CIMA F3 Exam With Confidence Using Practice Dumps

Workings (Modigliani & Miller with tax):

Current (unlevered) cost of capital ku=9%k_u = 9\%ku​=9%

Cost of debt kd=3%k_d = 3\%kd​=3%

Tax rate T=25%T = 25\%T=25%

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

Formula 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=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%k_e = 9\% + (9\% - 3\%) \times 0.75 \times 0.5 = 9\% + 6\% \times 0.375 = 9\% + 2.25\% = 11.25\% \approx 11.3\%ke​=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%

So the nearest option is 11.3% (C).

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.

Strategic reasons for a horizontal acquisition (same industry/level of value chain):

A Reduction of risk by building a larger portfolio – broader product / customer base in the same industry can reduce business risk → strategic.

C To achieve economies of scale – classic horizontal motive (sharing overheads, volume discounts, etc.).

E Reduction of competition – by acquiring a rival, the combined firm increases market power.

B is a financial motive (undervalued target), and D is a vertical integration motive.

Answer: A, C, E