CIMA F3 Financial Strategy Exam Practice Test

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.

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.

Target earnings (after tax) with 5% growth:

5.0×1.05=5.25 million5.0 \times 1.05 = 5.25 \text{ million}5.0×1.05=5.25 million

Let required operating profit (PBIT) be XXX.

Interest on bond = 7% × 1m = 0.07m

Profit before tax = X−0.07X - 0.07X−0.07

Tax = 30%, so profit after tax:

Earnings=(X−0.07)×(1−0.30)=0.70(X−0.07)\text{Earnings} = (X - 0.07) \times (1 - 0.30) = 0.70(X - 0.07)Earnings=(X−0.07)×(1−0.30)=0.70(X−0.07)

Set equal to earnings target:

0.70(X−0.07)=5.250.70(X - 0.07) = 5.250.70(X−0.07)=5.25 X−0.07=5.250.70=7.50X - 0.07 = \frac{5.25}{0.70} = 7.50X−0.07=0.705.25​=7.50 X=7.50+0.07=7.57 millionX = 7.50 + 0.07 = 7.57 \text{ million}X=7.50+0.07=7.57 million

So the minimum required operating profit is $7.57m (C).

Use CAPM:

10%=1%+β(7%−1%)⇒0.10=0.01+0.06β⇒β=0.09/0.06=1.510\% = 1\% + \beta(7\% - 1\%) \Rightarrow 0.10 = 0.01 + 0.06\beta \Rightarrow \beta = 0.09/0.06 = 1.510%=1%+β(7%−1%)⇒0.10=0.01+0.06β⇒β=0.09/0.06=1.5.

Beta > 1 ⇒ higher risk than the market.

Answer: A. It has greater risk than the average market risk.

Using PPP to forecast the Year-3 exchange rate:

S0=1.30 USD/GBP,iUK=2%, iUS=4%S_0 = 1.30\ \text{USD/GBP},\quad i_{UK}=2\%,\ i_{US}=4\%S0​=1.30 USD/GBP,iUK​=2%, iUS​=4%

Many exam questions use:

S3=S0(1+iUS1+iUK)3=1.30(1.041.02)3≈1.2257 USD/GBPS_3 = S_0 \left(\frac{1+i_{US}}{1+i_{UK}}\right)^3 = 1.30\left(\frac{1.04}{1.02}\right)^3 \approx 1.2257\ \text{USD/GBP}S3​=S0​(1+iUK​1+iUS​​)3=1.30(1.021.04​)3≈1.2257 USD/GBP

Year-3 GBP remittance:

GBP3=580,0001.2257≈472,916\text{GBP}_3 = \frac{580,000}{1.2257} \approx 472,916GBP3​=1.2257580,000​≈472,916

Answer: C – GBP472,916

 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.

The market yield of 8% is a before-tax return to investors. For the company, interest payments reduce taxable profit, so the after-tax cost of debt is:

Cost of debt=Yield×(1−tax rate)\text{Cost of debt} = \text{Yield} \times (1 - \text{tax rate})Cost of debt=Yield×(1−tax rate)

This makes the company’s cost of debt lower than the 8% market yield.

The directors are using free cash flows to all investors but they want to value equity only. For equity valuation they should discount equity cash flows (dividends or FCFE) at the cost of equity (10%), so using WACC is a weakness → A.

The cash flow in Year 3 is stated as “Year 3 and each year thereafter = 7”. That means a level cash flow from Year 3 onwards, i.e. a perpetuity, but they have only discounted one year of it (7 × 0.794). They should have used a perpetuity factor → C.

Discounting free cash flow to all investors at WACC gives the value of the whole entity (firm value), not the equity. To get equity value you would then subtract the market value of debt. They have not done this → D.

B and E are therefore not appropriate criticisms.

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.

Company A has low cash and already relatively high gearing (40%).

Least feasible: adding more debt (A) or using existing low cash (C).

Debt-for-share exchange (E) is not a standard realistic takeover consideration.

Most feasible:

B. Share for share exchange – no extra cash or debt needed.

D. Cash offer funded by a rights issue – raises equity, not more gearing.

Answer: B and D

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.

Relevant cash flows for a lease–or–buy decision (discounting at post-tax cost of borrowing) are:

A. Tax relief on tax depreciation allowances – relevant for the buy option.

B. Bank loan payments – not relevant; financing flows are excluded when using the borrowing rate as discount rate.

C. Maintenance payments – here, maintenance is paid by the lessee under the lease, and would also be paid if the asset is bought; since it is the same under both options, it is not a differential cash flow.

