You are on page 1of 180

Question Bank 2015 Syllabus

CIMA
Paper F3
Financial Strategy

ii I n t r o d u c t i o n

CIMA F3 Question Bank (2015 Syllabus)

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F

No part of this publication may be reproduced, stored in a retrieval system
or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without the prior written permission
of First Intuition Publishing Ltd.

Any unauthorised reproduction or distribution in any form is strictly
prohibited as breach of copyright and may be punishable by law.
We are grateful to the Chartered Institute of Management Accountants for
permission to reproduce past examination questions and model answers.
Additional comments and guidance have been prepared by First Intuition
Publishing Ltd.

© First Intuition Publishing Ltd, 2015

CIMA F3 Question Bank (2015 syllabus)

Introduction

iii

Contents
Topic

Question numbers

Page ref
Q
A

Chapter questions and answers
1 Business objectives

1 - 42

1

85

2 Sustainability and integrated reporting

43 - 50

10

90

3 Financial strategy

51 - 61

12

91

4 Hedge accounting

62 - 72

14

93

5 Equity finance

73 - 134

17

95

6 Debt finance

135 - 184

30

104

7 Capital structure

185 - 235

41

113

8 Dividend policy

236 - 249

52

122

9 Business valuations

250 - 299

55

124

10 Mergers and acquisitions

Fir Cop
st I
yri
ntu ght
itio
n2
015
300 - 359

67

132

360 - 370

81

141

CIMA Pilot paper (60 questions to be answered in 90 mins)

145

165

Maths tables and Formulae

173

11 Business reorganisations

Pilot paper questions and answers

iv I n t r o d u c t i o n CIMA F3 Question Bank (2015 Syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

6 2.63 1.CIMA F3 Question Bank (2015 syllabus) 1: Business objectives 1 Chapter questions Chapter 1: Business objectives 1 Company X and Company Y operate in the same industry but have different price earnings (P/E) ratios as follows: Company X Company Y P/E ratio 7 13 Which of the following is the most probable explanation of the difference in the P/E ratios between the two companies?     2 Company Y has a greater profit this year than Company X. What is the price/earnings ratio?     0. Company Y has higher expected growth than Company X. Company Y has higher gearing than Company X. Company Y is higher risk than Company X. Extracts from company Z's accounts are as follows: Turnover Operating profit Interest payable Profit before tax Profit after tax Fir Cop st I yri ntu ght itio n2 015 $m 200 50 10 40 20 What is company Z's interest cover?     3 20 times 5 times 4 times 2 times WK’s profit or loss account contains the following: Gross profit Operating profit Interest payable Taxation The nominal value of the ordinary shares is $1 and their market value is $8.67 5 $m 50 30 6 8 . The issued share capital is 10 million shares.

Better Worse . Prospects for future profits have improved. not-for profit entities’ primary aim is achieving value for money. whereas this is not an important concern for not-for-profit entities. The earnings yield on HN’s shares has risen.2 1: Business objectives 4 Shareholder wealth maximisation is most consistent with     5 Profit maximisation Sales maximisation Maximisation of the present value of future cash flows Maximisation of future growth During 20X5. High Low The same The agency problem arises because managers have accountability to shareholders and access to information as shareholders. not-for-profit entities are responsible to a wide range of stakeholders. For-profit entities will be concerned about the balance between capital gain and dividends. Complete the sentence below by placing one of the following options in each of the spaces. For-profit entities have financial objectives. Which of the following could be a reason why this might have happened?     6 CIMA F3 Question Bank (2015 syllabus) Interest rates in the economy have risen. HN has performed better than other companies in its industry. Which of the following is most likely to benefit from strategies that increase the risk and return of a company?     Equity shareholders Preference shareholders Trade receivables Debentureholders t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 7 Which of the following is not a valid difference between the objectives of for-profit and not-for profit entities?     8 For-profit entities’ primary aim is maximisation of long-term value. HN's price-earnings ratio fell from 12 to 9. not-for-profit entities don’t. For-profit entities are primarily responsible to their shareholders.

not-for-profit entity Private sector.60 during 20X4. It has $20 million nominal value of share capital and $4 million worth of bonds.8% 13.2% 20.60 per share. not-for-profit entity Public sector.0% 30. What was the annual return to Dandy’s investors in 20X4?     12 Which of the following figures should be used in the calculation of return on capital employed?     13 2.2% 13. The target for the company is to earn a return each year of 5% on the amount that the government invested.25 and the bonds are currently trading at $95 per cent.4% 40.22 1.75 1. What kind of entity is RJ Coaches?     10 Private sector. which had experienced financial difficulties. The shares are currently trading at $1.9% Gross profit Profit before interest and tax Profit before tax Profit after tax Louie’s current dividend yield is 9% and its dividend payout ratio is 12%.CIMA F3 Question Bank (2015 syllabus) 9 1: Business objectives 3 RJ Coaches was a nationwide coach company.6% 2.20 to $7. What is the P/E ratio of Louie?     0.03 1.33 .0% Co st I pyri ntu ght itio n2 015 Fir Dandy’s share price rose from $7. for-profit entity Littlekit is listed on its local stock exchange. What is the gearing ratio of Littlekit. Five years ago the government of Earland bought out the shareholders and now own all of the company. During 20X4 Dandy paid out a dividend of $0. using market values and calculated as debt/equity?     11 15. The nominal value of each ordinary share is $2. for-profit entity Public sector.

0% t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F What was the asset turnover for Oldbear in 20X4?     17 0. for profit entity Public sector.07 2.6% 5. What is Dan’s dividend payout ratio?     16 1.4 1: Business objectives 14 CIMA F3 Question Bank (2015 syllabus) Dewie’s current P/E ratio is 8 and it retains 75% of after-tax earnings.1% 6. What is the dividend yield of Dewie?     15 2.5% The accounting ratios for Oldbear for 20X4 included the following:    Gross profit margin 40% Operating profit margin 15% Return on capital employed 16. not for profit entity . What was the operating profit margin for Sydney Co in 20X6 to the nearest 0.0% 3.4% 40% 62. for profit entity Private sector.94 1.50 Sydney’s Return on capital employed for 20X6 was 25% and its asset turnover was 2. not for profit entity Public sector.1%? % 18 Achieving value for money is most likely to be the prime objective of a:     Private sector.0% 9.40 0.4% Dan’s current P/E ratio is 5 and its dividend yield is 8%.

$000 200 100 50 20 30% Revenue Cost of sales Other operating expenses Finance costs Tax rate 19 What is the operating profit margin and the margin of profit before tax to revenue?     20 What is the interest cover?     21 10 7.80) to $/€ 0. The € has appreciated and European buyers will find US goods to be cheaper. Post-tax earnings of RJ were $5. then:     24 Increase  The € has depreciated and European buyers will find US goods to be cheaper.5 5 2. The € has appreciated and European buyers will find US goods to be more expensive. The firm has high operating leverage. Variable and fixed costs are roughly equal.5 Co st I pyri ntu ght itio n2 015 Fir All other things being equal.2 million 4 years ago.CIMA F3 Question Bank (2015 syllabus) 1: Business objectives 5 Use the following data to answer the next two questions.01%? % . RJ has just announced post-tax earnings of $7. Variable costs are the highest proportion of its expenses.90).4 million. a firm’s sensitivity to swings in the business cycle is lowest when:     22 50%:25% 25%:15% 50%:15% 25%:10. The € has depreciated and European buyers will find US goods to be more expensive. What is the effect on the prices of German imports and exports when the Euro appreciates? Import prices Export prices 23 Decrease    If the $/€ exchange rate moves from $/€0. CS’s accounts for the year ended 31 December 20X5 included the following information. What is RJ’s compound annual growth rate in earnings to the nearest 0.5% The firm has a high beta factor.80 ($1 = €0.90 ($1 = €0.

The current spot rate of the $ to the £ is $/£ 0. What is the forecast forward rate of exchange to 4 decimal places in 1 year’s time using expectations theory? 28 The current €/$ exchange rate is 1. The current spot rate of the Krone to the Euro is Kr/€ 0.2000). 6% in Japan. Expected interest rates in Denmark and Europe for the next year are 3% and 5% respectively.000 in Japan in a year’s time. The Euro is expected to depreciate by 4% each year over the next few years. What is the expected exchange rate in 3 years’ time.2500 (€1 = $1.01%? % 26 HJ is based in Denmark where the functional currency is the Krone.6200 ($1 = £0.7000 (R1 = ¥9.30 0.7000) and interest rates over the next year are expected to be 4% in South Africa. What is the expected value of the purchases in Rand in a year’s time to the nearest R100? R .2500).1400 (Kr1 = €0. The current R/¥ exchange rate is 9.27 0.34 20X1 20X2 20X3 20X4 What is AW’s compound annual rate of dividend growth between 20X1 and 20X4 to the nearest 0.29 0. UK interest rates are expected to be 2% over the next few years.6 1: Business objectives 25 CIMA F3 Question Bank (2015 syllabus) AW has paid the following dividend per share in the last few years: $ 0. Expected interest rates in UK and the US for the next year are 2% and 4% respectively. to 4 decimal places? 29 The current £/Kr exchange is 9. to 4 decimal places? 30 RP is based in South Africa and is planning to make purchases of ¥600. RP is trying to estimate the foreign exchange rate in a year’s time so that it can estimate the likely expenditure in Rand.1400). What is the forecast forward rate of exchange to 4 decimal places in one year’s time using interest parity theory? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 27 KP is based in the USA.2000 (£1 = Kr9.6200). Danish interest rates are expected to be 5%. What is the expected exchange rate in 2 years’ time.

achieved between 20X6 and 20X9? % . Assume 360 days in the year. Yes.400.5% in the UK and 4% in Australia.000 and on 90 day credit terms. If all suppliers were to withdraw credit at the end of the year. The agreed overdraft facility is $1. purchases were also $5.000. the overdraft limit would be exceeded by $550.000 of the facility would still be available for withdrawal. Sales revenue (cash sales) Purchases (90 days credit) Other costs (settled immediately) $000 10. would the overdraft figure still be adequate?     34 Yes.8000 (£1 = Aus$ 1.000.01%.000. approximately $250. Interest rates over the next three months are expected to be 2. approximately $50. What is the expected value of the purchases in Aus$ in three months’ time to the nearest Aus$100? $ 32 Improving the welfare of beneficiaries is most likely to be the objective of:     33 A public sector organisation A private limited company A public limited company A charity NW has produced the following forecast data for the next year. NW has a current overdraft balance of $200. The following data has been taken from the annual accounts of CC.000 of the facility would still be available for withdrawal. Year ended Earnings ($m) Number of shares in issue 20X6 200 50 20X7 220 50 20X8 250 60 20X9 270 60 CC undertook a 1 for 5 rights issue on 2 January 20X8.000 Co st I pyri ntu ght itio n2 015 Fir In the previous year prior to the forecast. to the nearest 0. The current £/Aus$ exchange is 1. What is the compound average growth rate in earnings per share.000.8000) and the value of goods is £280.000 5. No.CIMA F3 Question Bank (2015 syllabus) 31 1: Business objectives 7 SS Co is based in Australia and is looking to buy goods in the UK in three months’ time. Sales and purchases will arise evenly over the year.400 4. Yes.000. the bank account would not be overdrawn.

including rural routes with few passengers.500 (400) 3.     36 Which of the following definitions is incorrect in relation to value for money?     37 The objectives of CH will be more difficult to define. Which of the following statements concerning the objectives of the two companies are true? Select ALL that apply. The following figures are taken from AK’s latest accounts. $000 5. Effectiveness means doing the right thing.     39 A reduction in the rate of inflation A rise in the level of government borrowing Government relaxing constraints on growth in the money supply Greater demand for borrowing from businesses AK has 1 million ordinary $0. Interest rates fall. The management of CH will have more impact over its objectives. LG is a publicly-listed coach company that runs routes between the major towns and cities in Larland. The level of service provided is more likely to be an objective of LG.50. The exchange rate of a company with high inflation falls against countries with lower inflation. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F  38 Which of the following would lead to an increase in the general level of interest rates? Select ALL that apply.100 Profit before tax Tax Profit after tax Dividend Retained profits What is the dividend yield of AK. Which of the following is not generally an effect of inflation?    Companies increase their level of inventory. Value for money means providing an economical. Efficiency means doing things as quickly as possible. Economy means seeking the minimum cost of inputs. CH will have to demonstrate value for money.500) 3. efficient and effective service. to the nearest %? % .50 shares in issue with a market price of $2. The level of uncertainty for companies increases.000 (1.8 1: Business objectives 35 CIMA F3 Question Bank (2015 syllabus) CH is a publicly-owned bus company which runs routes over many areas of Larland.

