CIMA F3 Financial Strategy Exam Practice Test

In CIMA F3, the evaluation of mergers and acquisitions focuses on whether shareholder wealth is increased through strategic and operational synergies, rather than accounting or cosmetic effects. When assessing benefits, CIMA emphasises real economic advantages arising from the acquisition.

A. Access to technical expertise ✔ Correct

This is the most significant benefit in this scenario. Company Q operates in a highly technical service industry and derives much of its value from human capital. CIMA F3 explicitly recognises that acquiring skilled employees and specialist knowledge constitutes a knowledge-based synergy, which can enhance innovation, service quality, and competitive advantage for the acquirer.

D. Gain economies of scale ✔ Correct

Both companies operate in the same industry, making economies of scale highly achievable. CIMA F3 identifies cost synergies—such as shared infrastructure, reduced overheads, and improved purchasing power—as a primary motive for horizontal acquisitions. These efficiencies directly enhance shareholder value.

E. Improve earnings per share (EPS) ✔ Correct

Although CIMA warns that EPS growth alone does not guarantee value creation, it remains a likely outcome where genuine synergies and earnings growth exist. Given Company Q’s consistent earnings growth and Company M’s ability to apply its listed-company resources, EPS enhancement is a plausible benefit to shareholders.

Why the other options are incorrect

B. Reduction of risk through diversification ✘ Incorrect

CIMA F3 states that diversification benefits arise mainly from unrelated acquisitions. As both firms operate in the same industry, shareholders gain little additional risk reduction.

C. Improved asset backing due to intangible assets ✘ Incorrect

Intangible assets—especially human capital—are generally not acceptable collateral for borrowing. CIMA F3 highlights that asset backing depends primarily on tangible, transferable assets.

✅ Final Answer:

A, D, E\boxed{A,\ D,\ E}A, D, E​

You can send the next CIMA F3 question whenever you’re ready.

Verified Answer: = C

Comprehensive and Detailed Step by Step Explanation with all CIMA F3: Financial Strategy documents: =

CIMA F3 explains warrants as equity-linked sweeteners often attached to debt issues (such as bonds) to make them more attractive, allowing the issuer to reduce the coupon rate. This aligns directly with statement A, which is therefore correct: warrants are indeed used to “sweeten” a bond and drive down the interest rate.

Statement B is also correct: a warrant gives the holder the right, but not the obligation, to subscribe for a company’s ordinary shares at a fixed exercise price on or before a specified future date. This is a core definition in the F3 syllabus under hybrid and derivative instruments.

Statement D reflects the idea that warrants can be costly to existing shareholders. If the share price in future is well above the exercise price, new shares will be issued at what is effectively a discount, diluting existing shareholders’ value. This is a recognised downside in CIMA discussions of equity-linked incentives.

Statement C is the incorrect one. Warrants are typically detachable and tradeable, but they are not normally redeemable by the issuer at nominal share value at the discretion of the holder. They’re exercised into shares or sold in the market, not “sold back” to the company for par. Hence C is NOT correct.

Questions no: 199044

Founder of Company C owns 52% and wants to keep control.

A share-for-share exchange means issuing new shares → dilutes the founder’s holding and may reduce control.

A cash offer financed by borrowing does not issue new shares → founder’s percentage holding (and control) is preserved.

That is exactly what option A states.

Answer: A. A share-for-share exchange would result in a significant change in control… whereas a cash offer would not.

 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 – Retained earnings: When you value equity by discounting cash flows to equity, the result already represents the total value of equity. You don’t then add book retained earnings on top – that would double-count equity.

B – Deducting $400m for the bond: With a FCFE valuation you do not deduct the value of debt at all – the cash flows are already after interest and principal. So deducting the bond is wrong, and in any case they used nominal value ($400m) instead of market value ($380m).

C – Using WACC: Cash flows to equity must be discounted at the cost of equity, not at WACC. WACC is used only when discounting free cash flow to the firm.

Using cash flows to equity (D) is fine, and deducting replacement capex (E) is correct because only free cash after maintaining assets belongs to shareholders.

A and B similar market cap.

A’s gearing (D / (D+E)) = 30% vs industry 50% → relatively under-geared.

Rumours of bid good for A (A share price up) and bad for B (B share price down).

Financing choices: share exchange or cash raised by new debt.