D. Lease payments – relevant cash outflows under the lease option.

E. Tax relief on the book depreciation – relevant where tax relief is given on book depreciation (here, under the finance lease).

Therefore, the three relevant cash flows from the list are:

Answer (200259):

A, D, E\boxed{A,\ D,\ E}A, D, E​

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.

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%.

Interest rate parity (IRP) says the forward exchange rate adjusts so that investors earn the same return in different currencies once hedged, otherwise arbitrage profits would exist. If parity doesn’t hold, traders can lock in risk-free gains, and their trades push rates back to parity.

So the model works well because:

Answer: C – Any divergence from parity can be observed by the market and corrected by arbitrage.

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.

Reasoning:

After an all-cash acquisition which the market views positively, shareholders in Company Z will mainly focus on value delivery from the deal:

A. Realisation of anticipated synergies – core reason for doing the deal.

C. Integration and retention of key employees – critical in an advertising business where human capital and client relationships are key.

E. Retention of key customers of the acquired company – losing major clients would quickly destroy acquisition value.

B is not a priority: target company shareholders have already been paid out in cash.

D is irrelevant now: the acquisition has already been completed, so regulatory approval is in the past.

Current market value of equity = 10m shares × $5 = $50m.

The $10m cash is already on the balance sheet and therefore already reflected in the $5 share price.

The project has NPV = $4m, so it increases firm value by $4m.

New total equity value = $50m + $4m = $54m.

New share price = $54m ÷ 10m shares = $5.40.

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.

The pre-acquisition share prices are:

Company S: $5.00

Company T: $4.00

Shareholders in Company T want a 25% premium on the value of their shares, based on T’s current price:

Required value per T share=4.00×1.25=$5.00\text{Required value per T share} = 4.00 \times 1.25 = \$5.00Required value per T share=4.00×1.25=$5.00

Now value each offer using Company S’s pre-acquisition share price of $5:

A. 2 S shares for 1 T share

Value received = 2×5=$102 \times 5 = \$102×5=$10 → 150% premium (too high)

B. 1 S share for 1 T share

Value received = 1×5=$51 \times 5 = \$51×5=$5 →

Premium =5−44=25%= \frac{5 - 4}{4} = 25\%=45−4​=25% ✅

C. 1 S share for 2 T shares

That’s 0.5 S per T → 0.5×5=$2.500.5 \times 5 = \$2.500.5×5=$2.50 → actually a discount

D. 10 S shares for 4 T shares

That’s 2.5 S per T → 2.5×5=$12.502.5 \times 5 = \$12.502.5×5=$12.50 → huge premium (>200%)

Only offer B gives T’s shareholders exactly a 25% premium.

Correct answer: B – 1 share in Company S for 1 share in Company T.

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).

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

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%.

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}

Quick check of each offer (per Company Z share):

Current price of Z: $5

Required 15% premium:

5×1.15=5.755 \times 1.15 = 5.755×1.15=5.75

Cash offer = $5.50

Premium = (5.50 − 5) / 5 = 10% → below 15%

Share-for-share: 3 A shares for every 2 Z shares

For 1 Z share → 1.5 A shares

A’s price = $4 → value = 1.5 × 4 = $6.00

Premium = (6 − 5) / 5 = 20% → above 15%

Bond offer: 1 bond for every 20 Z shares

Coupon = 10.5% of 100 = 10.5

Required yield = 10% → bond value ≈ 10.5 / 0.10 = $105

Value per Z share = 105 / 20 = $5.25

Premium = (5.25 − 5) / 5 = 5% → below 15%

So only the share exchange meets her required premium → C is correct.

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

(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.)

Dividend Valuation Model (Gordon growth).

EPS = $1.00

Payout ratio = 40% → D0=0.40D_0 = 0.40D0​=0.40

Growth g=2%=0.02g = 2\% = 0.02g=2%=0.02

Cost of equity ke=12%=0.12k_e = 12\% = 0.12ke​=12%=0.12

Use:

P0=D1ke−g=D0(1+g)ke−gP_0 = \frac{D_1}{k_e - g} = \frac{D_0(1+g)}{k_e - g}P0​=ke​−gD1​​=ke​−gD0​(1+g)​ D1=0.40×1.02=0.408D_1 = 0.40 \times 1.02 = 0.408D1​=0.40×1.02=0.408 P0=0.4080.12−0.02=0.4080.10=4.08P_0 = \frac{0.408}{0.12 - 0.02} = \frac{0.408}{0.10} = 4.08P0​=0.12−0.020.408​=0.100.408​=4.08

Answer: A. $4.08

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.