000 (500) 1. Profit before tax Tax Profit after tax Dividend Retained profits Co st I pyri ntu ght itio n2 015 Fir What is the earnings yield of KY. to the nearest %? % $000 2.CIMA F3 Question Bank (2015 syllabus) 40 1: Business objectives 9 Which of the following ratios would be least appropriate for comparing the profitability of two companies?     Price-earnings ratio Return on capital employed Return on shareholders’ funds Earnings per share 41 The current market price of SS’s shares is $2. What is the dividend cover to 2 decimal places? 42 KY has 4 million ordinary S1 shares in issue at a current market price of $1.50.40. SS has a dividend yield of 5% and the shares have a P/E ratio of 12. The following figures are taken from KY’s latest accounts.500 (600) 900 .

following Global Reporting Initiative guidelines. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F     46 Danl has recently won an important legal case in its home country. True  False    . Capitals in integrated reporting can be defined as resources and relationships Integrated reporting is part of sustainability reporting. Where would information about this case be disclosed in Danl’s integrated report?     47 Sustainability Clarity Completeness Comparability Social and relationship capitals Intellectual capitals Manufactured capitals Natural capitals Identify whether the following statements are true or false. environmental and social performance Increase quantity of information available to stakeholders Improve quality of information available to providers of financial capital Ensure consistency between the different reports that make up the annual report Which of the following are Principles for Defining Report Quality according to the Global Reporting Initiative? Select ALL that apply. enforcing its patent over its biggest selling product and preventing copies being made. Which of the following headings would appear in the General Standards section of the report?     44 Which of the following is an objective of Integrated Reporting.10 2 : S u s t a i n a b i l i t y a n d i n t e g r a t e d r e p o r t i n g CIMA F3 Question Bank (2015 syllabus) Chapter 2: Sustainability and integrated reporting 43 Fluted is preparing a sustainability report. according to the International integrated Reporting Council?     45 Stakeholder Engagement Employee Welfare Impact on Society Externalities Disclose economic.

CIMA F3 Question Bank (2015 syllabus)

48

A company has no obligation to state that it has omitted information.
If information is unavailable, no disclosure is required.
Information can be omitted if it is subject to confidentiality constraints.
If information is omitted due to legal restrictions, the company does not need to explain
what has happened.

Which of the following is not a principle for defining report content under the Global Reporting
Initiative?



50

11

VV has adopted the Global Reporting Initiative and issued an annual sustainability report in
accordance with the guidelines. Which of the following statements relating to incomplete
disclosure is correct?



49

2: Sustainability and integrated reporting

Materiality
Completeness
Accuracy
Stakeholder inclusiveness

Which of the following is not a category under the Specific Standard Disclosures in the Global
Reporting Initiative guidance?



Economic
Ethical
Social
Environmental

Co
st I pyri
ntu ght
itio
n2
015

Fir

12 3 : F i n a n c i a l s t r a t e g y

CIMA F3 Question Bank (2015 syllabus)

Chapter 3: Financial strategy
51

52

Would either or both of the following actions increase the wealth of shareholders in an allequity financed company?
Paying out a dividend

Yes

No

Making a bonus issue

Would either or both of the following actions increase the wealth of shareholders in a currently
all-equity financed company?
Raising new equity finance
Raising new debt finance

53

Yes

No

Which of the following are generally objectives of regulatory bodies? Select ALL that apply.



Promotion of social objectives
Promotion of relationships with stakeholders
Protection of customers from full competition
Protection of customers from monopoly power

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F
54

AJ has an A credit rating from a credit rating agency, while BF has a BB credit rating.
Will BF find it easier or harder to raise debt finance than AJ and is the rate of interest that BF is
pays likely to be higher or lower than that paid by AJ?




55

Which of the following are valid reasons for holding cash? Select ALL that apply.





56

Easier Higher
Easier Lower
Harder Higher
Harder Lower

Meet future needs
Maintain sufficient balances to be able to complete day-to-day transactions
Maintain gearing levels
Take advantage of opportunities in short-term financial markets

Oldted has $2 million net assets. Oldted is all equity-financed, and its earnings before interest and
tax are $400,000. If Oldted changes its capital structure so that its current level of net assets is
financed by 75% equity, 25% debt, what is the return on equity before and after the change?
The tax rate is 20% and the interest rate on debt is 8%.



100% equity - 20%, 75% equity - 24%
100% equity - 20%, 75% equity - 12.6%
100% equity - 16%, 75% equity - 24%
100% equity - 16%, 75% equity - 19.2%

CIMA F3 Question Bank (2015 syllabus)

57

3: Financial strategy

13

Pipshirl has the following objectives:

Achieve an annual dividend growth rate of at least 8% per annum
Keep gearing (debt to equity, measured in market value) below 50%

In the last 4 years the dividend paid by Pipshirl has increased from $0.8 million to $1.1 million.
Pipshirl has 5 million $2 shares currently trading at $2.62 and $6 million of bonds with a current
market value of $115 per cent.
Which of the objects has Pipshirl achieved?




58

Which of the following strategies are likely to enhance shareholder wealth? Select ALL that
apply.



59

Neither objective
Both objectives
The dividend objective only
The gearing objective only

Paying a constant dividend
Making directors’ remuneration partly dependent on increases in share price
Investing in projects with a positive net present value
Purchasing shareholders’ shares with surplus cash

Co
st I pyri
ntu ght
itio
n2
015

Fir

AA has been generally successful in the last few years, although its cash flows have varied
considerably over time, following no clear pattern.

Which of the following may be motives why AA would wish to hold surplus cash? Select ALL that
apply.




60

Which of the following payments could be made as an earn-out arrangement?



61

Income
Transaction
Precautionary
Hedging

Golden handcuffs for directors
Share options for directors
Incentive payments for staff
Consideration for the sale of a business

A small, recently-established, private company requires funding for a long-term investment and
does not wish to take out bank loan finance.
Which of the following sources of finance is most likely to be suitable?



Commercial paper
Eurobond
Funds already generated from operations
New equity subscribed by the directors

000 Debit statement of profit or loss loss of $10. The hedge is expected to be at least 90% effective. what is the accounting entry at 31 December 20X5 to reflect the change in the value of the oil?     Credit statement of profit or loss gain of $10. IFRS 9 thereafter Counterparty risk for a forward contract can be avoided by trading on a recognised exchange. To reduce market risk. At JB Energy’s year-end on 31 December 20X4. futures contracts must be closed out at the due date. The hedging requirement satisfies the requirement for offset in IAS 39 Financial Instruments: Recognition and Measurement.000 Debit statement of other comprehensive income loss of $10. It has partly funded an investment of $100 million in the USA with a loan of $80 million taken out on 1 April 20X4.6000) and the £/$ exchange rate on 31 March 20X5 was 1.6500.000 barrels of oil at $250. IFRS 9 thereafter IFRS 7 up to 31 December 2017.000 on 31 March 20X5.1%? % t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 64 The directors of Tomcat are considering investing in a foreign subsidiary. the market value of oil was $42 per barrel and the futures price was $52 per barrel.14 4 : H e d g e a c c o u n t i n g CIMA F3 Question Bank (2015 syllabus) Chapter 4: Hedge accounting 62 Which of the following is not a condition that must exist for hedge accounting to be permitted for a cash flow hedge under IAS 39 Financial Instruments: Recognition and Measurement?     63 The effectiveness of the hedge can be reliably measured.000 barrels of oil that cost $200. Futures contract terms can always be tailored to the purchaser’s exact requirement. JB Energy owns 5. on 31 March 20X5 . Pravtank is a UK company. The £/$ exchange rate on 1 April 20X4 was 1. JB Energy took out futures contracts to sell 5. funding the investment with a foreign currency loan and using hedge accounting.000 No entry should be made until the date the contract is due to be closed out. Under the hedge accounting rules of IAS 39 Financial Instruments: Recognition and Measurement. What standard will apply to this arrangement?     65 Which of the following statements futures and forwards contracts is true?     66 IAS 39 whenever the hedge is set up IFRS 7 whenever the hedge is set up IAS 39 up to 31 December 2017. What is the effectiveness of the net investment hedge at 31 March 20X5 to the nearest 0.000 on 1 January 20X4.6000 (£1 = $1. Futures contracts require a margin deposit. The forecast transaction that is the subject of the hedge must be highly likely to occur. The hedge is assessed on an ongoing basis. Once entered.

It took out a forward contract to hedge this transaction. liability or firm commitment that is attributable to a particular risk and could affect profit or loss Which of the following should a company that sells in its home country and overseas and also sources its supplies from its home country and overseas consider disclosing under IFRS 7 Financial Instruments: Disclosures? Select ALL that apply.500 due to movements in the spot rate. two months before the order was due to be delivered. On NA’s year-end date. 70 What profit or loss figure would be shown in NA’s accounts for the year ended 31 December 20X2 in respect of the export contract plus forward contract if hedge accounting was not used (show a loss as a negative number using a minus sign (─))? $ 71 15 Which of the following could be the subject of a fair value hedge? Select ALL that apply.000 in its local currency.      69 Management of political risk affecting the value of overseas operation Maximum exposure to credit risk Management of liquidity risk Maturity analysis of financial liabilities Sensitivity analysis to currency risk Which of the following would not need to be disclosed under IFRS 7 Financial Instruments: Disclosures by a company that trades and sources all of its supplies in its home country and has a mix of equity and debt finance?     Co st I pyri ntu ght itio n2 015 Fir Sensitivity analysis to interest rate risk Information about financial assets that are overdue Details of how customers are credit checked Exposure to losses of goods in transit Use the following information to answer the next two questions. 31 December 20X2. The forward contract had been revalued and its value had fallen by $500. NA accepted an export order on which it expected to make a profit of $5.      68 4: Hedge accounting What profit or loss figure would be shown in NA’s accounts for the year ended 31 December 20X2 in respect of the export contract plus forward contract if cash flow hedge accounting was used (show a loss as a negative number using a minus sign (─))? $ . its Finance Director calculated that the expected profit on the contract was $4.CIMA F3 Question Bank (2015 syllabus) 67 Net investment in a foreign operation Changes in the value of assets or liabilities Variability in cash flows Unrecognised firm commitment Identified part of an asset.