Assess statements:

A. A’s price ↑ and B’s price ↓. For a given value per B share, fewer A shares are now needed than a few weeks ago → True.

B. With a share exchange, B’s shareholders receive A’s shares, so they share in future performance of combined entity → True.

C. Financing method does affect EPS (interest expense vs number of shares) → False.

D. Under MM with tax and given A is under-geared vs the 50% industry norm, adding debt is likely to lower WACC via the tax shield (ignoring distress costs) → Most likely true.

E. A share exchange issues equity, not debt; gearing effect is ambiguous and not necessarily an increase → Not “most likely”.

Answer: A, B and D.

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.

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.

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

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

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

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

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.

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

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

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

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

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

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

So correct choices: A, B, D.

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.

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

A – Integrated reporting is designed to improve the quality of information for providers of financial capital.

B – A core aim is to show the interdependencies between the different capitals (financial, manufactured, human, social, natural, intellectual).

E – It explicitly aims to support integrated decision-making and value creation over the short, medium and long term.

C is wrong (it usually increases work), and D is wrong (focus is long-term, not short-term).

Approach A

Issue 10-year bond at 6% → net interest cost = 6.0%

Approach B

Borrow from bank at Libor + 2.5%

Enter 10-year swap. Market quote 4.0–4.2% vs Libor.

For a borrower wanting to pay fixed, it will pay the higher fixed rate (4.2%) and receive Libor.

Net cost under B:

Pay bank: Libor + 2.5%

Pay swap fixed: 4.2%

Receive from swap: Libor

Overall:

(Libor+2.5%)+4.2%−Libor=6.7%(\text{Libor} + 2.5\%) + 4.2\% - \text{Libor} = 6.7\%(Libor+2.5%)+4.2%−Libor=6.7%

So B costs 6.7% p.a. vs A at 6.0% p.a.

Difference = 0.7% per year, with Approach A cheaper.

Answer: A – Approach A is 0.7% a year less expensive.

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.

CIMA F3 clearly states that acquisitions enhance shareholder wealth only if they create real economic value, not just strategic or reputational benefits.

A. Press coverage – ✘

Media exposure does not directly generate cash flows or economic value.

B. New opportunities for employees – ✘

While beneficial socially, this does not directly enhance shareholder wealth unless it improves profitability.

C. Cultural diversity – ✘

CIMA F3 treats this as a soft benefit with no guaranteed financial return.

D. Acquiring Intellectual Property – ✔

IP can generate monopoly power, licensing income, and sustainable competitive advantage, directly increasing future cash flows.

E. Exploiting production synergies – ✔

Cost savings and operational efficiencies are a primary source of acquisition value highlighted throughout the F3 syllabus.

F. Elimination of competition – ✔

Reduced competition can increase pricing power and market share, improving long-term profitability and shareholder value.

Price to buy each target (equity market value):

A = 25

B = 62

C = 67

D = 60 (all $m)

Combined equity value before deducting cash consideration:

Z + A = 620

Z + B = 655

Z + C = 666

Z + D = 652 (all $m)

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

A: 620 − 25 = 595

B: 655 − 62 = 593

C: 666 − 67 = 599

D: 652 − 60 = 592

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

Answer: C – Acquire Company C.

Correct answer: D. Companies A and B have the same business risk

Business risk is measured by asset beta.

A and B both have asset beta = 1.16, so same business risk.

C has higher asset beta (1.20), so highest business risk.

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

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

Where:

FCF₁ = free cash flow in one year’s time

kek_eke​ = cost of equity

ggg = constant growth rate

Here:

FCF₁ = $100,000

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

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

Correct valuation:

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

The analyst instead did:

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

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

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

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

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.

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

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.

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.

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

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.

In lease vs buy decisions, the relevant risk is essentially that of secured debt, and the cash flows (lease payments, tax shields, loan repayments) are after tax. Therefore, you discount incremental cash flows at the after-tax cost of borrowing, not WACC or cost of equity.

