REPORT ON THE CORPORATE FINANCE QUALIFICATION EDUCATION PROGRAM INTERMEDIATE STAGE / DIPLOMA EXAMINATION. March 2008

Transcription

1 The Canadian Institute of Chartered Accountants and The Institute of Chartered Accountants in England and Wales REPORT ON THE CORPORATE FINANCE QUALIFICATION EDUCATION PROGRAM INTERMEDIATE STAGE / DIPLOMA EXAMINATION March 2008 Copyright 2008 The Canadian Institute of Chartered Accountants (CICA) 277 Wellington Street West, Toronto, M5V 3H2 Canada and The Institute of Chartered Accountants of England and Wales (ICAEW) Metropolitan House, 321 Avebury Boulevard, Central Milton Keynes, MK9 2FZ UK

2 TABLE OF CONTENTS THE EXAM REVIEW BOARD S REPORT Page The March 2008 Corporate Finance Qualification Intermediate Stage / Diploma Examination... 1 Appendix A Candidates Performance by Competency Area... 4 Appendix B Corporate Finance Qualification Intermediate Stage / Diploma Program Objectives and Learning Outcomes.. 8 Page 2 of 13

3 THE EXAMINATION REVIEW BOARD S REPORT on the CORPORATE FINANCE QUALIFICATION EDUCATION PROGRAM INTERMEDIATE STAGE / DIPLOMA EXAMINATION MARCH 2008 The objective of this report is to assist in the development of the Corporate Finance Education Program and, in turn, the performance of candidates. The Examination Review Board (ERB) is actively involved in the preparation of the examination, the setting of the passing profile, the preparation of the marking key, and the supervision of the marking process. ERB members are jointly responsible for determining the passing standard. The Corporate Finance Qualification Education Program Intermediate Stage / Diploma Examination The purpose of the examination is to assess whether candidates have acquired the competencies described in the Corporate Finance Qualification Objectives and Learning Outcomes (see Appendix B) through a written examination that all candidates must pass in order to qualify for entry to the Advanced Stage of the Programme. The Decision Model The ERB applied the following two key decision points, or levels, in reaching the pass/fail decision: 1. Level 1 The response must have been sufficient, i.e., the candidate must have demonstrated competence on the indicators of performance. In assessing sufficiency, the ERB considered the number of times that a candidate achieved Competent and/or Reaching Competence across all indicators (both specific competencies and pervasive qualities). Pervasive Qualities are the professional skills required of a practitioner, such as the ability to draw conclusions and to make recommendations. In the March 2008 examination, pervasive qualities were required to move candidates from Reaching Competence to Competent as opposed to being tested separately. This was as a result of the nature of the examination and therefore, in future examinations, pervasive qualities may again be tested as separate indicators. 2. Level 2 The response must have demonstrated depth in the areas of Interpretation of Financial Statements and Valuation. In assessing depth, the ERB considered the number of times that a candidate achieved Competent in each of the Interpretation of Financial Statements and Valuation indicators. Preparation and Structure of the Examination The Corporate Finance Qualification staff, the chief examiners and the Exam Review Board worked together to select a comprehensive case study which would achieve the overall intent and design objectives while adhering to the competencies specified in the Corporate Finance Qualification Objectives and Learning Outcomes document. Page 1 of 15

4 Nature of the Comprehensive Case Study The four-hour paper covered the specified learning outcomes and comprised a balance of directed and non-directed questions all stemming from the case study. Detailed comments by the ERB on the March 2008 examination appear in Appendix A. Marking Key The ERB applies marking procedures that enable it to decide which candidates demonstrate competence in the learning outcomes. An overall marking key is prepared which includes carefully defined performance levels to assist markers in evaluating a candidate s competence relative to the indicators on a consistent basis. The chief examiners provide valuable input to the marking key before the live marking begins. Five categories of performance are defined for each indicator. Below is a sample description of the categories that are used to rank a candidate s performance for some of the indicators. Similar levels of expectation are defined for all indicators. Not Addressed The candidate did not address this indicator or did not attain the standard of nominal competence Nominal Competence The candidate recognized some of the issues but did not provide any context Reaching Competence The candidate identified some of the issues Competent The candidate identified some of the issues in the case and discussed their impact on the future of the companies involved. The candidate incorporated the risks and opportunities into his/her quantitative analysis Highly Competent The candidate discussed many issues in depth and either drew a conclusion or made a recommendation based on this discussion Indicators of Competence To attain a pass standing, candidates must address the issues in the case that are considered mission-critical. Indicators of competence answer the question: What would a competent professional do in these circumstances? If the issues identified as indicators are not adequately addressed, the client could be placed in jeopardy. ERB members devote a great deal of time to reviewing and refining the marking key to ensure that the expectations for achieving competence are fair and reasonable as defined by the learning outcomes. Double Marking Each candidate s paper is marked for all primary indicators and all failing papers are re-marked independently by one of the chief examiners. If the two initial markings differ on any indicator, the chief examiners discuss the difference and agree upon the final result for that indicator. Page 2 of 13

