F3 Financial Strategy Questions and Answers

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.

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.

R is a retailer; S is its supplier (manufacturer). The classic vertical-integration synergy is lower purchase costs and better value-chain control.

Answer: A. Savings due to a reduction in purchase costs and more control over the valu

Disadvantages of accepting cash for ZYY’s shareholders:

A. Low interest rates – cash reinvested in deposits earns little.

B. Capital gains tax is crystallised on disposal.

E. No chance to share in YZZ’s future growth once they’ve taken cash.

C and D are not disadvantages of cash (D is actually an advantage: certainty).

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.

Working

Equity (book value) = Share capital 20 + Reserves 40 = B$60m

Debt (book value) = 5% Bonds = B$50m

Thin cap gearing (as defined) =

Book value of debtBook value of equity=5060=0.8333=83.33%\frac{\text{Book value of debt}}{\text{Book value of equity}} = \frac{50}{60} = 0.8333 = 83.33\%Book value of equityBook value of debt​=6050​=0.8333=83.33%

Cut-off = 75%.

83.33% > 75% → thin capitalisation rules are breached.

So option C is correct (market value of bonds, P/E, profit, tax rate are all red herrings here).

 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.

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.

A scrip (or bonus) issue capitalises reserves: an amount is transferred from retained earnings to share capital.

Effects:

Retained earnings decrease (transfer out).

Share capital increases by the same amount.

Total equity (book value of equity) is unchanged (it’s just a reclassification).

Number of shares increases, so with unchanged earnings, EPS decreases.

That matches exactly the effects listed, so the transaction is a scrip dividend.

A. An IPO is normally underwritten – Correct. For a fixed-price IPO, underwriters usually guarantee that the issue will be taken up, giving certainty of proceeds.

B. The government will receive significant financial resources from the sale – Correct. In a privatisation, the government is selling its ownership stake; the cash from selling these shares flows to the government.

C. The national airline employees will no longer be public sector employees – Correct. Once privatised, the airline becomes a private-sector company; its staff cease to be public-sector employees.

D is incorrect: a fixed-price offer does not guarantee maximum proceeds – the shares are often deliberately underpriced to ensure the issue is fully subscribed.

E is incorrect: in this scenario the proceeds go to the government as seller of existing shares, not directly to the airline itself.

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

Verified Answer: = B

CIMA F3 compares different forms of long-term finance, including preference shares and bonds/Eurobonds, focusing on control, tax treatment, gearing impact, and flexibility.

Statement B captures a key advantage of preference shares from the company’s perspective: if profits are poor, preference dividends can be omitted or deferred, especially when they are cumulative. Although unpaid dividends accumulate, non-payment does not normally constitute default in the same way as missing an interest payment on a bond. For a Eurobond, failure to pay interest when due would place the company in default, triggering legal and reputational consequences. This extra flexibility is exactly why preference shares might be favoured over bonds.

Statement A is misleading: Eurobonds are often unsecured, and security (or lack of it) is not a defining difference versus preference shares.

Statement C is incorrect in this context: redeemable cumulative preference shares are typically treated as a financial liability under IFRS (like debt), so they would generally increase gearing, not reduce it.

Statement D is clearly wrong as dividends are not tax-deductible, whereas bond interest normally is. Therefore, the best justification for issuing preference shares rather than a Eurobond is B.