They care most about ability to service debt and their security:

A: Cash flow forecasts – show ability to meet interest and principal. ✅

B: Current capital structure – shows gearing, ranking of claims, overall risk. ✅

E: Book value of assets – relevant as potential security / collateral. ✅

Answer: A, B, E

Pre-acquisition:

Company X: earnings = $50m, P/E = 10 → value = 50 × 10 = $500m; shares = 100m → price = $5

Company Y: earnings = $15m, P/E = 10 → value = 15 × 10 = $150m; shares = 50m → price = $3

Combined earnings = 50 + 15 = $65m

Post-acquisition assumptions:

Earnings increase by 10% → 65 × 1.10 = $71.5m

Combined P/E remains 10 → total market value = 71.5 × 10 = $715m

We want X’s new share price to be 10% higher than $5 → target price = $5.50.

Share price = total value ÷ total X shares after issue:

5.50=715Total shares⇒Total shares=7155.5=130m5.50 = \frac{715}{\text{Total shares}} \Rightarrow \text{Total shares} = \frac{715}{5.5} = 130\text{m}5.50=Total shares715​⇒Total shares=5.5715​=130m

X currently has 100m shares, so must issue 30m new shares to Y’s shareholders.

Y has 50m shares → each Y share must get:

30m50m=0.6 X shares per Y share\frac{30m}{50m} = 0.6 \text{ X shares per Y share}50m30m​=0.6 X shares per Y share

Check options:

B: 3 X for 5 Y → 3/5 = 0.6 X per Y ✔

So that exchange ratio gives exactly 30m new X shares and hence a 10% increase in X’s share price.

Correct answer: B – 3 shares in Company X for 5 shares in Company Y.

Current KKA share price = $5.00

Cash offer: $5.75 per share

Premium = (5.75 − 5.00) / 5.00 = 0.75 / 5 = 15%

Bond offer: market value $90 bond for 15 KKA shares

Value per KKA share = 90 / 15 = $6.00

Premium = (6.00 − 5.00) / 5.00 = 1 / 5 = 20%

The highest premium is therefore 20% on the bond offer, i.e. option B.

In CIMA F3, a money market hedge is a contractual-style hedge created using the spot rate today plus borrowing/lending in the two currencies to lock in a known domestic-currency outcome for a future foreign-currency receipt or payment. Under interest rate parity, the synthetic forward rate implied by money-market borrowing and lending is broadly consistent with the forward market, so the hedge typically delivers roughly the same outcome as a forward contract (A). Unlike leaving the position unhedged, the money market hedge does not leave the company exposed to currency risk once set up because the future cash flows are effectively fixed through today’s borrow/lend transactions (so B is false). Because a money market hedge can be tailored using available loan/deposit maturities and amounts (and can sometimes be implemented when a forward is unavailable or less convenient), it may be a little more flexible than a forward in practical terms (C). However, it requires multiple steps—borrow or invest, convert at spot, and invest/repay—so it is more complex than a forward contract (D). “Easy to set up” is not usually considered a defining advantage versus forwards because it depends on access to credit lines and money-market instruments (so E is not selected).

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.

They need cash within 6 months and Divisions A and B are core. Options:

A. Sale of Division B – sells a core division; strategically undesirable.

B. Closure of a division – doesn’t raise cash, likely costs cash (redundancies, closure costs).

C. Management buy-out of Division C – disposes of a non-core asset, raises cash, and there is known management interest. ✅

D. Demerger of Division C – typically does not raise cash; it just separates ownership.

So the most suitable exit strategy is C.

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 – 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.

A: Net position is pay floating (fixed to bank, receive fixed in swap, pay floating) → True.

B: No principal is exchanged in an interest rate swap → False.

C: LIBOR, not LIBID, is normally the reference rate → False.

D: Interest cash flows are exchanged periodically (e.g. annually) → True.

E: Swaps are usually between a company and a bank → True.

Answer: A, D, E

In CIMA F3, capital structure choice affects tax, risk and shareholder expectations. Debt interest is tax-deductible whereas dividends are not, so using more debt reduces taxable profit. Therefore statement A (“no impact on tax”) is false. Retained earnings are not “free”: shareholders could have taken that cash and invested elsewhere, so the cost of retained earnings equals the cost of equity – B is false.

As gearing rises, equity becomes riskier because fixed interest must be paid before any earnings go to shareholders. Under Modigliani–Miller with or without tax, this raises the cost of equity, so D is true. Replacing debt with equity reduces the probability of default and so reduces overall financial risk, making E true.

