F3 Financial Strategy Questions and Answers

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 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.

Company currently pays fixed 7% on its bonds.

Swap quote 6.0%–6.5% fixed against LIBOR means:

Bank will pay 6.0% fixed and receive LIBOR, or

Receive 6.5% fixed and pay LIBOR.

To move from fixed to variable, the company should receive fixed and pay LIBOR, so it takes the 6.0% fixed leg.

Net position:

Pay 7% fixed on bond

Receive 6% fixed from swap

Pay LIBOR on swap

Total = (7% − 6%) + LIBOR = LIBOR + 1%

Answer: C. VARIABLE at LIBOR + 1.0%

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):

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.

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%.

Because taking on more debt risks breaching a debt covenant, the company should avoid additional borrowings (bonds or overdraft). A rights issue raises new equity from existing shareholders, improving gearing rather than worsening it, and is therefore the most appropriate source of the $800m expansion finance.

Thin capitalisation rules in Country B restrict tax relief on excessive interest deductions of companies resident there. That means they limit deductions for:

Interest paid by BB, the subsidiary in Country B.

Answer: C. Interest paid by BB

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.

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

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

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

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

C. It manages transaction risk.

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

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

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

E. It avoids the need to find immediate finance.

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

✅ Answer to Q29: A, B, C

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.

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

Two percentage adjustments are to be made to the proxy P/E ratio:

20% reduction because Company K is unlisted (unlisted companies usually trade at a discount).

15% increase because Company K has better growth prospects than the proxy (higher growth → higher P/E).

In exam-style CIMA F3 questions, unless stated otherwise, these adjustments are usually treated additively:

Net adjustment = +15% − 20% = −5%, i.e. a 5% decrease in the proxy P/E ratio.

So the total adjustment is a 5% decrease.

 A – 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.

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

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.)

Dividend Valuation Model (Gordon growth).

EPS = $1.00

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

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

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

Use:

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

Answer: A. $4.08

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).

Debt becomes more attractive when:

Corporate tax increases → larger tax shield on interest.

Bond yields decrease → lower pre-tax cost of debt.

So the combination that makes a bond issue more attractive is higher tax and lower yields.

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 question asks for advantages to the acquiring company (ADC/ABC) of using shares rather than cash to pay for DEF.

C. It incentivises DEF to continue creating value for the combined group

If DEF’s shareholders (and possibly managers) receive shares in ADC, they now own part of the combined business. That aligns their interests with ADC’s existing shareholders and encourages them to help grow the value of the group.

E. The risk of poor future performance of the acquisition is shared with the DEF company shareholder.

If ADC pays with shares, DEF’s shareholders share in both the upside and downside. If the acquisition underperforms, the fall in value is shared instead of all the risk resting on ADC’s original shareholders. That’s an advantage for ADC.

F. It preserves liquidity

Paying with shares means ADC does not need to use up cash or raise new debt. This preserves cash balances and borrowing capacity, which is a clear advantage.

Why not the others?

A (sharing benefits of future growth with DEF shareholders) is actually a cost from ADC’s existing shareholders’ viewpoint – they give away more of the upside.

B dilution of ownership is also a disadvantage, not an advantage.

D a tax saving for ABC – the tax impact is usually more relevant for sellers or when using debt, not typically a direct advantage of share consideration to the acquirer.

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.

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

Step 1: Identify the company’s current position

HHH Company currently has fixed-rate debt at 10.0%

It wants to swap to variable interest

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

Step 2: Interpret the swap quotation

The bank quotes swap rates of:

3.1% (bid)

3.5% (ask)

In CIMA F3:

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

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

Step 3: Combine the loan and the swap

Component

Cash flow

Fixed loan

Pay 10.0% fixed

Swap

Pay 3.5% fixed, receive risk-free rate

Net fixed paid:

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

So after the swap, the company effectively pays:

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

Step 4: Select the correct option

Risk-free rate + 6.5% ✔

“Boot-strapping” in takeover valuation is the shortcut where you:

Add the current post-tax earnings of bidder and target;

Apply the bidder’s (usually higher) P/E ratio to that combined earnings figure to estimate the post-acquisition value.

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 buyback is appropriate when the company has a one-off cash surplus and no good investment opportunities.

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 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.

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

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

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

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

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

Answer: B. Fall by 1%.

 A 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.

