REPORT ON THE CORPORATE FINANCE QUALIFICATION PROGRAMME DIPLOMA / INTERMEDIATE STAGE EXAMINATION SEPTEMBER 2007

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1 The Canadian Institute of Chartered Accountants and The Institute of Chartered Accountants in England and Wales REPORT ON THE CORPORATE FINANCE QUALIFICATION PROGRAMME DIPLOMA / INTERMEDIATE STAGE EXAMINATION SEPTEMBER 2007 Copyright 2007 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) Gloucester House, 399 Silbury Boulevard, Central Milton Keynes, MK9 2HL UK

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3 THE EXAMINATION REVIEW BOARD S REPORT on the CORPORATE FINANCE QUALIFICATION EDUCATION PROGRAMME DIPLOMA / INTERMEDIATE STAGE EXAMINATION SEPTEMBER 2007 The objective of this report is to assist in the development of the Corporate Finance Education Programme 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 Programme Diploma / Intermediate Stage 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 document through a written examination that all candidates must pass in order to qualify for entry to the Advanced Diploma /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 corporate finance practitioner, such as the ability to draw conclusions and to make recommendations. In the September 2007 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 Valuation and Financial Statement Interpretation. In assessing depth, the ERB considered the number of times that a candidate achieved Competent in each of the Valuation and Financial Statement Interpretation 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. 1

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 September 2007 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. The ERB members also meet with the chief examiners who provide valuable input to the marking keys before the live marking begins. The marking key includes carefully defined performance levels to assist markers in evaluating a candidate s competence relative to the indicators on a consistent basis. Five categories of performance are defined for each indicator. The candidate s performance is ranked in one of five categories, namely: 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 of 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 The ERB applies evaluation procedures that enable it to decide which candidates demonstrate competence in the learning outcomes. 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 corporate finance 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 ERB members also meet with the chief examiners during the marking process. Each candidate s paper is marked independently for all primary indicators by the chief examiners from both countries. If the two initial markings differ on any indicator, the chief examiners discuss the difference and agree upon the final result for that indicator. 2

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 corporate finance professional. To meet the passing profile, a candidate s response must meet the two levels defined earlier. 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; and 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 chief examiners, the ERB reviews its already-established passing profile and set preliminary requirements for Level 1 sufficiency and Level 2 depth in the areas of Valuations and Financial Statement Interpretation. 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 September 2007 pass rate is 66.2% 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. 3

6 APPENDIX A CANDIDATES PERFORMANCE BY COMPETENCY AREA Financial Statement Interpretation Not addressed % Nominal competence % Reaching competence % Competent % Highly competent % Valuation Debt and Equity Changes in Control Framework COMMENTS ON CANDIDATES PERFORMANCE Candidates were requested to present a report to GI Partners and the Yates Management Team regarding their intended management buyout of the Yates Group plc. In general the examiners were pleased with candidates performance. However it was noted that the general level of computations in this examination was of poorer quality than in prior sittings. 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 evidence of pervasive qualities as evidenced by a report to the Board that is consistent and draws conclusions based on the analyses performed throughout the report. Financial Statement Interpretation Candidates were required to provide an analysis of the financial health of the Yates Group plc and to identify key trends. From their analysis, candidates were asked to conclude whether the shareholders of the Yates Group plc might be tempted to accept an offer from GI Partners and the Yates Management Team. Candidates performance in this area was satisfactory however some candidates displayed the following weaknesses: an inappropriate choice of ratios no depth of analysis. Merely stating that a particular ratio or trend had increased or decreased with no comment upon the implications for the shareholders is insufficient poor or no conclusions regarding the reaction of the shareholders to the financial health of the company. The examiners would like to emphasise that analysis includes a conclusion and comments upon what the implications of the movement in a particular ratio or trend mean. In addition a conclusion was specifically asked for in the requirements. 4

7 Valuation Candidates were asked to recommend the price that GI Partners and the Yates Management Team should offer for the shares of the Yates Group plc. Candidates were also specifically asked to provide a range of values for the shares and to include a discounted cash flow valuation. Candidates performance in this area was satisfactory however some candidates displayed the following weaknesses: General 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 as how up-to-date valuations might be, the quality and type of assets and also how appropriate it is to use such a valuation methodology for the Yates Group plc where a candidate arrived at an unusually high or low range of values there was often little comment. Recommendations on the price to be offered to the shareholders of the Yates Group plc was often based on unrealistically high valuations many 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 to automatically apply it to an offer for the shares of the Yates Group plc. The examiners would encourage candidates to consider the bid premium in relation to the particular case and the range of values that they have computed. In DCF computing the free cash flow for one year and then treating it as a perpetuity using an unusually short number of years for the primary period (planning horizon) using growth figures that were unrealistic omitting working capital using unrealistically low CAPEX figures In Multiples no support for the multiple used no discussion about how comparable the companies were to the Yates Group plc use of EV/EBITDA multiples from other companies with no reference to the current multiple of the Yates Group plc poor EBITDA computations inappropriate use of P/E ratios 5