5 Setting the Passing Standard In determining which candidates pass the examination, the ERB defines a passing profile. Each candidate is judged in relation to the ERB s pre-established expectations of an intermediate stage professional. To meet the passing profile, a candidate s response must meet the two levels defined earlier: sufficiency and depth. In setting the passing profile, the ERB considers the following: The competency area requirements The level of difficulty of the case The level of difficulty of each competency indicator The design and application of the marking key Comments from the chief examiners regarding any marking difficulties encountered or any time constraints noted Possible ambiguity of wording or of translation of a case Determining which Candidates Pass Near the completion of the marking process, ERB members each read a sample of candidate responses to satisfy themselves that the markers have applied the judgments as intended. Based principally on these readings, and on the evaluation of each candidate made by the markers and chief examiners, the ERB reviews its alreadyestablished passing profile and sets preliminary requirements for Level 1 sufficiency and Level 2 depth in the areas of Interpretation of Financial Statements and Valuation. Prior to the fair pass meeting, ERB members each read a sample of candidate responses to satisfy themselves as to the requirements they had set for Levels 1 and 2. The resulting March 2008 pass rate is 73.2% for first-time attempts. In reaching its decision, the ERB determines which candidates pass on an international basis only, without regard to country of origin or language. Similarly, the detailed comments are based on analyses of the performance of all candidates. Reporting The ERB reported the overall pass/fail standing and pass/fail standing for each topic area as defined by the Corporate Finance Qualification Objectives and Learning Outcomes document to each country by candidate number. Page 3 of 13

6 CANDIDATES PERFORMANCE BY COMPETENCY AREA APPENDIX A Interpretation of Financial Statements Not addressed % Nominal Competence % Reaching Competence % Competent % Highly Competent % Valuation Debt and Equity Changes in Control Foundations of Corporate Finance COMMENTS ON CANDIDATES PERFORMANCE Candidates were requested to present a draft report to a partner in Arco Corporate Finance who was due to attend a meeting with the Directors of Kian Ho Bearings Ltd (Kian Ho). The meeting was being held to discuss whether the Directors of Kian Ho should recommend to their shareholders that they accept or reject an offer for the shares of the company by CIMB-GK Securities Pte. Ltd, for and on behalf of Tat Hong Holdings Ltd. The candidates draft report should have provided information which would have been used as the basis for a circular giving such advice to the shareholders of Kian Ho on whether they should accept or reject the offer. Candidates were also asked to conclude on how their analysis would affect the overall advice to be included in the report. The examiners noted that the overall standard of the students in this sitting was below that of previous examination cohorts. This is not reflected in the overall pass rate but in the profile of the passing candidates. The examiners would like to emphasize that, where a candidate has passed with areas of weakness, it is important to reinforce their knowledge in those areas to ensure a smooth progression to the Advanced stage. The examiners saw evidence of poor time management in some of the responses and would urge candidates to observe the suggested time allocation given to them in the requirements. The examination is designed to test all of the competency areas. Candidates should be aware that, in addition to assessing their performance in individual competency areas, examiners also look for indications of pervasive qualities as evidenced by a report to the partner in Arco Corporate Finance that is consistent and draws conclusions based on the analyses performed throughout the report. Page 4 of 13

