F3 Financial Strategy Questions and Answers

Sales in S$ and T$

Purchases in U$

Profit margin measured in R$

To improve or maintain operating margin in R$ terms:

You want costs in R$ to fall and/or revenues in R$ to rise.

Strengthening of the R$ against U$ means each U$ costs fewer R$, so purchase costs fall in home-currency terms → margin improves.

Weakening of customer currencies (S$ or T$) against R$ would reduce revenue in R$, harming the margin.

Weakening of the R$ against U$ would make U$ costs more expensive.

So the helpful change is: R$ strengthens against U$ → option C.

The question asks for advantages to the acquiring company (ADC/ABC) of using shares rather than cash to pay for DEF.

C. It incentivises DEF to continue creating value for the combined group

If DEF’s shareholders (and possibly managers) receive shares in ADC, they now own part of the combined business. That aligns their interests with ADC’s existing shareholders and encourages them to help grow the value of the group.

E. The risk of poor future performance of the acquisition is shared with the DEF company shareholder.

If ADC pays with shares, DEF’s shareholders share in both the upside and downside. If the acquisition underperforms, the fall in value is shared instead of all the risk resting on ADC’s original shareholders. That’s an advantage for ADC.

F. It preserves liquidity

Paying with shares means ADC does not need to use up cash or raise new debt. This preserves cash balances and borrowing capacity, which is a clear advantage.

Why not the others?

A (sharing benefits of future growth with DEF shareholders) is actually a cost from ADC’s existing shareholders’ viewpoint – they give away more of the upside.

B dilution of ownership is also a disadvantage, not an advantage.

D a tax saving for ABC – the tax impact is usually more relevant for sellers or when using debt, not typically a direct advantage of share consideration to the acquirer.

We need to raise $45m with minimum dilution, so choose the highest price at which there is sufficient demand.

Demand at or above each possible offer price:

$5.00 → 5m shares → $25m (insufficient)

$4.75 → (2 + 5) = 7m shares → 7 × 4.75 = $33.25m (insufficient)

$4.50 → (3 + 2 + 5) = 10m shares → 10 × 4.50 = $45m (exactly enough)

$4.25 or $4.00 would raise more than $45m but require issuing more shares → more dilution.

So the best price that still raises $45m is $4.50.

Answer: A – $4.50

In CIMA F3, a money market hedge is a contractual-style hedge created using the spot rate today plus borrowing/lending in the two currencies to lock in a known domestic-currency outcome for a future foreign-currency receipt or payment. Under interest rate parity, the synthetic forward rate implied by money-market borrowing and lending is broadly consistent with the forward market, so the hedge typically delivers roughly the same outcome as a forward contract (A). Unlike leaving the position unhedged, the money market hedge does not leave the company exposed to currency risk once set up because the future cash flows are effectively fixed through today’s borrow/lend transactions (so B is false). Because a money market hedge can be tailored using available loan/deposit maturities and amounts (and can sometimes be implemented when a forward is unavailable or less convenient), it may be a little more flexible than a forward in practical terms (C). However, it requires multiple steps—borrow or invest, convert at spot, and invest/repay—so it is more complex than a forward contract (D). “Easy to set up” is not usually considered a defining advantage versus forwards because it depends on access to credit lines and money-market instruments (so E is not selected).

CIMA F3 covers takeover defences under Mergers and Acquisitions and Corporate Governance. A crucial distinction is made between legitimate post-offer defences, which are actions taken after a bid has been announced and are consistent with directors’ fiduciary duties, and illegitimate or unethical actions, which may mislead shareholders or breach takeover regulations.

Once a bid is hostile, the directors of the target company (Company B) are required under governance principles emphasised in F3 to act in the best interests of shareholders, not merely to preserve their own positions.

Option A is a legitimate defence.

Having the company’s assets independently and professionally revalued is acceptable and encouraged under CIMA F3. This provides shareholders with objective evidence that the bid undervalues the company and supports informed decision-making without misleading the market.

Option C is a legitimate defence.

Making a counter-bid (often called a “Pac-Man defence”) is permitted provided it can be justified as enhancing shareholder wealth. CIMA F3 stresses that directors may pursue alternative strategic actions if they genuinely believe these will create greater value for shareholders than accepting the hostile offer.

Option E is a legitimate defence.

Referring the bid to competition authorities is allowed where there are genuine competition concerns. CIMA F3 notes that regulatory intervention is an appropriate and lawful route if the acquisition may breach competition law or significantly reduce market competition.

The remaining options are not legitimate:

B is not allowed post-offer, as changing the articles to block a bid breaches takeover rules and shareholder rights.

D is unethical and unlawful, as knowingly publishing misleading forecasts violates disclosure requirements and directors’ duties.

✅ Final Answer: A, C and E

Against DDA

Fixed: ZZZ 10% vs DDA 10.5% → ZZZ cheaper by 0.5%

Floating: ZZZ rf+1 vs DDA rf+1.5 → ZZZ cheaper by 0.5%

ZZZ is better in both markets by the same margin → no comparative advantage, little reason for DDA to swap.

Against CCA

Fixed: ZZZ 10% vs CCA 9% → CCA cheaper by 1%

Floating: ZZZ rf+1 vs CCA rf+0.5 → CCA cheaper by 0.5%

CCA is cheaper in both, and also the one with greater advantage is fixed. There’s no natural “ZZZ better at one, CCA better at the other” pairing.

Against BBA ✅

Fixed: ZZZ 10% vs BBA 12% → ZZZ cheaper in fixed by 2%

Floating: ZZZ rf+1 vs BBA rf+0.25 → BBA cheaper in floating by 0.75%

So ZZZ has an advantage in fixed, BBA has an advantage in floating.

ZZZ wants floating, so it can:

Borrow fixed at 10% (where it is strong),

Enter a swap with BBA (who wants fixed but is strong in floating),

End up with an effective floating rate below rf+1.

Against AAB

Fixed: ZZZ 10% vs AAB 9.5% → AAB cheaper by 0.5%

Floating: ZZZ rf+1 vs AAB rf+0.75 → AAB cheaper by 0.25%

AAB is cheaper in both; no obvious mutual gain.

So the classical swap pairing is ZZZ with BBA → Option C.

Dividend Growth Model (DGM):

P0=D1ke−gP_0 = \frac{D_1}{k_e - g}P0​=ke​−gD1​​

Dividend just paid: D0=0.08D_0 = 0.08D0​=0.08

Dividend growth: g=2%=0.02g = 2\% = 0.02g=2%=0.02

Cost of equity: ke=15%=0.15k_e = 15\% = 0.15ke​=15%=0.15

Future dividend:

D1=D0(1+g)=0.08×1.02=0.0816D_1 = D_0 (1+g) = 0.08 \times 1.02 = 0.0816D1​=D0​(1+g)=0.08×1.02=0.0816

Theoretical price:

P0=0.08160.15−0.02=0.08160.13≈0.63P_0 = \frac{0.0816}{0.15 - 0.02} = \frac{0.0816}{0.13} \approx 0.63P0​=0.15−0.020.0816​=0.130.0816​≈0.63

Current market price = 0.60

Expected change: 0.63−0.60=0.030.63 - 0.60 = 0.030.63−0.60=0.03 increase → Option A.

 B – Shareholders care about real income, so they want dividend growth at least in line with inflation.

 C – Retained earnings must earn a return above inflation to create real value.

 D – Inflation’s effect on future cash flows and required returns must be considered when setting dividend policy.

 A. The corporate tax rate in country P is 40%.

Tax in P (40%) is higher than in T (20%), so moving profits to P via a subsidiary gives a tax disadvantage, not an advantage.

 B. There are restrictions on companies wishing to remit profit from country P

That makes it harder to get cash out of P – this is a disadvantage of having a subsidiary there.

 C. Year 1 tax depreciation allowances of 100% are available in country P. ✅

This is very attractive for an investment in a manufacturing subsidiary. A 100% first-year allowance means the company can deduct the full cost of qualifying assets immediately, reducing taxable profit and tax in early years. That’s a clear advantage to setting up in P.

 D. There is a double tax treaty between country T and country P. ✅

A double tax treaty usually prevents the same profits being taxed twice and provides tax credits/relief for foreign taxes. This especially matters when you operate via a foreign subsidiary. So it’s an advantage to establishing a subsidiary in P.

 E. There are high customs duties payable on products entering country P. ✅

If the company exports directly from T, it pays high customs duties into P. If it manufactures inside P via a subsidiary, those import duties are avoided. So high customs duties on imports are an argument in favour of local production via a subsidiary – a clear advantage of establishing the subsidiary.

 A – True: a scrip dividend converts distributable reserves into share capital (non-distributable).

 C – True: more shares in issue increases future dividend expectations.

 D – True: it creates extra admin/secretarial work versus simply paying no dividend.

A. Net book value (NBV) is based on historical cost and accounting conventions → it often doesn’t reflect current economic value. This is a disadvantage.

C. Many intangibles (brands, know-how, human capital, internally generated IP) are not recognised on the balance sheet, so a net asset valuation can seriously understate value → disadvantage.

