ICSAN Financial Strategy common mistakes
ICSAN Financial Strategy · Understand the traps and how to avoid them.
Computing NPV by discounting each year's cash flow at a different ad hoc rate (e.g., using the risk-free rate for early years and a higher rate later) instead of a single cost of capital appropriate to the project's risk class.
Candidates conflate the time value of money with risk adjustment and believe 'riskier later cash flows' justify varying discount rates, which double-counts risk and invalidates the NPV comparison.
What to do instead
State one discount rate per project, justified as the return on a comparable-risk investment; if the project risk differs from the firm, use a risk-adjusted rate (e.g., proxy company WACC or CAPM with project beta) applied consistently. Practise writing the rate rationale in one sentence before calculating.
Mixing nominal cash flows with a real discount rate (or vice versa) when inflation is present, then presenting the NPV without noting the inconsistency.
Exam questions often supply inflation rates and cash flows 'in today's prices'; candidates apply the nominal WACC because it is the number they memorised, without checking whether cash flows are nominal or real.
What to do instead
Adopt a fixed rule: either inflate every cash flow and discount at the nominal rate, or keep cash flows real and discount at the real rate via (1+nominal)/(1+inflation)−1. Show a one-line check that numerator and denominator are both real or both nominal before finalising.
Calculating WACC using book values of debt and equity, or using the historical coupon rate on debt as the cost of debt, rather than market values and the current yield-to-maturity or pre-tax market rate.
Balance sheet figures are the easiest numbers to lift from the scenario, and candidates confuse the coupon (a contractual cash flow) with the required return (a market price-based rate).
What to do instead
Always use market values of equity (share price × shares) and market value of debt (or its book value only if stated to approximate market). Derive the pre-tax cost of debt from YTM or the rate on newly issued comparable debt, then multiply by (1−tax rate). Write the formula with 'MV' labels to force the distinction.
Treating a project's financing cash flows (interest, loan drawdown, repayment) as part of the incremental project cash flows while discounting at WACC.
Candidates see interest in the scenario and include it as a cash outflow, forgetting that WACC already embeds the cost of finance and that including interest double-counts it.
What to do instead
Separate investment appraisal from financing: project cash flows contain only operating and capital expenditure items, tax on operating profit, and working capital changes. Handle financing separately (e.g., APV if financing is project-specific). Highlight and strike through any interest line in the scenario before starting.
Ignoring working capital in NPV: omitting the initial working capital investment and the recovery at the end of the project, or forgetting incremental working capital in intermediate years.
Working capital appears as a narrative detail rather than a labelled cash flow, and candidates focus on capex and revenues; they also assume it is recovered automatically without modelling it.
What to do instead
Build a standard NPV template with a dedicated working capital row: outflow at t0, incremental changes per year linked to sales growth, full recovery at the end unless the question says otherwise. Check the template against a past question before the exam.
Choosing between mutually exclusive projects with different lives by comparing raw NPVs, or ranking by IRR when projects differ in scale or timing.
NPV is the 'correct' method drilled in revision, so candidates apply it mechanically without recognising that unequal lives require a common-horizon comparison, and IRR's scale blindness is easily missed.
What to do instead
For unequal lives use equivalent annual annuity (NPV ÷ annuity factor) or a replacement-chain approach. For scale differences use NPV or profitability index, not IRR. For non-conventional cash flows use MIRR or NPV. State the selection criterion explicitly in the answer.
Valuing a business by applying a P/E multiple to the target's earnings without adjusting for non-recurring items, different accounting policies, or the acquirer's post-synergy earnings, and without cross-checking against a DCF or asset-based value.
Multiples are quick and look authoritative; candidates treat the quoted P/E as directly transferable and skip the comparability adjustments the question is testing.
What to do instead
Normalise earnings (strip one-offs, align depreciation and capitalisation policies), select a peer P/E that reflects the target's growth and risk, and present a range. Triangulate with at least one other method (DCF or net asset value) and explain the weight given to each.
Confusing the mechanics of a rights issue: mis-stating the theoretical ex-rights price, the value of a right, or the wealth position of a shareholder who does or does not take up the rights.
Candidates memorise TERP = (market value + proceeds)/new share count but then apply the discount to the wrong base or forget that non-takers are diluted in capital terms while their wealth is preserved only if they sell the rights.
What to do instead
Work through the standard sequence: cum-rights value, subscription proceeds, shares in issue after, TERP, value of one right (TERP − subscription price), and the wealth test for a holder of N shares. Rehearse with a numerical example and check that total shareholder wealth is unchanged before and after.
Describing dividend policy irrelevance or the clientele effect in general terms without linking it to the specific constraints in the scenario (covenants, investment opportunities, signalling, tax position of the shareholder base).
Candidates reproduce textbook theory but do not apply it, because they treat the question as a memory test rather than a decision problem with a named company.
What to do instead
Structure the answer as: theory (MM, Gordon, signalling, clientele, agency) → the firm's actual constraints and shareholder profile → recommendation with residual-dividend logic where investment needs exist. Each theoretical point must be tied to a fact from the scenario to earn application marks.
Answering governance and stakeholder questions by listing codes and principles without identifying the specific conflict, the affected stakeholder, and the mechanism that resolves it (board independence, audit committee, NED challenge, disclosure).
Governance is perceived as descriptive content to be recited; candidates under-prepare for the applied judgement the examiner wants and default to generic statements about 'good governance'.
What to do instead
Use a three-part answer frame: identify the agency or stakeholder conflict in the scenario, cite the relevant principle (e.g., board balance, integrity of reporting), then prescribe a concrete mechanism and its limitation. Practise on short scenarios where a dominant CEO or a related-party transaction is described.