7 Interpretation of Financial Statements Candidates were required to provide a review of the financial statements of Kian Ho which should have included at least six appropriate ratios and the identification of key trends; commentary on, and analysis of, the volume of shares that had been traded; and a review of the financial structure of the company. Candidates were asked to conclude on how their analysis would affect the overall advice that would be included in their draft report. Candidates performance in this area was satisfactory; however, some candidates displayed the following weaknesses: making an inappropriate choice of ratios calculating ratios and trends based on only two years of financial information, typically 2005 and 2006 or 2002 and 2006 not providing any depth of analysis. Merely stating that a particular ratio or trend had increased or decreased with no comment upon the implications for the shareholders providing a factual analysis of the volume of shares traded with no comment. The examiners would like to emphasize that analyses should include a conclusion and comments upon what the implications of the movement in a particular ratio or trend mean. Moreover, a conclusion was specifically asked for in the requirements. Valuation Candidates were asked for a comparison of the offer price to a range of values, including a discounted cash flow valuation, and to a selection of concluded takeovers of companies listed on the Singapore Exchange Securities Trading Limited. Candidates were also asked to conclude on how their analysis would affect the overall advice to be included in their draft report. Candidates performance in this area was satisfactory; however, some candidates displayed the following weaknesses: poor support for assumptions and calculations lack of a qualitative assessment of the valuation methodologies used the use of a net asset-based valuation with little reference to how up-to-date the valuations might be, the quality and type of assets being valued, as well as how appropriate it is to use such a valuation methodology where a candidate arrived at an unusually high or low range of values, there was often little comment. Comparisons with the offer price were often based on unrealistically high valuations some candidates recommended offering a premium of 30% with the justification that this is an average bid premium. However, there was little comment on the use of an average bid premium and how appropriate it might be in the Singaporean markets. Candidates had been provided with information on bid premiums for some recent takeovers. Page 5 of 13

8 Some candidates displayed the following weaknesses in these specific areas: DCF using growth figures that were unrealistically high omitting working capital and/or CAPEX making unrealistically high adjustments for working capital based on the change from 2005 to 2006 using unrealistic CAPEX figures using cash flow figures from the Consolidated Statement of Cash Flows for the year ended 31 December 2006 with no adjustments Multiples providing no support for the multiple used using a simple average with no exclusion of the outliers not discussing how comparable the companies were to Kian Ho not referencing the current multiples of Kian Ho making poor EBITDA computations using inappropriate P/E ratios not providing a range of values for the multiples, i.e., low, medium, high Comparison with Other Takeovers providing little analysis. Debt and Equity WACC In preparing their discounted cash flow valuation, candidates were required to prepare a detailed weighted average cost of capital (WACC). The analysis should have included detailed assumptions, calculations and support for all component figures in the estimation of the WACC. Candidates performance in this area was satisfactory; however, some candidates displayed the following weaknesses: providing little support for their assumptions computing an unusually high or low WACC and then using it in the DCF valuation with no comment. Often candidates calculated a WACC that was less than the cost of debt providing poor support for the selection of the equity beta. (However, other candidates clearly spent too much time on beta calculations.) using asset betas in the CAPM adding premiums to the WACC with little or no comment choosing incorrect gearing (or leverage) ratios to weight the cost of equity and after-tax cost of debt not deducting tax from the cost of debt Page 6 of 13

9 Financial Structure Review Candidates performance in this area was weak with little added value to the gearing (leverage) and interest cover computations in their review of the financial statements of Kian Ho. In general, the examiners noted that candidates gave no consideration to the following issues: the amount of debt in current liabilities the company s ability to repay debt whether or not the company should consider refinancing. Changes in Control The examiners were surprised that few candidates commented that Tat Hong Holdings Ltd required 50% acceptances and that its intention was to preserve the listed status of Kian Ho. Also, few candidates commented on the intention of Tat Hong Holdings Ltd not to exercise any rights of compulsory acquisition in connection with the offer. The draft report was to be used to give advice to the shareholders of Kian Ho. Since its shares have been historically thinly traded, the above points would be of concern to some of the shareholders. Few candidates gave consideration to the plans that Tat Hong Holdings Ltd had for Kian Ho. Candidates listed many other points but often they were very general and not linked to the facts of the case. Framework Candidates were required to identify and communicate issues arising from the acquisition which would have been of relevance to the Directors. Also they were specifically asked to discuss any ethical and corporate governance issues that might arise in making a recommendation to the shareholders of Kian Ho. Most candidates failed to consider this area in any depth. Candidates who addressed the area were generally able to demonstrate competence in their overall conclusion and advice to be included in their draft report. No candidates gave consideration to information that might be included in a circular giving advice to the shareholders of Kian Ho. Page 7 of 13