Differences in borrowing costs:

VVV:

Floating: rf + 3%

Fixed: 7%

Counterparty:

Floating: rf + 1%

Fixed: 8%

Relative advantages:

Counterparty is 2% cheaper in floating (rf+1 vs rf+3).

VVV is 1% cheaper in fixed (7 vs 8).

Many CIMA questions treat total potential saving from the swap as the sum of these advantages:

2% + 1% = 3% total savings.

Bank takes 10% ⇒ 0.3%.

Remaining savings = 3% − 0.3% = 2.7%, shared equally ⇒ 1.35% each.

VVV wants fixed; its direct fixed borrowing cost is 7%, so its effective fixed rate after sharing the savings:

7% − 1.35% = 5.65%.

Answer: B – VVV would pay 5.65%.

CIMA F3 discusses exit strategies for owner-managed businesses under Business Valuation, Mergers and Acquisitions, and Private Equity. A key principle is that an appropriate exit route must align with the owners’ objectives, particularly the time horizon, desire for full value realisation, and the size and structure of the business.

In this scenario, Company AB is a medium-sized, owner-managed private company, with two founders who each control divisions and wish to realise the full value of their investment within 12 months. This tight timeframe significantly narrows the range of feasible exit strategies.

Option B – Management Buyout (MBO) is likely to be acceptable. CIMA F3 highlights that MBOs are common exit routes for founder-owned businesses where management has strong operational knowledge and where continuity of the business is important. Given that some employees are highly paid and critical to profitability, an MBO can help retain key staff while allowing the founders to exit fully, usually with private equity support. This route is realistic within a 12-month timeframe.

Option C – Sale to a larger competitor is also highly appropriate. F3 guidance explains that strategic buyers often pay a control premium because they can extract synergies such as economies of scale, elimination of duplicate functions, and enhanced market power. A trade sale is one of the fastest ways to realise full value and is commonly recommended where owners want a complete exit in a short period.

The other options are less suitable:

A (IPO) is unlikely due to high cost, regulatory burden, and long preparation time, making it unrealistic within 12 months.

D (Private equity earn-out) delays full value realisation and conflicts with the owners’ desire for a clean exit.

E (Spin-off/demerger) does not provide liquidity or an exit for the owners.

Correct answer: C – Net asset based valuation using replacement cost best suits a capital-intensive company with reliable tangible asset values and highly uncertain future earnings/cash flows.

The seller will mainly care about:

Protecting the rest of the group – whether the sale would damage the remaining divisions.

Receiving an acceptable price – whether the MBO team can actually finance the deal.

Evaluate each option:

A: Confidential information about other divisions – If the team leaves and runs an independent business, they could use that confidential information against the remaining divisions. This clearly influences the parent’s decision. ✅

B: Skills/experience important to other divisions – If these managers are key to the success of other divisions, the parent may not want to lose them. This also directly affects the decision. ✅

C: Ability to raise finance at a reasonable price – If the team cannot raise sufficient funds, or can only do so on terms that depress the price, the parent might not proceed. This is crucial to whether the sale can happen. ✅

D: Ability to manage the divested division successfully – this matters more to the venture capitalist than to the selling company once the division is sold.

E: Conditions imposed by the venture capitalist – primarily a concern for the management team and VC, unless they somehow affect the sale price or parent’s risk, which is not indicated here.

Correct answer: A, B and C.

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.

The company is repurchasing and cancelling its own shares.

When shares are cancelled:

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

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

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

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

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

So the one fully correct statement is:

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

Current price = $5.00

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

Funds required = $20m

Number of new shares:

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

Currently 20m shares in issue, so ratio:

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

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

Why not A?

For A:

Spot: F$1 = K$1.40

1-year forward: F$1 = K$1.44

Interest: F$ at 5%, K$ at 8%

Covered interest parity condition:

F=S×1+iK1+iFF = S \times \frac{1+i_{K}}{1+i_{F}}F=S×1+iF​1+iK​​ F=1.40×1.081.05=1.40×1.028571…≈1.44F = 1.40 \times \frac{1.08}{1.05} = 1.40 \times 1.028571… \approx 1.44F=1.40×1.051.08​=1.40×1.028571…≈1.44

Forward rate is consistent with interest rates → no arbitrage.

