CAP 2: Room for improvement?

Aug 30, 2018
Although students performed very well in the CAP 2 exams, there remains one critical area of weakness that is easily remedied.

BY PHILIP NICOLLS

It’s great to see some strong performances in the recent CAP 2 summer exams, but it’s always worth reflecting on the opportunities for further improvement. A read through the recently-published examiner feedback shows one clear theme across all papers: candidates generally understand the theory reasonably well, but often struggle to apply that theory to the facts presented in the question. This is particularly evident in narrative-style questions.

Whether you’re re-taking the Autumn papers or progressing to FAE, such commercial application is a critical skill. It’s well worth stopping to evaluate how you approached these types of questions at the summer sitting and carry the lessons into 2018/19. At a high level, the examiner is looking for students to demonstrate three things:
 
  • An understanding of the theory;
  • The ability to apply the theory to the facts in the question as you develop your analysis; and
  • Some “common sense” commercial understanding to fill in the gaps, as appropriate to an aspiring business professional.
If you left the exam hall having answered a narrative question by simply outlining the relevant theory, then you only partly answered that question. In fact, you missed at least half of the available marks and have most likely failed that particular requirement.

Example

Let’s look at a narrative question from the summer 2018 SFMA paper. Question 1 (C) was worth six marks and asked: “Advise on THREE significant risks facing THERMAL, assuming Jane proceeds to acquire the company as outlined.”

Three risks, six marks – almost certainly two marks available per risk. It’s easy to pull these risks from a textbook, your lecture notes, or a past paper solution. However, this is far from enough. Identifying a generic risk will probably earn you a half a mark. Before you put pen to paper, take a few seconds to think about how you can develop your answer using the facts in the question to earn the remaining 1.5 marks. The pointers below provide useful guidance but of course, every question is a little bit different.

Conclusion

As with all exam technique, you can’t learn it on the day. As you prepare for the autumn exams, practice this skill as you attempt the narrative type questions on past papers.  For many candidates, the extra marks will make all the difference. Good luck.

RISK ONE
Business Model Risk

THERMAL manufactures oil-fuelled heating equipment (1). The use of oil and other fossil fuels for heating is likely to decline in the future as economies reorient towards less carbon intensive fuels (2).

This presents a long-term risk to THERMAL. The decline in sales over the past number of years may reflect this trend (3).

THERMAL should, as a long-term objective, seek to diversify into non-fossil fuel heating equipment (4).

RISK ONE – STUDENT GUIDANCE NOTES

  1. The point links to the products/industry in which THERMAL operates.
  2. Good use of “general knowledge” trends (use of sustainable energy) in the business environment.
  3. The response appropriately explains the impact on THERMAL’s business by referring back to the declining sales information presented in the question.
  4. A valid conclusion/recommendation, in this case to mitigate the risk.

RISK TWO
Foreign Exchange Risk

If Jane acquires the company, she intends to focus on sales to international markets, in particular the US and Canadian markets (1). As THERMAL is a €/£ based company, this move is likely to create foreign exchange risk for the company.  Transaction risk will arise from sales to these markets and translation risk may arise if THERMAL acquires assets in these markets. The fact that THERMAL does not have experience in FX markets compounds this risk (2). THERMAL should seek expert advice on developing a FX risk management policy. It should investigate the use of forward contracts, option contracts and other mechanisms to manage this risk (3).

RISK TWO – STUDENT GUIDANCE NOTES

  1. The answer links to the new strategy proposed in the question and explains what changes as a result.
  2. This is good use of more case-specific context – THERMAL has no previous experience in international markets.
  3. A sensible conclusion linked to the question’s specifics and suggesting appropriate hedging techniques.

RISK THREE
Financial Risk

Jane’s proposal to acquire the company involves THERMAL significantly increasing its gearing.

Its current debt ratio (debt/debt+equity) is  0.37.  If it adds €/£ 1,500,000 of additional debt, this ratio will increase to 0.51. This is a significant increase.

This debt will increase interest charges by €/£ 1,500,000 * 8% = €/£ 120,000 per year. THERMAL’s interest cover ratio will decline from 4.65 (2018 forecast) to 2.61 times (1).

RISK THREE – STUDENT GUIDANCE NOTES

The response is supported by appropriate calculations based on data provided in the question.