D. Net realisable value (what assets could actually be sold for) is usually different from NBV, again showing NBV is a poor proxy for real value → disadvantage.

B. “Can be obtained from the financial statements” – that’s an advantage (it’s easy and cheap).

E. NBV of current assets is often reasonably close to realisable value (especially cash, receivables less bad debts, short-term inventory), so that’s not a disadvantage.

So the three disadvantages are A, C and D.

Two percentage adjustments are to be made to the proxy P/E ratio:

20% reduction because Company K is unlisted (unlisted companies usually trade at a discount).

15% increase because Company K has better growth prospects than the proxy (higher growth → higher P/E).

In exam-style CIMA F3 questions, unless stated otherwise, these adjustments are usually treated additively:

Net adjustment = +15% − 20% = −5%, i.e. a 5% decrease in the proxy P/E ratio.

So the total adjustment is a 5% decrease.

Cash flows:

Years 1–3: 100, 100, 100

From year 4: grow at 2% forever. Cost of capital = 12%.

PV of years 1–3:

PV1−3=1001.12+1001.122+1001.123≈240\text{PV}_{1-3} = \frac{100}{1.12} + \frac{100}{1.12^2} + \frac{100}{1.12^3} \approx 240PV1−3​=1.12100​+1.122100​+1.123100​≈240

Terminal value at end of year 3:

Year 4 CF = 100×1.02=102100 \times 1.02 = 102100×1.02=102

TV3=1020.12−0.02=1020.10=1,020\text{TV}_3 = \frac{102}{0.12 - 0.02} = \frac{102}{0.10} = 1{,}020TV3​=0.12−0.02102​=0.10102​=1,020

PV of terminal value:

PV(TV)=1,0201.123≈726\text{PV(TV)} = \frac{1{,}020}{1.12^3} \approx 726PV(TV)=1.1231,020​≈726

Total value ≈ 240+726=966240 + 726 = 966240+726=966.

So the value is $966 million → Option A.

Step 1 – Work out current gearing

Current values:

Equity = $80m

Debt = $20m

Total value VVV = 80 + 20 = $100m

So:

DE=2080=0.25\frac{D}{E} = \frac{20}{80} = 0.25ED​=8020​=0.25

Tax rate T=20%T = 20\%T=20% → after-tax cost of debt:

Kd(1−T)=6%(1−0.2)=4.8%K_d(1-T) = 6\%(1-0.2) = 4.8\%Kd​(1−T)=6%(1−0.2)=4.8%

Given cost of equity Ke=14%K_e = 14\%Ke​=14%.

Step 2 – Find the ungeared (asset) cost of capital KuK_uKu​

Use Modigliani–Miller with tax for equity:

Ke=Ku+(Ku−Kd)(1−T)DEK_e = K_u + (K_u - K_d)(1-T)\frac{D}{E}Ke​=Ku​+(Ku​−Kd​)(1−T)ED​

Substitute:

14=Ku+(Ku−6)×0.8×0.2514 = K_u + (K_u - 6)\times 0.8 \times 0.2514=Ku​+(Ku​−6)×0.8×0.25 14=Ku+0.2(Ku−6)14 = K_u + 0.2(K_u - 6)14=Ku​+0.2(Ku​−6) 14=1.2Ku−1.214 = 1.2K_u - 1.214=1.2Ku​−1.2 1.2Ku=15.2⇒Ku≈12.67%1.2K_u = 15.2 \Rightarrow K_u \approx 12.67\%1.2Ku​=15.2⇒Ku​≈12.67%

Step 3 – Re-gear the cost of equity for the new structure

New target mix: Debt : Equity = 40 : 60 ⇒

DE=4060=0.6667\frac{D}{E} = \frac{40}{60} = 0.6667ED​=6040​=0.6667

Reapply MM with tax:

Ke′=Ku+(Ku−Kd)(1−T)DEK_e' = K_u + (K_u - K_d)(1-T)\frac{D}{E}Ke′​=Ku​+(Ku​−Kd​)(1−T)ED​ Ke′=12.67+(12.67−6)×0.8×0.6667K_e' = 12.67 + (12.67 - 6)\times 0.8 \times 0.6667Ke′​=12.67+(12.67−6)×0.8×0.6667 Ke′≈12.67+3.56=16.23%K_e' \approx 12.67 + 3.56 = 16.23\%Ke′​≈12.67+3.56=16.23%

Step 4 – Calculate new WACC

New proportions:

E/V=60100=0.6,D/V=40100=0.4E/V = \frac{60}{100} = 0.6,\quad D/V = \frac{40}{100} = 0.4E/V=10060​=0.6,D/V=10040​=0.4 WACC′=0.6×16.23%+0.4×4.8%\text{WACC}' = 0.6 \times 16.23\% + 0.4 \times 4.8\%WACC′=0.6×16.23%+0.4×4.8% WACC′≈9.74%+1.92%=11.66%\text{WACC}' \approx 9.74\% + 1.92\% = 11.66\%WACC′≈9.74%+1.92%=11.66%

 Interest cover = PBIT / Interest = 20 / 5 = 4 times ≥ 3 ⇒ covenant met.

 Next year dividend per share = 0.04 × 1.10 = 0.044.

Total dividend = 0.044 × 200m = 8.8m.

Retained earnings = Earnings – Dividends = 12 – 8.8 = 3.2m < 3.5m ⇒ retained-earnings covenant breached only.

In CIMA F3, rights issues and post-issue valuation are taught under the learning outcomes relating to financing decisions, equity issuance, and shareholder value analysis. The Theoretical Ex-Rights Price (TERP) represents the price a share should trade at immediately after the rights issue when the “value dilution” and “value added” of the project are taken into account.

According to the financial strategy principles taught in F3, the TERP is calculated by adding:

The current market value of equity,

The cash raised from the rights issue, and

The net present value (NPV) of the investment project,

then dividing by the total number of shares after the issue. This reflects the CIMA F3 view that share prices should adjust to reflect both new financing inflows and future economic benefits associated with positive-NPV projects.

Step-by-step application of the F3 method

(1) Current shareholders’ equity value:

(2) Rights issue price:

Rights issued at a 10% discount:

(3) Number of new shares issued:

(4) Total shares after issue:

(5) Total value after issue and project:

Add value of cash raised and NPV:

(6) TERP formula:

Rounded to two decimal places:

This calculation follows the CIMA F3 principle that positive-NPV projects increase shareholder wealth, and therefore must be added to the total post-issue company valuation before dividing by the enlarged share capital.

Competition authorities are mainly concerned with market power and abuse of dominance.

Proposing to increase prices significantly on routes where no other airlines operate (i.e. monopoly routes) is a classic competition concern → C.

Reducing destinations (A), selective disclosure to shareholders (B), or redundancies (D) are governance, disclosure, or employment issues, not the core focus of competition law.

EBIT = 5.0m

Interest (10% × 10m) = 1.0m

Profit before tax = 5.0 − 1.0 = 4.0m

Tax (25%) = 1.0m → Earnings = 3.0m

Payout ratio 50% → current dividend = 1.5m

Growth g = 3% → D1=1.5×1.03=1.545D_1 = 1.5 × 1.03 = 1.545D1​=1.5×1.03=1.545m

Cost of equity ke=10%k_e = 10\%ke​=10%. Using Gordon model:

P0=D1ke−g=1.5450.10−0.03=1.5450.07≈22.1mP_0 = \frac{D_1}{k_e - g} = \frac{1.545}{0.10 - 0.03} = \frac{1.545}{0.07} \approx 22.1\text{m}P0​=ke​−gD1​​=0.10−0.031.545​=0.071.545​≈22.1m

Answer: B. $22.1 million

For WWW (geared 1:3 debt:equity):

D/E=1/3D/E = 1/3D/E=1/3

Let E=3xE = 3xE=3x, D=xD = xD=x ⇒ V=4xV = 4xV=4x

E/V=3/4=0.75E/V = 3/4 = 0.75E/V=3/4=0.75, D/V=1/4=0.25D/V = 1/4 = 0.25D/V=1/4=0.25

Cost of debt Kd=6%K_d = 6\%Kd​=6%

Unlevered cost relation:

Ku=EVKe+DVKdK_u = \frac{E}{V}K_e + \frac{D}{V}K_dKu​=VE​Ke​+VD​Kd​ 0.15=0.75Ke+0.25×0.060.15 = 0.75K_e + 0.25 \times 0.060.15=0.75Ke​+0.25×0.06 0.15=0.75Ke+0.0150.15 = 0.75K_e + 0.0150.15=0.75Ke​+0.015 0.75Ke=0.135⇒Ke=0.1350.75=0.18=18%0.75K_e = 0.135 \Rightarrow K_e = \frac{0.135}{0.75} = 0.18 = 18\%0.75Ke​=0.135⇒Ke​=0.750.135​=0.18=18%

Answer: B. 18.0%

In lease vs buy decisions, the relevant risk is essentially that of secured debt, and the cash flows (lease payments, tax shields, loan repayments) are after tax. Therefore, you discount incremental cash flows at the after-tax cost of borrowing, not WACC or cost of equity.

Notional principal = $200m

Pay fixed 4%, receive floating (6-month risk-free).