Issuing more equity increases the number of shares; investors will expect dividends on those shares in future, so total dividend outflows are likely to rise even if DPS stays the same. This added distribution pressure makes F true. C (“debt is always preferable”) is rejected in F3 because of higher financial risk and potential increase in WACC beyond an optimal gearing level.

(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.

Issue price at 20% discount to $5 = $4 per share.

Amount to raise = 20m → new shares = 20m / 4 = 5m.

Existing shares = 20m → rights ratio = 5m : 20m = 1 : 4.

Answer: A. 1 new share for every 4 existing shares

Swap quote: 5.50%–5.55% vs LIBOR.

To turn its 6.25% fixed loan into variable, the company must receive fixed and pay LIBOR, so it deals at the bank’s bid rate of 5.50%.

Net cost = pay 6.25% (loan) − receive 5.50% (swap) + pay LIBOR

= 0.75% + LIBOR = 0.75% + 5.00% = 5.75%

Answer: B. 5.75%

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.

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

The offer gives only a small premium over Company C’s current share price, and Company C has positive, unannounced plans for its substantial cash balances. Under good corporate-governance practice, the most appropriate response to a hostile bid is to communicate clearly with shareholders, explaining why the bid undervalues the company and why remaining independent may create more value. Changing the Articles to entrench management (B) and using a special dividend as a “poison pill” (C) are generally discouraged and may breach takeover rules; competition issues (D) are not indicated here. So A is the best option.

Against DDA

Fixed: ZZZ 10% vs DDA 10.5% → ZZZ cheaper by 0.5%

Floating: ZZZ rf+1 vs DDA rf+1.5 → ZZZ cheaper by 0.5%

ZZZ is better in both markets by the same margin → no comparative advantage, little reason for DDA to swap.

Against CCA

Fixed: ZZZ 10% vs CCA 9% → CCA cheaper by 1%

Floating: ZZZ rf+1 vs CCA rf+0.5 → CCA cheaper by 0.5%

CCA is cheaper in both, and also the one with greater advantage is fixed. There’s no natural “ZZZ better at one, CCA better at the other” pairing.

Against BBA ✅

Fixed: ZZZ 10% vs BBA 12% → ZZZ cheaper in fixed by 2%

Floating: ZZZ rf+1 vs BBA rf+0.25 → BBA cheaper in floating by 0.75%

So ZZZ has an advantage in fixed, BBA has an advantage in floating.

ZZZ wants floating, so it can:

Borrow fixed at 10% (where it is strong),

Enter a swap with BBA (who wants fixed but is strong in floating),

End up with an effective floating rate below rf+1.

Against AAB

Fixed: ZZZ 10% vs AAB 9.5% → AAB cheaper by 0.5%

Floating: ZZZ rf+1 vs AAB rf+0.75 → AAB cheaper by 0.25%

AAB is cheaper in both; no obvious mutual gain.

So the classical swap pairing is ZZZ with BBA → Option C.

 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.

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.

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%

Step 1 – Determine rights price and number of new shares

Current share price = $12.50

20% discount → rights price = 12.50 × 0.8 = $10.00

Amount to be raised = $15m → new shares = 15 / 10 = 1.5m

Total shares after issue = 3m + 1.5m = 4.5m

Step 2 – Total equity value after financing and project

Current equity value = 3m × 12.50 = $37.5m

Add cash raised = +15m → 52.5m

Add NPV of project = +9m → $61.5m

Step 3 – Yield-adjusted TERP

TERP=61.54.5=13.666⋯≈$13.67\text{TERP} = \frac{61.5}{4.5} = 13.666\dots \approx \$13.67TERP=4.561.5​=13.666⋯≈$13.67

✅ Answer: D. $13.67

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.

B – Securing sufficient funding for the MBO

C – The ability of the TTP management team to take over the head office functions successfully

D – The ability of the TTP management team to develop the brand and achieve the expected growth

(Constraints imposed by KKL will disappear after the buy-out, and motivation is already clearly present, so the key determinants of success are funding and the team’s capability to run and grow the business independently.)

The division is:

Currently loss-making

Has generated negative free cash flow

Requires significant new investment to return to profitability

Under CIMA F3 valuation principles:

Dividend growth model (A) – not suitable: the division does not pay dividends and may not be a standalone listed entity.

P/E ratio on forecast earnings (D) – inappropriate where current earnings are negative and future earnings highly uncertain.