Current year:

Revenue = $50m

PBIT = $10m → margin = 10/50 = 20%

Tax = 20%

Earnings = 10 × (1 − 0.20) = $8m

Next year:

Revenue still $50m

40% of revenue = $20m → margin falls to 18%

PBIT on this part=20×18%=3.6\text{PBIT on this part} = 20 \times 18\% = 3.6PBIT on this part=20×18%=3.6

60% of revenue = $30m → margin stays 20%

PBIT on this part=30×20%=6.0\text{PBIT on this part} = 30 \times 20\% = 6.0PBIT on this part=30×20%=6.0

Total PBIT next year:

3.6+6.0=9.6 million3.6 + 6.0 = 9.6\ \text{million}3.6+6.0=9.6 million

Earnings after tax next year:

9.6×(1−0.20)=9.6×0.8=7.68 million9.6 \times (1 - 0.20) = 9.6 \times 0.8 = 7.68\ \text{million}9.6×(1−0.20)=9.6×0.8=7.68 million

Percentage reduction in earnings:

8.00−7.688.00=0.328=0.04=4%\frac{8.00 - 7.68}{8.00} = \frac{0.32}{8} = 0.04 = 4\%8.008.00−7.68​=80.32​=0.04=4%

Correct option:

C. Reduction of 4.0%\boxed{\text{C. Reduction of 4.0\%}}C. Reduction of 4.0%​

This is a fair value hedge of inventory.

Under fair value hedge accounting, both:

the change in fair value of the hedged item (inventory), and

the change in fair value of the hedging instrument (futures)

go to profit or loss.

Inventory: fair value rises from $400,000 to $480,000 → gain $80,000.

Futures: fair value becomes a $75,000 liability → loss $75,000.

Net effect in P&L: $80,000 – $75,000 = $5,000 gain.

Nothing goes to OCI for a fair value hedge.

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.

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.

The mechanics of the DVM calculation are fine:

D1=500,000×1.08=540,000D_1 = 500,000 × 1.08 = 540,000D1​=500,000×1.08=540,000

Required return = 15% + 3% = 18%

Value = D1/(ke−g)=540,000/(0.18−0.08)D_1 / (k_e − g) = 540,000 / (0.18 − 0.08)D1​/(ke​−g)=540,000/(0.18−0.08).

The conceptual problem is assuming dividends can grow at 8% indefinitely when earnings only grow at 6%; over time dividends cannot consistently grow faster than earnings.

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

Short-term interest rate futures (STIRs) are:

Standardised, exchange-traded contracts

Not tailored exactly to one company’s needs (that’s FRAs)

Traded on an exchange, so you can close out early by taking an opposite position

If interest rates fall, futures prices rise (since price ≈ 100 – interest rate)

Now check each statement:

A. “Tailored to exact needs” → False (that’s an FRA)

B. “If interest rates go down the price will have fallen” → False (it rises)

C. “Must be kept for whole duration” → False

D. “Date is flexible and the position can be closed quickly and easily” → True (you choose the contract month and can close out any time before expiry)

Answer: D. The date is flexible and the position can be closed quickly and easily.

For tax planning and compliance, transfer prices between group companies must follow the arm’s length principle: intra-group prices should be those that would be charged between independent parties in comparable circumstances.

Option D explicitly states this – same price as would be charged to independent supermarkets in that foreign country.

Options B and C suggest manipulating prices based on tax rates, which risks breaching transfer pricing rules. Thin capitalisation (A) is about debt levels, not intra-group pricing. So D is the key factor.

Delta: 12% fixed or rf + 3% floating

Kappa: 15% fixed or rf + 4% floating

Delta’s advantage:

Fixed: 3% better (15 − 12)

Floating: 1% better (rf+4 − (rf+3))

Comparative advantage is in fixed; total potential gain from a swap = 3% − 1% = 2%, shared equally → 1% saving each.

So:

Delta (wants floating): (rf + 3%) − 1% = rf + 2%

Kappa (wants fixed): 15% − 1% = 14%

So D: Delta pays rf + 2%, Kappa pays 14%.

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

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.

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

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%.

“Only pay a dividend once all positive NPV projects have been funded.” → Residual policy

Under a residual dividend policy, the firm first uses earnings to finance all projects with a positive NPV.

Whatever profit is left over (the “residual”) may be paid out as dividends.

So dividends are not the target; investment in value-adding projects is. That’s exactly what the statement describes.

