Free and Premium CIMA F3 Dumps Questions Answers

Under traditional (pre–Modigliani & Miller) capital structure theory, there is an assumed inverse relationship between WACC and company value. The idea is:

As a firm moves towards its optimal capital structure, the WACC falls, and the total value of the firm (equity + debt) rises.

Beyond that optimal point, extra gearing increases financial risk, so the required return from both debt and equity goes up, causing WACC to rise and firm value to fall.

So, within this framework, if a company’s WACC increases, that means it has moved away from its optimal capital structure, and the value of the company will decrease.

Therefore, under traditional theory, an increase in WACC → decrease in company value, so the correct answer is B.

We want methods that give the value of equity, not the value of the whole entity.

A. D₁ / (kₑ – g) → Gordon growth dividend model = value of equity (share value). ✅

B. Total earnings × P/E → market capitalisation = equity value. ✅

C. Free cash flows to all investors discounted at WACC → enterprise / firm value (equity + debt). ❌

D. Free cash flows to equity discounted at cost of equity → equity value. ✅

E. NCA + CA − CL → value of net assets before deducting long-term debt, i.e. value of the business to all capital providers, not just equity. ❌

So correct choices: A, B, D.

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.

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.

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.

For a listed company in the food retailing industry, the most relevant non-financial objectives are typically focused on customers and people, because success depends heavily on service quality, shopping experience and motivated staff.

A. Reduce customer complaints – Very appropriate. Complaints are a direct indicator of service problems, product quality issues, or process failures. Reducing complaints improves reputation and customer retention.

B. Increase customer service quality – Core objective for food retailers. Better service quality (speed at checkout, helpful staff, availability of products) improves competitive position and supports long-term sales growth.

D. Improve staff morale – Also highly relevant. Retail is labour-intensive and customer-facing. Motivated staff deliver better service, are more productive, and turnover is reduced.

Options C (Reduce production time) and E (Reduce raw material wastage) are more typical of manufacturing businesses, not retailers, who primarily buy finished goods rather than “produce” them. A retailer might track stock wastage or shrinkage, but the wording “raw material wastage” points clearly to a production environment.

So the best three for a listed food retailer are A, B and D.

A company has a 5.25% fixed-rate loan and wants to swap it to variable using a swap quoted:

4.50% – 4.55% in exchange for Libor

(Libor currently 4%)

To turn its fixed loan into a synthetic floating-rate loan, the company needs to:

Receive fixed (to offset part of the 5.25% it pays on the loan), and

Pay Libor (to end up with variable cost).

From the swap quote, if the company wants to receive fixed, it gets the lower rate: 4.50% (the bank’s bid rate).

Cash flows:

Pay 5.25% fixed on the loan

Receive 4.50% fixed on the swap

Pay Libor (4.00%) on the swap

Net cost:

5.25%−4.50%+4.00%=0.75%+4.00%=4.75%5.25\% - 4.50\% + 4.00\% = 0.75\% + 4.00\% = 4.75\%5.25%−4.50%+4.00%=0.75%+4.00%=4.75%

✅ Answer to Q28: B. 4.75%

IFRS 7 requires sensitivity analysis for market risks: currency risk, interest rate risk and other price risk (which includes commodities), not credit or liquidity.

Answer: A, C, D

The most appropriate swap is to receive fixed and pay floating on $50 million of the new debt.

Answer: D. Receive fixed pay floating interest rate swap for $50 million.

Interest rate swaps are covered in CIMA F3 under risk management and derivative instruments, specifically as tools for managing interest rate risk. An interest rate swap is an agreement between two parties to exchange interest payment obligations, typically swapping fixed-rate interest payments for floating-rate payments, or vice versa, on a notional principal amount.

Option A is TRUE.

CIMA F3 recognises that although swaps are primarily used for hedging, some companies may enter into interest rate swaps for speculative or risk-taking purposes. If management believes it has superior forecasts of future interest rate movements compared to the market, it may deliberately increase exposure to interest rate risk by swapping into floating rates or fixed rates accordingly. This behaviour is discussed in F3 as speculation rather than pure hedging.

Option E is TRUE.

An interest rate swap is an external hedging technique. CIMA F3 clearly distinguishes between:

Internal hedging (e.g. matching assets and liabilities, netting, leading and lagging), and

External hedging, which involves using financial instruments with third parties, such as forwards, futures, options and swaps.

Since a swap involves a counterparty (often a bank or financial institution), it is classified as an external hedge.

The remaining options are incorrect:

B is FALSE. Default risk does not automatically become “high” for the floating-rate payer when interest rates rise; it depends on the firm’s overall financial strength and cash flows. Rising rates increase payments, but not necessarily default risk to a high level.

C is FALSE. When interest rates fall, the fixed-rate payer is at a disadvantage (paying above-market rates), which may increase rather than reduce financial strain.

D is FALSE. An interest rate swap is not an internal hedging technique; it requires an external counterparty.