For the first 6 months, the floating rate fixed on 1 Jan = 5% p.a.

Difference = 5% − 4% = 1%

Settlement for 6 months:

0.01×200 m×612=$1 000 0000.01 \times 200\,\text{m} \times \frac{6}{12} = \$1\,000\,0000.01×200m×126​=$1000000

Floating > fixed, so the company receives this amount under the swap.

Correct answer: D. $1,000,000 net receipt to the company.

PBIT = $1.1m

Debt = $2m at 5% → interest = $0.1m

Profit before tax = 1.1 – 0.1 = $1.0m

Tax at 20% = 0.2m → Earnings after tax = $0.8m

Earnings yield = Earnings ÷ Market value of equity = 10%:

0.8=0.10×MV⇒MV=0.80.10=$8m0.8 = 0.10 \times \text{MV} \Rightarrow \text{MV} = \frac{0.8}{0.10} = \$8\text{m}0.8=0.10×MV⇒MV=0.100.8​=$8m

Shares in issue = 4m → share price:

Price=84=$2.00\text{Price} = \frac{8}{4} = \$2.00Price=48​=$2.00

Answer: C: $2.00

Equity: $30m

Debt: $35m at 5% interest, redeemable in 5 years

They require 30% p.a. compound on the equity and no dividends are paid.

Equity value required in 5 years

Future value=30×1.35=30×3.71293≈$111.39m\text{Future value} = 30 \times 1.3^5 = 30 \times 3.71293 \approx \$111.39\text{m}Future value=30×1.35=30×3.71293≈$111.39m

Debt cash flows

Annual interest: 35×5%=$1.75m35 \times 5\% = \$1.75\text{m}35×5%=$1.75m → over 5 years: 1.75×5=$8.75m1.75 \times 5 = \$8.75\text{m}1.75×5=$8.75m

Principal repaid in year 5: $35m

Total due to venture capitalists

111.39+8.75+35=$155.14m (approx)111.39 + 8.75 + 35 = \$155.14\text{m (approx)}111.39+8.75+35=$155.14m (approx)

Answer: A. $155.14 million

Company HGG is young, unlisted, loss-making so far, and has uncertain growth.

Weaknesses of using the dividend growth model here:

A. Future growth rate in earnings/dividends is hard to estimate – very true for an early-stage, high-uncertainty business.

C. It has been unprofitable and has no established dividend pattern, so the basic inputs to the model (D₀ and g) are unreliable.

E. Cost of capital is difficult to estimate for an unlisted company (no directly observable beta or market data).

B is just a description of the model, not a specific weakness here, and D is incorrect because the dividend growth model does discount future dividends (it fully incorporates time value of money).

✅ Answer Q121: A, C, E

PPP says identical goods should cost the same when prices are expressed in a common currency, but in reality transport costs, taxes, tariffs, and market imperfections can allow differences to persist.

Answer: C. Economic forces should eliminate the price difference, but imperfections may permit it to persist.

 A – True. A special dividend can create expectations of similar future payouts, while a buyback is more clearly one-off.

 B – True. A repurchase can be interpreted by some investors as management having no positive-NPV projects, i.e. a possible negative signal about growth opportunities.

 C – False. The repurchase price is not automatically the open-market price; it may involve negotiation or a premium/discount.

 D – True. In many tax regimes, capital gains (from buybacks) are taxed more favourably than dividend income, so some shareholders may prefer repurchases.

 E – False. Even if approved, individual shareholders are usually free to choose whether or not to tender their shares.

Pre-acquisition standalone values:

ABB = $55m

BBA = $25m

Total pre-deal value = $80m.

After the acquisition, ABB (the combined business) is expected to generate post-tax cash flows of $10m per year in perpetuity. Cost of equity = 10%, and the firm is all-equity financed, so:

Post-acquisition value=100.10=$100m\text{Post-acquisition value} = \frac{10}{0.10} = \$100\text{m}Post-acquisition value=0.1010​=$100m

Synergy value = value of combined firm − sum of standalone values:

Synergy=100−80=$20m\text{Synergy} = 100 - 80 = \$20\text{m}Synergy=100−80=$20m

So the best estimate of the synergy from the acquisition is $20 million.

CIMA F3 clearly distinguishes between not-for-profit/public sector organisations and for-profit private sector organisations, particularly in relation to objectives, performance measurement, and stakeholder focus.

Statement A – Correct

Clinic A is funded by central government and provides free healthcare. This fits the CIMA F3 definition of a not-for-profit (public sector) organisation, whose primary purpose is service delivery rather than profit generation.

Clinic B is a listed company owned by shareholders and charges patients directly, making it a for-profit organisation.

✔ Therefore, statement A is correct.

Statement B – Incorrect

Maximising shareholder wealth is the primary financial objective only of for-profit companies, such as Clinic B.

Public sector organisations like Clinic A do not have shareholders and therefore cannot have shareholder wealth maximisation as an objective.

✘ Statement B is incorrect.

Statement C – Correct

CIMA F3 teaches that public sector organisations are primarily assessed on value for money, which incorporates:

Economy

Efficiency

Effectiveness

Since Clinic A is government-funded, its performance would be appraised mainly using value-for-money criteria rather than profitability.

✔ Statement C is correct.

Statement D – Incorrect

While Clinic B may consider some non-financial objectives (such as service quality or reputation), its primary objectives are financial, particularly profit and shareholder wealth maximisation.

The statement implies equal weighting, which is inconsistent with CIMA F3 theory.

✘ Statement D is incorrect.

Statement E – Correct

Despite differing ownership and funding, both organisations share the same primary non-financial objective: the provision of quality healthcare.

CIMA F3 highlights that organisations in the same sector often share common service objectives, regardless of profit motive.

✔ Statement E is correct.

C. True – If the new project has a positive NPV, the company’s total value increases, so the actual ex-rights price can be higher than the purely mechanical TERP, which ignores project NPV.

E. True – Under Modigliani & Miller with tax, the cost of equity increases with gearing (more debt → more financial risk). A rights issue used to finance a project reduces D/E, so the cost of equity will fall compared with a more highly geared structure.

The others are false:

A. No rule that the issue price must be 20% below the market price.

B. A deep discount encourages take-up but cannot guarantee it.

D. Low gearing would usually allow more debt, not force an equity issue.

Last year’s profit before interest and tax (PBIT) = $4.0m

Objective: PBIT to increase by 10% →

PBITthis year=4.0×1.10=4.4m\text{PBIT}_{\text{this year}} = 4.0 \times 1.10 = 4.4\text{m}PBITthis year​=4.0×1.10=4.4m

New long-term debt = $2m at 5% interest →

Interest = 2.0×0.05=0.1m2.0 \times 0.05 = 0.1\text{m}2.0×0.05=0.1m

Profit before tax (PBT):

4.4−0.1=4.3m4.4 - 0.1 = 4.3\text{m}4.4−0.1=4.3m

Tax at 20%:

Tax=4.3×0.20=0.86m\text{Tax} = 4.3 \times 0.20 = 0.86\text{m}Tax=4.3×0.20=0.86m

Earnings after tax:

Earnings=4.3−0.86=3.44m\text{Earnings} = 4.3 - 0.86 = 3.44\text{m}Earnings=4.3−0.86=3.44m

Dividend payout ratio = 40% of earnings:

Total dividends=3.44×0.40=1.376m\text{Total dividends} = 3.44 \times 0.40 = 1.376\text{m}Total dividends=3.44×0.40=1.376m

Shares in issue = 2m → Dividend per share:

DPS=1.3762=0.688≈$0.69\text{DPS} = \frac{1.376}{2} = 0.688 \approx \$0.69DPS=21.376​=0.688≈$0.69

So, correct DPS by calculation is about $0.69 per share. Since none of the given options (A–D) equals this, there is likely a typo or omission in the provided options, but the financially correct figure is $0.69.

When valuing an unlisted company using a P/E ratio from a similar listed company, we normally reduce the proxy P/E to reflect the extra risk and reduced attractiveness of the unlisted investment.

A. Relative lack of marketability – Unlisted shares are harder to sell and usually take longer to realise, so investors demand a higher return, i.e. a lower P/E. ✔

B. Lower level of scrutiny and regulation – Unlisted companies face less disclosure and governance requirements, so information risk is higher. Greater risk ⇒ lower valuation multiple ⇒ reduced P/E. ✔

C. Smaller and less established – Unlisted companies tend to be smaller, less diversified and less stable, so investors again expect a higher return, implying a lower P/E. ✔

D. Control premium not included – If the proxy P/E excludes a control premium but you are valuing a controlling stake, you would increase the P/E, not reduce it. ✘

E. Higher forecast earnings growth – Higher expected growth justifies a higher P/E, not a lower one. ✘

F. One-off profit item in latest earnings – This should be dealt with by adjusting the earnings, not by cutting the P/E multiple. ✘

So the three factors justifying a reduction in the proxy P/E are A, B and C.

This is a fair value hedge of inventory.

Under fair value hedge accounting, both:

the change in fair value of the hedged item (inventory), and

the change in fair value of the hedging instrument (futures)

go to profit or loss.