“Investors prefer a predictable cash flow.” → Stable growth

A stable (or steadily growing) dividend policy aims to provide shareholders with a smooth, predictable stream of dividends.

Even if earnings are volatile, management tries to keep dividends level or with a modest regular increase.

This appeals to investors who value certainty of income, which is what the statement is referring to.

“May create volatile dividend movements.” → Constant payout ratio

With a constant payout ratio, the company always pays the same percentage of earnings as dividends (e.g. 40% of earnings every year).

If earnings go up and down, the dividend per share will also go up and down proportionally.

That leads to volatile dividend movements, which is exactly what the statement says.

So the final mapping is:

Residual policy → “Only pay a dividend once all positive NPV projects have been funded.”

Stable growth → “Investors prefer a predictable cash flow.”

Constant payout ratio → “May create volatile dividend movements.”

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%.

 Covenants are mainly there to protect the lender (B),

 to impose financial discipline on the borrower (C), and

 if breached, they usually give the lender rights to call in the loan or renegotiate (D).

They are not designed simply to penalise the company (A) or eliminate tax (E).

Discursive_F0

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.

Notional principal = $200m

Pay fixed 4%, receive floating (6-month risk-free).

For the first 6 months, the floating rate fixed on 1 Jan = 5% p.a.

Difference = 5% − 4% = 1%

Settlement for 6 months:

0.01×200 m×612=$1 000 0000.01 \times 200\,\text{m} \times \frac{6}{12} = \$1\,000\,0000.01×200m×126​=$1000000

Floating > fixed, so the company receives this amount under the swap.

Correct answer: D. $1,000,000 net receipt to the company.

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.

A scrip dividend (stock dividend) means shareholders receive additional shares instead of cash. CIMA F3 explains that this is commonly used when a company wants to maintain a “visible” dividend policy but conserve cash because of short-term liquidity or profit pressures. Shareholders get something of value – more shares – while the company avoids a large immediate cash outflow, keeping funds available to support operations and future growth.

In the scenario, the company has strong long-term prospects but current profit and cash-flow problems. That is exactly the situation where F3 suggests that a scrip dividend is attractive: it encourages shareholders to leave cash in the business while still signalling confidence.

A is incorrect: a scrip dividend does not raise new external finance; it just capitalises reserves. B is wrong because issuing more shares normally reduces earnings per share, all else equal. D is misleading: dividend per share usually falls or at best is unchanged in cash terms; what increases is the number of shares, not the cash amount per share. Therefore, C is the most appropriate reason.

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.

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.

This question examines the appropriateness of debt financing instruments in the context of a high-risk, growth-oriented pharmaceutical company, which is a classic scenario discussed within CIMA F3 under Financing Decisions, Risk and Capital Structure, and Hybrid Finance.

Company P operates in a sector characterised by long development cycles, high uncertainty, and intangible asset bases. Its value derives primarily from human capital and intellectual property rather than tangible fixed assets. According to CIMA F3 study guidance, such firms face significant difficulty raising conventional straight debt, as lenders typically require stable cash flows and asset security. Furthermore, the company’s existing cash flows are only sufficient for operational needs, not major R&D expenditure, increasing perceived credit risk.

A convertible bond is explicitly highlighted in CIMA F3 as a suitable financing instrument for companies with high growth potential but limited current cash flows. Convertible bonds combine features of debt and equity, offering investors downside protection through fixed interest payments while providing upside potential through conversion into equity if the company succeeds. This reduces the required coupon rate (4% in this case), easing short-term cash flow pressure, which is crucial for Company P during the development phase of the new drug.

Importantly, the doctors who own and manage Company P wish to retain control, a key strategic constraint. Convertible bonds delay equity dilution until conversion occurs and only if the company performs well. This aligns with F3 principles that hybrid instruments are appropriate when firms wish to balance financing needs with control considerations.

The alternative options are unsuitable:

Eurobonds and conventional bonds (Options A and B) require strong credit standing and asset backing.