8 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: little support for their assumptions computation of an unusually high or low WACC, which was then used in the DCF valuation with no comment poor support for the selection of the equity beta addition of premiums to the WACC incorrect gearing (or leverage) ratios chosen to weight the cost of equity and after tax cost of debt no deduction of tax from the cost of debt Debt Service Candidates were asked to confirm whether GI Partners and the Yates Management Team will be able to service the debt required to finance the purchase of the shares of the Yates Group plc. This is an important consideration having regard to the fact that the case is based on a management buyout. Many candidates performed well in this area. However some candidates only considered interest cover and not the capital repayments. Changes in Control Candidates were required to discuss how GI Partners and the Yates Management Team might create value out of the acquisition. While candidates listed many factors, 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 Board of Directors. Also they were specifically asked to discuss any ethical and corporate governance issues that might arise in the management buyout of the Yates Group plc. Most candidates failed to consider this area in any depth. Candidates who addressed the area were generally able to demonstrate competence in their discussions of: Corporate governance Corporate responsibility Due diligence Many candidates failed to include a supported recommendation to the Board. 6

9 APPENDIX B CORPORATE FINANCE QUALIFICATION INTERMEDIATE / DIPLOMA PROGRAMME OBJECTIVES AND LEARNING OUTCOMES MODULE 1: FOUNDATION Objectives 1.1 Determine the scope of ethical issues in corporate finance and recommend ethically appropriate actions 1.2 Identify corporate governance issues in corporate finance 1.3 Identify corporate responsibility issues in the context of corporate finance 1.4 Apply relevant laws and regulations to corporate finance transactions Learning Outcomes Apply relevant codes of business ethics Demonstrate a wide knowledge of relevant examples of ethical and unethical behaviour by companies in corporate finance transactions Identify ethical dilemmas arising from corporate finance 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 corporate finance transactions Analyse the relation between corporate governance and value creation for shareholders Identify a wide range of corporate governance issues for companies engaged in corporate finance 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 corporate finance transactions Demonstrate understanding of the extent of personal and corporate responsibility undertaken by a principal, an adviser, a regulator and others in corporate finance Demonstrate wide knowledge of how corporate responsibility has been put into effect by companies engaged in corporate finance Construct a plan for the management of corporate responsibility issues of a company engaged in the provision of corporate finance advice Analyse the comparative role of regulatory agencies in a range of jurisdictions Apply relevant securities and laws to the procedures, policies and practices of corporate finance 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 corporate finance transactions which can be undertaken by a privately-held company. 7

10 MODULE 1: FOUNDATION Objectives 1.5 Analyse and advise a company on the most appropriate corporate finance course of action 1.6 Prepare and present effectively the case for a corporate finance transaction 1.7 The role of project finance and public private partnerships and their interaction with corporate finance. Learning Outcomes Analyse a company s business and finance contexts through review of appropriate documents and interviews with key stakeholders Analyse the trade-offs among alternative corporate finance transactions that are appropriate in light of a company s context (consider all ethical, regulatory, responsibility and financial aspects) Identify the most appropriate corporate finance 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 corporate finance transaction to a client (board and/or management) Prepare and present effectively the case for a corporate finance transaction to a prospective client (board and/or management) Prepare and present effectively the case for a corporate finance transaction to a counterpart (board and/or management) Describe and explain the differences and similarities between project finance and public private partnerships and corporate finance, the scope and reasons for its development. Analyse the role of the participating parties in a wide range of project finance transactions Identify the key documentation involved 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 structures 8

11 MODULE 2: INTERPRETATION OF FINANCIAL STATEMENTS Objectives 2.1 Analyse a firm s financial situation from financial statements. 2.2 Construct financial models. 2.3 Analyse the feasibility and value creation potential of financial decisions. Learning Outcomes Interpret a firm s reporting of critical transactions (measurement and recognition) according to appropriate accounting standards (IASB, CICA, FASB) Interpret a firm s financial statements within the context of its current strategy, competitive position and capital markets flexibility Analyse how value is created for a firm within a given context (industry, ownership, country) Analyse a firm s financial situation based upon its financial statements Interpret financial decisions by a range of firms 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 corporate finance 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 firm Interpret financial decisions by a range of firms and analyse their comparative value creation potential. 9

12 MODULE 3: VALUATION 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. 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 corporate finance decisions (asset sale, M&A, financing, etc.) Analyse contextual factors that determine prices for various corporate finance 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 (e.g., 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. 10

13 MODULE 4: DEBT AND EQUITY 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. 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 (e.g., choice between project and corporate finance, disclosure quality) Evaluate a company s financing needs, based on its strategic and operating environment Analyse capital markets (e.g., 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. 11

14 MODULE 5: CHANGES IN CONTROL 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. 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 (e.g., 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 12