Option D – Covered interest arbitrage

For D, everything is the same except K$ interest = 9%:

Fno-arbitrage=1.40×1.091.05=1.40×1.038095…≈1.45F_{\text{no-arbitrage}} = 1.40 \times \frac{1.09}{1.05} = 1.40 \times 1.038095… \approx 1.45Fno-arbitrage​=1.40×1.051.09​=1.40×1.038095…≈1.45

But given forward is only 1.44, so:

Borrow F$, convert to K$, invest at 9%, and lock in selling K$ forward at 1.44.

This produces a risk-free return greater than 5%, so covered interest arbitrage exists.

Option B vs C – Triangular arbitrage

From the first two quotes:

\text{F$1} = \text{K$1.40},\quad \text{K$1} = \text{L$2.10} \Rightarrow \text{F$1} = 1.40 \times 2.10 = \text{L$2.94}

So the implied rate is:

\text{L$1} = \frac{1}{2.94} \approx \text{F$0.3401}

Option B gives L$1 = F$0.34 → essentially equal (no exploitable difference assumed in exam context) → no arbitrage.

Option C gives L$1 = F$0.40, which is far from 0.3401 → direct L$/F$ quote is inconsistent with cross-rate ⇒ triangular arbitrage opportunity.

Answer: Options C and D offer arbitrage opportunities.

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.

Acceptable actions:

Negotiate with lenders (A)

Drop the project if funding would breach the covenant (B)

Look for other finance such as cutting dividends (D)

Breaching covenants deliberately or relying on shareholders to “approve” a breach is not acceptable.

Answer: A, B, D

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.

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%​

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

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

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

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

Most feasible:

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

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

Answer: B and D

CIMA F3 covers takeover defences under Mergers and Acquisitions and Corporate Governance. A crucial distinction is made between legitimate post-offer defences, which are actions taken after a bid has been announced and are consistent with directors’ fiduciary duties, and illegitimate or unethical actions, which may mislead shareholders or breach takeover regulations.

Once a bid is hostile, the directors of the target company (Company B) are required under governance principles emphasised in F3 to act in the best interests of shareholders, not merely to preserve their own positions.

Option A is a legitimate defence.

Having the company’s assets independently and professionally revalued is acceptable and encouraged under CIMA F3. This provides shareholders with objective evidence that the bid undervalues the company and supports informed decision-making without misleading the market.

Option C is a legitimate defence.

Making a counter-bid (often called a “Pac-Man defence”) is permitted provided it can be justified as enhancing shareholder wealth. CIMA F3 stresses that directors may pursue alternative strategic actions if they genuinely believe these will create greater value for shareholders than accepting the hostile offer.

Option E is a legitimate defence.

Referring the bid to competition authorities is allowed where there are genuine competition concerns. CIMA F3 notes that regulatory intervention is an appropriate and lawful route if the acquisition may breach competition law or significantly reduce market competition.

The remaining options are not legitimate:

B is not allowed post-offer, as changing the articles to block a bid breaches takeover rules and shareholder rights.

D is unethical and unlawful, as knowingly publishing misleading forecasts violates disclosure requirements and directors’ duties.

✅ Final Answer: A, C and E

Equity: $30m

Debt: $35m at 5% interest, redeemable in 5 years

They require 30% p.a. compound on the equity and no dividends are paid.

Equity value required in 5 years

Future value=30×1.35=30×3.71293≈$111.39m\text{Future value} = 30 \times 1.3^5 = 30 \times 3.71293 \approx \$111.39\text{m}Future value=30×1.35=30×3.71293≈$111.39m

Debt cash flows

Annual interest: 35×5%=$1.75m35 \times 5\% = \$1.75\text{m}35×5%=$1.75m → over 5 years: 1.75×5=$8.75m1.75 \times 5 = \$8.75\text{m}1.75×5=$8.75m

Principal repaid in year 5: $35m

Total due to venture capitalists

111.39+8.75+35=$155.14m (approx)111.39 + 8.75 + 35 = \$155.14\text{m (approx)}111.39+8.75+35=$155.14m (approx)

Answer: A. $155.14 million

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.

Modigliani and Miller’s original capital structure theory without tax (covered in F3) assumes perfect markets, no tax, and no bankruptcy costs. Under these assumptions, the overall cost of capital (WACC) is constant regardless of gearing, but the mix between cost of debt and cost of equity changes.