Discounted forecast free cash flow (C) is theoretically strong, but here forecasts are likely to be very uncertain because profitability depends on substantial new investment by the buyer.

In such cases, the asset-based valuation (B) is often most useful as a negotiation tool: it provides a defensible view of what the business is worth in terms of its underlying net assets and sets a floor for acceptable sale price.

So the most useful approach in negotiations is B. Asset basis.

VC wants to exit in 5 years at a significant profit.

A: Buyback at original cost → no profit → not preferred.

B: IPO within 5 years → creates market to sell at premium → preferred.

C: Put option to sell back to company at twice cost → guarantees profit → preferred.

D: Right to sell to any third party if no listing → provides liquidity / exit route → preferred.

E: Management can buy at nominal value → would likely be a loss → not preferred.

Answer: B, C, D

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

A – B$ debt as a natural hedge: Borrowing in B$ to finance the B$ investment creates a natural hedge: B$ operating cash inflows help service B$ interest and principal. This reduces the net exposure of A$ shareholders to movements in the B$/A$ rate and so lowers economic risk.

D – Diversifying export markets: Selling into a variety of international markets spreads exposure across multiple economies and currencies, reducing dependence on any single one. This diversification reduces economic risk.

The other options are not true:

B: Forwards hedge specific transactions, not long-term economic risk.

C: Higher local inflation usually comes with currency depreciation and cost increases; economic risk cannot be ignored.

E: If A$ is expected to strengthen, that actually increases economic exposure to B$ earnings, it doesn’t remove it.

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.

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.

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

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

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

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

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

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

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

 A – Correct definition of natural capital under .

 C – States the primary purpose correctly: explaining value creation over time to providers of financial capital.

 D – Sustainability information is a key component of an integrated report.

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 – 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.

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.

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.

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 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.

 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.

The company invoices exports in customers’ currencies, so between invoicing and cash receipt it faces transaction risk (actual foreign-currency cash flows to convert).

Because it competes internationally, long-term exchange rate movements can affect sales volumes and margins, so it also faces economic risk.

It has no foreign subsidiaries or overseas balance sheets to translate, so translation risk is not relevant.

Q36

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.

G has effectively created an interest rate collar:

Buys a cap at 10% (protects against high rates).

Sells a floor at 8.5% (gives up benefit if rates fall too low, to reduce cost).

So:

A – True: G sacrifices gains from falling rates to help fund the cap.

B – True: the structure keeps G’s effective borrowing rate between 8.5% and 10%.

C – True: the main concern is rates rising above 10%, hence the cap.

D and E misinterpret the direction of the concern.

Zero NPV project → total shareholder wealth should be unchanged if rights are used or sold, not wasted.

A – Exercising all rights: shareholders put cash in, get extra shares; wealth unchanged.

C – Selling all rights: they don’t invest but receive the rights’ value in cash; wealth unchanged.

E – Part exercise, part sell: combination of A and C, still no loss of wealth.

Letting rights lapse (B or part-lapse in D) destroys value → those are not wealth-neutral.

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.

(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.)

 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.

Dividend Growth Model (DGM):

P0=D1ke−gP_0 = \frac{D_1}{k_e - g}P0​=ke​−gD1​​

Dividend just paid: D0=0.08D_0 = 0.08D0​=0.08

Dividend growth: g=2%=0.02g = 2\% = 0.02g=2%=0.02

Cost of equity: ke=15%=0.15k_e = 15\% = 0.15ke​=15%=0.15

Future dividend:

D1=D0(1+g)=0.08×1.02=0.0816D_1 = D_0 (1+g) = 0.08 \times 1.02 = 0.0816D1​=D0​(1+g)=0.08×1.02=0.0816

Theoretical price:

P0=0.08160.15−0.02=0.08160.13≈0.63P_0 = \frac{0.0816}{0.15 - 0.02} = \frac{0.0816}{0.13} \approx 0.63P0​=0.15−0.020.0816​=0.130.0816​≈0.63

Current market price = 0.60

Expected change: 0.63−0.60=0.030.63 - 0.60 = 0.030.63−0.60=0.03 increase → Option A.