✅ Final Answer: A and E

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.

Company B (all equity):

Cost of equity = asset return = Ku = 17%

Company A:

Gearing D:E = 1:2 → D/E = 0.5

Pre-tax cost of debt Kd = 7%

Tax rate T = 30%

Levered cost of equity with tax:

Ke=Ku+DE(1−T)(Ku−Kd)K_e = K_u + \frac{D}{E}(1 - T)(K_u - K_d)Ke​=Ku​+ED​(1−T)(Ku​−Kd​) Ke=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%K_e = 17\% + 0.5 \times 0.7 \times (17\% - 7\%) = 17\% + 0.5 \times 0.7 \times 10\% = 17\% + 3.5\% = 20.5\%Ke​=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%

✅ Correct: A. 20.5%

IFRS 7 requires detailed disclosures about financial instruments and risk management, including currency risk, sensitivity analysis, and how those risks are managed. When these are published for the first time, investors may learn new information about:

The extent of US$ exposure (40% export sales), and

The quality of risk management (hedging, matching, etc.).

Efficient market theory (covered in F3) says prices adjust to new, relevant information. That new information could make investors more confident (if risks are well managed) or more concerned (if risks are high and poorly managed). So the share price could either increase or decrease, depending on the market’s reaction.

That matches option D.

Options A and C assume a one-way direction (always up or always down), which is unrealistic. B is wrong because segmental analysis does not normally give the same detailed, risk-focused disclosure as IFRS 7.

The company is repurchasing and cancelling its own shares.

When shares are cancelled:

Share capital is reduced by the nominal value of the shares bought back. ✅

Any amount paid above nominal value reduces equity reserves (such as share premium and/or retained earnings), but it does not go through the Income Statement.

Total equity does decrease by the full repurchase amount (so option C is wrong).

No element of the repurchase (including any “premium to market value”) is treated as an expense in the Income Statement under IFRS – it’s purely an equity transaction (so D is wrong).

Option A is too specific and not strictly correct, because the premium over nominal is not necessarily all charged only to retained earnings – it can also be charged to share premium / other reserves.

So the one fully correct statement is:

B. The share capital figure would reduce by the nominal value of the shares purchased.

B. Using present value of earnings (or free cash flows) is more appropriate when valuing a controlling interest, because the acquirer can change the dividend policy. ✅

C. A 5% historical dividend growth rate may not reflect future growth – assuming it will continue indefinitely is a big weakness. ✅

D. The industry average beta may not reflect Company B’s specific financial (gearing) risk; it should ideally be adjusted to reflect B’s capital structure. ✅

The others:

A is incorrect – you should generally use the target’s cost of equity (or project-specific) not Company A’s.

E is incorrect – unlisted companies can use CAPM via proxy/industry betas.

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.

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.

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.

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 – 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.

Competition authorities focus primarily on market structure and competition, not on whether the bid is generous or on employment promises. Their concern is: Will this merger substantially lessen competition?

In food retailing, a key issue is local market concentration – for example, a single group owning too many supermarkets in particular towns or regions. A classic remedy is for the bidder to divest overlapping outlets so that effective competition remains.

B. Agreeing to dispose of specified outlets which overlap geographically directly addresses the competition authority’s main concern and is the standard structural remedy used in practice.

A (more cash) is irrelevant to competition issues.

C (job guarantees) is mainly a political/employment concern, not an antitrust one.

D (promise to pass on cost savings) is difficult to monitor and enforce and is normally viewed as less credible than structural remedies.

So the action most likely to persuade the competition authorities is B.

A – Shareholders who want cash can sell into the repurchase.

B – Fewer shares in issue → higher EPS for remaining shareholders.

C – Reduces surplus cash that might attract predators.

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).

The bid is hostile and partly for diversification. Directors’ primary duty is to shareholders: they should explain why they believe the company is undervalued (e.g. unannounced plans and cash). Changing articles or using defensive payouts is poor governance; competition concerns are unlikely to be central here.

Answer: A. Write to shareholders explaining fully why the company's share price is undervalued.

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.

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%.

Current:

Revenue = $450m at $2.50/kWh → units = 450 / 2.5 = 180m kWh

Costs = $250m → Profit = $200m

After cap: price = $2.00, demand up 15%:

New volume = 180 × 1.15 = 207m kWh

New revenue = 207 × 2.00 = $414m

Costs unchanged = $250m → New profit = 414 − 250 = $164m

Answer: B. $164.00 million profit

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.

B. Diversification into another product market will lower business risk

Diversifying into a different sector can reduce unsystematic (business-specific) risk, as cash flows from different industries may be less correlated.

C. Greater protection from transaction risk

Company A already has B$ exposures (manufacturing and a B$ loan). Acquiring Company B, which operates and earns in B$, can provide B$ inflows that help naturally hedge B$ outflows, reducing transaction risk.