When a firm introduces debt into an all-equity structure, the fixed obligations to debt holders make the equity stream more volatile and therefore riskier. MM show that the cost of equity rises linearly with the debt–equity ratio:

ke=k0+(k0−kd)DEk_e = k_0 + (k_0 - k_d)\frac{D}{E}ke​=k0​+(k0​−kd​)ED​

where k0k_0k0​ is the ungeared cost of capital. As D/ED/ED/E increases from zero, kek_eke​ must therefore increase to compensate shareholders for higher financial risk.

Because the question explicitly states “without tax”, we ignore interest tax shields and any possible WACC reduction: the key prediction is that cost of equity rises with gearing. Hence option C is correct; A and B contradict MM, and D incorrectly links the equity cost to the bond coupon rather than to leverage.

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 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

Given:

Shares: 100m; market cap = $500m ⇒ share price = $5.

Target debt-to-equity = 40%; currently 30%.

Equity (market) = 500m

Current debt = 0.30 × 500 = $150m

Target debt = 0.40 × 500 = $200m

⇒ Extra debt capacity = $50m.

Current earnings = $100m.

Last dividend = $1 per share → $100m total.

Objective: increase dividends by at least 10% each year.

No cash reserves.

Options:

A. Share repurchase instead of dividend – violates objective to increase dividends.

B. Increase debt to meet target D/E – raises $50m (exactly what’s needed) and keeps dividend policy intact → Best fit.

C. Cut dividend to $0.50 – directly contradicts dividend growth objective.

D. Hold dividend at $1 for two years – no 10% annual increase, also violates objective.

Answer: B – Increase debt to meet the target debt to equity ratio.

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.

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

Option A is TRUE.

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

Option E is TRUE.

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

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

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

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

The remaining options are incorrect:

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

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

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

✅ Final Answer: A and E

In 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.

Workings (Modigliani & Miller with tax):

Current (unlevered) cost of capital ku=9%k_u = 9\%ku​=9%

Cost of debt kd=3%k_d = 3\%kd​=3%

Tax rate T=25%T = 25\%T=25%

Target D/E=1/2=0.5D/E = 1/2 = 0.5D/E=1/2=0.5

Formula with tax:

ke=ku+(ku−kd)(1−T)DEk_e = k_u + (k_u - k_d)(1-T)\frac{D}{E}ke​=ku​+(ku​−kd​)(1−T)ED​ ke=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%k_e = 9\% + (9\% - 3\%) \times 0.75 \times 0.5 = 9\% + 6\% \times 0.375 = 9\% + 2.25\% = 11.25\% \approx 11.3\%ke​=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%

So the nearest option is 11.3% (C).

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.

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

 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

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

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.

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.

This question applies the Price/Earnings (P/E) valuation method, which is covered in CIMA F3 under Business Valuation and Market-Based Valuation Techniques. The P/E method is commonly used to value unlisted companies by reference to a comparable listed company operating in the same industry, provided that earnings are representative and sustainable.

Under CIMA F3 guidance, when using a P/E multiple:

The earnings figure used should be the most recent maintainable earnings.

The P/E ratio should be taken from a listed comparator with similar business risk.

The valuation focuses on equity value, not enterprise value.

In this scenario, the unlisted company reported earnings of $6 million in the last financial year. A listed company in the same industry has a P/E ratio of 11, which is assumed to appropriately reflect market expectations regarding growth and risk for businesses in this sector.

The valuation is therefore calculated as follows:

This gives an estimated equity value of $66 million.

It is important to note, in line with CIMA F3 principles, that balance sheet items such as retained earnings, share capital, and revaluation reserves are not directly relevant to a P/E-based valuation. The P/E approach is an income-based valuation method, relying solely on earnings and market multiples, rather than book values.

Rounding to the nearest whole number, as required by the question, confirms the final valuation.