Commercial paper (Option C) is short-term, unsecured, and inappropriate for long-term R&D funding.

Therefore, consistent with CIMA F3 guidance on risk-adjusted financing strategy, the most appropriate choice is the convertible bond.

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

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 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

Workings:

Z$ profit after tax = 10m

Tax rate in Z = 20%

Pre-tax profit in Z:

101−0.20=100.8=12.5m\frac{10}{1 - 0.20} = \frac{10}{0.8} = 12.5\text{m}1−0.2010​=0.810​=12.5m

Home country Y taxes at 50%, with full double tax relief → overall tax rate becomes 50% on pre-tax profits:

Net profit after all tax in Z$:

12.5×(1−0.50)=6.25m12.5 \times (1 - 0.50) = 6.25\text{m}12.5×(1−0.50)=6.25m

Exchange rate: Y$1 = Z$5 → convert:

6.255=1.25m\frac{6.25}{5} = 1.25\text{m}56.25​=1.25m

So expected profit in Y$ = 1.25m → A.

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.

Step 1 – Work out the current P/E of Company A

From the table:

Share price A = $5.00

EPS A = $0.40

P/EA=PriceEPS=5.000.40=12.5\text{P/E}_A = \frac{\text{Price}}{\text{EPS}} = \frac{5.00}{0.40} = 12.5P/EA​=EPSPrice​=0.405.00​=12.5

So A trades on a P/E of 12.5.

Step 2 – Calculate A’s and B’s current earnings

A’s shares = 20m → Earnings A = 0.40 × 20m = $8m

B’s shares = 14m → Earnings B = 0.50 × 14m = $7m

Current equity value of A (check):

8m×12.5=100m(matches 5×20)8m \times 12.5 = 100m \quad (\text{matches } 5 \times 20)8m×12.5=100m(matches 5×20)

Step 3 – Revalue B using A’s P/E after acquisition

Company A believes that after acquisition, the combined group will be seen as having the same P/E as A (12.5).

So the value of B’s earnings inside the merged group is:

Value of B in merged group=7m×12.5=87.5m\text{Value of B in merged group} = 7m \times 12.5 = 87.5mValue of B in merged group=7m×12.5=87.5m

Step 4 – Value of A after paying for B in cash

To get the post-acquisition value to A’s shareholders, take:

Post-acquisition value=Current value of A⏟100m+Value of B in merged group⏟87.5m−Cash paid for B⏟65m\text{Post-acquisition value} = \underbrace{\text{Current value of A}}_{100m} + \underbrace{\text{Value of B in merged group}}_{87.5m} - \underbrace{\text{Cash paid for B}}_{65m}Post-acquisition value=100mCurrent value of A​​+87.5mValue of B in merged group​​−65mCash paid for B​​ =100+87.5−65=122.5 million= 100 + 87.5 - 65 = 122.5\ \text{million}=100+87.5−65=122.5 million

So Company A expects the value of the merged entity (i.e. A after acquiring B for cash) to be:

$122.5 million\boxed{\$122.5\ \text{million}}$122.5 million​

Correct option: A. $122.5 million

Relevant cash flows:

Finance lease option

Lease payments: 2,200 (cost)

Tax relief on interest element of lease: (200)

Tax relief on accounting depreciation: (400)

Tax relief on full lease payment (550) is NOT relevant – tax law says relief is only on interest and depreciation.

Maintenance (100) is incurred under both options → irrelevant.

Net PV cost of leasing:

2,200−200−400=1,6002,200 - 200 - 400 = 1,6002,200−200−400=1,600

Bank loan (buy) option

Initial asset cost is financed by the bank loan, so the financing inflow and the purchase outflow cancel. We focus on ownership-related flows:

Salvage value at end: (20) (benefit)

Tax relief on tax depreciation allowances: (450)

Maintenance 100 again occurs under both options → irrelevant.