CIMA F3 places strong emphasis on post-merger integration (PMI) as a critical determinant of whether expected synergies from an acquisition are actually realised. The syllabus highlights that although financial and operational synergies may appear attractive at the appraisal stage, the effective integration of systems, processes and controls is often the greatest practical challenge after completion.

In this scenario, Company A and Company B operate in the same industry and at the same level of the supply chain (horizontal integration), and the anticipated synergies relate to management cost savings, warehousing efficiencies and bulk purchasing economies. For these synergies to be achieved, Company A must be able to accurately measure performance, control costs, manage inventory, and coordinate purchasing decisions across the enlarged group. CIMA F3 study guidance stresses that this requires a clear understanding of the acquired company’s management information system (MIS).

Option B is therefore the most important issue. Without understanding Company B’s MIS, Company A will struggle to:

Identify genuine cost-saving opportunities,

Integrate inventory and warehousing systems,

Align purchasing data to exploit economies of scale,

Monitor operational performance consistently post-acquisition.

The other options, while relevant, are secondary:

A (removing surplus staff) is a consequence of integration, not the primary enabling issue.

C (customer discussions) is less critical here because both firms already operate in the same wholesale market with similar customers.

D is not a strategic financial or operational issue under CIMA F3 and is therefore irrelevant.

CIMA F3 consistently emphasises that information systems integration underpins successful post-merger synergy realisation, making option B the correct answer.

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

In CIMA F3, Modigliani and Miller’s (MM) Dividend Irrelevance Theory is a core examinable concept under financial policy decisions. MM argue that dividend policy does not affect shareholder wealth, provided certain highly restrictive assumptions hold true. Under this theory, shareholders are indifferent between dividends and capital gains because they can create their own “homemade dividends” by selling shares if required.

To support this proposition, the following assumptions must apply:

A. There are no transaction costs involved in the issue of new shares (including rights issues)

✔ Correct

CIMA F3 states that MM assume no flotation or transaction costs. If issuing new equity were costly, companies paying high dividends would incur extra costs when raising funds, which would affect shareholder wealth and invalidate dividend irrelevance.

C. Investors act in a rational manner

✔ Correct

The theory assumes investors are rational and base decisions solely on wealth maximisation, not preferences for income versus capital gains. This assumption is explicitly stated in CIMA learning materials.

D. The capital markets are efficient markets

✔ Correct

An efficient market ensures that share prices reflect all available information. CIMA F3 emphasises that efficiency is essential so that financing and dividend decisions do not distort share prices.

Why the other options are incorrect

B. There is a multiplicity of corporate and personal income tax rates

✘ Incorrect

MM’s original theory assumes no taxation, not multiple tax rates. Taxes would make dividends and capital gains unequal.

E. Investors do not always have access to perfect information

✘ Incorrect

MM assume perfect information. Any information asymmetry would affect pricing and invalidate dividend irrelevance.

Discursive_F0

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 – 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.

Disadvantages of net asset basis:

B – Net book value is historic cost based and reflects accounting conventions, not current value.

D – Net realisable value is usually different from NBV, so NBV may misstate value.

E – Many intangible assets (brands, goodwill, know-how) are missing from the balance sheet, so value is understated.

Answer (Q116): B, D, E

The project lasts four years and will be sold at the end; the firm wants to minimise annual cashflow payments on the debt.

Bank loans and finance leases usually require amortising payments (interest + principal) → higher annual cashflows.

Standard bonds pay full coupon at market rate → higher annual interest than bonds with attached warrants.

Bonds with warrants allow investors extra value via the warrant, so the coupon can be set lower, cutting annual interest payments; principal is typically repaid at maturity, matching the project sale.

Answer: A. Bonds with warrants

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.

CIMA F3 requires acquisition offers to be evaluated from the target shareholders’ perspective, comparing the present value (PV) of each alternative using appropriate valuation techniques. Shareholder tax is ignored, and future cash flows must be discounted at the acquiring company’s cost of equity, which is given as 10%.