16 4 : H e d g e a c c o u n t i n g 72 CIMA F3 Question Bank (2015 syllabus) Complete the sentence below by placing one of the following options in each of the spaces. both the investment and the borrowing must be translated at rate at each year end and gains or losses on both items should be offset in t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F . Average Closing Historic Profit or Loss Other Comprehensive Income If a business is using hedge accounting in relation to a net investment in a foreign operation. .

00 $3. $ 77 PM has 3 million $0. The rate of return on existing funds is 8%. What is the theoretical ex-rights price of the shares following the issue?     74 HF has 3 million $1 ordinary shares in issue with a current market price of $3 per share.80 $4.01. It decides to make a 1 for 5 rights issue at $3.40 per share.35 per share. but the rate of return on the new funds is expected to be 10%.75 ordinary shares in issue with a current market price of $1.40 $0.60 per share. $ 78 LW has 4 million $1 ordinary shares in issue with a current market price of $4. What is the value of a right per new share?     75 $2.40.00 $0.80.01. Calculate the yield adjusted theoretical ex-rights price to the nearest $0.56 $0.45 $0. Calculate the theoretical ex-rights price of the shares following the issue to the nearest $0. It decides to make a 1 for 4 rights issue at $3.32 per share.40. $ .01.CIMA F3 Question Bank (2015 syllabus) 5: Equity finance 17 Chapter 5: Equity finance 73 SO has 4 million $1 ordinary shares in issue with a current market price of $4 per share.50 ordinary shares in issue with a current market price of $0. It decides to make a 2 for 5 rights issue at $3. Calculate the value of a right per new share to the nearest $0. It decides to make a 1 for 4 rights issue at $0. It decides to make a 1 for 3 rights issue at $2.50 $3.15 HD has 5 million $0. It decides to make a 1 for 4 rights issue at $0.60 $0.58 Co st I pyri ntu ght itio n2 015 Fir AL has 4 million $1 ordinary shares in issue with a current market price of $5 per share.40 $0. but the rate of return on the new funds is expected to be 7%.50 $0. The rate of return on existing funds is 5%. What is the yield adjusted theoretical ex-rights price?     76 $3.80.

00 $3. the total value of a company’s ordinary shares is likely to fall. The cum-rights price is $4. How much would Helen have to pay BS for her new shares?     81 $300. Which of the following rankings of prices is most valid? (Note: the symbol '<' below means 'is less than')     Ex rights < Cum rights < Issue price Ex rights < Issue price < Cum rights Cum rights < Ex rights < Issue price Issue price < Ex rights < Cum rights t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 82 A company currently has 10 million $1 shares in issue with a market value of $3 per share.000 $7. The theoretical ex-rights price is:     84 $2.80.000.20 Identify whether the following statements are True or False.   Following a rights issue.00 $100. $ 80 BS has 10 million ordinary shares in issue with a nominal value of $1 and a market value of $3. Helen holds 100 shares in the company. The company wishes to raise new funds using a 1 for 4 rights issue.80 $3.000 $5.50 per share. If the theoretical ex-rights price per share turns out to be $2.000.500.00 $240.50 $2.000.18 5 : E q u i t y f i n a n c e 79 CIMA F3 Question Bank (2015 syllabus) AS has 5 million $0.00 $Nil A listed company makes a rights issue.01. It decides to make a 1 for 4 rights issue at a 20% discount on current market price. True False Following a rights issue.000 $4. how much new finance was raised?     83 A company makes a 2 for 3 rights issue at an issue price of $2. a company’s share price is likely to fall. BS is intending to make a one-for-four scrip issue. Calculate the theoretical ex-rights price of the shares following the issue to the nearest $0.50 ordinary shares in issue with a current market price of $1.   .000 $2.

because of greater about their return and variability of their return.000. The theoretical ex-rights price is $7 per share. It proposes to make a 1 for 4 rights issue at a 30% discount. Calculate the proceeds from the rights issue. Share capital will increase by $500.000 shares at a nominal value of $2 and a market value of $3. Share capital will increase by $750.000. reserves will decrease by $750. TS is proposing to make a 1 for 4 bonus issue. Greater Smaller Uncertainty Certainty The providers of equity finance face risk than the providers of debt finance.50. $ . reserves will be unchanged. Share capital will increase by $750.000. As a result Co st I pyri ntu ght itio n2 015 Fir providers of equity finance will require a level of return on their investment than providers of debt. What will be the effect of the issue on the share capital and reserves figures in the statement of financial position?     88 Share capital will increase by $500. reserves will decrease by $500. The cum-rights price is $8 per share. reserves will be unchanged. 87 TS has 1 million ordinary shares in issue with a nominal value of $2 and a market value of $3.CIMA F3 Question Bank (2015 syllabus) 85 5: Equity finance 19 A company makes a rights issue at an issue price of $5 per share.000. XX has 200. What were the terms of the rights issue?     86 1 for 3 3 for 1 1 for 2 2 for 1 Complete the sentence below by placing one of the following options in each of the spaces.000.000.

what is the cost of equity for AE?     92 2. The net dividend for the year was 3c and 15% annual growth is expected for dividend payments for the foreseeable future.400 3.60 3. a weighted average cost of capital of 8% and a debt: equity ratio of 1:2. and the dividend for the previous year has very recently been paid. QQ has received the following tenders. Using the dividend growth model. What is its cost of equity?     3% 7% 9. Number of shares applied for at price 000 500 800 1.90 3.1m? $ m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 90 JS has recently undertaken a 2 for 5 rights issue.200 1.3% A company has a cost of debt of 5%.0% 17.00 3.900 $ 4.700 2.300 9.50 QQ has decided to issue 4 million shares and that partial acceptance would mean allotting to each of the applicants an equal proportion of shares for which they have applied.70 3.80 3.01? $ 91 The ordinary share price of AE is currently 150c. What is the theoretical market value of a right to the nearest $0. Its share price fell by $0. Dividends are paid once a year.0% 17.5% 14% .4% 15.30 as a result.20 5 : E q u i t y f i n a n c e 89 CIMA F3 Question Bank (2015 syllabus) QQ has just achieved a stock market listing and is making a public issue of shares by an offer for tender. How much money will QQ raise from the issue to the nearest $0.

Calculate the cost of equity using the dividend model to the nearest 0. % 97 The equity shares of SH are quoted at $4. True False An increase in the dividend growth rate would result in a lower share price. If a realistic cost of equity is to be calculated.   Complete the sentences below by placing one of the following options in each of the spaces. SH aims to pay a constant dividend each year. % . the should be used in the calculation.8% 14% Examine the validity of each of the following statements with respect to the dividend valuation model. It expects to earn a rate of return of 14% on capital employed.1%. what would the rate of earnings growth be in future? Ignore tax.00 ex div with a dividend of 50 cents per share that has just been paid. For each $1 of earnings.70 cum div with a dividend of 40 cents per share that is due to be paid. Each statement should be considered separately and in each case all other factors stay constant.     94 95 4.1%. The equity shares of LH are quoted at $4. Fir Cop st I yri ntu ght itio n2 015 Dividends paid Retained profit adjusted for dividends Nominal Market Current dividend Dividend expected next year If dividends are expected to grow.CIMA F3 Question Bank (2015 syllabus) 93 5: Equity finance 21 ZZ is all equity financed. it consistently pays 30c in dividend and retains 70c for reinvestment. Calculate the cost of equity using the dividend model to the nearest 0. it is necessary to know the 96 value of shares. According to the Gordon Growth Model.2% 7% 9.   An increase in the cost of equity would result in a lower share price. The expected growth rate of dividends is 4% per year.

22 5 : E q u i t y f i n a n c e
98

CIMA F3 Question Bank (2015 syllabus)

The equity shares of MW are quoted at $9.40 ex div. The directors wish to pay a dividend of
$1.20 per share in one year’s time and maintain an expected growth rate of dividends of 4%.
Calculate the cost of equity using the dividend model to the nearest 0.1%.
%

99

The equity shares of RC are quoted at $4.20 cum div, with a dividend of $0.20 per share about
to be paid. RC’s return on capital employed is 40% and the directors aim to retain 30% of aftertax earnings in the business.
Calculate the cost of equity, using the dividend model, to the nearest 0.1%.
%

100

The equity shares of RW are quoted at $2.60 ex div, with RW having just paid a dividend of
$0.20 per share. RW’s return on capital employed is 10% and the directors aim to pay 40% of
earnings after tax each year as dividend.
Calculate the cost of equity, using the dividend model, to the nearest 0.1%.
%

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F
101

The equity shares of JP are quoted at $10.30 ex div, with JP having just paid a dividend of $0.45
per share. Details of JP’s dividend payments over the last few years are as follows:
$ per share

20X5

0.28

20X6

0.34

20X7

0.39

20X8 (current year)

0.45

Calculate the cost of equity, using the dividend model, to the nearest 0.1%.
%

102

The $2 preferred shares of JH are quoted at $2.50 ex div, with JH having just paid a dividend of
5% of the nominal value of the shares.
Calculate the cost of the preferred shares to the nearest 0.1%.
%

103

YM has just paid a dividend of $0.60 per share, with dividends expected to grow at 8%. YH’s cost
of equity is 12%.
Calculate the market value per share of YM’s shares to the nearest $0.01.
$

CIMA F3 Question Bank (2015 syllabus)

104

5: Equity finance

23

AS has 5 million $1 ordinary shares and 1 million 7% $1 preferred shares currently in issue.
The ordinary shares are currently trading at $1.20 cum div and the preferred shares are
currently trading at $1.12 cum div. The expected dividend growth rate is 9%.
Calculate the cost of the preferred shares to the nearest 0.1%.
%

.

105

Which of the following statements are correct if a company’s cost of equity capital falls? Select
ALL that apply.



106

The weighted cost of capital would increase.
The cost of debt capital would not change.
The share price would go up.
More investment projects would be worth undertaking.

The price of a company’s shares is currently $8 and the latest dividend is $1.25. The cost of
equity is 18%.
Calculate the dividend growth rate to the nearest 0.1%.
%

107

Co
st I pyri
ntu ght
itio
n2
015

Fir

TF plans to pay a dividend next year of $0.80 per share, with dividends expected to grow at 7%
in subsequent years. TF’s cost of equity is 11%.
Calculate the market value per share of TF’s shares.
$

108

The equity shares of CJ are quoted at $6.00 cum div with a dividend of $1 per share that is
about to be paid. However because CJ is expecting to make some major investments in the next
years, dividends are expected to fall by 5% per annum for the foreseeable future.
Calculate the cost of equity using the dividend model to the nearest 0.1%.
%

109

The Stock Exchange may grant a quotation where shares in a large company are already widely
held, so that a market can be seen to exist. No shares are made available to the market. What is
this process called?



Placing
Introduction
Share split
Bonus issue

24 5 : E q u i t y f i n a n c e
110

An arrangement where most of the shares in a share issue are bought by a small number of
institutional investors is known as:



111

Introduction
Offer for sale
Underwriting arrangement
Placing

Which of the following reasons is the least likely reason for seeking a stock market listing?