D. Greater protection from translation risk

The acquisition adds net assets in B$, which can act as a balance sheet hedge against existing B$ liabilities (such as the B$ loan). On consolidation, this can reduce the volatility of reported equity due to exchange rate movements, i.e. translation risk.

Option A is weak: political risk in Country B is not reduced by owning more assets there. E is doubtful because Company B is in a different industrial sector, so classic production scale economies are unlikely to be a primary justification.

In response to a hostile bid, one recognised defensive tactic is to seek a “white knight” – a friendlier alternative bidder whose terms may better protect existing management and shareholders. The other options are either pre-bid structural measures or not typical primary response strategies once a hostile bid has been received.

 Revenues are in E$ and F$, costs are in G$, and reporting currency is D$.

 If the D$ strengthens against G$ (option C), then G$ costs translate into fewer D$, so reported costs fall and operating profit margin improves.

 A stronger D$ against E$ or F$ (A or B) reduces the D$ value of sales, hurting margins.

 A weaker D$ against G$ (D) makes G$-denominated costs more expensive in D$, also hurting margins.

So the change that most helps maintain/improve margin is C.

 C – More cash = able to react quickly to unexpected investment opportunities.

 D – Cash buffer reduces the likelihood of liquidity problems in a downturn.

 E – If excess cash were returned, markets might read it as “no good growth opportunities”, so retaining avoids that negative signal.

The company is deciding between:

Selling the business via a Management Buyout (MBO), or

Selling to an external private equity (PE) buyer.

From the original company’s viewpoint, an advantage of an MBO is:

The buyers are the existing management team. Relationships already exist, and there’s usually more trust and alignment.

Post-divestment, the original company may still trade with the divested unit (e.g., as a supplier or customer). Cooperation tends to be better with a familiar internal team than with an external PE house whose primary focus is financial returns.

Why the others are wrong:

B. Enhanced big data opportunities – unrelated to the divestment method.

C. Improved relationships with MBO team in the event of a sale to PE – logically inconsistent; if sold to PE, it’s not an MBO.

D. Higher price due to synergistic benefits – PE typically looks for financial engineering and operational improvements, not classic corporate synergies. You are more likely to see synergy premia when selling to a trade buyer, not in an MBO.

So the key pro-MBO argument here is better cooperation post divestment → A.

Current debt interest:

Existing: 5m×8%=0.40m5\text{m} \times 8\% = 0.40\text{m}5m×8%=0.40m

New: 2m×10%=0.20m2\text{m} \times 10\% = 0.20\text{m}2m×10%=0.20m

Total interest = 0.60m

Let annual sales = SSS.

Operating profit margin = 20% → OP = 0.20 S.

Interest cover covenant:

0.20S0.60≥4⇒0.20S≥2.4⇒S≥2.40.20=12.0 million\frac{0.20 S}{0.60} \ge 4 \Rightarrow 0.20 S \ge 2.4 \Rightarrow S \ge \frac{2.4}{0.20} = 12.0\ \text{million}0.600.20S​≥4⇒0.20S≥2.4⇒S≥0.202.4​=12.0 million

Correct answer: A. $12.00 million

Current situation:

Earnings = $2m

P/E = 10 → Market value = 2 × 10 = $20m

After expansion:

Earnings increase by 25% → new earnings = 2 × 1.25 = $2.5m

New P/E = 8 → New market value = 2.5 × 8 = $20m

Shareholder wealth (equity value) stays at $20m, so the **most likely change is:

D. No change in shareholder wealth.**

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

 A. The shareholder can choose whether to take the cash or not.

With a repurchase, shareholders can decide to sell (take cash) or keep their shares. A one-off dividend forces all shareholders to receive cash.

 C. It means that the company will be able to pay lower total dividends in the future.

After a buyback there are fewer shares in issue. If the company keeps the same dividend per share, the total dividend outlay falls – good for future cash flow and flexibility.

 E. It will not create an expectation for future increased dividends.

A large one-off dividend may be interpreted as a permanent increase, creating pressure to maintain higher payouts. A buyback is seen as a more one-off, discretionary event, so it avoids that expectation.

 B is wrong: a repurchase reduces, not increases, shares in issue.

 D is not an advantage relative to a dividend – both methods return cash that shareholders can spend as they wish.

Current value of Z = 590m.

Price for targets: A 25m, B 62m, C 67m, D 60m.

Synergy (or value added) = Combined value – (Z value + Target price):

A: 620 – (590 + 25) = 5m

B: 655 – (590 + 62) = 3m

C: 666 – (590 + 67) = 9m

D: 652 – (590 + 60) = 2m

Largest gain is with C.

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.

Current price = $5.00

Rights discount = 20% → Issue price = 5 × 0.8 = $4.00

Funds required = $20m

Number of new shares:

20m4=5m shares\frac{20\text{m}}{4} = 5\text{m shares}420m​=5m shares

Currently 20m shares in issue, so ratio:

5m20m=14\frac{5\text{m}}{20\text{m}} = \frac{1}{4}20m5m​=41​

So terms = 1 new share for every 4 existing → A.