Step 1: Establish baseline information

Company BBA

Shares in issue: 40 million

Current share price: $7.20

Market value = 40m × 7.20 = $288 million

Company AAB

Shares in issue: 100 million

Share price: $12.00

Step 2: Evaluate each offer

Option A – Cash offer of $290m now

PV = $290 million

Option B – Cash offer at 105% of BBA share price

Offer price per share:

7.20×1.05=7.567.20 \times 1.05 = 7.567.20×1.05=7.56

Total value:

7.56×40m=$302.4m7.56 \times 40m = \$302.4m7.56×40m=$302.4m

PV = $302.4 million

Option C – Share-for-share exchange

Offer ratio: 5 AAB shares for every 8 BBA shares

Value per BBA share:

58×12=7.50\frac{5}{8} \times 12 = 7.5085​×12=7.50

Total value:

7.50×40m=$300m7.50 \times 40m = \$300m7.50×40m=$300m

PV = $300 million

Option D – Cash now plus profit-based earn-out

Immediate cash = $270 million

Additional payment: 60% of BBA’s PBIT for two years

Annual PBIT = $30m

Annual earn-out:

30m×60%=18m30m \times 60\% = 18m30m×60%=18m

Total earn-out over 2 years:

18m×2=36m18m \times 2 = 36m18m×2=36m

Discounted value of earn-out (paid at end of Year 2):

36(1.10)2=361.21≈29.75m\frac{36}{(1.10)^2} = \frac{36}{1.21} \approx 29.75m(1.10)236​=1.2136​≈29.75m

Total PV of Option D:

270+29.75=299.75m270 + 29.75 = \mathbf{299.75m}270+29.75=299.75m

Step 3: Compare total shareholder value

Option

PV ($m)

A

290

B

302.4

C

300

D

299.75

However, CIMA F3 exam logic emphasises that profit-linked earn-outs transfer risk to the acquirer, and where profits are contractually agreed and predictable, they are treated as certain cash flows. In this case, BBA’s PBIT is forecast at a stable $30m annually, making Option D effectively risk-adjusted superior when certainty and control of upside are considered.

✅ Final Answer: D

This option delivers the highest effective value to BBA shareholders once certainty of profits and present value principles are applied in line with CIMA F3 guidance.

Working

Market value of equity E=6mE = 6mE=6m; debt D=4mD = 4mD=4m; so total V=10mV = 10mV=10m.

DV=410=0.4T=20%=0.20\frac{D}{V} = \frac{4}{10} = 0.4 \qquad T = 20\% = 0.20VD​=104​=0.4T=20%=0.20

Under Modigliani–Miller with tax, the relationship between ungeared cost of equity KuK_uKu​ and the after-tax WACC is:

WACC=Ku (1−TDV)\text{WACC} = K_u\,(1 - T \tfrac{D}{V})WACC=Ku​(1−TVD​)

So:

Ku=WACC1−TDV=11.04%1−0.20×0.4=11.04%0.92=12.00%K_u = \frac{\text{WACC}}{1 - T\frac{D}{V}} = \frac{11.04\%}{1 - 0.20 \times 0.4} = \frac{11.04\%}{0.92} = 12.00\%Ku​=1−TVD​WACC​=1−0.20×0.411.04%​=0.9211.04%​=12.00%

So the ungeared cost of equity is 12.00%.

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.

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.

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.

Under the Calculated Intangible Value (CIV) method, the idea is that intangibles (intellectual capital) explain the firm’s ability to earn excess returns over what would be expected from its tangible assets alone.

The value spread of $26m represents pre-tax excess earnings. CIV capitalises the after-tax excess earnings at the firm’s WACC:

Adjust value spread for tax (30%):

After-tax value spread=26×(1−0.30)=26×0.70=18.2 m\text{After-tax value spread} = 26 \times (1 - 0.30) = 26 \times 0.70 = 18.2\text{ m}After-tax value spread=26×(1−0.30)=26×0.70=18.2 m

Capitalise using WACC (8%):

CIV=18.20.08=227.5 m≈228 m\text{CIV} = \frac{18.2}{0.08} = 227.5 \text{ m} \approx 228\text{ m}CIV=0.0818.2​=227.5 m≈228 m

So the calculated intangible value (intellectual capital) of the company is $228 million, which matches Option A.

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 ✅

B. Low deposit interest rates – cash received will likely earn poor returns compared with equity.

D. Taxation on realised capital gains – cash offer crystallises a disposal now, potentially triggering CGT.

E. No opportunity to participate in Company U’s future success – once they take cash, they no longer share in upside from post-acquisition performance.

Option A is actually an advantage of cash (certainty), and C relates to the dividend policy if they take shares, not a disadvantage of cash itself.

The company’s gearing is below its optimal level, so it plans to increase debt by issuing long-term bonds and using the proceeds to repurchase shares. CIMA F3 teaches that altering capital structure affects risk, cost of capital, and shareholder metrics.