10 CORPORATE FINANCE QUALIFICATION INTERMEDIATE STAGE / DIPLOMA PROGRAM OBJECTIVES AND LEARNING OUTCOMES APPENDIX B Objectives 1.1 Determine the scope of ethical issues in and recommend ethically appropriate actions FOUNDATIONS OF CORPORATE FINANCE Learning Outcomes Apply relevant codes of business ethics Demonstrate a wide knowledge of relevant examples of ethical and unethical behaviour by companies in transactions Identify ethical dilemmas arising from transactions Analyse the contrasting interests of all parties involved in corporate finance transactions Identify ethical uses for information or funds as well as choices available to companies in the course of transactions 1.2 Identify corporate governance issues in 1.3 Identify corporate responsibility issues in the context of Analyse the relation between corporate governance and value creation for shareholders Identify a wide range of corporate governance issues for companies engaged in transactions Analyse the basis for and consequences in practice of the OECD corporate governance principles and the current Corporate Governance code and relevant legislation Demonstrate a working knowledge of the components of a wellgoverned company (board of directors, reporting, transparency, internal and external audit functions) Analyse the concepts of corporate responsibility and corporate stakeholders for companies participating in transactions Demonstrate understanding of the extent of personal and corporate responsibility undertaken by a principal, an adviser, a regulator and others in Demonstrate wide knowledge of how corporate responsibility has been put into effect by companies engaged in Construct a plan for the management of corporate responsibility issues of a company engaged in the provision of advice Page 8 of 13

11 Objectives 1.4 Apply relevant laws and regulations to transactions FOUNDATIONS OF CORPORATE FINANCE Learning Outcomes Analyse the comparative role of regulatory agencies in a range of jurisdictions Apply relevant securities and laws to the procedures, policies and practices of professionals (individuals and companies) Identify and apply relevant securities laws and regulations to the listing process on either the Toronto or London exchanges Identify and apply relevant securities laws and regulations to the continued obligations of a listed company and their ability to raise further debt and equity Apply relevant laws and regulations to the takeover of a publiclytraded company Apply relevant laws and regulations to transactions which can be undertaken by a privately-held company 1.5 Analyse and advise a company on the most appropriate course of action 1.6 Prepare and present effectively the case for a transaction 1.7 Understand the role of project finance and its interaction with Analyse a company s business and finance contexts through review of appropriate documents and interviews with key stakeholders Analyse the trade-offs among alternative transactions that are appropriate in light of a company s context (consider all ethical, regulatory, responsibility and financial aspects) Identify the most appropriate transaction Analyse the interests of various parties involved in a transaction and explain to the client how it affects the potential outcome Prepare and present effectively the case for a transaction to a client (board and/or management) Prepare and present effectively the case for a transaction to a prospective client (board and/or management) Prepare and present effectively the case for a transaction to a counterpart (board and/or management) Understand the role of project finance and its interaction with Identify the key documentation required in a wide range of project finance transactions Identify the role and significance of debt, equity and credit support in project finance transactions Identify and analyse different risk evaluation methodologies and models, including country and non-financial risk, in project finance situations Page 9 of 13

12 Objectives 2.1 Analyse a company s financial situation from financial statements 2.2 Construct financial models 2.3 Analyse the feasibility and value creation potential of financial decisions Interpretation of Financial Statements Learning Outcomes Interpret a company s reporting of critical transactions (measurement and recognition) according to appropriate accounting standards (IASB, CICA, FASB) Interpret a company s financial statements within the context of its current strategy, competitive position and capital markets flexibility Analyse how value is created for a company within a given context (industry, ownership, country) Analyse a company s financial situation based upon its financial statements Interpret financial decisions by a range of companies and analyse their comparative value creation potential Construct and manipulate an income statement with a range of elements including income and cash flow projections Construct a plausible model of key firm variables from financial statements Apply a range of techniques to account for risk (financial implications, environmental threats/opportunities) into financial models (using appropriate software) Analyse the sensitivity of financial models to changes in the underlying assumptions Identify alternative financial courses of action in response to a given situation or problem (investment, financing, merger, takeover, joint venture, etc.) Analyse alternative evaluation methods for decision-making (Net present value, internal rate of return, payback, EVA, etc.) Identify the value creation potential of a range of possible financial and strategic decisions by the company Interpret financial decisions by a range of companies and analyse their comparative value creation potential Page 10 of 13