A. The issue of bonds might limit the availability of debt finance in the future.

If the project is financed by a bond, gearing rises to 2:5, increasing financial risk and using up debt capacity. A rights issue instead reduces gearing to 1:5, preserving future borrowing capacity.

C. The rights issue will lead to less pressure on the operating cash flows of the programme.

Bond finance requires fixed interest payments (and eventual redemption), which must be met regardless of project cash flow variability. Equity raised via a rights issue has no mandatory interest and dividends are discretionary, so it places less strain on operating cash flows.

So the answer is:

Answer: A and C

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.

Venture capitalists typically exit by:

Flotation/IPO (B)

Trade sale to another company (C)

Sale back to the original owners/management (D)

Liquidation (A) is a failure scenario, not a planned exit, and raising long-term debt (E) is not an exit at all.

Current dividend = $6m.

Target dividend in 5 years:

6×1.105=6×1.61051≈9.66m6 \times 1.10^5 = 6 \times 1.61051 \approx 9.66\text{m}6×1.105=6×1.61051≈9.66m.

Project profit in 5 years:

Sales: 100×1.085≈146.93m100 \times 1.08^5 \approx 146.93\text{m}100×1.085≈146.93m

Costs: 80×1.055≈102.10m80 \times 1.05^5 \approx 102.10\text{m}80×1.055≈102.10m

Profit ≈ 146.93−102.10=44.83m146.93 - 102.10 = 44.83\text{m}146.93−102.10=44.83m

Required payout ratio in 5 years:

9.66/44.83≈0.2169.66 / 44.83 \approx 0.2169.66/44.83≈0.216 → about 21.6%.

Closest option: A. 21.7%

Given current structure: D:E = 25:75, tax = 25%, asset beta ≈ 1.01.

Re-gear beta for new structure D:E = 35:65

βe′=βa[1+(1−T)DE]=1.01[1+0.75×3565]≈1.01×1.404≈1.42\beta_e' = \beta_a \big[1 + (1 - T)\frac{D}{E}\big] = 1.01 \big[1 + 0.75 \times \frac{35}{65}\big] \approx 1.01 \times 1.404 \approx 1.42βe′​=βa​[1+(1−T)ED​]=1.01[1+0.75×6535​]≈1.01×1.404≈1.42

Use CAPM with rf=4%r_f = 4\%rf​=4%, rm=12%r_m = 12\%rm​=12%:

ke′=rf+βe′(rm−rf)=4%+1.42×8%≈4%+11.4%≈15.4%k_e' = r_f + \beta_e'(r_m - r_f) = 4\% + 1.42 \times 8\% \approx 4\% + 11.4\% \approx 15.4\%ke′​=rf​+βe′​(rm​−rf​)=4%+1.42×8%≈4%+11.4%≈15.4%

Closest option: 15.36% → 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.

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.

A. Equity instead of debt reduces financial risk → ✅ True

B. Equity will create pressure for higher future DPS → too strong / not necessarily always → ❌

C. Debt always increases EPS → only if returns > cost of debt → ❌

D. Retained earnings is the cheapest form of equity finance (no issue costs) → ✅ True

E. More debt → higher financial risk → higher cost of equity (MM with gearing) → ✅ True

F. Debt is always preferable → clearly ❌

Correct three:

A, D, E\boxed{A,\ D,\ E}A, D, E​

The value of a call option increases when:

The underlying share price increases

The strike price decreases

The time to expiry increases

Volatility increases

Risk-free rate increases

Looking at the options:

A. Increase in strike price → reduces call value

B. Decrease in volatility → reduces call value

C. Increase in time to expiry → increases call value ✅

D. Decrease in share price → reduces call value

Answer: C. An increase in the time to expiry.

The company needs to raise $40 million via a rights issue.

Current share price = $10

Rights issue at a 20% discount, so issue price =

10×(1−0.20)=10×0.8=$810 \times (1 - 0.20) = 10 \times 0.8 = \$810×(1−0.20)=10×0.8=$8

Number of new shares needed:

New shares=40m8=5 million shares\text{New shares} = \frac{40\text{m}}{8} = 5\text{ million shares}New shares=840m​=5 million shares

There are currently 20 million shares in issue, so the rights issue ratio is:

New sharesExisting shares=520=14\frac{\text{New shares}}{\text{Existing shares}} = \frac{5}{20} = \frac{1}{4}Existing sharesNew shares​=205​=41​

So, shareholders will receive 1 new share for every 4 existing shares.

A: Reduce the annual dividend to a more sustainable level

Price controls are expected to be long-term and have cut annual profit from $3bn to $1bn. Continuing to pay a $1.5bn dividend would rely on running down cash and reserves, which is not sustainable. A rational response is to reset the dividend to a level that can be covered by ongoing earnings in the new regulatory environment.