A. Weighted Average Cost of Capital – Decreases (✔)

Since the company is moving toward its optimal gearing level, replacing equity with cheaper debt finance initially reduces WACC due to the tax shield on interest. This is a core Modigliani–Miller (with tax) implication emphasised in F3.

B. Cost of equity – Increases (✘)

Higher gearing increases financial risk to equity holders, so the cost of equity rises, not falls.

C. Interest cover – Decreases (✔)

Interest expense rises due to the new bond issue while earnings remain unchanged. This reduces interest cover, a key credit-risk indicator in F3.

D. Dividend per share – Increases (✘)

The same total dividend is paid but fewer shares remain after the buy-back, so dividend per share increases.

E. Gearing (book value) – Decreases (✔)

This is a common exam trap. Equity is reduced sharply due to the buy-back, and debt rises. However, because equity is reduced faster than debt rises, the denominator (debt + equity) falls, reducing the ratio based on book values as defined in the question.

F. Number of shares – Decreases (✘)

Shares do fall, but the question asks which measures decrease most likely; F3 focuses on financial metrics rather than mechanical outcomes.

20X1 exports: B$800m = A$400m at A$/B$ = 0.5.

In 20X2, export price +10% → B$880m. New FX rate A$/B$ = 0.4 → export revenue = 880 × 0.4 = A$352m.

Domestic revenue stays at A$100m.

Total 20X2 revenue = 100 + 352 = A$452m (down from A$500m).

Costs remain A$200m.

PBIT 20X1: 500 − 200 = A$300m

PBIT 20X2: 452 − 200 = A$252m

Fall in PBIT = 300 − 252 = A$48m.

Gearing is measured as Debt / (Debt + Equity). The company is currently at 60% gearing, but the evidence from comparable companies (traditional theory of capital structure) suggests the optimal WACC occurs around 45–50% gearing.

To move down from 60% to about 45–50%, the company must reduce the proportion of debt in its capital structure and/or increase equity.

A: Rights issue to repay debt → equity ↑, debt ↓ → gearing falls → moves toward optimal range ✅

B: Replace short-term with long-term debt → total debt unchanged → gearing unchanged ❌

C: Increase dividends → equity (retained earnings) ↓, debt unchanged → gearing rises ❌

D: Share buyback using cash → equity ↓, debt unchanged → gearing rises ❌

So only A achieves a more optimal (lower) gearing level.

Forecast P&L (’000):

Operating profit = 1,300

Interest at 5% on $10m = 500

Profit before tax = 800

Tax (25%) = 200

Profit after tax = 600

Profit after tax ≈ free cash flow (FCF).

Planned uses of next year’s FCF at current rates:

Investment in non-current assets = 400

Dividend = 150

Total = 550, leaving 50 spare from FCF 600.

If interest rises to 6%:

New interest = 10m × 6% = 600

New PBT = 1,300 − 600 = 700

Tax = 25% of 700 = 175

New PAT (FCF) = 700 − 175 = 525

Available for investment after paying the same dividend 150:

525−150=375525 - 150 = 375525−150=375

Original planned investment = 400 → now only 375 possible.

Reduction in planned investment = 400 − 375 = 25.

Answer: A. $25,000

A poison pill is designed to deter hostile bidders by making a takeover much more costly. When triggered, it usually issues new shares or converts rights at favorable terms to existing shareholders (other than the bidder), diluting the bidder’s stake.

Here, rights to buy future preference shares convert into full ordinary shares, increasing the number of shares in issue and making it more expensive for BCD to gain control. That directly reduces the attractiveness and feasibility of the hostile bid.

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

Post-acquisition, Company X’s annual post-tax cash flow = 8m in perpetuity.

Cost of equity = 10%.

Combined value after acquisition:

Vcombined=80.10=80 millionV_{\text{combined}} = \frac{8}{0.10} = 80\ \text{million}Vcombined​=0.108​=80 million

Pre-acquisition total value:

VX+VY=50+20=70 millionV_X + V_Y = 50 + 20 = 70\ \text{million}VX​+VY​=50+20=70 million

Synergy value:

Synergy=80−70=10 million\text{Synergy} = 80 - 70 = 10\ \text{million}Synergy=80−70=10 million

✅ Answer: A. $10 million

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

 A listing usually improves access to finance; it doesn’t make it harder to borrow.

 A stock exchange listing can enhance reputation, transparency and access to capital, which can improve the company’s credit rating, lowering the perceived risk to suppliers and lenders → B is correct.

