Advanced Management Accounting and Finance
Advanced Management Accounting and Finance tests decision-making, valuation, financing and performance measurement. Calculations are only part of the marks: you must explain assumptions, interpret results and recommend action.
Core rules
- Investment appraisal: use incremental after-tax cash flows. Include opportunity costs, working capital and the tax shield from capital allowances. Exclude sunk costs, allocated fixed overhead and financing cash flows when discounting at WACC.
- WACC: use market-value weights and after-tax cost of debt. Match the discount rate to the project's risk; do not use the company WACC for a diversifying project without adjustment.
- Valuation: free-cash-flow DCF, dividend growth, P/E and asset-based methods. Add synergies and control premium only when the question supports them.
- Risk: compare forward, money-market, futures and option hedges on the same cash-flow base; use PPP and interest-rate parity only for expected rates, not guaranteed outcomes.
- Performance: ROI can reject profitable investments; RI and EVA charge for capital. Transfer prices affect divisional profit and behaviour.
Worked example
A project costs Rs. 1,000m and attracts straight-line tax depreciation of Rs. 250m a year for four years. Incremental cash profit before tax is Rs. 400m a year for four years. Tax is 30%, paid in the same year. Working capital of Rs. 100m is required at the start and recovered at the end. WACC is 12%. Taxable profit = 400 − 250 = 150; tax = 45; annual cash flow = 400 − 45 = 355. NPV = −1,000 − 100 + 355 × 3.037 + 100/1.12^4 = −1,100 + 1,078.1 + 63.6 = Rs. 41.7m. Accept, subject to sensitivity and qualitative review.
Traps
- Discounting nominal cash flows at a real rate.
- Deducting interest and then discounting at WACC.
- Using book values instead of market values in WACC.
- Treating depreciation as a cash flow while ignoring the tax shield.
- Forgetting working-capital recovery.
- Applying the company WACC to a project with different risk.