B: Review costs and staffing to find savings

With revenues capped, GDE’s main lever to protect profitability and cash flow is cost efficiency. A thorough review of operating costs and staffing can help offset some of the profit reduction, which supports long-term shareholder value and the ability to pay dividends in future.

C: Seek new revenue streams outside the price controls

Since core electricity prices are constrained, diversifying into related goods and services that are not regulated (e.g. energy services, maintenance contracts, renewables consulting, etc.) is a sensible strategic response. This can grow earnings without breaching the price cap.

Why not D or E?

D: Rights issue to maintain historical dividend levels would mean issuing equity essentially to fund dividends, which destroys shareholder value and signals poor financial discipline.

E: Bringing in a private equity investor is not an obvious or necessary response here; private equity would demand high returns and major restructuring, and it doesn’t directly address the regulatory profit squeeze in the way cost control and new revenue lines do.

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.

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}

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:

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.

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.

Reasoning:

A share exchange allows Company B’s shareholders to stay invested and participate in the future gains (synergies, growth) of the combined business.

A is wrong: cash offers are what “realise” an investment and crystallise a capital gain.

B is wrong: a share exchange introduces foreign currency exposure (to A$), whereas a cash offer in B$ does not.

C is wrong: Company B is in the older, more established market, so it is more likely that market is efficient, not Company A’s.

So D is the correct explanation.

Target earnings after tax for 20X2:

8.0m×1.05=8.4m8.0 \text{m} \times 1.05 = 8.4 \text{m}8.0m×1.05=8.4m

Interest on the new bond:

1.0m×4%=0.04m1.0 \text{m} \times 4\% = 0.04 \text{m}1.0m×4%=0.04m

Let required operating profit (PBIT) = XXX.

Profit before tax = X−0.04X - 0.04X−0.04.

Tax at 20% → profit after tax:

Earnings=(X−0.04)×0.8\text{Earnings} = (X - 0.04)\times 0.8Earnings=(X−0.04)×0.8

Set equal to the target 8.4m:

(X−0.04)×0.8=8.4⇒X−0.04=8.40.8=10.5⇒X=10.5+0.04=10.54m(X - 0.04)\times 0.8 = 8.4 \Rightarrow X - 0.04 = \frac{8.4}{0.8} = 10.5 \Rightarrow X = 10.5 + 0.04 = 10.54 \text{m}(X−0.04)×0.8=8.4⇒X−0.04=0.88.4​=10.5⇒X=10.5+0.04=10.54m

So minimum operating profit = $10.54 million.

Under typical takeover regulation and CIMA F3 principles, the following are legitimate post-offer defences:

A. Independent professional revaluation of assets

This is legitimate: providing better information to shareholders to show that the bid undervalues the company.

C. Make a counter-bid for Company A (a “Pac-Man defence”)

This is acceptable if it can be justified as enhancing shareholder wealth.

E. Refer the bid to competition authorities

It is a legitimate defence to challenge the bid on competition/antitrust grounds if it may reduce competition.

In contrast:

B (altering the articles to change acceptance thresholds mid-bid) is a classic frustrating action, usually not allowed without shareholder approval during an offer period.

D (publishing knowingly unrealistic optimistic forecasts) is misleading and not permitted under market and takeover rules.

A. Any opportunity to benefit from future exchange rate movements is lost.

True – a money market hedge locks in the effective exchange rate now, so you remove both downside risk and upside potential.

B. It can be tailored to match the size of the payment.

True – you can structure the borrowing/lending and FX transaction to exactly match the foreign currency amount due.

C. It manages transaction risk.

True – transaction risk (uncertainty in the home currency value of a known future foreign-currency cash flow) is what a money market hedge directly addresses.

D. It offers a significantly better outcome than a forward contract.

False – under interest rate parity, a money market hedge and a forward contract should give similar effective rates (ignoring spreads and costs).

E. It avoids the need to find immediate finance.

False – for a payable, you normally borrow or use cash now as part of the hedge, so it does not avoid immediate financing; it actually requires it.

✅ Answer to Q29: A, B, C

A. True – holding more securities across different industries reduces unsystematic risk.

B. False – systematic risk (market risk) cannot be diversified away.

C. True – beta measures an investment’s systematic risk relative to the market.

D. False – beta of 1 means same risk as the market, not risk-free.

E. True – the Security Market Line (SML) plots expected return against beta (systematic risk).

So the correct three are A, C and E.

Residual dividend policy → dividends are not a good reflection of underlying performance → rules out A.

Highly cyclical earnings and capital structure not matched by listed peers make simple P/E comparison (D) unreliable.

Net asset value (C) rarely captures earnings potential for a going concern.

A discounted cash flow approach using free cash flows and a cost of equity derived from a proxy company (adjusted for gearing) is most appropriate.

Answer: B: Discounted cash flow analysis at WACC based on free cash flow to equity.

(Conceptually: FCFE discounted at cost of equity.)