Inventory: fair value rises from $400,000 to $480,000 → gain $80,000.

Futures: fair value becomes a $75,000 liability → loss $75,000.

Net effect in P&L: $80,000 – $75,000 = $5,000 gain.

Nothing goes to OCI for a fair value hedge.

Current year sales in M$

Units = 100,000

Price = M$12

Revenue = 100,000 × 12 = M$1,200,000

Convert to L$ at current rate

Spot: L$1 = M$5 → 1 M$ = 0.2 L$

Current L$ revenue = 1,200,000 × 0.2 = L$240,000

Target L$ revenue (10% growth)

240,000 × 1.10 = L$264,000

Effect of a 5% strengthening of the L$

L$ strengthens ⇒ more M$ per L$

New rate = 5 × 1.05 = M$5.25 per L$

1 M$ = 1/5.25 ≈ 0.190476 L$

Required units next year

L$ revenue = Units × 12 M$ × 0.190476 L$/M$

So Units = 264,000 ÷ (12 × 0.190476)

12 × 0.190476 ≈ 2.285712

Units ≈ 264,000 ÷ 2.285712 ≈ 115,500 units

So the correct choice is A. 115,500 units.

In a semi-strong efficient market, today’s share price already reflects all publicly available information, including the news about the successful new phone and revised growth forecasts. So the best estimate of equity value today is simply:

Market cap=Current share price×number of shares\text{Market cap} = \text{Current share price} \times \text{number of shares}Market cap=Current share price×number of shares

No adjustment for retained earnings, and no need to redo valuation models if the market is semi-strong efficient.

Answer: B: Today’s share price × number of shares in issue.

Current A$ revenue: Country A = 75m; Country B = 25m → total = 100m; B share = 25%.

At A$1 = B$2, B-revenue in B$ = 25m / 0.5 = 50m B$.

B$ depreciates 10% vs A$: approx new rate 1B$ ≈ 0.4545 A$.

New A$ revenue from B = 50m × 0.4545 ≈ 22.7m A$.

New total revenue ≈ 75 + 22.7 = 97.7m A$.

New percentage from B = 22.7 / 97.7 ≈ 23.3%.

This question examines the appropriateness of debt financing instruments in the context of a high-risk, growth-oriented pharmaceutical company, which is a classic scenario discussed within CIMA F3 under Financing Decisions, Risk and Capital Structure, and Hybrid Finance.

Company P operates in a sector characterised by long development cycles, high uncertainty, and intangible asset bases. Its value derives primarily from human capital and intellectual property rather than tangible fixed assets. According to CIMA F3 study guidance, such firms face significant difficulty raising conventional straight debt, as lenders typically require stable cash flows and asset security. Furthermore, the company’s existing cash flows are only sufficient for operational needs, not major R&D expenditure, increasing perceived credit risk.

A convertible bond is explicitly highlighted in CIMA F3 as a suitable financing instrument for companies with high growth potential but limited current cash flows. Convertible bonds combine features of debt and equity, offering investors downside protection through fixed interest payments while providing upside potential through conversion into equity if the company succeeds. This reduces the required coupon rate (4% in this case), easing short-term cash flow pressure, which is crucial for Company P during the development phase of the new drug.

Importantly, the doctors who own and manage Company P wish to retain control, a key strategic constraint. Convertible bonds delay equity dilution until conversion occurs and only if the company performs well. This aligns with F3 principles that hybrid instruments are appropriate when firms wish to balance financing needs with control considerations.

The alternative options are unsuitable:

Eurobonds and conventional bonds (Options A and B) require strong credit standing and asset backing.

Commercial paper (Option C) is short-term, unsecured, and inappropriate for long-term R&D funding.

Therefore, consistent with CIMA F3 guidance on risk-adjusted financing strategy, the most appropriate choice is the convertible bond.

A – Retained earnings: When you value equity by discounting cash flows to equity, the result already represents the total value of equity. You don’t then add book retained earnings on top – that would double-count equity.

B – Deducting $400m for the bond: With a FCFE valuation you do not deduct the value of debt at all – the cash flows are already after interest and principal. So deducting the bond is wrong, and in any case they used nominal value ($400m) instead of market value ($380m).

C – Using WACC: Cash flows to equity must be discounted at the cost of equity, not at WACC. WACC is used only when discounting free cash flow to the firm.

Using cash flows to equity (D) is fine, and deducting replacement capex (E) is correct because only free cash after maintaining assets belongs to shareholders.

A – Access to technical expertise: Q’s staff are leading experts and human capital is very valuable; acquiring this is a clear benefit.

D – Gain economies of scale: Both firms operate in the same technical service industry, so combining operations can reduce average costs and share overheads.

E – Improve EPS: Q has shown consistent earnings growth; if acquired at a reasonable price, this growth can enhance M’s earnings and potentially its EPS.

Diversification benefits (B) are limited because they are in the same industry, and intangible assets such as human capital are not strong collateral for borrowing (C).

Company currently pays fixed 7% on its bonds.

Swap quote 6.0%–6.5% fixed against LIBOR means:

Bank will pay 6.0% fixed and receive LIBOR, or

Receive 6.5% fixed and pay LIBOR.

To move from fixed to variable, the company should receive fixed and pay LIBOR, so it takes the 6.0% fixed leg.

Net position:

Pay 7% fixed on bond

Receive 6% fixed from swap

Pay LIBOR on swap

Total = (7% − 6%) + LIBOR = LIBOR + 1%

Answer: C. VARIABLE at LIBOR + 1.0%

Let’s walk it through carefully.

1. Current earnings and EPS

EBIT = 5m

Current interest (5% × 10m) = 0.5m

Profit before tax = 5.0 − 0.5 = 4.5m

Tax (20%) = 0.9m

Earnings = 4.5 − 0.9 = 3.6m

Shares = 10m → EPS₀ = 3.6 / 10 = 0.36

Current share price = 3.60 → current P/E = 3.60 / 0.36 = 10 (matches the question context).

2. Earnings next year with higher interest

New interest rate = 6% → interest = 10m × 6% = 0.6m

Profit before tax = 5.0 − 0.6 = 4.4m

Tax (20%) = 0.88m

Earnings = 4.4 − 0.88 = 3.52m

EPS₁ = 3.52 / 10m = 0.352

3. New share price using new P/E

Expected P/E next year = 9.5

Price1=EPS1×P/E1=0.352×9.5=3.344\text{Price}_1 = \text{EPS}_1 \times \text{P/E}_1 = 0.352 \times 9.5 = 3.344Price1​=EPS1​×P/E1​=0.352×9.5=3.344

4. Percentage reduction in share price

Current price = 3.60

New price ≈ 3.344

Drop = 3.60 − 3.344 = 0.256

% reduction=0.2563.60≈7.1%≈7%\%\ \text{reduction} = \frac{0.256}{3.60} \approx 7.1\% \approx 7\%% reduction=3.600.256​≈7.1%≈7%

So the closest option is A. Reduction of 7%.

This requirement is a standard interest rate parity (IRP) application from CIMA F3 foreign exchange management. Where the spot rate is quoted as foreign currency per unit of home currency (here, A$ per PS, since 1 PS = 5 A$), CIMA F3 applies the parity relationship to forecast the exchange rate over the period using relative money-market interest rates. The forward/forecast rate is derived as:

Given:

p.a. (home deposits)

p.a. (foreign deposits)

PPP will receive A$5,000,000 in 3 months; converting at the forecast rate:

Rounded to the nearest thousand PS:

Before announcement:

Equity = 4m shares × $4.0 = $16m

Debt = $7m

Gearing = 7 / 16 = 43.75% → already above 40%.

After additional $2m debt and higher share price:

Debt = 7 + 2 = $9m

Equity = 4m × $4.2 = $16.8m

Gearing = 9 / 16.8 ≈ 53.6% → even further above the 40% ceiling.

So the gearing objective is exceeded both before and after, and gearing rises.

For a capital-intensive, fast-growing, owner-managed start-up with many investment opportunities, the most suitable policy is to retain earnings to finance all positive NPV projects first, and only pay dividends out of any leftover (residual) earnings. That’s exactly what a residual dividend policy does.

They care most about ability to service debt and their security:

A: Cash flow forecasts – show ability to meet interest and principal. ✅

B: Current capital structure – shows gearing, ranking of claims, overall risk. ✅

E: Book value of assets – relevant as potential security / collateral. ✅

Answer: A, B, E

A residual dividend policy pays dividends only after all positive-NPV projects are funded – typical for firms whose investors want growth rather than income.

C is a small listed company whose investors seek maximum capital growth → classic residual policy case.

Answer: C. Entity C

Profit before tax = $10m (the “10 0” in the text).

Tax @ 20% ⇒ earnings after tax = 10 × (1 − 0.20) = $8m.

For a takeover, it’s appropriate to use the takeover P/E range in the same industry: 11–12 times.

Value range = 8 × 11 to 8 × 12 = $88m to $96m.

Answer: B – Minimum $88m, maximum $96m.

