CMA Sri Lanka SL2 Financial Strategy & Valuation Exam common mistakes
CMA Sri Lanka SL2 Financial Strategy & Valuation Exam · Understand the traps and how to avoid them.
Answering a strategic-options question with a generic PESTLE or five-forces list, then recommending whichever option 'sounds strongest' without converting the strategy into incremental cash flows, a value estimate or a financing consequence.
Candidates learn the frameworks as descriptive tools and treat the marks as being earned by naming forces, when SL2 rewards the link from strategic position to financial outcome; under time pressure the qualitative section feels like the easiest place to write quickly.
What to do instead
For each force or option, force out a quantified driver - price, volume, margin, capital expenditure, cost of capital, or a risk premium - and test the recommendation with a short NPV, sensitivity or scenario table. Finish with an explicit decision sentence, the key assumption behind it and what would reverse it.
Writing stakeholder analysis as a list of 'interests' (employees want job security, lenders want repayment) with no statement of how each interest changes the decision, the cash flows or the distribution of value.
Stakeholder and agency theory are treated as definitions to reproduce rather than analytical instruments, so the answer never connects to the numbers already calculated elsewhere in the script.
What to do instead
Map each material stakeholder to a specific financial consequence: a covenant giving lenders the power to force a distressed sale, a pension deficit ranking ahead of equity, a management incentive plan rewarding size rather than return. Use agency theory to explain why a manager may prefer the low-NPV option, and finish with the trade-off you would accept and why.
Discussing capital structure only as the textbook trade-off between the tax shield and financial distress costs, without quantifying the effect of each financing package on the cost of capital, on value or on covenant headroom.
The topic is memorised as a narrative debate (Modigliani–Miller versus trade-off versus pecking order) and the candidate never returns to the numbers, so the answer stays generic and unevaluative.
What to do instead
Show the mechanics: tax shield value as t × D, the effect of gearing on the cost of equity, and a before-and-after WACC and enterprise value for each option. Then test the practical constraints - interest cover, asset cover covenants, issue costs, refinancing risk, signalling and the effect on EPS - and state which constraint binds.
Building WACC from book-value weights and using the coupon rate as the cost of debt, frequently forgetting the tax relief on interest entirely.
The statement of financial position is the most convenient source of weights and the coupon is the only visibly quoted interest rate on the instrument; the tax adjustment is the single most commonly dropped line.
What to do instead
Use market value of equity (share price × shares in issue, ex-dividend) and market value of debt (ex-interest market price or present value of future cash flows at the redemption yield). Set Kd as the redemption yield × (1 − tax rate), re-gear the equity beta to the target or actual gearing, and derive Ke from CAPM rather than from a historical dividend yield alone.
Discounting real (constant-price) cash flows at a nominal WACC, or omitting the working-capital investment from a project cash flow and then charging it in full in year zero without any recovery.
Cash flows are built from today's prices and volumes while the discount rate is assembled from quoted nominal yields, and working capital is treated as a one-off rather than a reversible investment.
What to do instead
Apply the Fisher relationship ((1 + nominal) = (1 + real)(1 + inflation)) and keep every input on the same basis, stating the assumption. For working capital, compute the incremental investment each year as a change in the cycle-driven balance and release it in the final year; also check for sunk costs wrongly included and opportunity costs (land, existing assets) wrongly excluded.
Discounting every project at the company's existing WACC, even when the project sits in a different business line, country or risk class, and presenting the resulting NPV as decision-ready.
WACC is taught as 'the discount rate', and a single company figure is easy to reuse; the difference between the average and the marginal cost of capital is rarely applied under exam timing.
What to do instead
Treat WACC as the hurdle only for projects of similar risk to the existing portfolio. For a different line, take a pure-play proxy beta, ungear it, regear at the project or target gearing, and rebuild Ke and WACC; for country risk add a defensible premium. Then show the NPV under the risk-adjusted rate and a sensitivity on the adjustment itself.
Mismatching the multiple with the earnings base - applying a P/E to PBIT, or applying an EV/EBITDA multiple and reporting the result directly as the equity value.
Candidates select the multiple from comparables without checking what sits above or below the interest line in the denominator, and the entity-versus-equity distinction is easily lost once the arithmetic starts.
What to do instead
Fix the direction of the bridge before calculating. Equity multiples (P/E, dividend yield) take earnings after interest and tax and give equity value. Entity multiples (EV/EBITDA, EV/EBIT, EV/sales) take pre-interest measures and give enterprise value, from which deduct net debt (and minority interests, preferred stock, pension deficits) and add non-operating assets and surplus cash to reach equity value. Sanity-check with a second method.
Evaluating a lease-versus-buy decision by comparing total lease payments with the purchase price, or by discounting lease payments at the WACC instead of the after-tax cost of borrowing.
The lease payments sum to a big number and the purchase price is a big number, so the comparison feels natural; the correct approach is a differential present-value calculation whose discount rate is not the firm's WACC.
What to do instead
Discount the after-tax lease rentals at the after-tax cost of debt (the rate at which the firm could borrow) and compare with the cost of the asset less the present value of tax-allowance shields and the present value of the expected residual value, after tax. Note the tax timing lag and any maintenance or residual guarantees in the lease, and interpret the sign of the difference correctly.
Computing the cash operating cycle with sales revenue in the denominator for inventory and payables days, or with receivables valued at cost rather than at selling price.
One 'turnover' figure gets used for every ratio, and the three ratios are then added mechanically without checking that the numerators and denominators describe the same flow.
What to do instead
Inventory days and payables days use cost of sales; receivables days use revenue (sales), because receivables include margin. Multiply by 365 and use average balances where opening and closing figures are available. Reconcile the result to the movement in working capital used in the cash flow forecast, and flag seasonal or VAT-inclusive distortions.
Hedging with an incorrectly sized futures position, or reporting the gain or loss on the derivative alone instead of the combined outcome of the hedge and the underlying exposure.
The contract formula has several unit and currency conversions to get wrong, and the derivative is treated as a standalone speculative trade rather than as one leg of a single hedged position.
What to do instead
Size the position as exposure ÷ (contract size × price), checking currency, contract units and rounding, then evaluate the hedge by adding the spot settlement outcome to the futures gain or loss and comparing it with the unhedged outcome. Note that basis converges to zero at maturity, and discuss margin calls and daily settlement for futures versus no interim cash flow for forwards, plus counterparty risk on over-the-counter contracts.