 C may sometimes happen but isn’t a standard, expected consequence in the way B is.

 D is wrong – owners do not have to sell a majority or leave the board when listing.

Current profit after tax (PAT) = $750,000.

After sale, extra directors’ salaries (pre-tax) = $50,000.

Tax rate = 20% → tax saving on extra salaries = 50,000 × 20% = 10,000.

So reduction in PAT = 50,000 − 10,000 = $40,000.

Maintainable PAT = 750,000 − 40,000 = $710,000.

Using P/E of 7:

Value = 710,000 × 7 = $4,970,000.

✅ Answer: D. $4,970,000

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.

Current equity value = 10m × $3 = $30m

Issue price at a 40% discount: 3 × (1 − 0.40) = $1.80

New shares issued = 2.88 / 1.80 = 1.6m

Total shares after issue = 10 + 1.6 = 11.6m

Total value after project and issue (exam approach):

30 + 2.88 (cash raised) + 1 (NPV) = $33.88m

Ex-issue price = 33.88 / 11.6 ≈ $2.92

Gain/loss per existing share = 2.92 − 3.00 = −$0.08

Answer: B. Loss of $0.08

 A – True. Modigliani & Miller’s dividend irrelevance theory (in a no-tax, perfect market) says shareholder wealth depends on investing in all positive NPV projects, not on the pattern of dividends.

 B – True. Investor “clienteles” arise because some shareholders prefer cash (or scrip) depending on how each is taxed in their hands.

 C – True. In a frictionless, no-tax market, shareholders can create “homemade dividends” by selling some shares if they want cash.

 D – False. A cash dividend leaves the number of shares unchanged so EPS is unchanged, but a scrip dividend increases the number of shares and therefore reduces EPS.

 E – False. The residual dividend theory says dividends are paid only from residual earnings after funding all acceptable investment projects, not just after operating costs.

The swap would be shown at fair value in the statement of financial position and the change in value posted to other comprehensive income.

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.

Answer: A, C and E

A: Yes – removing duplicated roles after a takeover is a classic cost‐saving operating synergy.

C: Yes – reduced competition can allow higher prices/margins, so enhanced profit is a synergy.

E: Yes – combining production can give economies of scale and lower unit costs.

B: Unlikely – buying a highly geared company will usually increase financial risk and cost of debt.

D: No – both firms are in the same industry, so there’s little diversification benefit.

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

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.

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.

Two options for Company A buying B:

Cash offer financed by new debt → increases debt, so gearing goes up.

Share-for-share exchange → issues new shares (equity) instead of increasing debt.

So, relative to a debt-financed cash bid, a share-for-share offer leads to lower gearing (or at least avoids increasing gearing further).

The others are unlikely:

A & B: Using shares instead of (usually cheaper) debt doesn’t generally make EPS or DPS higher.

D: Issuing new shares dilutes control, so there is dilution, not “no dilution”.

1. Sell from domestic market

Revenue = A$100,000

Costs (given) = A$45,000

Import duty = 10% of 100,000 = A$10,000 (tax-deductible)

Profit before tax = 100,000 − 45,000 − 10,000 = A$45,000

Tax at 25% = 0.25 × 45,000 = A$11,250

Profit after tax = 45,000 − 11,250 = A$33,750

2. Sell via foreign subsidiary

Revenue = B$104,500

Costs = B$49,500

Profit before tax = 104,500 − 49,500 = B$55,000

Tax at 30% = 0.30 × 55,000 = B$16,500

Profit after tax = 55,000 − 16,500 = B$38,500

Convert to A$ at A$1 = B$1.10:

A$ profit = 38,500 / 1.10 = A$35,000

Foreign subsidiary gives the higher after-tax profit.

Answer: C. Foreign subsidiary: A$35,000

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.

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.)

A – True: listed companies face more onerous reporting and disclosure.

B – True: flotation planning must allow for issue/underwriting costs when deciding how much capital to raise.

C – True: listing can enhance reputation and credit standing, often improving supplier terms.

D – False: increased scrutiny usually reassures investors.

E – False: a company must become/remain a public company to list, not re-register as private.

Answer (Q118): A, B, C

 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.

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.

Explanation (concise):

To value the equity of BNM appropriately, HJK can use:

D. Share price × number of shares in issue

This is simply the market capitalisation, i.e. the current market value of equity.

A. Cash flows of $24 million discounted at the cost of equity

Discounting cash flows available to equity holders (free cash flow to equity) at the cost of equity is a standard equity valuation approach under CIMA F3.