Most appropriate is asset-based valuation because RRR is unlisted, has just made a loss and pays dividends only occasionally. Earnings- and dividend-based models (P/E, earnings yield, DVM) rely on stable, positive earnings or dividends, which RRR does not currently have, so valuing the tangible and identifiable intangible assets is more reliable.

F Co is private, owned 60% by founder, 20% each by two children.

Needs a large amount of long-term finance within 3 months.

IPO rejected because it would take up to 12 months.

Venture Capitalist (VC) offers finance (debt + equity) but wants:

60% of equity

25% annual return

A board seat

Veto over all expenditure over a certain level.

Question: From the family’s perspective, which are advantages of using the VC?

Option-by-option

A. The cost of the finance – DISADVANTAGE

A required return of 25% and taking 60% of the equity is expensive; the family is giving up control and paying a high expected return. That’s not an advantage.

B. Changes in shareholding – DISADVANTAGE

Post-investment, the VC would own 60%, the family only 40% collectively. They lose control. That’s clearly a downside for them.

C. Veto on expenditure – DISADVANTAGE (for the family)

A VC veto on capital and revenue spend restricts management/family autonomy. While it may improve governance, it’s not an “advantage from the family’s perspective”.

D. Speed with which finance can be obtained – ADVANTAGE ✅

VC money can typically be arranged much faster than an IPO, which is crucial because the company needs funds within 3 months. This is explicitly given as a reason IPO is not suitable.

E. Experience of the Venture Capitalist with growing businesses – ADVANTAGE ✅

VCs often bring expertise, contacts, and strategic guidance in scaling businesses. From the family’s point of view, this support can increase the chances of successful expansion.

So the genuine advantages to the family are:

D (speed) and

E (experience).

This question examines loan covenant compliance, a topic covered in CIMA F3 under Debt Finance, Financial Risk, and Dividend Policy. Loan covenants are contractual restrictions imposed by lenders to protect their interests. Breaching a covenant can trigger penalties or loan repayment demands, so directors must assess compliance carefully using projected financial information.

The company has two covenants:

Interest cover must not fall below 4 times

Retained earnings for the year must not fall below $5.00 million

Step 1: Interest Cover Covenant

CIMA F3 defines interest cover as:

From the projections:

EBIT = $25.00 million

Interest = $3.20 million

Since 7.8 > 4, the company meets the interest cover covenant.

Step 2: Retained Earnings Covenant

Earnings after tax are projected at $15.26 million.

The most recent dividend per share is $0.10, and dividends are planned to increase by 8%:

With 100 million shares in issue:

Retained earnings for the year:

Since $4.46 million < $5.00 million, the company breaches the retained earnings covenant.

Conclusion (CIMA F3 Interpretation)

Interest cover covenant: Complied with

Retained earnings covenant: Breached

Under CIMA F3 guidance, directors must recognise that even when profitability appears strong, dividend policy can cause covenant breaches if distributions are excessive.

Acceptable actions:

Negotiate with lenders (A)

Drop the project if funding would breach the covenant (B)

Look for other finance such as cutting dividends (D)

Breaching covenants deliberately or relying on shareholders to “approve” a breach is not acceptable.

Answer: A, B, D

Applying hedge accounting will better match the gains/losses on hedging instruments with the underlying forecast revenues, reducing artificial volatility in reported profit. This makes the performance figures more representative and therefore easier for the market to analyse and value when the company lists.

Option D is weaker because hedge accounting is optional under IFRS, and A and C do not address the key issue of earnings volatility and future market valuation.

Negatives for the bank:

A. Advanced, custom-made tech equipment – poor resale value and high obsolescence risk, weak security.

C. Premises on a long-term lease and not fully fitted out – limited asset security; further capital outlay still needed.

E. Essential ongoing R&D – continuing cash demands and uncertainty of returns.

Positives, so not negatives:

B. Continuing profitability and net cash generation – good for servicing debt.

D. Founders’ personal investment – shows commitment and loss-sharing; strengthens equity base.

A: Net position is pay floating (fixed to bank, receive fixed in swap, pay floating) → True.

B: No principal is exchanged in an interest rate swap → False.

C: LIBOR, not LIBID, is normally the reference rate → False.

D: Interest cash flows are exchanged periodically (e.g. annually) → True.

E: Swaps are usually between a company and a bank → True.

Answer: A, D, E

Equity: 400m shares at $3 → $1,200m

Existing debt: $800m

New debt raised: $200m

Project NPV: $100m

Step 1 – Initial firm value:

= 1,200 + 800 = $2,000m

Step 2 – After raising $200m debt and investing in project:

Debt becomes = 800 + 200 = $1,000m

Firm value increases by NPV of 100 → new firm value = 2,000 + 100 = $2,100m

Wait – careful: raising debt also adds cash before investment, then project adds NPV:

After raising debt: 2,000 + 200 = 2,200

After investing in project with NPV 100: +100 → 2,300m total firm value

So final:

Firm value = 2,300m

Debt = 1,000m

Equity (by MV) = 2,300 – 1,000 = 1,300m

Step 3 – Gearing ratio (market value):

Gearing = Debt / (Debt + Equity)

= 1,000 / (1,000 + 1,300)

= 1,000 / 2,300 ≈ 43.48%

To avoid an immediate breach, the bank’s maximum gearing must be at least above 43.48%.

The lowest option that does this is 44%.

Shares repurchased: 10% × 20m = 2m shares at $1.20 → cash outflow = $2.4m.

Cash balance falls from $4.8m to $2.4m → 50% decrease.

EPS before: 3.6m / 20m = $0.18

EPS after: 3.6m / 18m = $0.20

% change in EPS = (0.20 − 0.18) / 0.18 ≈ 11% increase.

So the correct statement is D: cash decreases by 50% and EPS increases by 11%.

CIMA F3 emphasises that shareholders expect directors to focus on value creation after an acquisition, particularly in the areas that protect and enhance the cash flows and synergies that justified the deal. Following an all-cash acquisition, the target’s former shareholders have exited, so the acquirer’s shareholders will not prioritise tailoring dividends to meet the target shareholders’ preferences (B is not relevant). Also, the question states the acquisition has just been completed, so regulatory approval needed to complete the acquisition (C) is no longer a priority stage item. What matters immediately is executing post-deal integration to secure the expected benefits. First, directors must ensure integration and retention of key employees from the acquired firm (A), especially in service/knowledge businesses where people drive client relationships and operational capability. Second, they must protect revenues by retaining the acquired firm’s key customers (D); losing customers can destroy acquisition value quickly. Third, they must deliver the deal logic by realising anticipated post-acquisition synergies (E), such as cost savings, higher capacity utilisation, cross-selling, and process improvements. These priorities align with F3’s post-merger integration focus: preserve the earnings base, then convert strategic fit into measurable synergy cash flows.

Company pays 3.5% fixed on its borrowing and enters a swap at 3.4–3.5% vs 12-month USD risk-free rate.

To move from fixed to floating, it will receive fixed 3.4% and pay floating (risk-free):

Net interest:

3.5%−3.4%+rf=rf+0.1%3.5\% - 3.4\% + \text{rf} = \text{rf} + 0.1\%3.5%−3.4%+rf=rf+0.1%

Answer to Q102: C – 12-month USD risk-free rate plus 0.1%

Profit before tax = $4.0m

Tax at 25% → earnings = $4.0m × (1 − 0.25) = $3.0m

For a takeover, the most relevant comparators are recent takeover P/E multiples in the same industry: 9–10x.

Minimum value = 3.0 × 9 = $27m

Maximum value = 3.0 × 10 = $30m

Answer: B. Minimum = $27m, maximum = $30m

(Existing value 2m × 15 = 30m; add $12m cash + $6m NPV = 48m total.

Shares after issue = 3m ⇒ 48 / 3 = $16.)QUESTION NO: 199047

A listed company is planning a share repurchase. 

The following data applies:

   • There are 10 million shares in issue

   • The  share repurchase will involve buying back 20% of the shares at a price of $0.75

   • The company is holding $2 million cash

   • Earnings for the current year ended are $2 million

The Directors are concerned about the impact that this repurchase programme will have on the company's cash balance and current year earnings per share (EPS) ratio.

Advise the directors which of the following statements is correct?

A. The cash balance will decrease by 75% and EPS will decrease by 25%.

B. The cash balance will decrease by 75% and EPS will increase by 25%.

C. The cash balance will decrease by 20% and the EPS will decrease by 25%.

D. The cash balance will decrease by 20% and the EPS will increase by 25%.

Answer: B

(Cash used = 2m shares × $0.75 = $1.5m; from $2m ⇒ 75% fall.

EPS: before = 2m / 10m = $0.20; after = 2m / 8m = $0.25 ⇒ 25% increase.)

Given (current): Debt:Equity = 20:80, tax = 25%, equity beta = 1.20, asset beta = 1.01.

Check/ungear beta (matches table):

βa=βeEE+D(1−T)=1.20×8080+20×0.75=1.01\beta_a = \beta_e \frac{E}{E + D(1-T)} = 1.20 \times \frac{80}{80 + 20×0.75} = 1.01βa​=βe​E+D(1−T)E​=1.20×80+20×0.7580​=1.01.