112

CIMA F3 Question Bank (2015 syllabus)

Enhancing the existing shareholders’ control over the company
Making the shares more marketable
Improving the company’s image
Attracting a wider range of investors

JP obtained a stock market listing six months ago and offered its shares to investors by an offer
for sale. Not all the shares were purchased by the public. The unsold shares were purchased by
a number of financial institutions under an agreement with JP.
This type of arrangement is known as:



Placing
Tender offer
Underwriting
Introduction

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F
113

The current annual risk-free rate of return is 6% and the required annual rate of return on a
security with a beta of 1.2 is 15.6%. Using the capital asset pricing model, what is the required
annual rate of return on the market portfolio?




114

11.52%
13.00%
14.00%
17.52%

SB has a published equity beta of 1.4. The expected return on three-month Treasury bills is 6%.
The expected return on the market is 11%.
The cost of equity for SB may be estimated as:



11%
12.4%
13%
15.4%

0% 13.0% 13. The risk-free rate is 3% and the excess return on the market is 8%.4. Primary trade on an initial offering and Co st I pyri ntu ght itio n2 015 Fir Secondary Primary and secondary markets are where shares and bonds markets are where shares and bonds trade after their initial offering. The cost of equity for TT may be estimated as:     117 10.0% 16.5% Complete the sentence below by placing one of the following options in each of the spaces. the beta of company X's shares is 1.5% 12.CIMA F3 Question Bank (2015 syllabus) 115 5: Equity finance 25 Using the capital asset pricing model (CAPM). but is concerned that the share offering will not be fully taken up.5. To whom should VB go to make arrangements to ensure that all the shares are taken up?     119 A merchant bank The stock exchange A stockbroker An underwriter Which of the following are reasons for discounting a rights issue? Select ALL that apply. the risk free rate is 5% and the required return of company X's shares is 16. Company Y is quoted in the same stock market.6.2% 14. What is the required rate of return on company Y's shares?     116 12.0% 15. 118 VB is considering an initial public offering of shares.2%.8% TT has a published equity beta of 1.     Maintain control by existing shareholders Make the shares attractive to existing shareholders Safeguard against a fall in the market value during the offer period Maximise revenue from the issue . but has a beta of 1.

HG is financed by equity of 2 million $1 ordinary shares.49 million. The share issue will be priced at a 10% discount to the current share price.26 5 : E q u i t y f i n a n c e 120 CIMA F3 Question Bank (2015 syllabus) Complete the sentence below by placing one of the following options in each of the spaces.01.66 million and give a positive net present value of $1. comprising 5 million ordinary $1 shares at a current market price of $2. to the nearest 0.4 million and give a positive NPV of $8 million.50 per share. The directors are concerned that current shareholders will object to the issue. at what price should new shares be issued if all the gains from them are to go to existing shareholders? $ 124 NX is financed entirely by equity. The issue will be priced at a 5% discount to the current market price. what will be the total gain per share for new shareholders? $ 123 WD wishes to invest $10 million in a project with a positive net present value of $6 million. using a new issue of shares to finance the project. NX is planning to make a share issue to the general public in order to raise funds to invest in a new project that will cost $5. HG is planning to make a share issue to the general public in order to raise funds to invest in a new project that will cost $2.01. Nominal Market Less than The same as Greater than A company is financed entirely by equity. as it will dilute the value of their shareholding. To the nearest $0. Funds for the new project will be raised entirely from new investors. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 121 To the nearest $. WD is financed by 20 million $1 shares with a market value of $4. what will be the total gain accruing to existing shareholders? $ 122 To the nearest $0.1%? % . What percentage of the gain from this project will go to existing shareholders.00 per share. In order to ensure that the current shareholders gain all the benefits of the new project. It is about to invest in a project with a positive net present value. Use the following information to answer the next two questions. The current market value is $4 per share. the issue price of each share must be the value of each share.

30 2.30. Under the rights issue 2 million new shares will be issued at $2. Partial acceptance would mean allotting to each of the applicants an equal proportion of shares for which they have applied.00 to $2.000 each year. 30m @ $2.20 2. Complete the sentence below by placing one of the following options in each of the spaces.00 2.01 after the rights issue has taken place and the project has generated the forecast earnings? $ 126 TV offered 50 million shares to the public by tender offer.20.20 50m @ $2. They expect earnings to increase by $200.88.20 50m @ $2.50 127 Co st I pyri ntu ght itio n2 015 Fir How will the shares be allocated?     Number of share bids received at price m 5 15 35 40 30 15 5m @ $2. Better off than Worse off than In the same position as Assuming an efficient market. The day after the rights issue KL had 10 million $1 shares in issue at a market price (cum rights) of $3. what is the expected earnings per share to the nearest $0. currently trading at $1. TD’s price/earnings ratio is 7. Interested parties were invited to bid for the shares in the range of $2.40.CIMA F3 Question Bank (2015 syllabus) 125 5: Equity finance 27 The directors of TD are considering raising finance of $1 million to fund a new investment.40 2. 15m @ $2.50.30 5m @ $2.00 and a theoretical ex-rights price of $2. TD has 5 million $1 shares. Any shareholder who does not wish to take up their rights will be able to sell them to the company at $0.5.10 2. 15m @ $2. . The results of the tender were as follows: Price offered $ 2. The investment has a return equal to KL’s weighted average cost of capital. If TD uses a 1 for 4 rights issue to fund the investment.50 KL wishes to raise $10 million from a rights issue to finance a new investment.40 on the basis of 1 new share for every 4 shares held. shareholders who take up their rights can expect to be financially shareholders who sell their rights to the company. 30m @ $2.00.10.12 for each share held.

Calculate the market value per share of YH’s shares to the nearest $0. the level of portfolio risk .01.5 1 -1 . $ t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 130 LY is to undertake a $50 million rights issue to raise funds for a new investment. Falls initially and then levels off Continues to fall Rises initially and then levels off Continues to rise Stays constant As the number of shares held increases. YH has just announced a 1 for 3 rights issue at a discount of 20% to the current share price to finance a project that has a yield of 12. YH’s cost of equity is 15%.01.5%.28 5 : E q u i t y f i n a n c e 128 CIMA F3 Question Bank (2015 syllabus) Complete the sentence below by placing one of the following options in each of the spaces. 200 million $0. $ 132 A portfolio consisting of entirely of risk-free securities will have a beta factor of:     0 0. with dividends expected to grow at 12%.80. and a current market price of $0. Calculate the yield adjusted theoretical ex-rights price to the nearest $0. the level of unsystematic risk and the level of systematic risk . Which of the following would not be affected by the amount of discount on current share price at which the shares are issued?     131 Number of shares issued Earnings per share Share premium account Amount raised YH is just about to pay a dividend of $0.50 per share.25 shares in issue. 129 YH currently has a WACC of 10%.

CIMA F3 Question Bank (2015 syllabus)

133

5: Equity finance

29

NM’s current post-tax earnings per share are $3.5 million and it has 5 million $0.50 shares in
issue. The current market price per share is $2.00. The directors are considering a project that
will increase pre-tax earnings by $1 million. The project will cost $2 million and be funded by a
rights issue at a 20% discount to the current market price.
Calculate the increase in earnings per share to the nearest $0.01 if the investment is
undertaken.
$

134

Anna has recently invested $50,000. $20,000 of this investment was in DS with an expected
return of 6%, $18,000 was in RL with an expected return of 8% and $12,000 was in a risk-free
asset with an expected return of 2%.
Calculate, to the nearest 0.01%, the expected return on Anna’s portfolio.
%

Co
st I pyri
ntu ght
itio
n2
015

Fir

30 6 : D e b t f i n a n c e

CIMA F3 Question Bank (2015 syllabus)

Chapter 6: Debt finance
135

HO has made an issue of 6% convertible loan stock with a par value of $100. The stock can be
redeemed in four years’ time at $129, or converted into shares at the rate of 30 shares per $100
loan stock.
Calculate, to the nearest $0.01, the share price at which an investor would be indifferent
between conversion and redemption.
$

136

Which one of the following lists of securities is ranged in order of increasing risk to the investor
(commencing with the lowest risk)?



137

Warrant; unsecured loan; preferred share
Unsecured loan; preferred share; warrant
Preferred share; unsecured loan; warrant
Warrant; preferred share; unsecured loan

The redemption yield on a redeemable bond can be defined (ignoring tax) as

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F


138

The annual interest payment divided by the nominal value of the bond
The annual interest payment divided by the market value of the bond
The rate of interest at which the total discounted value of future interest payments and
capital repayments is equal to the current market value of the bond
The rate of interest at which the total discounted value of future interest payments is
equal to the current market value of the bond

A bond has a coupon rate of 6% per annum and will repay its face value of $100 on its maturity
in four years’ time. The yield to maturity on similar bonds is 4% per annum. The annual interest
has just been paid for the current year.

Calculate the expected market value of the bond at today’s date to the nearest $.

$

139

A $100 bond has a coupon rate of 8% per annum and is due to mature in four years’ time. The
next interest payment is due in one year’s time. Similar bonds have a yield to maturity of 10%.
Calculate the expected purchase price of the bond at today’s date to the nearest $.
$

140

A $100 bond has a yield-to-maturity of 6% per annum and is due to mature in three years’ time.
The next interest payment is due in one year’s time. Today’s market value of the bond is
$108.06.
Calculate the coupon rate on the bond to the nearest %.
%

CIMA F3 Question Bank (2015 syllabus)

141

6: Debt finance

31

An investor is considering purchasing a bond with a par value of $100 and a coupon rate of 8%
payable annually. The bond is redeemable at par in six years’ time. Bonds with the same level of
risk have a yield to maturity of 7%.
Calculate the price the investor should pay for the bond to the nearest $ if the first interest
payment will be paid one year after the date of purchase.
$

142

A bond has a coupon rate of 8% and will repay its nominal value of $100 when it matures after
four years.
The bond will be purchased today for $103 ex-interest and held until maturity.
The current tax rate is 25%, with tax savings occurring in the same year that the interest
payments arise.
Calculate, to the nearest 0.1%, the post-tax cost of debt of the bond.
%

143

An unquoted bond has a coupon rate of 6% per annum and will repay its face value of $100 on
its maturity in 4 years’ time. The yield to maturity on similar bonds is estimated to be 3% per
annum. The annual interest has just been paid for the current year.