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.

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.

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.

The IIRC’s Integrated Reporting Framework is about showing how an organisation creates value over short, medium and long term, not just financial but using all capitals.

In semi-strong form market efficiency, share prices reflect all publicly available information, and they react quickly and unbiasedly to new public announcements.

Here, the share price was fairly static before the profit warning, then fell 20% on the day of the announcement. That suggests:

The market did not know this bad news beforehand.

When the profit warning was announced (new public info), the price immediately adjusted.

That is classic semi-strong efficiency behaviour.

Weak form only says prices reflect past price data, not necessarily public news.

Strong form would imply even insider information is already reflected, so you might have seen movement before the announcement.

“Random walk” describes the pattern of price movements, not a level of efficiency in this context.

Company X is an established, unquoted, specialist IT advisory firm with steady results, predictable dividends and cashflows. Company P is only buying 30% (a minority stake).

B. Dividend based using DVM – Very suitable because dividends are predictable and regular. For a minority stake, dividends are often the main measurable return, so a dividend valuation model is appropriate.

C. Cash based using free cash flow before interest – A DCF valuation based on free cash flow to the firm is also appropriate for a profitable, growing, going concern. You can value the whole business using FCFF and then take 30% of the equity value.

Asset-based (A) is less relevant for a specialist service company with relatively few tangible assets. P/E-based methods (D and E) are less ideal given there are few direct competitors, making comparables unreliable.

Practical considerations for dividend/retention policy of a high-risk exploration company facing volatile profits and major investment needs:

A. Timing and size of cash flows needed for the new investment – crucial for deciding how much to retain vs. pay out – Relevant.

B. Fluctuating projected profits – affects ability to sustain dividends – Relevant.

C. Legislation and regulation on distributable profits – always a hard constraint on dividends – Relevant.

D. Dividend policies of mature multinationals – not a practical constraint for a small, high-risk explorer – Not key.

E. Interest rates and tax savings on debt – less relevant where debt finance is unlikely to be available – Not key.

Answer (200289):

The Framework identifies six capitals: financial, manufactured, intellectual, human, social & relationship, and natural. From the options given, those that match are:

Manufactured ✅

Human ✅

Financial ✅

Answer: A, D, E

Semi-strong form efficiency means all publicly available information is already in the share price; only new information about future cash flows or risk will change shareholder wealth.

A positive-NPV project creates new value → share price should rise on announcement.

The other options (unchanged dividend, revaluation, impairment) either convey no new value creation, or even bad news (impairment).

Answer: A. Announcing that a project will be undertaken generating a positive net present value.

The assistant has discounted free cash flows to all investors at the WACC (10%). That gives the value of the business (enterprise value), not directly the value of equity.

For a geared company:

If you discount free cash flows to the firm (all investors) at the WACC, you obtain the total value of the firm (V).

To get equity value (E), you must then subtract the market value of debt (D):

E=V−DE = V - DE=V−D

Here, the company has a $6m 7% undated bond trading at par, so the market value of debt is $6m. That amount has not been deducted.

The other options are not errors:

The perpetuity discounting using 7.91.102×0.10\frac{7.9}{1.10^2 \times 0.10}1.102×0.107.9​ is correct for a constant cash flow from year 3 onward.

Using WACC (10%) is appropriate for FCFF.

Tax at 20% is already reflected in either the cash flows or the WACC; it is not “missing” as a separate line.

So the specific mistake is failing to deduct the $6m debt value, i.e. option D.

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.

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

Regulations likely to hurt ZZZ most:

A. Minimum staff-to-client ratio – raises operating costs, particularly for a large operator.

B. Maximum price controls – directly restrict ZZZ’s ability to charge premium prices.

C. Monopoly controls forcing disposals – may force ZZZ to sell homes and shrink.

D is a one-off hit, and E is less of a threat to a high-quality provider.

If the company switches from a residual dividend policy to a stable, growing dividend and increases its use of debt:

A. This does signal to the market that the company may be entering a more stable, mature growth phase – True.

B. A more stable dividend stream can attract a different type of investor (clientele effect) – True.

C. Directors still need to consider shareholder preferences; this statement is incorrect – False.

D. Retained earnings have an opportunity cost equal to the cost of equity and are generally not cheaper than debt – False.

E. More debt increases financial gearing and therefore financial risk – True.

Answer (200273):

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 spin-off/demerger normally involves separating a division or subsidiary and giving its shares to the existing shareholders. It doesn’t in itself raise finance (A), it doesn’t introduce new shareholders to the core entity (B), and it does not inherently increase takeover risk (D). Its main advantage is that it allows the market to value the demerged business separately, revealing its “true” value – C is correct.

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.

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

In CIMA F3’s coverage of short-term financing, commercial paper (CP) is identified as a very cost-effective funding source for large, high-credit-quality companies. CP is an unsecured, short-term promissory note, typically issued for periods up to 270 days, making it ideal for a 6-month funding need. Because it is issued directly into the money markets by strong credits, the interest cost is usually lower than overdrafts or short-term bank loans, which include a bank’s margin.