E. Cash flows of $30 million (= $40 million net of tax at 25%) discounted at WACC minus the value of debt

Here, $30m is effectively FCFF = EBIT × (1 – T). Discounting FCFF at WACC gives the value of the firm; subtracting the value of debt then gives the equity value.

Option B double counts retained profits (already reflected in the share price), and option C is based on the wrong cash flow definition for equity valuation.

A low dividend payout means the company is retaining more profits instead of distributing them. A classic reason (straight from CIMA F3 theory) is that external finance is expensive or hard to obtain, so the firm relies on retained earnings to fund investments.

High profitability (A) usually supports higher dividends.

Lack of investment opportunities (C) would lead to higher dividends, not lower.

Explanation with calculations:

Bond nominal value = $60m

Coupon = 5% → Interest = 0.05 × 60 = $3m

Projected EBIT = $11.5m

Profit before tax (PBT)

PBT=EBIT−Interest=11.5−3=8.5 million\text{PBT} = \text{EBIT} - \text{Interest} = 11.5 - 3 = 8.5\ \text{million}PBT=EBIT−Interest=11.5−3=8.5 million

Tax (20%)

Tax=0.20×8.5=1.7 million\text{Tax} = 0.20 \times 8.5 = 1.7\ \text{million}Tax=0.20×8.5=1.7 million

Earnings after tax (profit for the year)

Earnings=8.5−1.7=6.8 million\text{Earnings} = 8.5 - 1.7 = 6.8\ \text{million}Earnings=8.5−1.7=6.8 million

The covenant states that earnings must not fall below $7m. On the standard CIMA F3 treatment, “earnings” in such a covenant is interpreted as profit after interest and tax, i.e. the $6.8m we’ve just calculated.

6.8 million<7 million6.8\ \text{million} < 7\ \text{million}6.8 million<7 million

So the covenant will be breached.

The retention rate (80%) and bond market price (80% of nominal) are red herrings for the covenant calculation.

Therefore the correct option is:

C. The earnings will be = $6.80 million (The covenant will be breached).

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):

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.

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. “A bond issuer must appoint at least one market-maker…” – TRUE (in exam context)

On public bond markets, an issuer typically works with one or more banks/dealers as market-makers. Their role is to quote buy and sell prices and help ensure liquidity so investors can trade in and out. From an exam perspective, this is treated as a standard feature of traded corporate/government bonds.

B. “The redemption yield… can be determined by calculating the internal rate of return…” – TRUE

The redemption yield (yield to maturity) is exactly the IRR of the bond’s cash flows (all coupon payments plus redemption amount) based on the current market price. That’s standard CIMA F3 territory.

C. “Investors in traded bonds have an ownership stake…” – FALSE

Bondholders are creditors, not owners. They have a contractual right to interest and principal, but no equity participation, voting rights, or residual claim (except in liquidation after other priorities).

D. “A first-time bond issuer will find it easier to issue bonds than arrange a conventional term loan.” – FALSE

It’s usually the opposite. For a new issuer, arranging a bank term loan is typically quicker and simpler than accessing the bond market, which involves credit ratings, documentation, listing and investor marketing.

E. “Governments are the most frequent issuers of bonds…” – TRUE

Governments regularly issue sovereign bonds (treasuries, gilts, etc.) both to finance spending and to roll over existing national debt. This is exactly how public deficits are funded in practice and is a standard statement in financial strategy texts.

Hence: A, B and E.

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.

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.

Imports and exports are in US$, home currency is RS. Each company has the same total revenue/cost level; what differs is their net US$ exposure, which drives how sensitive profit growth is to the US$/RS rate.

From the table:

Company L: Imports 10, Exports 20 → net export +10 US$m

Company M: Imports 0, Exports 18 → net export +18 US$m

Company N: Imports 25, Exports 21 → net import −4 US$m

Company O: Imports 15, Exports 0 → net import −15 US$m

Sensitivity to exchange rate = size of the net US$ position (absolute value).

Comparing: |+10|, |+18|, |−4|, |−15| → the largest is 18 for Company M.

So Company M’s operating profit growth is most sensitive to movements in the US$/RS rate.

✅ Answer: B – Company M

A company with no projects for 2 years and a WACC of 10% should not lock surplus cash into investments earning less than 10%, as that destroys shareholder value. The best way to maximise shareholder wealth is to return the surplus so shareholders can invest at their own required return.

✅ Answer: D. Paying the surplus cash as a dividend at the earliest opportunity.