Co
st I pyri
ntu ght
itio
n2
015

Fir

Calculate the current expected market value of the bond to the nearest $.
$
144

A $1,000 bond has a coupon rate of 10% per annum and will repay its face value in 5 years’
time. Similar bonds have a yield to maturity of 8% per annum.
Calculate the current expected market value of the bond to the nearest $.
$

145

A $1,000 bond has a coupon rate of 8% and will repay its nominal value when it matures in
4 years’ time.
The bond will be purchased today for $900 ex interest and held until maturity.
Calculate, to the nearest 0.1%, the yield to maturity for the bond based on today’s purchase
price.
%

146

DK is considering investing in government bonds. The current price of a $100 bond with 10
years to maturity is $88. The bonds have a coupon rate of 6% and repay face value of $100 at
the end of the 10 years.
Calculate the cost of debt of the government bond to the nearest 0.1%.
%

1% % .80. Calculate the post-tax cost of the debt to the nearest 0. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Calculate the post-tax cost of the convertible securities to the nearest 0. The market value of the bonds after the recent payment of interest is $110 per $100 nominal. The bonds will be convertible into $0. Calculate the post-tax cost of debt for JS to the nearest 0. The tax rate is 30%.50 equity shares in five years’ time. % 149 JL has $10 million 8% convertible bonds in issue. The bonds are currently trading at $105 per $100 nominal. The shares are expected to have a market price of $6. The current market value of the bonds after the payment of interest in the last few days is $95 per $100 nominal. and all bondholders are expected to convert their bonds. The current market value of the debt is $1. % 148 NE has $5 million 5% convertible bonds in issue. The bonds will be convertible into $1 equity shares in three years’ time. at the rate of one share per $4 bond. but the market price is expected to have risen by 50% by the time conversion takes place.1%.22 million.1%. % 150 JS has in issue $200 million of long-dated bonds issued at par and paying a coupon rate of 11%. Calculate the cost of the convertible securities to the nearest 0. with tax savings occurring in the same year that the interest payments arise. The tax rate is 20%. at the rate of one share per $5 bond.50 each when conversion takes place.1%. The tax rate is 30%. All bondholders are expected to convert their bonds. The current market price of the shares is $2.32 6 : D e b t f i n a n c e 147 CIMA F3 Question Bank (2015 syllabus) PG has issued $1 million of irredeemable debt having an annual rate of interest of 9%.

$000 100 40 Operating profit Interest payable 60 18 42 Profit before tax Corporation tax (30%) Profit after tax The directors of SD estimate that the additional purchase of new equipment on 1 July 20X0 for $140.460 ($1. The lease has a primary period which covers all or most of the useful economic life of the asset.000 in five years' time. it can be leased for ten payments of $18.66 0.000 payable immediately. If the asset is purchased it would be paid for in cash on the day the asset is acquired. The same asset can be leased for a period of five years with rentals of $25. Ignore taxation.51 $990 $10. What would the projected interest cover for the company become if the directors purchased the new machine?     152 Which of the following is not true for a financial lease?     153 Co st I pyri ntu ght itio n2 015 Fir The lessee receives capital allowances for the asset. Alternatively.960) ($11. The lessee is responsible for servicing and maintenance of the asset.94 2.000. The asset is returned to the lessor at the end of the lease period.CIMA F3 Question Bank (2015 syllabus) 151 6: Debt finance 33 The projected profit or loss account of SD for the year to 30 June 20X1 shows the following figures.000 would increase the projected profit for the year by $18.000 per annum payable each year in advance. then leases it to the user on the above terms if it applies an annual discount rate of 10%? (Ignore tax. The machine would be financed by a loan raised on 1 July 20X0 with a coupon rate of 5%. The asset has a ten-year life with a zero residual value. It can be purchased for $120. What is the net present value (to the nearest $10) to the lessor company if it purchases the machine. Calculate whether the asset should be  Select an option from the drop down box: Option 1 Purchased Option 2 Leased . Its disposal value is expected to be $10.000. The cost of purchasing a machine is $100. The cost of capital is 10% per annum.440) A company’s Financial Director is deciding whether to purchase or lease an asset. The lessee records the leased asset as a non-current asset in statement of financial position.)     154 0.000 payable annually in advance.13 2.

The required rate of return is 10% per annum. it can be leased for five payments of $10. Calculate whether the asset should be  Select an option from the drop down box: Option 1 Purchased Option 2 Leased 156 A company is considering whether to buy an asset that has a 10-year economic life with a zero residual value. with a residual value of $10. Ignore taxation. The cost of capital is 10% per annum.000 per annum payable annually in arrears.34 6 : D e b t f i n a n c e 155 CIMA F3 Question Bank (2015 syllabus) A company’s Financial Director is deciding whether to purchase or lease an asset.000 after five years.000 payable immediately. Alternatively. the first one being payable immediately. It can be purchased for $51. It can be purchased for $80. The required rate of return is 10% per annum.000 per annum payable annually in advance. The company’s cost of capital is 10%.000 payable immediately.000. the asset will remain the property of the lessor and will be returned at the end of the five-year contract.000 after five years. It can be leased for six annual rentals of $20. Alternatively. It can be purchased for $81. and the asset will be handed back to the lessor at the end of this five-year contract. If the asset is purchased it would be paid for in cash on the day the asset is acquired.000. Alternatively. Calculate whether the asset should be  t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Select an option from the drop down box: Option 1 Purchased Option 2 Leased 157 A company is considering whether to buy an asset that has a five-year economic life. and will have a residual value of $40. payable immediately. The asset has a five-year life. Ignore taxation. it can be leased for 10 lease rentals of $12. it can be leased for five lease rentals of $14. Calculate whether the asset should be  Select an option from the drop down box: Option 1 Purchased Option 2 Leased 158 A company’s Finance Director is considering whether the company should purchase a machine for $100.000 after five years. Calculate whether the asset should be  Select an option from the drop down box: Option 1 Purchased Option 2 Leased . Ignore taxation. If leased.000 and will have a residual value of $20.000 per annum payable each year in arrears.

The market rate of interest has increased. Interest is allowable for tax purposes. The share price is $2.80 and it is expected to grow by 5% per annum. the first being payable in two years’ time. Calculate whether the asset should be  Select an option from the drop down box: Option 1 Purchased Option 2 Leased 160 The interest rate risk of a bond is:     161 The market yield of CD’s bonds is 9%. but its cost of debt is 7%. Bondholders have the option of converting each bond to 32 shares or receiving $100 cash on the redemption date. subordinated debtholders will be paid before senior debtholders. At what date would conversion be worthwhile?     163 31 December 20X3 31 December 20X4 31 December 20X5 31 December 20X6 Which of the following statements regarding subordinated debt are correct? Select ALL that apply. . Today’s date is 1 January 20X3. RR issued convertible bonds five years ago. In the case of default. subordinated debtholders will be paid before shareholders. In the case of default.000. with a zero residual value. the cost of debt does not.     Subordinated debt has a higher ranking than senior debt. payable immediately. In the case of default. It can be leased for five annual rentals of $14. The company’s cost of capital is 10%. subordinated debtholders will be paid after statutory creditors. What is the most likely reason for this difference?     162 The risk that interest will not be paid in a particular year The risk of bankruptcy due to changes in interest rates The risk of changes in a bond’s return due to changes in interest rates over time The risk that the bondholder is passing up the chance of an investment with a higher return by investing in the bond Co st I pyri ntu ght itio n2 015 Fir The cost of issuing new debt has become more expensive.CIMA F3 Question Bank (2015 syllabus) 159 6: Debt finance 35 A company’s Finance Director is considering whether the company should purchase a machine for $48. The market yield reflects market expectations of future value.500.

what is the tax relief on the interest paid in Year 2? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F $ Use the following information to answer the next two questions LW is looking to acquire new equipment. The life of the equipment is expected to be three years.000 per annum payable in arrears. LW can borrow from its bank at 12% per annum. Using the sum of the digits method. ST is considering a lease arrangement where the lessor will charge $132. If the equipment is leased.000 to purchase.000 per annum in arrears for five years. Tax at 25% is payable one year in arrears. using the sum of the digits method? $ 166 RC is considering acquiring an asset that will cost $350. what is the present value of the purchase option? $ 168 To the nearest $000. what is the present value of the lease option? $ 169 Which of the following are advantages of using an interest rate swap? Select ALL that apply.000 to purchase. Tax relief at 25% is available on the interest elements of lease payments in the year that they are made. 167 To the nearest $000. If purchased. the lease charge will be $40. A balancing allowance or charge will be made at the end of the asset’s life. the equipment will cost $100.000 and attract capital allowances on a reducing balance basis at 20% per annum.      Reduction in finance cost Elimination of uncertainty about the levels of finance cost Avoidance of counterparty risk Changing the profile of debt without changing the underlying instruments Protection of the market value of issued debt .36 6 : D e b t f i n a n c e 164 In a lease vs buy decision. with no residual value. What will be the interest charge in Year 4. RC is considering a lease arrangement where the lessor will charge $95.000 per annum for four years in arrears. the discount rate used in the net present value calculation for the lease versus buy option is:     165 CIMA F3 Question Bank (2015 syllabus) The company’s weighted average cost of capital The company’s cost of equity The company’s cost of debt The implied interest rate in the lease payment ST is considering acquiring an asset that will cost $600. with the full lease payment qualifying for tax relief.

4% What rate of interest will the companies end up paying if they choose the arrangement that is most advantageous to both of them? Assume that if they enter into a swap arrangement.5% Co st I pyri ntu ght itio n2 015 Fir DD and EE are contemplating new investment projects.6% DD 7% EE LIBOR + 0. The bank has quoted an interest rate of 5. EE would like to pay a floating rate. The two companies have been quoted the following rates of interest: DD EE Fixed Floating 7% LIBOR + 1% 6% LIBOR + 0. The directors wish to take advantage of favourable movements in interest rates and so have approached the bank to discuss the possibility of entering an interest rate swap. and have instructed the bank to arrange an interest rate swap. what interest rate will it pay?     172 5.     DD 6.6% DD 7% EE LIBOR + 0. what net interest rate will it end up paying?     171 LIBOR 6% 7% 8% TT has fixed rate borrowing at a rate of interest of 7%.2% DD 6. If TT enters the swap arrangement. DD would like to pay a fixed rate of interest on loan finance for its investment.5% against LIBOR.5% LIBOR + 1.8% EE LIBOR + 0.4% .5% LIBOR LIBOR – 1. the gains will be shared equally. If SS enters the swap. SS’s directors wish to fix the finance costs.8% EE LIBOR + 0.CIMA F3 Question Bank (2015 syllabus) 170 6: Debt finance 37 SS has floating rate borrowing at an interest rate of LIBOR + 2%. The bank has quoted a swap rate of 6% versus LIBOR.

. JJ would like to pay a floating rate.000 last year. TT proposes to borrow an additional $40 million from another bank to buy out minority shareholders.5% ER has 5 million $1 shares in issue and 50.0.0. Complete the sentence below by placing one of the following options in each of the spaces. It has borrowed $200 million from the bank at 8% interest. TT has an interest cover covenant (based on profit before interest and tax) of 5 times. the gains will be shared equally.13 5.08 If the additional borrowing is undertaken. ER’s directors are contemplating issuing $1 million of 4% coupon bonds.25% JJ LIBOR + 0.5% What rate of interest will the companies end up paying if they choose the arrangement that is most advantageous to both of them? Assume that if they enter into a swap arrangement. the interest cover would be and the interest cover covenant would .38 6 : D e b t f i n a n c e 173 CIMA F3 Question Bank (2015 syllabus) JJ and KK are contemplating new investment projects.75% JJ LIBOR . assuming operating profit remains constant? 175 TT has profit before interest and tax of $98 million. ER made an operating profit of $850. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F What will be the interest cover to 2 decimal places if the new bonds are issued. KK would like to pay a fixed rate of interest on loan finance for its investment.10 Be breached Not be breached 4.5% JJ LIBOR . The two companies have been quoted the following rates of interest: Fixed Floating JJ 6% LIBOR KK 7% LIBOR + 1.     174 KK 7. 6.25% KK 7% JJ LIBOR KK 6. The interest rate on this loan would be 10%.25% KK 6.000 6% coupon bonds with a par value of $100.90 4.

