F3 Exam Dumps : Financial Strategy

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.

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).

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.