Step 1 – Find TTT’s P/E ratio

Profit for the year (TTT) = $25m

Shares in issue = 100m → EPS = 25 / 100 = $0.25

Share price = $2.00

P/ETTT=2.000.25=8\text{P/E}_{TTT} = \frac{2.00}{0.25} = 8P/ETTT​=0.252.00​=8

Step 2 – Apply this P/E to YYY

Profit for the year (YYY) = $15m

Value of YYY’s equity = 15 × 8 = $120m

Shares in issue (YYY) = 200m

Price per YYY share=120200=$0.60\text{Price per YYY share} = \frac{120}{200} = \$0.60Price per YYY share=200120​=$0.60

✅ Answer: A. $0.60

In CIMA F3, equity valuation using P/E multiples is based on earnings available to ordinary shareholders (i.e. profit after interest and tax). The syllabus emphasises that when valuing a potential takeover target, you should (1) derive maintainable post-tax earnings and then (2) apply a P/E multiple that reflects prices actually paid in comparable acquisitions, not just average stock-market multiples.

Calculate maintainable earnings:

Profit before interest and tax (PBIT) = $5m

Less interest on 10% bonds: 10% × $10m = $1m

Profit before tax = $4m

Tax at 20% = $0.8m

Earnings for equity = $3.2m

Select the appropriate P/E multiple:

F3 explains that “takeover P/Es” are usually higher than sector trading P/Es, reflecting the control premium. Here we have:

Overall market P/E = 20

Retail sector P/E = 10

Recent retail takeovers P/E = 13

For a takeover valuation we use the 13× multiple from recent sector takeovers.

Compute equity value:

Equity value=3.2m×13=41.6m\text{Equity value} = 3.2\text{m} \times 13 = 41.6\text{m}Equity value=3.2m×13=41.6m

Debt’s market value (90% of $10m) is not added here because the P/E method already gives the equity value.

So, a reasonable expected equity value in a takeover is $41.6 million.

 Integrated reports under the Framework should include:

Governance and how it supports value creation → A

The organisation’s business model → B

Risks, challenges, and uncertainties affecting strategy and value creation → C

 Comparisons with competitors’ financials (D) and a summary of board meeting discussions (E) are not required content elements in the Framework.

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

C – Correct: only valuing three years of forecast cash flows ignores the continuing value of the business, so the valuation is understated.

D – Correct: based on typical CIMA F3 treatment, the forecast FX path should reflect expected weakening of the foreign currency (often due to higher inflation), but the assistant’s rates instead imply a strengthening B$, so the FX forecasts are inconsistent.

E – Correct: the assistant has effectively valued the business (entity value) by discounting cash flows to all providers of finance. To arrive at equity value, the B$5m of debt should be deducted.

A is incorrect because multiplying by an exchange rate quoted as AS per B$ is the right approach. B is incorrect because cash flows to all investors are appropriately discounted at WACC, not at the cost of equity.

C. Helps access to wider sources of finance – A key benefit of listing is easier access to equity and sometimes cheaper debt.

D. Provides an exit route for the founders – Listing 70% allows them to sell down and realise value.

E. Increases the profile and reputation of the business – Public companies usually gain visibility, credibility, and brand recognition.

A is doubtful (agency conflicts can increase with dispersed ownership), and B (higher dividends) is not a guaranteed benefit of listing.

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%.

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

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

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

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

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

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

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

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

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

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

Hence: A, B and E.

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.

Company pays 3.5% fixed on its borrowing and enters a swap at 3.4–3.5% vs 12-month USD risk-free rate.

To move from fixed to floating, it will receive fixed 3.4% and pay floating (risk-free):

Net interest:

3.5%−3.4%+rf=rf+0.1%3.5\% - 3.4\% + \text{rf} = \text{rf} + 0.1\%3.5%−3.4%+rf=rf+0.1%

Answer to Q102: C – 12-month USD risk-free rate plus 0.1%

For Company X: equity beta = 1.6, D/(D+E) = 50% ⇒ D = E, tax = 30%.

Ungear to get asset beta:

βa=βeEE+D(1−T)=1.6×11+1×0.7=1.6×11.7≈0.94\beta_a = \beta_e \frac{E}{E + D(1-T)} = 1.6 \times \frac{1}{1 + 1×0.7} = 1.6 \times \frac{1}{1.7} \approx 0.94βa​=βe​E+D(1−T)E​=1.6×1+1×0.71​=1.6×1.71​≈0.94

Re-gear for Company Y with 60% equity, 40% debt (D/V=0.4, E/V=0.6):