177 Are the following statements relating to convertible bonds TRUE or FALSE? Companies can claim tax relief on interest paid on the bonds. It pays annual interest of $4 million in the form of two equal payments on 30 June and 31 December. taking the borrowing and swap into account. How much in $m must the issuer pay the bondholder on 31 December 20X3? $ 180 m Which of the following are reasons why an organisation may prefer to acquire an asset under a finance lease rather than purchase it? Select ALL that apply. LIBOR LIBOR plus 3% 3% fixed 4. Bondholders must convert the bonds into shares on the conversion date. The organisation’s tax position may mean that it cannot benefit from the tax allowances that are available for purchasing the asset.     The lease might give the organisation the chance to upgrade the asset during the terms of the lease. The bond is trading at $115 per $100 nominal on 1 January 20X2 and is redeemable at a 10% premium on 31 December 20X3. Complete the sentence below by placing one of the following options in the space. . 178 False    Co st I pyri ntu ght itio n2 015 Which of the following bonds would not be issued by a company?     179 True  Fir Deep discount bonds Irredeemable bonds Bonds with warrants attached Scrip bonds A bond has a nominal value of $50 million. it has also had the bank arrange a 5 year swap with another customer of bank Y of 4.5% fixed 6% fixed The hedged rate. The organisation may not wish to take on the commitment to maintain and repair the asset.5% fixed against LIBOR.CIMA F3 Question Bank (2015 syllabus) 176 6: Debt finance 39 PP has entered into 5-year borrowing with its bank at a floating rate of LIBOR plus 1. is .5%. To fix its interest rate. The organisation may only want the asset for a short time.

Only the borrowing capacity of the individual company and its subsidiaries is considered. The lessor is responsible for maintaining and servicing the asset. $ 184 NE is a wholly-owned subsidiary of TY. At 31 December 20X6. Calculate the amount of interest on the loan from TY that will be eligible for tax relief to the nearest $0. The tax authorities in the country in which NE is locates consider a company to be thinly capitalised if its debt:equity ratio is above 75%. The loan from TY was 50% more than NE could have raised from the bank at that time.40 6 : D e b t f i n a n c e 181 Which of the following statements does not apply to operating leases?     182 CIMA F3 Question Bank (2015 syllabus) The lessor retains the risk and rewards of ownership The asset appears on the statement of financial position of the lessor. It can borrow in the USA at 8% and in the Eurozone at 6.7%. NH is a company located in the Eurozone that is looking to expand in America and wants to borrow $40 million.1m. The interest rate on both loans is 6%. The two companies decide to enter into a currency swap for one year. not the whole group. its share capital and reserves were $28 million.8. Are the following statements about thin capitalisation rules TRUE or FALSE? Interest on the part of a loan that an independent third party would be prepared to lend the company is disallowable.4%. $ m .5% and in the Eurozone at 6. and this is expected to stay the same for the foreseeable future. It can borrow in the USA at 8. NE’s last year-end. it had a bank loan of $8 million and a loan from TY of $30 million. The $/€ exchange rate is currently $1 = €0. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Calculate the saving in $ that YE will achieve by entering the swap. The lease is for most or all of the life of the asset. 183 True  False    YE is an American firm that is looking to expand in the Eurozone and is looking to raise €32 million.

9%.40 a share and aims to pay a constant dividend each year.CIMA F3 Question Bank (2015 syllabus) 7: Capital structure 41 Chapter 7: Capital structure 185 DH has 5 million $2 shares in issue currently trading at $4. 50% reserves and 35% debt capital. Market interest rates increase. The post-tax cost of debt has been calculated as 4. The post-tax cost of debt has been calculated as 7. Ordinary shares consist of 7. The cost of the equity capital is 14% and the cost of the debt capital is 9%. NQ is about to pay a dividend of $0.00. Calculate the weighted average cost of capital of DH to the nearest 0.50 per share and debt capital consists of 17.5% and the cost of equity at 10. . The required return on debt decreases.60 cum div.5 million bonds trading at $150 per $100 nominal.1%. Fir Which is the best method of calculating the weighted average cost of capital?     188 The traditional theory of gearing states that. then     The required return on equity increases.5%. It also has $4 million 10% irredeemable debenture stock currently trading at $125 per $1.1%. % 186 NQ has 5 million $1 shares in issue currently trading at $3. Calculate the weighted average cost of capital of NQ to the nearest 0. as gearing increases. % 187 Co st I pyri ntu ght itio n2 015 The statement of financial position of RT shows that its financing mix consists of 15% ordinary shares. It also has $10 million 7% irredeemable debenture stock currently trading at par. a company's weighted average cost of capital:     189 (30% × 14%) + (70% × 9%) (50% × 14%) + (50% × 9%) (65% × 14%) + (35% × 9%) (66% × 14%) + (34% × 9%) Rises initially then falls Remains constant Falls consistently Falls initially then rises If the financial gearing of a company increases.5 million $1 shares trading at $3. The level of dividend decreases.

BL has aimed to increase dividends by 5% per annum over the last few years. BL is expected to make a profit in the next year. Debt is risk-free. a weighted average cost of capital of 8% and a debt: equity ratio of 1:2. .42 7 : C a p i t a l s t r u c t u r e 190 A company has a cost of debt of 5%. Investors and companies can borrow at the same rate of interest. What is its cost of equity?     191 3% 7% 9. The cost of debt varies according to the level of gearing. a company’s target capital structure is consistent with:     Minimum cost of debt Minimum cost of equity Minimum weighted average cost of capital Minimum payments to finance providers t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 193 Does an entity’s capital structure affect or not affect the following? Return on capital employed Default risk 194 Not affect    Which of the following factors might cause a company to increase the proportion of debt in its capital structure?     195 Affect  A fall in the corporate tax rate An increase in economic uncertainty A fall in the base rate of interest A fall in the market value of its shares Which of the following is not an assumption of Modigliani and Miller’s 1963 gearing theory?     The capital market is strongly efficient. Under traditional theory. Which of the following factors is least likely to persuade the company to choose debt?     192 CIMA F3 Question Bank (2015 syllabus) Gearing is low.5% 14% BL is deciding whether to raise debt or equity to finance a new investment. Interest rates are falling.

Co st I pyri ntu ght itio n2 015 Fir What is the value per share of GH’s equity. TD’s cost of equity is 16% and LP’s pre-tax cost of debt is 9%. GH has 10 million shares and $45 million debt. to the nearest $0.01%? % 200 43 PD and SJ are identical companies except that PD is financed entirely by equity and SJ has a 2. Tax is payable at 25%. What is PD’s cost of equity to the nearest 0. EF has 20 million $1 shares. the cost of equity will always rise with greater gearing because:     198 Interest cover is greater. What is LP’s cost of equity to the nearest 0.01%? % . total value $80 million. The tax shield on debt increases the value of equity. Tax is payable at 30%. SJ’s cost of equity is 18% and its pre-tax cost of debt is 6%.01? $ 199 TD and LP are identic al companies except that TD is financed entirely by equity and LP has a 1:1 debt:equity ratio. The returns to shareholders become more variable. The cost of debt will be falling.CIMA F3 Question Bank (2015 syllabus) 196 7: Capital structure Do the Modigliani and Miller (1963) and traditional theories of capital structure conclude that there is an optimum capital structure at which the weighted average cost of capital is minimised and company value is maximised? Traditional Optimum level  No optimum level    Modigliani and Miller 197 According to Modigliani and Miller.25:1 equity:debt ratio. but their capital structures differ. The tax rate is 30%. EF has identical operating and risk characteristics to GH.

the cost of debt . If the cost of capital fell to 15%. 202 WC has a gearing ratio of 40% (based on market values and measured as debt/debt + equity) and a weighted average cost of capital of 11%. Its directors wish to issue debt and reduce its cost of capital to 15%. the weighted average cost of capital and the value of the company . DD is currently financed solely by equity. Keeps rising Keeps falling Eventually rises Falls then rises Rises then falls Stays the same Eventually falls Under the traditional view of gearing. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F % Use the following information to answer the next two questions. 203 What will be DD’s new value in $m? $ 204 m What will be DD’s new weighted average cost of capital. using Modigliani and Miller’s theory with tax. the theoretical WACC for WC if its gearing changes to 70%. Its shares have a market value of $40 million. DD plans to replace $16 million of equity with 8% irredeemable debt.01%? % 205 FX is an all-equity financed company with a cost of capital of 17%. Calculate to the nearest 0. DD’s cost of capital is 14% and the corporate tax rate is 25%. increasing gearing will mean that the cost of equity . using market values) to the nearest 0.44 7 : C a p i t a l s t r u c t u r e 201 CIMA F3 Question Bank (2015 syllabus) Complete the sentence below by placing one of the following options in each of the spaces. to the nearest 0.01%.01%? % . The tax rate is 25%. The tax rate is 20%. what would be the gearing ratio (debt/debt + equity.

GK’s weighted average cost of capital is at its lowest when gearing = 35%. DP’s cost of equity is currently 15% and the tax rate is 25%. The tax rate is 25%. % 207 FC currently has a gearing ratio of 30% (based on market values and measured as debt/debt + equity) and a weighted average cost of capital of 10. Calculate the new cost of capital to the nearest 0. Investors are indifferent between personal and corporate gearing. Its directors wish to issue more shares to pay off the bank loan but are unsure of the impact that this will have. using Modigliani and Miller’s theory with tax. Capital structure influences the weighted average cost of capital and the value of the entity. 209 A B C D 20% 35% 60% 100% 1 Theoretical 2 Conservative 3 Aggressive 4 Wealth-maximising Which of the following statements in relation to Modigliani and Miller’s 1963 with tax hypothesis are true? Select ALL that apply. Which of a company’s sources of capital normally has the highest cost?     Preference shares Ordinary shares Bonds Mezzanine debt .     210 Co st I pyri ntu ght itio n2 015 Fir The rate of interest at which investors and companies borrow is irrelevant.8%.CIMA F3 Question Bank (2015 syllabus) 206 7: Capital structure 45 DP currently has 10m equity shares with a market value of $25 million and a 10% $15million bank loan.1% if the bank loan is paid off by the share issue.01%. Match the following levels of gearing to their descriptions. the relative percentage change in the weighted average cost of capital if gearing was to increase to 50% % 208 Using the traditional model of capital structure theory. Tax relief on debt causes the weighted average cost of capital to fall initially and then rise as gearing increases. Calculate to the nearest 0.