Net PV cost of buying:

2,000 (asset cost)−20−450=1,5302,000\ (\text{asset cost}) - 20 - 450 = 1,5302,000 (asset cost)−20−450=1,530

(Effectively the trainee’s PVs imply a net cost of 1,530 for bank loan/own, versus 1,600 for lease.)

Difference in cost:

1,600−1,530=701,600 - 1,530 = 701,600−1,530=70

So the bank loan is $70,000 less expensive than the finance lease → Option C.

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

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.)

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.

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.

Under CIMA F3 (Financial Strategy), sensitivity of operating profit to exchange-rate movements is assessed using transaction exposure: where revenues/costs are denominated in a foreign currency, the home-currency value of those cash flows changes when the exchange rate moves. Because all four companies have the same total revenue and cost levels in K$, the company whose net EUR cash flow is largest (in absolute terms) will have the greatest potential impact on operating profit growth when the EUR/K$ rate changes.

Treat exports as EUR inflows and imports as EUR outflows. Compute each company’s net EUR position:

Company A: EUR exports 20 − EUR imports 10 = +10 (net EUR receivable)

Company B: EUR exports 18 − EUR imports 0 = +18 (net EUR receivable)

Company C: EUR exports 21 − EUR imports 25 = −4 (net EUR payable)

Company D: EUR exports 0 − EUR imports 15 = −15 (net EUR payable)

Now compare absolute exposures: |+10|, |+18|, |−4|, |−15| ⇒ largest is 18 for Company B. Therefore, Company B’s operating profit (and hence its year-on-year growth objective) is most sensitive to movements in the EUR/K$ exchange rate, because the K$ value of its EUR-denominated net inflows will vary the most as rates change.

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.

When valuing lease finance you discount actual cash flows only.

The cash outflow is the lease payment itself.

Because the tax regime follows the accounting treatment, the lessee gets tax relief on:

the implied interest component of the lease, and

the depreciation (straight-line) charged on the leased asset.

These tax reliefs are cash inflows (reduced tax paid) and must also be included in the discounted cash-flow calculation. Interest and depreciation themselves are not cash flows; only their associated tax shields are.

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.

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.

 B – Shareholders care about real income, so they want dividend growth at least in line with inflation.

 C – Retained earnings must earn a return above inflation to create real value.

 D – Inflation’s effect on future cash flows and required returns must be considered when setting dividend policy.

Pre-acquisition standalone values:

ABB = $55m

BBA = $25m

Total pre-deal value = $80m.

After the acquisition, ABB (the combined business) is expected to generate post-tax cash flows of $10m per year in perpetuity. Cost of equity = 10%, and the firm is all-equity financed, so:

Post-acquisition value=100.10=$100m\text{Post-acquisition value} = \frac{10}{0.10} = \$100\text{m}Post-acquisition value=0.1010​=$100m

Synergy value = value of combined firm − sum of standalone values:

Synergy=100−80=$20m\text{Synergy} = 100 - 80 = \$20\text{m}Synergy=100−80=$20m

So the best estimate of the synergy from the acquisition is $20 million.

This is the appropriate, code-compliant defence: communicate with shareholders, explain the company’s prospects (including use of cash for an acquisition) and why the bid undervalues the firm. The other options either breach takeover-code norms or are not well-justified.

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}

 G plc will borrow at base + 0.75% → 7.50% + 0.75% = 8.25%.

 To hedge, as a future borrower it uses the 6v9 FRA offer rate = 6.90%.

 Difference between actual base and FRA = 7.50% − 6.90% = 0.60%.

 Interest difference over 3 months on $5m = 0.006 × ¼ × 5,000,000 = $7,500 (received from FRA).

 Net interest paid = 8.25% interest − 0.60% benefit = 7.65% effective rate.

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.

 TERP = $4.80 (given).

 Issue price = $4.00 → value of one right per new share = 4.80 − 4.00 = $0.80.