The scenario states that the company is large, listed, has an “excellent credit rating”, minimal default risk and already has a commercial paper programme. This matches the textbook profile of a company for which CP is the cheapest source of short-term borrowing.

Treasury bills (C) are issued by governments, not companies, so they are an investment vehicle, not a borrowing method here. Bank overdrafts (A) are flexible but generally expensive and better for fluctuating day-to-day needs. A 6-month term loan (B) tends to involve higher arrangement fees and interest margins than CP. Therefore, option D is the most cost-effective choice.

Translation risk arises when the foreign subsidiary’s net assets (in BS) are translated into the parent’s currency (A$). The most effective hedge is to match those net assets with liabilities in the same foreign currency. By financing the acquisition with BS borrowings, AAB creates a BS liability that offsets BBA’s BS net assets, reducing the net exposure to translation movements.

A$: equity in A$ doesn’t hedge BS assets.

Multi-currency bank accounts and forward contracts mainly address transaction risk, not long-term translation of balance sheet net assets.

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.

Advantages of a debt-funded cash offer vs a share exchange:

A. Shareholder control will remain with AB’s current shareholders.

B. More of the synergistic benefits will accrue to AB’s current shareholders.

D. EPS will increase (no dilution of equity; if synergies materialise, earnings are spread over the same number of shares).

Answer: A, B, D

CIMA F3 examines acquisition financing choices under Financial Policy Decisions and Mergers and Acquisitions, with a particular focus on how cash offers versus share exchanges affect shareholder wealth, control, gearing and earnings. The key issue from the perspective of Company AB’s shareholders is whether the method of financing enhances shareholder value without undermining the firm’s optimal capital structure.

A debt-funded cash offer involves Company AB raising debt to pay cash to the shareholders of Company DC. In contrast, a share exchange issues new equity, diluting existing ownership.

Option A is an advantage.

CIMA F3 highlights that a cash offer allows existing shareholders to retain control, because no new shares are issued. With a share exchange, ownership and voting power are diluted as DC’s shareholders become part-owners of the combined company.

Option B is an advantage.

Under a cash offer, all future synergies accrue to AB’s existing shareholders. F3 explains that with a share exchange, synergy benefits are shared with the target’s shareholders through their new equity stake. Therefore, a debt-funded cash offer concentrates the upside of synergies with the acquirer’s shareholders.

Option D is an advantage.

CIMA F3 notes that debt financing can lead to EPS growth, provided the return on the acquisition exceeds the cost of debt. Because no new equity is issued, earnings are spread over the same number of shares, and financial gearing magnifies returns to equity holders.

The remaining options are not advantages:

C (Gearing will increase) is a consequence, not an advantage. Since AB is already at its optimum capital structure, higher gearing increases financial risk.

E is incorrect; increasing WACC would reduce shareholder value, not enhance it.

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

Net book value of equity = $20m

Net realisable value of equity = $25m

Free cash flow to equity = $3.5m indefinitely

Cost of equity (ke) = 10%

Value from FCFE (perpetuity):

Vequity=3.50.10=35mV_{\text{equity}} = \frac{3.5}{0.10} = 35\text{m}Vequity​=0.103.5​=35m

A reasonable minimum is the break-up / net realisable value = $25m.

A reasonable maximum is the going-concern DCF value = $35m.

Answer: A. Minimum $25.0m, maximum $35.0m

Answer: A. $129.6

Working

Current share price = $5.60

Growth for 3 years at 5% p.a.:

P3=5.60×1.053=5.60×1.157625=6.4827≈$6.48P_3 = 5.60 \times 1.05^3 = 5.60 \times 1.157625 = 6.4827 \approx \$6.48P3​=5.60×1.053=5.60×1.157625=6.4827≈$6.48

Conversion terms = 20 shares per $100 bond

Conversion value in 3 years:

Conversion value=20×6.4827=129.654≈$129.6\text{Conversion value} = 20 \times 6.4827 = 129.654 \approx \$129.6Conversion value=20×6.4827=129.654≈$129.6

So the expected conversion value per $100 bond is $129.6.

Price to buy each target (equity market value):

A = 25

B = 62

C = 67

D = 60 (all $m)

Combined equity value before deducting cash consideration:

Z + A = 620

Z + B = 655

Z + C = 666

Z + D = 652 (all $m)

After paying cash, equity value = “combined value” − “price paid”:

A: 620 − 25 = 595

B: 655 − 62 = 593

C: 666 − 67 = 599

D: 652 − 60 = 592

Best post-acquisition value is with C (599m).

Answer: C – Acquire Company C.

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

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.

A – “X may be able to sell the receipts forward.”

If X invoices in customers’ currencies, it will receive known foreign-currency amounts and can hedge the exchange risk using forward contracts. So this is correct.