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%

A: VCs typically want at least one board seat – conflicts with directors wanting full board control.

B: VCs mainly provide equity-type finance; reluctance to provide a debt–equity mix would disrupt the plan.

D: VCs normally expect an exit in around 3–7 years, much earlier than an IPO in 10 years.

(C) high cost is possible but not a defining structural conflict, and (E) “always >50% ownership” is not generally true.

Compared with a share repurchase, a one-off special dividend:

is administratively simpler to arrange,

returns surplus cash directly to shareholders (all shareholders receive cash, ownership proportions are unchanged).

Answers: D and E

Key convertible bond points:

Investors accept a lower coupon on convertibles because they get the equity conversion option.

If converted, no new cash comes in: debt simply becomes equity.

On conversion, debt falls and equity rises, so gearing falls, not rises.

So:

A – False (convertible debt is usually cheaper, not more expensive).

B – False (no extra cash on conversion).

C – True (coupon is usually lower on convertibles).

D – False (conversion lowers gearing).

Answer Q73: C

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.

A – Seek a White Knight alternative bidder.

B – Appeal to shareholders, emphasising strong growth prospects and the undesirability of break-up.

D – Inform shareholders about the higher underlying value of assets (including intangibles) to demonstrate undervaluation.

(Competition authorities focus on competition, not redundancies, and giving rights to buy bonds is not a standard or effective takeover defence.)

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.

From the projections, the company’s interest cover remains above the required 3 times, so that covenant is satisfied. However, after paying the increased dividend (10% rise in DPS), the retained earnings for the year fall below the required $3.5 million, so the company would breach only the retained earnings covenant.

This question tests understanding of interest rate swaps, a core topic in CIMA F3: Financial Strategy, particularly under financial risk management.

Step 1: Identify the company’s current position

HHH Company currently has fixed-rate debt at 10.0%

It wants to swap to variable interest

Its floating-rate borrowing cost is risk-free rate + 8%

Step 2: Interpret the swap quotation

The bank quotes swap rates of:

3.1% (bid)

3.5% (ask)

In CIMA F3:

If a company wants to pay fixed and receive floating, it must pay the ask rate.

Therefore, HHH will pay fixed 3.5% and receive floating (risk-free rate) under the swap.

Step 3: Combine the loan and the swap

Component

Cash flow

Fixed loan

Pay 10.0% fixed

Swap

Pay 3.5% fixed, receive risk-free rate

Net fixed paid:

10.0%−3.5%=6.5%10.0\% - 3.5\% = 6.5\%10.0%−3.5%=6.5%

So after the swap, the company effectively pays:

Risk-free rate+6.5%\text{Risk-free rate} + 6.5\%Risk-free rate+6.5%

Step 4: Select the correct option

Risk-free rate + 6.5% ✔

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%.

The regulator has been asked to see whether competition is being distorted by a dominant firm. Under competition / antitrust principles, regulators normally look at:

Profits (A): persistently high profits may indicate market power or abuse of dominance.

Market shares (B): high and stable market share for one firm can signal dominance and lack of effective competition.

Prices across the industry (C): higher-than-expected or similar prices between competitors may indicate weak competition or collusion.

Entry barriers (E): high barriers (e.g. licences, regulation, capital intensity, brand strength) reduce competitive pressure and help a dominant firm maintain power.

Medical treatment efficacy (D) relates to quality of clinical outcomes, which is important for health regulators, but it is not primarily a competition issue, so it’s less relevant to whether the market is operating “fairly” in a competition sense.

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

In CIMA F3, when selecting an appropriate source of finance, you match the type and maturity of finance to the purpose of the funds, and you must also respect any constraints such as debt covenants and target gearing. Here the company “is financed by debt and equity” and is already close to breaching a debt covenant if it increases the proportion of debt. That immediately rules out additional long-term borrowing such as a private placement of a bond (B) and also makes a bank overdraft (D) inappropriate: an overdraft is short-term, potentially repayable on demand, and is still debt, so it worsens gearing and covenant pressure.

The project is a major expansion programme, so it requires long-term, stable capital. F3 material emphasises that for a listed company needing substantial equity finance, a rights issue is usually the preferred mechanism: it raises new equity, does not increase financial risk, and allows existing shareholders to maintain their proportional ownership by taking up their rights.

“Retained earnings” (A) represent accumulated past profits already part of equity; they are not a mechanism for raising an immediate $800m of new cash for investment. Therefore, the most appropriate source of finance in this situation is a rights issue.

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%

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%.