**FREE ACCA BOOKS DOWNLOAD - P4 REVISION & MOCK QUESTION & ANSWERS 2017-2018**

**Report to the Board of Directors (BoD) of MMD plc **

This report is to advise MMD plc on an appropriate hedging strategy to manage the

foreign exchange exposure in five months’ time, the appropriate cost of capital to be

used to calculate the net present value of the game project, the value of the project

with and without the option to delay.

It also discusses the argument for and against

hedging foreign exchange exposure.** FREE ACCA BOOKS DOWNLOAD **

**Hedging foreign exchange exposure (a)**

The company can use forward contract, money market hedge, currency futures and

currency options. The forward contract results into a net guaranteed payment of

£604,341 which is lower than the money market hedge of £609,017. The option is more

expensive than the other hedging methods. However, should the dollar weaken more

than the relative strike price the company could let the option lapse in order to take

advantage of the market exchange rate. The currency futures is more favourable than

the forward market. However, FREE ACCA BOOKS PDF futures contract is standardized and there may be over or under hedge. For example the number of contract is as; £604,150/62500 =9.67

contracts Also currency futures require margin payments and there exist basis risk.

Holding all other factors constant MMD should use the futures contract as it gives the

lowest net payment of £604,150.

**Appropriate cost of capital for the game project (b)**

XYZ Co’s information was used to estimate the project’s asset beta as it is assumed that

the business risk of XYZ’s film product is same as that of the one undertaken by MMD.

Then based on MMD plc’s FREE ACCA STUDY MATERAILS capital structure, the project’s equity beta and weighted

average cost of capital was be estimated as 11% (appendix B).

**Value of the game project (c and d)**

The overall value of the project was calculated as the net present value of the project

plus the value of the option to delay.

The project without the option produces negative net present value of $2·98 which

would be financially unacceptable but with the flexibility provided by real options to

delay the project managers could take action to help boost the project’s NPV if it falls

behind forecast. An option to delay gives the company the right to undertake the

project in a later period without losing the opportunity. This option will give the

company’s managers the time to monitor and take appropriate actions to respond to

changing situations such as increase in competition and how popular the film will be

within the next two years before it will commit capital and other resources into the

project. FREE ACCA BOOKS DOWNLOAD PDF They can create and take advantage of options in managing the project. The

value of the flexibility to delay has a value of $9·61 which would turn the negative NPV

to positive making the overall value of the project $6·55 million. However, it should be

emphasised that the value of the option is based on the Black-Scholes model which has

many assumptions such as the risk free rate, the difficulties of calculating the standard

deviation which measures the volatility of the present value of the cash inflows. It was

also assumed that debt is risk free, FREE ACCA STUDY MATERAILS hence debt beta is zero.

**Argument for and against hedging**

The marketing manager’s position is based on the theoretical case put forward for not

managing corporate risk. In a situation of market efficiency where information is known

and securities are priced correctly, holding well diversified portfolios will eliminate (or

at least significantly reduce) unsystematic risk. The position against hedging states that

**FREE ACCA BOOKS DOWNLOAD - P4 Revision & Mock Question & Answers 2017-2018**