WY’s weighted average cost of capital would move to:  13.32% = 14% [1 – (  15.8%)( 3 1 )] 3 0. The tax rate is 25%. so that its debt:equity ratio will be 1:3.09% = 15% [1 – ( 1. According to Modigliani and Miller’s theory with tax. .450 0. Investors are indifferent between dividends and capital gains. to the nearest 0.46 7 : C a p i t a l s t r u c t u r e 211 CIMA F3 Question Bank (2015 syllabus) YS is currently all equity-financed and its cost of capital is 12%.25 ×350 )] 1.33% = 12% + [(12% .200 million and debt with market value of $600 million.7%)(  13.8%)( )]  214 1 13.01%? % 212 WY has equity with market value of $1. According to Modigliani and Miller’s theory with tax.800 0.800 0.7%)( )] 12.67% = 12% + [(12% . The cost of equity will rise as gearing increases.7  13.27% = 15% [1 – ( 0.7 3 )] Modigliani and Miller’s 1963 theory of capital structure with tax assumes that:     The cost of debt is zero.03% = 16% [1 – (  14. WY plans to issue $250 million of new shares and use the proceeds to pay off part of the debt. It is planning to issue irredeemable bonds with a coupon rate of 6% and have a debt:equity ratio of 1:2. if the new share capital was issued and the debt was paid off. What will be YS’s weighted average cost of capital.25 ×350 )] 1.450 )] YW is an ungeared company with a cost of capital of 12%.25 ×350 )] t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F  213 14.17% = 12% + [(12% .25 ×350 1. YW’s cost of equity will become:  3 0.93% = 12% + [(12% . Financial distress costs will mean that the weighted average cost of capital will eventually rise. WY’s current cost of equity is 16% and XZ (an equivalent ungeared company operating in the same business sector) has a cost of equity of 15%. The tax rate is 30%. WY’s current weighted average cost of capital is 14% and the tax rate is 25%. It is planning to issue 7% bonds with a yield of 8%.

what will be the cost of equity after the reorganisation to the nearest 0.53% and a WACC of 10. LM plans to redeem $25m of debt by a new share issue.CIMA F3 Question Bank (2015 syllabus) 215 7: Capital structure 47 LM has a geared cost of equity of 12% .67% = 11. KT is identical in all respects to LO except that it is financed 75% by equity and 25% by debt using market values. The tax rate is 20%. what will be the weighted average cost of capital of the geared company.95%. Its weighted average cost of capital is 16%. % . As a result the cost of equity will fall by 2%. to the nearest 0. The cost of debt will remain unchanged. 80% of which is equity and $10 million of which is 7% bonds.53% [1 – ( 250 6.01%? Assume no tax. valued at par. WACC would move to: 216 18.24% = 11. Assuming Modigliani and Miller’s net operating income view of capital structure is correct.75 250 6. The market value of equity is $200 million and the market value of debt is $50 million.01%? % 218 JC makes an annual profit before interest of $8 million. Co st I pyri ntu ght itio n2 015 Fir Assuming the traditional view of gearing is correct.75  11. if gearing is changed as planned? $ 217 m LO is an ungeared company with a cost of equity of 11%.25 )] )] 250 18. The tax rate is 25%.25 250 )] )] KL operates in a no-tax country with the following structure: Equity Debt Annual payments to investors $m 64 12 76 Dividends Interest Market value $m 400 100 500 KL plans to change its debt: equity ratio to 1:7 by the redemption of debt by the issue of new shares. an ungeared cost of equity of 11. JC proposes to redeem $5 million of bonds by issuing additional share capital. what will be the new market value to the nearest $m of KL. According to Modigliani and Miller’s theory with tax. JC has a total market valuation of $50 million. According to Modigliani and Miller.70% = 12% [1 – (  10.53% [1 – (  11.10% = 12% [1 – (  11.

It has 50 million 9% irredeemable debt in issue. It plans to raise $20 million of fixed rate debt at 5%.01%. According to Modigliani and Miller’s theory.1% if BW changes its debt:equity ratio to 40%. According to Modigliani and Miller. what would be the market value of an ungeared company that was identical in all other respects to LR? $ 221 m NS is an ungeared company that has a market capitalisation of $80 million and a cost of capital of 10%. The tax rate is 25%. The cost of equity is 12% and the tax rate is 25%. The risk-free cost of debt is 4% and the tax rate is 20%. with a market price of $2. % 223 BW is currently financed by $50 million of equity and $30 million of debt. The tax rate is 30%. % . what would the new cost of equity be to the nearest 0.40 per share.01%? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F % 222 KT has 100 million $0. It has a cost of equity of 12% and a pre-tax cost of debt of 6%. Calculate the cost of equity to the nearest 0. Calculate KT’s weighted average cost of capital.48 7 : C a p i t a l s t r u c t u r e 219 CIMA F3 Question Bank (2015 syllabus) LB is a ungeared company with a cost of capital of 9%. with a current market value of 108 per cent. The business risk profile of NS will remain unchanged and tax can be ignored. to the nearest 0. what would be the cost of equity to the nearest 0.01% in a similar geared company that was 70% equity financed and 30% debt financed? % 220 LR is financed by a combination of equity valued at $150 million and debt capital at $40 million.50 shares in issue. According to Modigliani and Miller.

Calculate KH’s cost of equity to the nearest 0. 224 Calculate the interest cover if the new finance is raised to 2 decimal places. A similar listed company in the same sector has an equity beta of 1.CIMA F3 Question Bank (2015 syllabus) 7: Capital structure 49 Use the following information to answer the next two questions. measuring gearing as (debt/debt + equity) and using book values. Statement of financial position $m 33 18 51 Non-current assets Current assets Total assets Equity and liabilities Share capital Irredeemable preferred shares Reserves Long-term 8% bank loan Trade payables Bank overdraft Total equity and liabilities 7 2 19 12 8 3 51 Statement of profit or loss Operating profit Finance costs Profit before tax Tax at 25% Profit after tax 3. KH’s debt:equity ratio is 20:80. 225 Calculate the gearing level if the new finance is raised to the nearest 0. Indications are that KS’s bank intends to renew its overdraft facility for the indefinite future. an unlisted company.7.01%.1%.1 0. Operating profit is expected to remain constant. The expected return on the market portfolio is 9% and the current return on a risk-free asset is 3%.1%? % 227 The Finance Director of KH. The following information is taken from the most recent accounts of KS.4 0. % .35 and a debt:equity ratio of 40:60. Debt can be assumed to be risk-free. is trying to derive its cost of equity. The tax rate is 25%.6 1. Risk free debt has a pre-tax cost of 4% per annum.8 Co st I pyri ntu ght itio n2 015 Fir KS is planning to raise $4 million additional debt finance at 11%. The expected return on the market portfolio is 9% and tax is 25%. What is SA’s geared cost of equity to the nearest 0.7 2. % 226 SA has a debt/equity ratio of 1 to 3 and equity beta of 0.

75 JM is looking to diversify and is considering the acquisition of UN. MK has a debt/equity ratio of 40% and an equity beta of 1.0 1. They have decided to use the Adjusted Present Value approach and therefore need to calculate an ungeared cost of equity. This company has a debt:equity ratio of 40:60 and an equity beta of 1. The tax rate is 30% and debt is assumed to be risk-free. The tax rate is 25%. JM has a debt:equity ratio of 20:80 and UN has a debt:equity ratio of 25:75. The following information is available about three companies that have similar business risk to KS. a company in a different market sector. % .5 1. which is an unlisted company. Calculate. TR currently has a debt-equity ratio of 25:75 and an equity beta of 1.6.3 QL 45:55 2. The tax rate is 20%. to the nearest 0. % 229 YT is looking at a potential acquisition. the cost of equity that should be used as part of the adjusted present value calculation. The current return on a risk-free investment is 2% and the return on the market portfolio is 9%. JM has obtained information about a similar company to UN in the same business sector. Calculate. The current return on a risk-free investment is 3% and the market risk premium is 7%. Calculate TR’s ungeared cost of equity to the nearest 0. KS has a debt/equity ratio of 25:75.50 7 : C a p i t a l s t r u c t u r e 228 CIMA F3 Question Bank (2015 syllabus) TR’s directors are currently considering replacing all the company’s debt with equity and want to know what the new cost of capital will be.25 1.1%. KS.0 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Which of the following is likely to be the best estimate of KS’s equity beta?     230 1.1%. % 231 The directors of MK are about to undertake a new investment and need to carry out an investment appraisal. The return on risk-free assets is 5% and the expected return on the market portfolio is 10%.YT needs to identify an appropriate cost of capital to be used in this calculation and therefore it needs to identify a suitable equity beta for KS.7. to the nearest 0.6 ZW 15:85 1. but different capital structures.1%. JM needs to calculate the cost of equity of UN as part of a valuation exercise.2. the cost of equity that should be used as part of the valuation of UN. Debt/equity ratio Equity beta XP 30:70 1.

the weighted average cost of capital of BQ.23 – 0. to the nearest 0. Debt can be assumed to be risk-free and have a pre-tax cost of 4%. A similar quoted company to BQ has an equity beta of 1.CIMA F3 Question Bank (2015 syllabus) 232 7: Capital structure 51 The directors of PN are currently considering raising debt finance to fund a new investment.1%. to the nearest 0.3) 70 The directors of ZX are considering whether to acquire BQ. XR. using a proxy listed company. BQ currently has a debt:equity ratio of 22:78. Taking on the debt finance will result in a debt-equity ratio of 25:75. The return on the market portfolio is 11% and the return on a risk-free investment is 5%.23 + (1.1%. The expected return on the market portfolio is 11% and the tax rate is 25%.05. in the same industry.15)  βg = 1.3) 55 30 (1−0.18 – 0. to the nearest 0. Calculate. PN’s cost of equity if it uses the debt to fund the investment.15)  βg = 1. The tax rate is 25%. PN is currently an all-equity financed company with a Beta factor of 1. % . They are looking to value BQ by discounting its future earnings and hence need to compute its weighted average cost of capital.18 – 0.18 + (1.3. XR’s debt:equity ratio is 45:55 and its equity beta is 1. The tax rate is 30% and the beta of debt is 0. Calculate.15)  βg = 1. Its debt can be assumed to be risk-free and have a pre-tax cost of 4%.2. LL’s geared cost of equity. Calculate.3) 70 30 (1−0. The return on the market portfolio is 12% and the tax rate is 30%. JN’s Finance Director wishes to calculate its geared cost of equity.23 + (1.23 – 0. % 233 LL has a debt:equity ratio of 35% and an asset beta of 1.4 and a debt:equity ratio of 35:65.85.15. Which of the following shows the correct formula for regearing XR’s asset beta and hence obtaining an equity beta for JN? 235  βg = 1. % 234 JN is an unlisted company with a debt/equity ratio of 30:70.15) Co st I pyri ntu ght itio n2 015 Fir 45 (1−0.18 + (1.1%.3) 55 45 (1−0. an unlisted company. Debt has a beta of 0.

Redemption of debt is certain. according to Modigliani and Miller? Select ALL that apply. which of the following is least likely to be a reason why its market price might fall?     Investors who need cash will sell their shares. Dividends need not be paid if a company makes a loss. The market will see lower dividends as indicating poor expected performance. The tax regime for capital gains is more favourable than the tax regime for dividends. Dividends are paid out of pre-tax earnings. Investors who do not regard dividend levels as acceptable will sell their shares. Higher retentions will mean lower dividend growth. shareholders will prefer dividends to capital gains. The impact of dividend policy will depend on the tax rate on investment income. A policy of no dividends gives shareholders greater control over management. Shareholders who need cash can sell their shares rather than rely on dividend payments.52 8 : D i v i d e n d p o l i c y CIMA F3 Question Bank (2015 syllabus) Chapter 8: Dividend policy 236 Which of the following factors are company directors least likely to take into account when setting the level of dividends for the year?     237 Which of the following is true of Modigliani and Miller’s theory on the relevance of dividend policy?     238 The law on distributable profits The previous level of dividends The liquidity position The level of other liabilities The value of equity depends on the investments that the firm has selected. If a company reduces dividend payments. Dissatisfied shareholders who sell their shares will be liable to transaction costs. In a perfect capital market. Which of the following arguments could not be used to justify a policy of not paying any dividends? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F     239 For which of the following reasons are interest costs lower than dividend costs. The company is using retained earnings rather than debt to finance projects with positive net present values.     240 Pecking order theory suggests that companies should use retained earnings as their first source of finance. .