Re-gear for new structure D:E = 30:70:

βe′=βaE+D(1−T)E=1.01×70+30×0.7570=1.01×92.570≈1.33\beta_e' = \beta_a \frac{E + D(1-T)}{E} = 1.01 \times \frac{70 + 30×0.75}{70} = 1.01 \times \frac{92.5}{70} \approx 1.33βe′​=βa​EE+D(1−T)​=1.01×7070+30×0.75​=1.01×7092.5​≈1.33

CAPM with rf=3%r_f = 3\%rf​=3%, rm=10%r_m = 10\%rm​=10%:

Ke′=3%+1.33×(10%−3%)≈3%+9.3%=12.3%K_e' = 3\% + 1.33 × (10\%-3\%) \approx 3\% + 9.3\% = 12.3\%Ke′​=3%+1.33×(10%−3%)≈3%+9.3%=12.3%

The offer gives only a small premium over Company C’s current share price, and Company C has positive, unannounced plans for its substantial cash balances. Under good corporate-governance practice, the most appropriate response to a hostile bid is to communicate clearly with shareholders, explaining why the bid undervalues the company and why remaining independent may create more value. Changing the Articles to entrench management (B) and using a special dividend as a “poison pill” (C) are generally discouraged and may breach takeover rules; competition issues (D) are not indicated here. So A is the best option.

Current PBIT = $25m

Existing debt = $60m at 5% → interest = 0.05 × 60 = $3m

Current interest cover = 25 / 3 = 8.3 times (as stated).

New borrowing: $20m at 10% → extra interest = 0.10 × 20 = $2m

Total interest after borrowing = 3 + 2 = $5m

PBIT in first year is unchanged at $25m, so:

New interest cover=255=5 times\text{New interest cover} = \frac{25}{5} = 5 \text{ times}New interest cover=525​=5 times

Loan covenant requires minimum cover of 4 times. New cover (5x) is above this, so covenant is not breached.

Correct answer: D – Interest cover would reduce to 5 times and the covenant would NOT be breached.

Current borrowing cost = LIBOR + 1.0%

If it swaps to fixed:

Pay LIBOR + 1.0% on the loan

Receive LIBOR and pay fixed 3.5% on the swap

Net cost = (LIBOR + 1.0%) − LIBOR + 3.5% = 4.5% fixed

So, at current LIBOR, the company would move from LIBOR + 1.0% to an effective 4.5%, which is higher unless LIBOR exceeds 3.5%. The question asks about “current LIBOR rates”, which are implied to be below this level, so the swap increases interest cost.

Answer: D. No, because interest cost will increase with the interest rate swap in place.

Conversion value = (conversion ratio) × (share price).

Share price is expected to grow 5% p.a. from $4.50, so the conversion value rises each year. With a steadily rising price and no other constraints given, a rational bondholder delays conversion as long as possible among the dates offered, to maximise value.

So the most worthwhile of the dates listed is the latest one: 31 December 20X3.

Answer: C. 31 December 20X3

The division is:

Currently loss-making

Has generated negative free cash flow

Requires significant new investment to return to profitability

Under CIMA F3 valuation principles:

Dividend growth model (A) – not suitable: the division does not pay dividends and may not be a standalone listed entity.

P/E ratio on forecast earnings (D) – inappropriate where current earnings are negative and future earnings highly uncertain.

Discounted forecast free cash flow (C) is theoretically strong, but here forecasts are likely to be very uncertain because profitability depends on substantial new investment by the buyer.

In such cases, the asset-based valuation (B) is often most useful as a negotiation tool: it provides a defensible view of what the business is worth in terms of its underlying net assets and sets a floor for acceptable sale price.

So the most useful approach in negotiations is B. Asset basis.

CIMA F3 discusses exit strategies for owner-managed businesses under Business Valuation, Mergers and Acquisitions, and Private Equity. A key principle is that an appropriate exit route must align with the owners’ objectives, particularly the time horizon, desire for full value realisation, and the size and structure of the business.

In this scenario, Company AB is a medium-sized, owner-managed private company, with two founders who each control divisions and wish to realise the full value of their investment within 12 months. This tight timeframe significantly narrows the range of feasible exit strategies.

Option B – Management Buyout (MBO) is likely to be acceptable. CIMA F3 highlights that MBOs are common exit routes for founder-owned businesses where management has strong operational knowledge and where continuity of the business is important. Given that some employees are highly paid and critical to profitability, an MBO can help retain key staff while allowing the founders to exit fully, usually with private equity support. This route is realistic within a 12-month timeframe.

Option C – Sale to a larger competitor is also highly appropriate. F3 guidance explains that strategic buyers often pay a control premium because they can extract synergies such as economies of scale, elimination of duplicate functions, and enhanced market power. A trade sale is one of the fastest ways to realise full value and is commonly recommended where owners want a complete exit in a short period.

The other options are less suitable:

A (IPO) is unlikely due to high cost, regulatory burden, and long preparation time, making it unrealistic within 12 months.

D (Private equity earn-out) delays full value realisation and conflicts with the owners’ desire for a clean exit.

E (Spin-off/demerger) does not provide liquidity or an exit for the owners.

Zero NPV project → total shareholder wealth should be unchanged if rights are used or sold, not wasted.

A – Exercising all rights: shareholders put cash in, get extra shares; wealth unchanged.

C – Selling all rights: they don’t invest but receive the rights’ value in cash; wealth unchanged.

E – Part exercise, part sell: combination of A and C, still no loss of wealth.

Letting rights lapse (B or part-lapse in D) destroys value → those are not wealth-neutral.

A higher P/E ratio usually reflects higher expected future growth and/or lower perceived risk. Among the options, only higher expected growth explains why Company B’s P/E (15) is greater than Company A’s (8). Higher risk or higher gearing would normally reduce the P/E, not increase it, and current profit level alone doesn’t determine the multiple.

✅ Answer: C. Company B has higher expected future growth than Company A.

CIMA F3 explains that the Dividend Growth Model (DGM) is only suitable where dividends are stable, predictable, and capable of being forecast with reasonable confidence. It is therefore weak when applied to young, unlisted, high-risk companies, especially those with uncertain future cash flows.

A. No established dividend payment pattern – ✔ Correct

Company B has made losses in its first three years and has not paid dividends. CIMA F3 explicitly states that the dividend growth model is unsuitable where there is no dividend history, because the model relies on extrapolating future dividends from past patterns.

B. Uses future projected dividends – ✘ Incorrect

This is not a weakness, but a fundamental feature of the dividend growth model. All valuation models are forward-looking, and CIMA F3 does not consider this a limitation.

C. Growth rate difficult to determine – ✔ Correct

The business operates in a unique, high-risk sector, and future earnings and dividends are highly uncertain. CIMA F3 highlights that the DGM is extremely sensitive to the assumed growth rate, making it unreliable when growth cannot be estimated with confidence.

D. Time value of money ignored – ✘ Incorrect

The dividend growth model explicitly discounts future dividends, meaning it fully incorporates the time value of money, a core principle taught in F3.

E. Cost of capital difficult to estimate – ✔ Correct

As an unlisted company, Company B has no observable beta or market data. CIMA F3 stresses that estimating the cost of equity for private, high-risk businesses is problematic, reducing the reliability of DGM outputs.

Interest on debt is treated as a tax-deductible expense, so it is deducted in arriving at profit before tax:

A – incorrect: security over assets doesn’t affect tax relief on interest.

B – incorrect: preference dividends are not tax-deductible.

C – incorrect: if it were deducted from post-tax profits there would be no tax relief.

D – correct: interest is deducted from pre-tax profits.

Current revenue = $300m at $2.00/kWh → units = 300/2 = 150m kWh

New price cap = $1.50; demand rises 10% → units = 150m × 1.10 = 165m kWh

New revenue = 165m × $1.50 = $247.5m

Costs remain $200m → new profit = 247.5 − 200 = $47.5m profit

✅ Answer: A. $47.5 million profit

Issue price at 20% discount to $5 = $4 per share.

Amount to raise = 20m → new shares = 20m / 4 = 5m.

Existing shares = 20m → rights ratio = 5m : 20m = 1 : 4.

Answer: A. 1 new share for every 4 existing shares

Free cash flow year 3 = Z$240m

Spot rate now: Z$1 = X$2

Inflation: X 2%, Z 4% → expected depreciation of Z$ via PPP:

Factor k=1.021.04=51/52k = \frac{1.02}{1.04} = 51/52k=1.041.02​=51/52

Year-3 expected rate:

S3=2×k3≈2×0.9434=1.8868 X/ZS_3 = 2 \times k^3 \approx 2 \times 0.9434 = 1.8868 \ \text{X$/Z$}S3​=2×k3≈2×0.9434=1.8868 X/Z

FCF in X$:

240×1.8868≈X$452.8m240 \times 1.8868 \approx X\$452.8\text{m}240×1.8868≈X$452.8m

Discount at 8% using given factor 0.794:

452.8×0.794≈X$359.5m452.8 \times 0.794 \approx X\$359.5\text{m}452.8×0.794≈X$359.5m

Nearest million: X$360m

Answer: D – X$360 million

Debt becomes more attractive when:

Corporate tax increases → larger tax shield on interest.