D – “The overseas customers may have difficulty obtaining X's home currency … so the proposal may increase sales.”

Right now, customers must obtain X’s currency to pay, bearing FX costs and risk. If X invoices in their local currency, buying becomes easier and could boost sales. So D is correct.

Why the others are wrong:

B: Effective sales price might go up or down; it isn’t necessarily lower.

C: Invoicing in customers’ currency removes certainty for X in home-currency terms unless hedged.

E: That describes the current position (customers bear the risk), not the proposed change.

Bond alone: pay 6% on $100m = 6m per year.

Add swap (receive 5% fixed, pay Libor + 1):

Net rate = 6% (bond) − 5% (received) + (Libor + 1%).

With Libor = 4% → 6 − 5 + (4 + 1) = 5% total.

Interest cost falls from 6% to 5% → 1% reduction.

Answer: B. Fall by 1%.

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).

PBIT = $4m

Interest on loan = 10% × $10m = $1m

Profit before tax = $3m

Tax at 20% → earnings after tax = $3m × 0.8 = $2.4m

Use the P/E multiple for the food-processing sector (10x), as this best reflects the business risk and industry.

Equity value = $2.4m × 10 = $24m

Answer: D. $24 million

Current values (before project):

Equity = 1,100

Debt = 500

Firm value = 1,600

Project cost = 200; NPV = +10.

After the project:

Financed by rights issue (equity only)

Equity = 1,310 → increase of 210

But shareholders have to inject 200 cash themselves.

Net gain in shareholder wealth = 210 − 200 = 10

Financed by bond issue (all debt)

Equity = 1,150 → increase of 50

No new equity cash is put in by shareholders.

Net gain in shareholder wealth = 50

This equals: project NPV (10) + tax shield on extra debt (0.20 × 200 = 40).

Financed by mix of debt & equity at existing D/E

Equity = 1,260 → increase of 160

New equity raised ≈ 137 (since extra debt is 63, total 200).

Net gain = 160 − 137 = 23 (NPV 10 + extra tax shield ≈ 13).

The company’s objective is maximisation of shareholder wealth, so it should choose the financing that gives the highest net increase, which is the bond issue (all debt) with a gain of $50m to equity holders.

This is exactly what Modigliani & Miller with corporate tax predicts: increasing gearing creates value for shareholders via the interest tax shield.

Answer: B. $50 million if financed by debt

Increase initially then decrease

This question tests understanding of the traditional theory of capital structure, a core topic within CIMA F3 under Cost of Capital and Capital Structure. The traditional view differs from Modigliani and Miller by arguing that there is an optimal capital structure where a company’s Weighted Average Cost of Capital (WACC) is minimised.

According to traditional theory, at low levels of gearing, introducing debt into the capital structure reduces WACC. This occurs because debt is generally cheaper than equity, largely due to lower risk for lenders and the tax deductibility of interest payments. Initially, equity holders do not perceive a significant increase in financial risk, so the cost of equity remains relatively stable. As a result, replacing some equity with cheaper debt lowers the overall WACC.

However, as gearing continues to rise beyond a certain point, the financial risk borne by both debt holders and equity holders increases substantially. Lenders demand higher interest rates to compensate for increased default risk, and shareholders require a higher return due to greater earnings volatility. This leads to rising costs of both debt and equity. Beyond the optimal gearing level, these rising costs outweigh the benefits of cheaper debt, causing WACC to increase.

CIMA F3 study guidance therefore concludes that under traditional theory, WACC:

Falls initially as gearing increases, and

Rises after the optimal capital structure is exceeded.

Since the directors are increasing gearing toward an industry average, the most appropriate description of WACC behaviour under traditional theory is that it will decrease initially and then increase.

Vertical integration means moving up or down the value chain (suppliers or distributors), not acquiring similar producers (horizontal integration) or unrelated accessory businesses. Buying a listed international logistics firm brings distribution in-house and so is the clearest example of vertical integration that could improve margins.

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.

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 P/E valuation should use forecast sustainable earnings, not just the last year’s profit. ✅ (C)

The “E” in P/E is earnings after interest and tax, not profit before interest and tax. ✅ (D)

The P/E multiple should be based on comparable companies in the same sector, not the whole market. ✅ (E)

Statement A is wrong (unlisted companies usually get a discount, not an uplift).

Statement B is wrong (P/E gives an equity value, not whole entity value).

Answer Q34: C, D, E

Company issues new shares and uses proceeds to repay high-interest debt.

Effects:

Cost of equity (A): financial risk falls as gearing falls → cost of equity is more likely to decrease, not increase.

Number of shares (B): new share issue → increases.

Corporate tax payment (C): interest expense falls, taxable profit rises → tax paid increases.

Gearing (D): debt falls and equity rises → gearing decreases, not increases.

Interest cover (E): operating profit unchanged, interest lower → interest cover increases.

Answer: B, C and E

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