conflate the P/E (an equity) multiple with entity multiples such as EV/EBITDA and double-count the capital structure.
What to do instead
A P/E multiple multiplies earnings to give equity value directly - do not add debt. If using an entity multiple, value the whole business and then deduct debt to reach equity. Value synergy as a separate increment to combined earnings, not by re-multiplying the whole.
Classifies every foreign-currency item as transaction exposure and hedges a translation exposure with a forward contract.
The three exposure types overlap in exam scenarios, and forwards are the most familiar hedging tool, so candidates match the tool before identifying the exposure.
What to do instead
Classify first. Transaction exposure = known future foreign-currency cash flows; translation exposure = consolidation of a foreign subsidiary's statements; economic exposure = change in competitive position from exchange-rate movements. Then select a hedge that offsets that specific exposure.
Calculates the theoretical ex-rights price as the simple average of the current share price and the rights issue price.
The formula looks like an average, and candidates ignore that the two prices apply to different numbers of shares.
What to do instead
Use TERP = (market value of existing shares + rights issue proceeds) ÷ total shares after the issue. Work in fractions: if one new share is issued for every N held, TERP = (N × cum-rights price + issue price) ÷ (N + 1).
Recommends accepting a project because it increases reported accounting profit, even though its NPV is negative.
Candidates carry over the profit-maximisation objective from earlier studies and treat accounting profit as the same as cash flow to shareholders.
What to do instead
The primary financial objective is maximisation of shareholder wealth, measured by NPV. Reconcile accounting profit to cash flow by adding back depreciation and adjusting for working capital and capital expenditure, then evaluate the incremental cash flows.
Recovers working capital at the start of the project, or includes sunk market research costs as an incremental cash flow.
Candidates memorise 'include working capital' and 'include all relevant costs' without applying the timing and incrementality tests.
What to do instead
Working capital is invested at the start (or as it builds up) and recovered at the end of the project unless the question states otherwise. Exclude sunk costs such as completed market research; include opportunity costs and only incremental overheads.
States that an increase in interest rates is an expansionary monetary policy that will raise consumer spending.
Candidates confuse the direction of the policy instrument with its effect on the economy, and conflate monetary policy with fiscal policy.
What to do instead
Map the transmission mechanism: higher interest rates raise borrowing costs, reduce consumption and investment, and are contractionary. Fiscal policy operates through government spending and taxation. State the policy, the mechanism and the expected effect separately.
Estimates dividend growth as retention ratio × accounting return on equity, then uses that growth rate in the dividend growth model without checking it against the cost of equity.
The formula g = b × r is recalled but r is taken from the financial statements rather than being the return earned on funds reinvested.
What to do instead
Use g = b × r only where r is the return on reinvested funds. Otherwise use historical dividend growth. Check that g is below the cost of equity; if not, the model is invalid and an alternative valuation approach is needed.