Bond yields decrease → lower pre-tax cost of debt.

So the combination that makes a bond issue more attractive is higher tax and lower yields.

At the rumour stage (pre-bid), suitable defences are pre-emptive ones:

A – Communicate effectively with shareholders: build support and explain strategy to keep the share price fair and reduce vulnerability.

B – Revalue non-current assets: helps ensure the shares are not undervalued and makes any bid look less attractive.

D – Poison pill: introduce mechanisms (e.g. rights issues to existing shareholders) that make a hostile bid very costly.

C (competition authorities) and E (white knight) are reactive and typically used only once an actual bid has been made.

Director A – You can issue bonds without having listed equity, but a “public issue” of bonds still involves heavy regulation and doesn’t remove the need for disclosure. This is not what the question is really getting at → treat as not correct.

Director B – AIM still has regulatory requirements; they are lighter, not non-existent → incorrect.

Director C – Rights issues are for existing shareholders of (normally) listed companies; an unlisted company cannot raise unlimited equity this way → incorrect.

Director D – Listing improves marketability and visibility and generally increases the ability to raise both equity and debt → correct.

Director E – Listed status makes shares more easily tradable and the company more visible, so it becomes a more likely takeover target → correct.

Answer: D and E.

In CIMA F3, equity valuation using P/E multiples is based on earnings available to ordinary shareholders (i.e. profit after interest and tax). The syllabus emphasises that when valuing a potential takeover target, you should (1) derive maintainable post-tax earnings and then (2) apply a P/E multiple that reflects prices actually paid in comparable acquisitions, not just average stock-market multiples.

Calculate maintainable earnings:

Profit before interest and tax (PBIT) = $5m

Less interest on 10% bonds: 10% × $10m = $1m

Profit before tax = $4m

Tax at 20% = $0.8m

Earnings for equity = $3.2m

Select the appropriate P/E multiple:

F3 explains that “takeover P/Es” are usually higher than sector trading P/Es, reflecting the control premium. Here we have:

Overall market P/E = 20

Retail sector P/E = 10

Recent retail takeovers P/E = 13

For a takeover valuation we use the 13× multiple from recent sector takeovers.

Compute equity value:

Equity value=3.2m×13=41.6m\text{Equity value} = 3.2\text{m} \times 13 = 41.6\text{m}Equity value=3.2m×13=41.6m

Debt’s market value (90% of $10m) is not added here because the P/E method already gives the equity value.

So, a reasonable expected equity value in a takeover is $41.6 million.

C. Helps access to wider sources of finance – A key benefit of listing is easier access to equity and sometimes cheaper debt.

D. Provides an exit route for the founders – Listing 70% allows them to sell down and realise value.

E. Increases the profile and reputation of the business – Public companies usually gain visibility, credibility, and brand recognition.

A is doubtful (agency conflicts can increase with dispersed ownership), and B (higher dividends) is not a guaranteed benefit of listing.

Correct answer: D. Companies A and B have the same business risk

Business risk is measured by asset beta.

A and B both have asset beta = 1.16, so same business risk.

C has higher asset beta (1.20), so highest business risk.

A company is moving from all-equity to a geared structure (D:E = 1:2) with corporate tax.

Using Modigliani & Miller with tax:

ke=ke0+(ke0−kd)(1−T)DEk_e = k_{e0} + (k_{e0} - k_d)(1-T)\frac{D}{E}ke​=ke0​+(ke0​−kd​)(1−T)ED​

Where:

ke0=8%k_{e0} = 8\%ke0​=8% (ungeared cost of equity)

kd=4%k_d = 4\%kd​=4%

T=30%T = 30\%T=30%

D/E=1/2=0.5D/E = 1/2 = 0.5D/E=1/2=0.5

ke=8%+(8%−4%)×0.7×0.5=8%+4%×0.35=8%+1.4%=9.4%k_e = 8\% + (8\% - 4\%) \times 0.7 \times 0.5 = 8\% + 4\% \times 0.35 = 8\% + 1.4\% = 9.4\%ke​=8%+(8%−4%)×0.7×0.5=8%+4%×0.35=8%+1.4%=9.4%

Answer: A. 9.4%

 Integrated reports under the Framework should include:

Governance and how it supports value creation → A

The organisation’s business model → B

Risks, challenges, and uncertainties affecting strategy and value creation → C

 Comparisons with competitors’ financials (D) and a summary of board meeting discussions (E) are not required content elements in the Framework.

CIMA F3 clearly states that acquisitions enhance shareholder wealth only if they create real economic value, not just strategic or reputational benefits.

A. Press coverage – ✘

Media exposure does not directly generate cash flows or economic value.

B. New opportunities for employees – ✘

While beneficial socially, this does not directly enhance shareholder wealth unless it improves profitability.

C. Cultural diversity – ✘

CIMA F3 treats this as a soft benefit with no guaranteed financial return.

D. Acquiring Intellectual Property – ✔

IP can generate monopoly power, licensing income, and sustainable competitive advantage, directly increasing future cash flows.

E. Exploiting production synergies – ✔

Cost savings and operational efficiencies are a primary source of acquisition value highlighted throughout the F3 syllabus.

F. Elimination of competition – ✔

Reduced competition can increase pricing power and market share, improving long-term profitability and shareholder value.

Exposure: Company A will receive B$20 million.

Spot rate: A$1 = B$2 ⇒ 1 B$ = A$0.5

Current A$ value of the receipt:

20,000,000×0.5=A$10,000,00020{,}000{,}000 \times 0.5 = A\$10{,}000{,}00020,000,000×0.5=A$10,000,000

Daily standard deviation of the exchange rate = 0.5% = 0.005

1-day 95% VaR uses Z ≈ 1.645

VaR:

VaR=Z×σ×exposure=1.645×0.005×10,000,000\text{VaR} = Z \times \sigma \times \text{exposure} = 1.645 \times 0.005 \times 10{,}000{,}000VaR=Z×σ×exposure=1.645×0.005×10,000,000 0.005×10,000,000=50,0000.005 \times 10{,}000{,}000 = 50{,}0000.005×10,000,000=50,000 1.645×50,000=82,2501.645 \times 50{,}000 = 82{,}2501.645×50,000=82,250

So the 1-day 95% VaR is A$82,250 → Option C.

A – Industry average asset beta: The company is geared, so the appropriate beta for use in CAPM is an equity beta (asset beta re-geared to the firm’s capital structure). Using an asset beta directly will understate equity risk and therefore understate the cost of equity and overvalue the company.

B – Constant dividend growth unlikely: The Gordon growth (dividend valuation) model assumes a constant growth rate in dividends in perpetuity. Here, a major new high-growth project means growth is likely to be uneven (possibly high for a period then stabilising), so the constant-g assumption is weak.

C – Future vs historical growth: They have simply projected the historical 4% growth into the future, but with a “very high growth potential” project, future dividend growth is unlikely to match the historic rate. That makes the choice of g highly questionable.

D is not inherently a weakness – the model values total equity; a 10% stake is simply 10% of that value (before considering any minority discounts).

E is incorrect – CAPM can be used for unlisted companies by using proxy betas from comparable listed firms.

Answer: D. Discounted cash flow analysis based on forecast future free cash flows.

Because the company is unlisted, growing faster than the industry, and pays only a fixed dividend (not linked to performance), dividend or simple P/E methods won’t capture its value properly. A DCF based on future free cash flows is most suitable.

 Value of V currently = 300m × $5 = $1,500m

 Offer price = $5 × 1.10 = $5.50 → cost = 300m × 5.50 = $1,650m

 Synergy = $100m

 Net gain to T’s shareholders = 100 − 150 = –$50m → a loss of $50m, so they’d reject.

 A – Founders’ pension/income adequacy is important in a closely held, owner-managed firm.

 C – Their future cash needs are central to dividend decisions.

 E – Personal tax position of the (few) shareholders is very relevant.

Differences in borrowing costs:

VVV:

Floating: rf + 3%

Fixed: 7%

Counterparty:

Floating: rf + 1%

Fixed: 8%

Relative advantages:

Counterparty is 2% cheaper in floating (rf+1 vs rf+3).

VVV is 1% cheaper in fixed (7 vs 8).

Many CIMA questions treat total potential saving from the swap as the sum of these advantages:

2% + 1% = 3% total savings.

Bank takes 10% ⇒ 0.3%.

Remaining savings = 3% − 0.3% = 2.7%, shared equally ⇒ 1.35% each.

VVV wants fixed; its direct fixed borrowing cost is 7%, so its effective fixed rate after sharing the savings:

7% − 1.35% = 5.65%.

Answer: B – VVV would pay 5.65%.

The company invoices exports in customers’ currencies, so between invoicing and cash receipt it faces transaction risk (actual foreign-currency cash flows to convert).

Because it competes internationally, long-term exchange rate movements can affect sales volumes and margins, so it also faces economic risk.

It has no foreign subsidiaries or overseas balance sheets to translate, so translation risk is not relevant.

Q36

Applying an industry P/E ratio to DDD's forecast earnings.