 The company offers $1.00 per right, which is more than the theoretical value.

So shareholders who don’t want to invest more cash are better off selling the rights back to the company for $1 rather than exercising them or selling on the market.

That means fewer shareholders will take up the rights, so the company is likely to raise less cash → option D.

The primary purpose of the IIRC’s Integrated Reporting Framework is to help organisations explain how they create value in the short, medium and long term. That wording is taken directly from how integrated reporting is framed conceptually. So B is correct.

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.

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.

B. New profitable contract improves the company’s credit quality → lower default risk → investors accept a lower yield.

C. Convertible bond gives investors equity upside → they are willing to accept a lower coupon / YTM than on an equivalent straight bond.

A (shorter term) might affect yield, but the effect depends on the yield curve, so it’s less clear-cut.

D (unsecured instead of secured) increases risk, so yield would rise, not fall.

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

In CIMA F3, finance leases are analysed as a form of debt financing and are compared directly with bank loans when evaluating long-term funding options. The syllabus (under Financing Decisions and Leasing vs Buying) explains that a finance lease is economically similar to borrowing to purchase an asset, because the lessee assumes substantially all the risks and rewards of ownership.

Option B is correct because one key advantage of a finance lease over a bank loan is that the lessor retains legal ownership of the asset, which provides strong security for the lender. As a result, the lessor’s risk is lower than that of a bank providing an unsecured or partially secured loan. CIMA F3 study guidance highlights that this reduced risk can allow the lessor to offer more favourable interest rates or financing terms than a conventional bank loan.

The other options are incorrect under current accounting and financial strategy principles:

A is incorrect because finance leases are not off-balance sheet. Under IFRS 16 (examined in F3), finance leases must be recognised on the statement of financial position, increasing both assets and liabilities and therefore affecting gearing.

C is incorrect because tax depreciation (capital allowances) normally remain with the legal owner, the lessor. These benefits are not “passed on” directly, although they may be reflected indirectly in lease pricing.

D is incorrect because maintenance is a feature of operating leases, not finance leases. In a finance lease, the lessee is responsible for maintenance and insurance.

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.

We use the Dividend Valuation Model (DVM) with a one-year zero-growth period followed by constant growth:

Last year’s dividend = $2m → with 1m shares, DPS₀ = $2.00.

No growth in year 1 → D₁ = $2.00.

From year 2, dividends grow at 4% in perpetuity →

D₂ = 2.00 × 1.04 = $2.08

Using the Gordon growth model from year 2 onwards:

P1=D2ke−g=2.080.10−0.04=2.080.06≈34.67P_1 = \frac{D_2}{k_e - g} = \frac{2.08}{0.10 - 0.04} = \frac{2.08}{0.06} ≈ 34.67P1​=ke​−gD2​​=0.10−0.042.08​=0.062.08​≈34.67

Now discount D₁ and P₁ back to today at 10%:

P0=D11.10+P11.10=2.001.10+34.671.10≈1.82+31.52≈33.34P_0 = \frac{D_1}{1.10} + \frac{P_1}{1.10} = \frac{2.00}{1.10} + \frac{34.67}{1.10} ≈ 1.82 + 31.52 ≈ 33.34P0​=1.10D1​​+1.10P1​​=1.102.00​+1.1034.67​≈1.82+31.52≈33.34

Rounded: $33.33 per share → Option A.

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%.

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 ✅

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

Holding excess cash increases equity (retained earnings) without necessarily increasing profits proportionately. This dilutes returns to shareholders, so ROE falls. Liquidity actually increases, and vulnerability to takeover may fall, not rise.

