CIMA F3 Exam With Confidence Using Practice Dumps

For a company valued using the free cash flow to equity with constant growth, the standard Gordon growth formula is:

Value of equity=FCF1ke−g\text{Value of equity} = \frac{\text{FCF}_1}{k_e - g}Value of equity=ke​−gFCF1​​

Where:

FCF₁ = free cash flow in one year’s time

kek_eke​ = cost of equity

ggg = constant growth rate

Here:

FCF₁ = $100,000

ke=10%=0.10k_e = 10\% = 0.10ke​=10%=0.10

g=5%=0.05g = 5\% = 0.05g=5%=0.05

Correct valuation:

Value=100,0000.10−0.05=100,0000.05=$2,000,000\text{Value} = \frac{100{,}000}{0.10 - 0.05} = \frac{100{,}000}{0.05} = \$2{,}000{,}000Value=0.10−0.05100,000​=0.05100,000​=$2,000,000

The analyst instead did:

100,000×(1+0.05)/0.10=105,000/0.10=$1,050,000100{,}000 \times (1 + 0.05) / 0.10 = 105{,}000 / 0.10 = \$1{,}050{,}000100,000×(1+0.05)/0.10=105,000/0.10=$1,050,000

So the true value is $2,000,000 and the analyst’s value is $1,050,000.

Undervaluation=2,000,000−1,050,000=$950,000\text{Undervaluation} = 2{,}000{,}000 - 1{,}050{,}000 = \$950{,}000Undervaluation=2,000,000−1,050,000=$950,000

So the company has been undervalued by $950,000 → Option A.

Workings:

BBA remits BS40 million.

Withholding tax in country B = 25%:

Tax = 25% × 40 = BS10m

Net remitted = 40 − 10 = BS30m

Company AAB pays tax of 10% on cash received:

Tax = 10% × 30 = BS3m

Net after tax = 30 − 3 = BS27m

Exchange rate: A$1 = BS3 →

\text{AAB receives in A$} = \frac{BS27m}{3} = \text{A\$9m}

A – Quality of current management: affects risk of default and how well the business is run.

B – Current gearing ratio: shows how much existing leverage there is and the risk of over-gearing.

E – Interest cover on existing debt: key indicator of the firm’s ability to service interest payments.

EPS (C) and dividend cover (D) are more relevant to equity investors than to new long-term lenders.