Value for Money is usually assessed using the 3 Es:

Economy – acquiring inputs at the lowest cost for a given quality (they pay less than other schools, so economy is actually good).

Effectiveness – achieving objectives (exam pass rates are high, so effectiveness is good).

Efficiency – the relationship between outputs and inputs (how well resources are turned into results).

Here, small class sizes mean more teaching resource per pupil. Even though results are good, they’re achieved with relatively high input (lots of teacher time per pupil), indicating weaker efficiency, not economy or effectiveness.

Verified Answer: = B

This is exactly what statement B describes: “Dividends are paid only if no further positive NPV projects are available.” Under this policy, if the firm has many profitable projects, dividends may be low or even zero; if investment opportunities are scarce, dividends may be higher because more earnings are surplus.

Statement A is too vague: all companies must cover operational needs before paying dividends, so that does not uniquely describe a residual policy.

Statement C describes an extreme retention policy where all earnings are reinvested, which is not the same as residual dividends (where some surplus can be paid out).

Statement D refers to a stable dividend policy, where a constant or smoothly growing dividend per share is targeted, regardless of short-term earnings volatility.

Therefore, the best description of a residual dividend policy in F3 terms is B.

Pre-acquisition:

Company X: earnings = $50m, P/E = 10 → value = 50 × 10 = $500m; shares = 100m → price = $5

Company Y: earnings = $15m, P/E = 10 → value = 15 × 10 = $150m; shares = 50m → price = $3

Combined earnings = 50 + 15 = $65m

Post-acquisition assumptions:

Earnings increase by 10% → 65 × 1.10 = $71.5m

Combined P/E remains 10 → total market value = 71.5 × 10 = $715m

We want X’s new share price to be 10% higher than $5 → target price = $5.50.

Share price = total value ÷ total X shares after issue:

5.50=715Total shares⇒Total shares=7155.5=130m5.50 = \frac{715}{\text{Total shares}} \Rightarrow \text{Total shares} = \frac{715}{5.5} = 130\text{m}5.50=Total shares715​⇒Total shares=5.5715​=130m

X currently has 100m shares, so must issue 30m new shares to Y’s shareholders.

Y has 50m shares → each Y share must get:

30m50m=0.6 X shares per Y share\frac{30m}{50m} = 0.6 \text{ X shares per Y share}50m30m​=0.6 X shares per Y share

Check options:

B: 3 X for 5 Y → 3/5 = 0.6 X per Y ✔

So that exchange ratio gives exactly 30m new X shares and hence a 10% increase in X’s share price.

Correct answer: B – 3 shares in Company X for 5 shares in Company Y.

Current year:

Revenue = $50m

PBIT = $10m → margin = 10/50 = 20%

Tax = 20%

Earnings = 10 × (1 − 0.20) = $8m

Next year:

Revenue still $50m

40% of revenue = $20m → margin falls to 18%

PBIT on this part=20×18%=3.6\text{PBIT on this part} = 20 \times 18\% = 3.6PBIT on this part=20×18%=3.6

60% of revenue = $30m → margin stays 20%

PBIT on this part=30×20%=6.0\text{PBIT on this part} = 30 \times 20\% = 6.0PBIT on this part=30×20%=6.0

Total PBIT next year:

3.6+6.0=9.6 million3.6 + 6.0 = 9.6\ \text{million}3.6+6.0=9.6 million

Earnings after tax next year:

9.6×(1−0.20)=9.6×0.8=7.68 million9.6 \times (1 - 0.20) = 9.6 \times 0.8 = 7.68\ \text{million}9.6×(1−0.20)=9.6×0.8=7.68 million

Percentage reduction in earnings:

8.00−7.688.00=0.328=0.04=4%\frac{8.00 - 7.68}{8.00} = \frac{0.32}{8} = 0.04 = 4\%8.008.00−7.68​=80.32​=0.04=4%

Correct option:

C. Reduction of 4.0%\boxed{\text{C. Reduction of 4.0\%}}C. Reduction of 4.0%​

Shares repurchased = 20% × 10m = 2m

Cash used = 2m × $0.75 = $1.5m

Original cash = $2m → decrease = 1.5/2 = 75%

EPS:

Earnings = $2m

Shares before = 10m → EPS = 2/10 = $0.20

Shares after = 8m → EPS = 2/8 = $0.25

Increase in EPS = (0.25 − 0.20)/0.20 = 25%

Answer: B. The cash balance will decrease by 75% and EPS will increase by 25%.

A. An IPO is normally underwritten – Correct. For a fixed-price IPO, underwriters usually guarantee that the issue will be taken up, giving certainty of proceeds.

B. The government will receive significant financial resources from the sale – Correct. In a privatisation, the government is selling its ownership stake; the cash from selling these shares flows to the government.

C. The national airline employees will no longer be public sector employees – Correct. Once privatised, the airline becomes a private-sector company; its staff cease to be public-sector employees.

D is incorrect: a fixed-price offer does not guarantee maximum proceeds – the shares are often deliberately underpriced to ensure the issue is fully subscribed.

E is incorrect: in this scenario the proceeds go to the government as seller of existing shares, not directly to the airline itself.

Founder of Company C owns 52% and wants to keep control.

A share-for-share exchange means issuing new shares → dilutes the founder’s holding and may reduce control.

A cash offer financed by borrowing does not issue new shares → founder’s percentage holding (and control) is preserved.

That is exactly what option A states.

Answer: A. A share-for-share exchange would result in a significant change in control… whereas a cash offer would not.

Once Division B is sold, Division A becomes heavily reliant on B as a major external customer. If the new owner reduces purchases or switches supplier, Division A’s volumes and viability are at risk. That makes:

C. Division A's going concern is highly dependent on its relationship with Division B – the main risk.

A is false: IFRS 7 applies to all entities that have financial instruments, not just regulated financial institutions.

B is true: IFRS 7 explicitly requires disclosures by class of financial instrument, so users can understand the nature and risks of different categories.

C is false: IFRS 7 requires both qualitative and quantitative disclosures, including carrying amounts, risk exposures, and sensitivity analyses.

D is false: sensitivity analysis is required for market risks (interest rate, currency, other price), not specifically credit risk.

So the correct statement is B.

We’re looking for long-term changes that would improve a company’s credit rating (i.e. reduce perceived credit risk and increase capacity to service debt):

A. Increase in interest cover (EBIT / interest) → higher coverage, safer for lenders → positive.

B. Decrease in (Net debt)/(EBITDA) → lower leverage relative to earnings → positive.

C. Increase in free cash flow from operations → more internally generated cash to pay interest and repay debt → positive.

D. Decrease in (Book debt)/(Book equity) is also a good sign in reality, but the question restricts us to three; exam focus is usually on coverage and cash flow-based ratios, so A, B and C are the best three.

E. Decrease in dividend cover (earnings / dividend) means paying a larger proportion of earnings out as dividends → less retained profit and weaker protection for creditors → negative for credit rating.

So the three most likely to improve the rating: A, B, C.

All the options are debt with the same maturity, but convertible bonds include an equity conversion option for investors. Because of that option, the coupon rate at issue is usually lower than on straight bonds or bank loans. However, CIMA F3 emphasises that if the company’s share price is expected to rise significantly (as in this question, where the project should greatly improve the share price), holders are very likely to convert.

When conversion happens, the company settles the debt by issuing shares that, at that point, are worth much more than the original debt value. The effective total cost of finance (interest paid plus the value of equity given up) can end up higher than for ordinary bonds, leases, or bank loans over the full term.

Therefore, given the expectation of a strong future share price, the source of debt finance likely to be most expensive over the full term is:

C. Convertible bonds ✅

Competition authorities focus on market power and the potential for abuse of a dominant position.

A is most concerning: raising prices on routes where there are no competing operators suggests the merged entity could exploit monopoly power.

B, C and D relate more to service rationalisation, disclosure/insider issues, and employment, which are not the core focus of competition law.

STU’s value is mainly in its people (human capital) and has few tangible assets. Net asset valuation relies on balance sheet assets, but internally generated intangibles like human capital are not recognised under normal accounting rules. So the accounts understate the real value of the business.

Answer: B. STU does not account for its intangible assets.

CIMA F3 links the cost of debt to the tax shield created by the tax deductibility of interest. The effective cost of servicing debt to a company is therefore the post-tax cost of debt, commonly expressed as kd(1−T)k_d(1-T)kd​(1−T). This makes statement C correct: when evaluating financing decisions and WACC, the company benefits from interest tax relief, so the relevant servicing cost is after tax. Statement A is also treated as correct in the standard F3 exam context: zero-coupon debt pays no periodic coupon interest, so there are no regular interest payments generating the conventional annual tax-deductible interest expense and therefore the familiar tax-shield effect on “interest payments” is not obtained in the same way (i.e., the typical coupon-based shield is eliminated). Statement B is incorrect because the size of the tax shield depends on the tax rate; if corporation tax changes, the value of the tax relief changes. Statement D is incorrect because if corporation tax rates rise, the tax shield from deductible interest would increase, not reduce (a higher tax rate increases the tax saving per dollar of interest). Hence the two correct statements are A and C.