PBIT = $1.1m

Debt = $2m at 5% → interest = $0.1m

Profit before tax = 1.1 – 0.1 = $1.0m

Tax at 20% = 0.2m → Earnings after tax = $0.8m

Earnings yield = Earnings ÷ Market value of equity = 10%:

0.8=0.10×MV⇒MV=0.80.10=$8m0.8 = 0.10 \times \text{MV} \Rightarrow \text{MV} = \frac{0.8}{0.10} = \$8\text{m}0.8=0.10×MV⇒MV=0.100.8​=$8m

Shares in issue = 4m → share price:

Price=84=$2.00\text{Price} = \frac{8}{4} = \$2.00Price=48​=$2.00

Answer: C: $2.00

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.

Economy = obtaining quality inputs at minimum cost → D

Efficiency = obtaining maximum output from minimum inputs → C ✅

Effectiveness = spending funds so as to achieve the objectives → A

So efficiency is correctly defined by C.

 Indonesia has higher inflation, so its currency is expected to depreciate, not appreciate.

A: Wrong – says appreciate.

B: Correct – FTT receives a currency likely to fall in value, so it has transaction risk.

 C: Correct – invoicing in FTT’s home currency shifts/reduces its own currency risk.

 D: Incorrect – that’s more about business/operational risk, not translation risk.

 E: Correct – if FTT also pays out Indonesian currency (e.g. imports from Indonesia), receipts and payments can naturally hedge each other.

 Interest cover = PBIT / Interest = 20 / 5 = 4 times ≥ 3 ⇒ covenant met.

 Next year dividend per share = 0.04 × 1.10 = 0.044.

Total dividend = 0.044 × 200m = 8.8m.

Retained earnings = Earnings – Dividends = 12 – 8.8 = 3.2m < 3.5m ⇒ retained-earnings covenant breached only.

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:

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.

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

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.

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).

Current year sales in M$

Units = 100,000

Price = M$12

Revenue = 100,000 × 12 = M$1,200,000

Convert to L$ at current rate

Spot: L$1 = M$5 → 1 M$ = 0.2 L$

Current L$ revenue = 1,200,000 × 0.2 = L$240,000

Target L$ revenue (10% growth)

240,000 × 1.10 = L$264,000

Effect of a 5% strengthening of the L$

L$ strengthens ⇒ more M$ per L$

New rate = 5 × 1.05 = M$5.25 per L$

1 M$ = 1/5.25 ≈ 0.190476 L$

Required units next year

L$ revenue = Units × 12 M$ × 0.190476 L$/M$

So Units = 264,000 ÷ (12 × 0.190476)

12 × 0.190476 ≈ 2.285712

Units ≈ 264,000 ÷ 2.285712 ≈ 115,500 units

So the correct choice is A. 115,500 units.

(A) describes a collar, not a pure cap. With a collar you sell a floor and buy a cap; that reduces the premium cost. (B) is wrong because with a collar you don’t benefit from rates falling below the floor. (D) is not necessarily true – options can be traded via markets or other counterparties, not just the company’s bank.

Interest on debt is treated as a tax-deductible expense, so it is deducted in arriving at profit before tax:

A – incorrect: security over assets doesn’t affect tax relief on interest.

B – incorrect: preference dividends are not tax-deductible.

C – incorrect: if it were deducted from post-tax profits there would be no tax relief.

D – correct: interest is deducted from pre-tax profits.

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.

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. 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

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

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%.

Explanation

Value of Company J at present

Earnings J = $80m

P/E J = 15

Equity value of J=80×15=$1,200m\text{Equity value of J} = 80 \times 15 = \$1{,}200\text{m}Equity value of J=80×15=$1,200m

Current value and number of shares of Company K

Earnings K = $50m

P/E K = 10

Current equity value of K=50×10=$500m\text{Current equity value of K} = 50 \times 10 = \$500\text{m}Current equity value of K=50×10=$500m

Current share price K = $2, so:

Number of K shares=5002=250m shares\text{Number of K shares} = \frac{500}{2} = 250\text{m shares}Number of K shares=2500​=250m shares

Value of K if it is re-rated to J’s P/E

J believes it can turn K around so that the market applies J’s P/E of 15 to K’s earnings:

Post-acquisition value of K=50×15=$750m\text{Post-acquisition value of K} = 50 \times 15 = \$750\text{m}Post-acquisition value of K=50×15=$750m

Maximum total price J should pay

To avoid destroying value, J should not pay more than the value it expects K to have in the merged group, i.e. $750m.