The items that most clearly enhance shareholder wealth are those that increase future cash flows or create valuable strategic assets:

D. Exploiting production synergies – cost savings / higher margins.

E. Elimination of existing competition – greater pricing power and market share.

F. Acquiring intellectual property assets – unique products, barriers to entry, licensing income.

We want items that are most likely to reduce the long-term credit rating (i.e. make lenders view the company as riskier).

B. Issue of a new bond for an NPV = 0 project – Adds more debt without adding extra value. Higher gearing = more financial risk → likely worse credit rating.

C. New shares funding expansion into a high-risk market – Even though financed by equity, this increases business risk (earnings more volatile, uncertainty higher). Rating agencies also consider business risk → rating can fall.

D. Loss of a major customer (30% of revenue) – Big hit to revenue concentration and stability. Very likely to be credit-negative.

Not chosen:

A. New shares + NPV 0 project – Adds equity, no extra risk; may even strengthen the balance sheet.

E. Disposal of loss-making division, funds paid as special dividend – You lose equity, but you also remove a division that was destroying profits and cash. Net effect is mixed, but not as clearly rating-negative as B, C, or D.

So the “most likely to reduce” ones are B, C, D.

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.

A company financed by both equity and debt (the whole firm) is valued using free cash flow to the firm (before interest) discounted at the WACC.

So the correct combination is:

Free cash flow before interest at WACC → A.

The other options mismatch cash flow type and discount rate (either equity-only or post-interest flows).

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.

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

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.)

PBIT = $4m

Interest on loan = 10% × $10m = $1m

Profit before tax = $3m

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

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

Equity value = $2.4m × 10 = $24m

Answer: D. $24 million

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).

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

 A. The corporate tax rate in country P is 40%.

Tax in P (40%) is higher than in T (20%), so moving profits to P via a subsidiary gives a tax disadvantage, not an advantage.

 B. There are restrictions on companies wishing to remit profit from country P

That makes it harder to get cash out of P – this is a disadvantage of having a subsidiary there.

 C. Year 1 tax depreciation allowances of 100% are available in country P. ✅

This is very attractive for an investment in a manufacturing subsidiary. A 100% first-year allowance means the company can deduct the full cost of qualifying assets immediately, reducing taxable profit and tax in early years. That’s a clear advantage to setting up in P.

 D. There is a double tax treaty between country T and country P. ✅

A double tax treaty usually prevents the same profits being taxed twice and provides tax credits/relief for foreign taxes. This especially matters when you operate via a foreign subsidiary. So it’s an advantage to establishing a subsidiary in P.

 E. There are high customs duties payable on products entering country P. ✅

If the company exports directly from T, it pays high customs duties into P. If it manufactures inside P via a subsidiary, those import duties are avoided. So high customs duties on imports are an argument in favour of local production via a subsidiary – a clear advantage of establishing the subsidiary.

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.

The division is loss-making, with poor management and obsolete assets. It needs a $20m investment, but PV of future cash flows is only $15m → negative NPV of –$5m if retained.

The company wants to raise cash, so methods that don’t raise cash (de-merger, spin-off) are inappropriate.

Trade sale (C): sell the division to another company that may be better able to invest/manage it – brings in cash.

Liquidation (D): close the division and sell the assets – also raises cash and avoids further losses.

MBO (A) is unlikely, since current management is identified as part of the problem.

Answer: C and D

Regulations likely to hurt ZZZ most:

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

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

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

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

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).

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 – 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.

Profit before tax = $4.0m

Tax at 25% → earnings = $4.0m × (1 − 0.25) = $3.0m

For a takeover, the most relevant comparators are recent takeover P/E multiples in the same industry: 9–10x.

Minimum value = 3.0 × 9 = $27m

Maximum value = 3.0 × 10 = $30m

Answer: B. Minimum = $27m, maximum = $30m

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

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

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

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

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

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

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

Answer (200273):

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

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

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

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

That matches option D.

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

Current A$ revenue: Country A = 75m; Country B = 25m → total = 100m; B share = 25%.

At A$1 = B$2, B-revenue in B$ = 25m / 0.5 = 50m B$.

B$ depreciates 10% vs A$: approx new rate 1B$ ≈ 0.4545 A$.

New A$ revenue from B = 50m × 0.4545 ≈ 22.7m A$.

New total revenue ≈ 75 + 22.7 = 97.7m A$.

New percentage from B = 22.7 / 97.7 ≈ 23.3%.