βe′=βaE+D(1−T)E=0.94×0.6+0.4×0.70.6=0.94×0.880.6≈1.38\beta_e' = \beta_a \frac{E + D(1-T)}{E} = 0.94 \times \frac{0.6 + 0.4×0.7}{0.6} = 0.94 \times \frac{0.88}{0.6} \approx 1.38βe′​=βa​EE+D(1−T)​=0.94×0.60.6+0.4×0.7​=0.94×0.60.88​≈1.38

CAPM ( rf=5%r_f = 5\%rf​=5%, rm=10%r_m = 10\%rm​=10% ):

Ke′=5%+1.38×(10%−5%)=5%+1.38×5%≈5%+6.9%=11.9%K_e' = 5\% + 1.38 × (10\%-5\%) = 5\% + 1.38×5\% \approx 5\% + 6.9\% = 11.9\%Ke′​=5%+1.38×(10%−5%)=5%+1.38×5%≈5%+6.9%=11.9%

Newly established, unincorporated service entity → focuses on growth, service quality and staying liquid; dividends and optimal capital structure are not primary yet.

Answer: B, C, D

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

When valuing a business by discounting free cash flows to the firm (FCFF), CIMA F3 explains that the correct discount rate is the weighted average cost of capital (WACC) of that specific business, not the parent’s WACC. FCFF are cash flows available to both debt and equity providers, so they must be discounted using a rate that blends the required returns of debt and equity in proportion to the company’s own capital structure.

The subsidiary operates in training, a different line of business from the publishing parent, so its business risk is better represented by the asset beta of a comparable listed training company. F3 teaches that you should use a sector asset beta to capture operating risk, then apply the gearing (debt-to-equity mix) of the business being valued to derive an appropriate WACC. Because the intention is to dispose of the subsidiary as a stand-alone entity, the relevant gearing is that of the subsidiary, not the publishing group.

Option C is therefore correct: it uses a WACC (appropriate for FCFF), based on the subsidiary’s capital structure (financial risk) and the training-sector asset beta (business risk). Options A and D wrongly use the parent’s gearing, and B uses only a cost of equity rather than WACC, so they are inconsistent with F3 valuation principles.

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.

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.

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

4.50% – 4.55% in exchange for Libor

(Libor currently 4%)

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

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

Pay Libor (to end up with variable cost).

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

Cash flows:

Pay 5.25% fixed on the loan

Receive 4.50% fixed on the swap

Pay Libor (4.00%) on the swap

Net cost:

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

✅ Answer to Q28: B. 4.75%

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).

A – Access to technical expertise: Q’s staff are leading experts and human capital is very valuable; acquiring this is a clear benefit.

D – Gain economies of scale: Both firms operate in the same technical service industry, so combining operations can reduce average costs and share overheads.

E – Improve EPS: Q has shown consistent earnings growth; if acquired at a reasonable price, this growth can enhance M’s earnings and potentially its EPS.

Diversification benefits (B) are limited because they are in the same industry, and intangible assets such as human capital are not strong collateral for borrowing (C).

A 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.

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.

Last year’s profit before interest and tax (PBIT) = $4.0m

Objective: PBIT to increase by 10% →

PBITthis year=4.0×1.10=4.4m\text{PBIT}_{\text{this year}} = 4.0 \times 1.10 = 4.4\text{m}PBITthis year​=4.0×1.10=4.4m

New long-term debt = $2m at 5% interest →

Interest = 2.0×0.05=0.1m2.0 \times 0.05 = 0.1\text{m}2.0×0.05=0.1m

Profit before tax (PBT):

4.4−0.1=4.3m4.4 - 0.1 = 4.3\text{m}4.4−0.1=4.3m

Tax at 20%:

Tax=4.3×0.20=0.86m\text{Tax} = 4.3 \times 0.20 = 0.86\text{m}Tax=4.3×0.20=0.86m

Earnings after tax:

Earnings=4.3−0.86=3.44m\text{Earnings} = 4.3 - 0.86 = 3.44\text{m}Earnings=4.3−0.86=3.44m

Dividend payout ratio = 40% of earnings:

Total dividends=3.44×0.40=1.376m\text{Total dividends} = 3.44 \times 0.40 = 1.376\text{m}Total dividends=3.44×0.40=1.376m

Shares in issue = 2m → Dividend per share:

DPS=1.3762=0.688≈$0.69\text{DPS} = \frac{1.376}{2} = 0.688 \approx \$0.69DPS=21.376​=0.688≈$0.69

So, correct DPS by calculation is about $0.69 per share. Since none of the given options (A–D) equals this, there is likely a typo or omission in the provided options, but the financially correct figure is $0.69.