Maximum price per share for K

Max price per K share=750250=$3.00\text{Max price per K share} = \frac{750}{250} = \$3.00Max price per K share=250750​=$3.00

So the highest price J should place on each of K’s shares in negotiations is $3.0, answer C.

Likely outcomes after two listed companies in the same industry merge:

A. Increase in customer base – yes, customers of both firms now belong to the combined entity.

B. Competition authorities step in to stop… – that usually happens before or to prevent the merger, not “after it has happened”, so not chosen.

C. Decrease in employee motivation due to internal changes – very common effect of mergers (uncertainty, restructuring).

D. Changes to supplier relationships owing to internal changes – the merged firm will have different bargaining power and processes; very likely.

E. Cost savings from synergistic benefits and economies of scale – one of the main motives for merger.

Answer: A, C, D, E

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.

Company currently pays fixed 10% but wants variable.

Swap quotes: 3.1% (bid), 3.5% (ask).

To convert to variable, it receives fixed and pays LIBOR. So it receives the bid rate 3.1%.

Net outflow:

Pay 10% on loan

Receive 3.1% fixed from swap

Pay LIBOR on swap

Net cost = LIBOR + (10% − 3.1%) = LIBOR + 6.9%.

Answer: C. Risk-free rate + 6.9%

We’re comparing valuation using forecast cash flows to equity (DCF / FCFE) vs P/E multiple:

A. Using cash is theoretically superior to using profits – True. Valuation theory (and CIMA F3) say value is based on cash flows, not accounting profits. Cash flow–based valuation is more theoretically robust than P/E-based (profit-based) methods.

B. It gives an estimate of the likely shareholder value that will be created – True. Discounting forecast cash flows to equity gives a direct estimate of the present value of future benefits to shareholders, i.e. shareholder value. A P/E multiple is more of a relative/comparative shortcut.

D. It incorporates the time value of money – True. DCF explicitly discounts future cash flows back to present value at the cost of equity. A simple P/E multiple does not explicitly model timing.

Not correct:

C – DCF is more complex, not simpler.

E – You still need long-term growth assumptions (terminal value), so it does not avoid growth forecasting problems.

For reviewing the effectiveness of hospital services, the focus is on quality of care and outcomes:

A. Proportion of surgical procedures successful – direct clinical effectiveness measure ✅

B. Average waiting times for treatment – key access and service delivery metric ✅

C. Patient satisfaction ratings – captures perceived quality and experience ✅

Options D (staff costs) and E (car park revenue) are financial/operational efficiency measures, not direct indicators of service effectiveness, so they are less relevant here.

Conversion value = (conversion ratio) × (share price).

Share price is expected to grow 5% p.a. from $4.50, so the conversion value rises each year. With a steadily rising price and no other constraints given, a rational bondholder delays conversion as long as possible among the dates offered, to maximise value.

So the most worthwhile of the dates listed is the latest one: 31 December 20X3.

Answer: C. 31 December 20X3

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.

 A – True: a scrip dividend converts distributable reserves into share capital (non-distributable).

 C – True: more shares in issue increases future dividend expectations.

 D – True: it creates extra admin/secretarial work versus simply paying no dividend.

Profit after preference dividend = $400m

Shares currently in issue = 2,000m

Current EPS = 400 / 2,000 = $0.20

Repurchase: 20% of 2,000m = 400m shares → new shares = 1,600m

New EPS = 400 / 1,600 = $0.25

Increase in EPS = 0.25 − 0.20 = $0.05

Answer: A. $0.050