13 Objectives 3.1 Analyse the relationship between value, worth and price 3.2 Apply valuation methods to reach plausible valuations for a range of companies 3.3 Analyse differences in valuations between companies Valuation Learning Outcomes Identify concepts of value, worth and price that are relevant in business valuation contexts Identify and analyse the relationship between financial data inputs and discounted cash flows valuation Identify value drivers for a range of companies (capital structure, cost of capital, risks, non-financial, investments, etc.) Analyse contextual factors that determine prices for various decisions (asset sale, M&A, financing, etc.) Analyse contextual factors that determine prices for various decisions taking place in private capital markets (asset sale, M&A, financing, etc.) Identify the critical assumptions and facts that underlie valuation methodologies and estimates Determine what the appropriate data sources for different valuation methodologies are Identify which valuation method(s) are appropriate for companies in different contexts (eg, ownership, tax, regulation, competition) Identify the strengths and weaknesses of valuation methodologies, including DCF, comparable multiples, EVA tm, CFROI and asset based valuations Apply appropriate valuation method(s) to obtain a plausible range of values for a company Apply valuation methodologies to compare companies over time Identify the determinants of comparable valuation estimates (for a company, asset or group of assets) Construct plausible comparative forecasts of company valuation Identify and analyse valuation differential components (for a company, asset or group of assets) Identify strategies for improving a company s valuation over time Page 11 of 13

14 Objectives 4.1 Determine the value of debt, equity and derivative securities 4.2 Analyse a company s capital structure in a capital markets context 4.3 Determine financing options for a company Debt and Equity Learning Outcomes Explain critical assumptions underlying the market s assessment of specific securities Apply basic concepts, such as the time value of money, cost of capital and Black-Scholes, into debt, securities and derivative valuation models Analyse the value of a company s securities Evaluate the differential between a company s securities estimated values based on a range of methodologies and their market-based prices Evaluate key risk factors that underlie a company s capital structure Determine a company s cost of capital using a range of methodologies Evaluate the sensitivity of a company s cost of capital to changes to its business operations, underlying risk factors and capital structure Determine managerial actions/decisions that may affect a company s cost of capital, with the exception of new financing (eg, choice between project and, disclosure quality) Evaluate a company s financing needs, based on its strategic and operating environment Analyse capital markets (eg, availability of project finance, role of ratings) and the feasibility of particular financing options Identify and analyse the advantages/disadvantages of alternative sources for a specific financing option Evaluate the consequences, relative costs and benefits and implications for operational and future financing decisions of alternative financing options for a company Identify the key milestones in the process leading to a successful financing outcome Page 12 of 13

15 Objectives 5.1 Identify the ways in which both public and private company ownership can change (buyouts, takeovers and restructurings in particular) 5.2 Identify and determine issues that arise from change in control transactions (structure, auction, pricing, risks, due diligence, exits, regulations) 5.3 Demonstrate how a change in control transaction can create value for a company Changes in Control Learning Outcomes Identify and analyse the financial and contractual aspects of various types of ownership change transactions (leveraged or management buyout, takeover, restructuring, etc.) Identify the value-creation potential of the various types of ownership change transactions Identify the criteria which render companies likely to undergo a change of control and explain the various reasons for ownership change transactions Identify the financial statement implications from each type of change in control transaction Identify key elements of the process leading to a change in ownership, according to type of transaction and type of company (auction, due diligence, pricing) Construct exit scenarios for different types of ownership change transactions Describe key regulations and laws that govern a range of types of ownership change transaction Analyse (and calculate) the impact of a proposed change in control transaction on a company s financing capability and value Identify critical risks surrounding a change in control transaction Evaluate how a company s ownership structure relates to its strategic and financial plans Identify value-creation opportunities that entail change in control transactions (eg undervalued assets) Analyse if an ownership change is feasible in light of a company s current business environment (legal, economic, contractual) Analyse the benefits/costs of a particular ownership structure against alternatives in light of a company s current business environment Analyse and recommend the form of a change in control transaction Page 13 of 13