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.

Advantages of issuing 20-year bonds vs a 20-year bank loan:

A. Larger capital market – bond markets tap many investors.

B. Greater availability of long-term funds – banks often prefer shorter maturities.

E. Lower interest rate – disintermediation can give cheaper funding for a strong credit.

C and D are usually disadvantages of bonds (higher arrangement cost and more admin).

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

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

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

Quick explanation:

A. True – A positive (or affirmative) covenant requires the borrower to do certain things (e.g. maintain insurance, provide financial statements).

B. False – Covenants are contractually binding; breaching them can trigger penalties or default.

C. True – A restrictive (or negative) covenant prevents the company from taking certain actions (like raising more debt, selling key assets) without lender consent.

D. False – That describes a conversion option or convertible debt, not a standard covenant.

E. True – A financial covenant typically sets financial ratio targets (e.g. interest cover, gearing) that must be maintained.

✅ Correct: A, C, E

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.

Applying an industry P/E ratio to DDD's forecast earnings.

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.

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

Reasoning:

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

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

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

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

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

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

EBIT = 5.0m

Interest (10% × 10m) = 1.0m

Profit before tax = 5.0 − 1.0 = 4.0m

Tax (25%) = 1.0m → Earnings = 3.0m

Payout ratio 50% → current dividend = 1.5m

Growth g = 3% → D1=1.5×1.03=1.545D_1 = 1.5 × 1.03 = 1.545D1​=1.5×1.03=1.545m

Cost of equity ke=10%k_e = 10\%ke​=10%. Using Gordon model:

P0=D1ke−g=1.5450.10−0.03=1.5450.07≈22.1mP_0 = \frac{D_1}{k_e - g} = \frac{1.545}{0.10 - 0.03} = \frac{1.545}{0.07} \approx 22.1\text{m}P0​=ke​−gD1​​=0.10−0.031.545​=0.071.545​≈22.1m

Answer: B. $22.1 million

Step 1: Dividend per share next year

0.045×1.04=0.04680.045 \times 1.04 = 0.04680.045×1.04=0.0468

Step 2: Total dividend payment

0.0468×100 million=4.68 million0.0468 \times 100\ \text{million} = 4.68\ \text{million}0.0468×100 million=4.68 million

Step 3: Interest expense

Bond nominal = 60m

Coupon = 5%

Interest=60×0.05=3.0 million\text{Interest} = 60 \times 0.05 = 3.0\ \text{million}Interest=60×0.05=3.0 million

(Market value is irrelevant for covenant calculations — CIMA F3 rule)

Step 4: Profit after tax

EBIT=11.25\text{EBIT} = 11.25EBIT=11.25 EBT=11.25−3.0=8.25\text{EBT} = 11.25 - 3.0 = 8.25EBT=11.25−3.0=8.25 \text{Tax (20%)} = 1.65 Profit after tax=6.60 million\text{Profit after tax} = 6.60\ \text{million}Profit after tax=6.60 million

Step 5: Retained earnings

6.60−4.68=1.92 million6.60 - 4.68 = 1.92\ \text{million}6.60−4.68=1.92 million

Step 6: Covenant test

Required minimum retained earnings = $2 million

1.92<2.001.92 < 2.001.92<2.00

❌ Covenant breached

✅ Correct Option:

C. Covenant is breached as retained earnings = $1.92 million\boxed{\textbf{C. Covenant is breached as retained earnings = \$1.92 million}}C. Covenant is breached as retained earnings = $1.92 million​

1. Sell from domestic market

Revenue = A$100,000

Costs (given) = A$45,000

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

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

Tax at 25% = 0.25 × 45,000 = A$11,250

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

2. Sell via foreign subsidiary

Revenue = B$104,500

Costs = B$49,500

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

Tax at 30% = 0.30 × 55,000 = B$16,500

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

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

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

Foreign subsidiary gives the higher after-tax profit.

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

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

Current:

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

Costs = $250m → Profit = $200m

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

New volume = 180 × 1.15 = 207m kWh

New revenue = 207 × 2.00 = $414m

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

Answer: B. $164.00 million profit

Explanation (concise):

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

D. Share price × number of shares in issue

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

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

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

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

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

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

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