70. and which is just about to be listed on its local stock exchange PP plans to pay a special cash dividend to its shareholders.6 million EPS $0. Earnings per share will improve. GG has 20 million $1 shares in issue trading at $1. Which of the following is the most likely consequence of this plan?     Shareholder wealth will decrease by the value of cash paid.60.50 shares in issue but its directors are planning to repurchase 2 million shares at a price of $0.25 and $10 million of bonds in issue trading at $96 per cent. .1%.CIMA F3 Question Bank (2015 syllabus) 241 8: Dividend policy 53 FT currently has a cash balance of $3 million and earnings per share of $0. What will be the cash balance and earnings per share after the repurchase?     242 Cash $2 million EPS $0.50 Cash $1. GG’s directors have decided to repurchase some of its shares at market value. What will be the new gearing level of GG after the repurchase to the nearest 0.50 Cash $2 million EPS $0. Shareholders will believe that PP lacks profitable opportunities for investing cash. privately-owned and managed company where dividends are taken instead of salaries In a tax regime where individuals pay more tax on dividends than capital gains A private company that has expanded over recent years. and measuring gearing as debt/(debt + equity) using market values? % 243 For which of the following reasons might a scrip dividend be preferable to a normal dividend?     244 In which of the following situations is a residual dividend policy most likely to be appropriate?     245 Co st I pyri ntu ght itio n2 015 Fir Keeping cash to finance investments Increasing earnings per share Making shares more marketable Improving the price/earnings ratio A large publicly listed company A small. PP is funded by a mix of debt and equity.75 GG has $5 million cash that is surplus to requirements.75 Cash $1. FT has 10 million $0. with increases in earnings and dividends. Gearing levels will improve.6 million EPS $0.

A company should adopt a smooth dividend policy. Using retained cash surpluses avoids possible changes of control that may result from a share issue. ensuring dividends are never lower than the previous year. IJ has surplus cash of E$20 million.54 8 : D i v i d e n d p o l i c y 246 Which of the following statements is consistent with Modigliani and Miller’s dividend irrelevancy policy?     247 CIMA F3 Question Bank (2015 syllabus) Shareholder wealth can be maximised by a residual dividend policy. and only pay out dividends if no such projects are available. What is the maximum after-tax amount that GH could receive in €? € t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 248 Which of the following are valid reasons why directors may decide to retain cash surpluses rather than pay them as dividends? Select ALL that apply. GH is a company located in the Eurozone. Shareholder wealth can only be increased by increases in the share price. The tax rate on corporate profits in Earland is 25% and there is also a 10% withholding tax on profits remitted to overseas parent companies. Companies should prefer debt finance to equity finance if possible. Shareholder return is equal to dividends plus growth in the share price. A company should invest all available funds in projects that have positive net present values. GH wishes to use these funds to pay a special dividend to its shareholders.     249 Finance from retained cash surpluses has no cost. as tax relief is available on interest paid. where the functional currency is the E$. in Earland. Tax rates on capital gains are higher than the tax rates on dividends. Using retained cash surpluses means directors can undertake investment projects without involving shareholders. . GH would pay tax of 20% on profits received from IJ. and use remaining funds to finance investments. The exchange rate is expected to be stable and currently is €1 = E$4. What is the residual theory of dividend policy?     A company should pay a fixed proportion of post-tax earnings as dividends each year. GH has a foreign subsidiary. Dividend policy will have no impact on share price. and use remaining funds to finance investments. IJ.

Which of the following best describes this form of market efficiency?     253 Co st I pyri ntu ght itio n2 015 Fir No efficiency Weak form efficiency Semi-strong form efficiency Strong form efficiency NO is planning to acquire ON. If the market is efficient and the share price moves immediately to reflect this information when the investment is announced.906c HP has 5 million $1 ordinary shares in issue. Earnings per share Dividend cover Published dividend yield 50c 2. A proposed investment is expected to have a net present value of $1. The local stock market is exhibiting what form of efficiency?     No efficiency Weak form efficiency Semi-strong form efficiency Strong form efficiency .2% The price of BC's ordinary shares implied by the data above is:     251 78c 153c 625c 3.6 million and require an initial investment of $3 million. The directors of the two companies have been involved in secret talks with no public announcements being made.40 per share. what is the new share price to the nearest $0.5 3.01? $ 252 The prices quoted on a stock exchange are observed to reflect only historical share price information and other historical information about a company.CIMA F3 Question Bank (2015 syllabus) 9: Business valuations 55 Chapter 9: Business valuations 250 The following information relates to the ordinary shares of BC. However the market price of ON’s shares has risen on the local stock exchange on the assumption that NO will make a bid for ON. at a market value of $2.

The present value of net cash flows generated by this investment is $40 million and KS does not need to raise any extra funds to finance it. Profit before tax Depreciation and amortisation Finance costs paid and due Capital expenditure to sustain operations Tax paid Repayment of borrowings Equity dividend paid The best estimate of free cash flow to equity in $m is: $ m $m 360 85 25 120 80 65 40 .30.80 $3. If the stock market is efficient and the share price moves to reflect this information on the day that the investment is announced. A proposed investment requires initial expenditure of $25 million. The current share price is $2.60 $2. what is the share price likely to be at the end of the day?     255 $2.56 9 : B u s i n e s s v a l u a t i o n s 254 CIMA F3 Question Bank (2015 syllabus) KS has 50 million $1 shares in issue. Operating profit Depreciation and amortisation Finance costs paid and due Capital expenditure to sustain operations Tax paid Repayment of borrowings Equity dividend paid t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F $m 240 60 20 75 45 55 25 The best estimate of free cash flow to equity in $m is: $ 256 m The following data relates to DF for the year ended 31 December 20X5.10 The following data relates to CC for the year ended 31 December 20X4.30 $2.

$ 259 Fir m Companies BC and DE operate in the same industry. 0. Complete the calculation of CIV by placing one of the following numbers in each of the spaces.70 0.11 0. The tax rate is 25%. The following data is available about three companies. The industry average return on tangible assets is 12%. LK’s cost of equity is 11%. Co st I pyri ntu ght itio n2 015 Calculate the value of the intangible assets in $m. A B C Rank the companies in descending order of market capitalisation. its WACC is 9% and its cost of debt is 6%.09 CIV = ($50 million ─ (12% × $35 million)) × 258 1. HM’s cost of equity is 13%. They have the same level of earnings but company BC has a lower P/E ratio. A B C Earnings for the year $m 50 60 70 P/e ratio 10 8 7 . The industry average return on tangible assets is 10%. HM’s average profit before tax is $70 million. Company BC has a lower share price. HM’s tangible assets are $40 million.11 / HM is using the Calculated Intangible Value method of company valuation to value its intangible assets.CIMA F3 Question Bank (2015 syllabus) 257 9: Business valuations 57 LK is using the Calculated Intangible Value method of company valuation to value its intangible assets.09 0. The tax rate is 30%. LK’s tangible assets are $35 million. Company BC has lower market capitalisation.30 1. its WACC is 10% and its cost of debt is 6%. Which of the following can be deduced from the information about the two companies?     260 Company BC has higher growth prospects. LK’s average profit before tax is $50 million. Company BC’s shareholders are exposed to lower risk.

Assets (book value) Assets (realisable value) Liabilities (excluding borrowings) Borrowings (book value) Borrowings (fair value) Equity (book value) $m 300 340 60 70 90 170 What is the minimum purchase price for AT in $m on an asset valuation basis? $ m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 263 Which of the following is a description of the free cash flows to equity method that can be used to value a company’s equity?     264 Deduct interest and dividends to arrive at the free cash flow and then discount at the company’s WACC. The latest accounting data for AT is as follows.58 9 : B u s i n e s s v a l u a t i o n s 261 CIMA F3 Question Bank (2015 syllabus) Zoe is an investor in Parkinson Co. What is the ex-dividend value of Zoe’s shareholding? $ 262 LB would like to purchase AT. Deduct interest and dividends to arrive at the free cash flow and then discount at the company’s cost of equity. Deduct interest but not dividends to arrive at the free cash flow and then discount at the company’s cost of equity. which is a private company. $ m $m 150 500 180 890 70 230 . Deduct interest but not dividends to arrive at the free cash flow and then discount at the company’s WACC. Parkinson Co has just declared a dividend of $0. Calculate GF’s free cash flow. The following data relates to GF for the year ended 31 December 20X7. worth $565 at the cum div market price.14 per share. Interest Investment in non-current assets Dividends Operating profit Investment in working capital Depreciation The tax rate is 25%. holding 250 shares in the company.

It generated $35m free cash flow last year and this figure is forecast to grow by 5% per annum each year.10 shares in issue.01? $ . PL has a cost of equity of 10% and a weighted average cost of capital of 8%.CIMA F3 Question Bank (2015 syllabus) 265 9: Business valuations 59 MW is an all-equity financed company. trading at $90 per cent. what is the value of YH’s equity capital in $m? $ 268 m SR has 50 million $0. YH expects profits after tax to grow at 4% indefinitely. YH’s cost of equity is 14% and its weighted average cost of capital is 11%. What is the value of MW to the nearest $100m? $ 266 m The forecast post-tax cash flows of PL before finance costs for the next few years are expected to be as follows: Year 1 $m 400 Year 2 $m 420 Year 3 $m 450 Year 4 $m 480 The forecast cash flows are expected to grow by 5% after Year 4 into perpetuity. PL looks to maintain a gearing ratio of 50% (measured as debt/debt + equity). Its forecast post-tax cash flows before finance costs for the next few years are expected to be as follows: Year 1 $m 340 Year 2 $m 380 Year 3 $m 440 Year 4 $m 510 The forecast has assumed that year 4 tax cash flows will be constant into perpetuity. It has 5 million bonds in issue. Assuming profits are equivalent to cash flows. after deducting finance costs of $40m and dividends paid of $150m. MW has a cost of capital of 10%. Co st I pyri ntu ght itio n2 015 Fir What is the value of PL’s equity to the nearest $100m? $ 267 m YH’s accounts show that it has made a retained profit of $470m. Tax allowable deprecation was $15m. SR’s cost of equity is 15% and its weighted average cost of capital is 12%. YH reinvests cash to a value equal to tax allowable depreciation. What is the estimated value of a share in SR to the nearest $0.

10 per share. Its ordinary shares are currently trading at $0. a dividend cover of 3 and a dividend yield of 4%. What is the current market capitalisation of HD’s ordinary shares? $ 273 TH has a P/E ratio of 8 and dividend cover of 4.40 per share.000 and a preference dividend of $20. The company’s growth prospects are poor.50 ordinary shares and 200.39.84. What is the market capitalisation of MK? $ . a dividend cover of 5 and a dividend yield of 4%.80. What is the market price per share of TH.50 preferred shares.50 shares and its dividend is $0. What is UJ’s price-earnings ratio to two decimal places? 270 A low P/E ratio normally indicates:     271 Dividend payments are high. The company’s earnings have temporarily fallen. Its share capital is 5 million $0.60 9 : B u s i n e s s v a l u a t i o n s 269 CIMA F3 Question Bank (2015 syllabus) UJ has 1 million $0.01? $ 274 MK has a P/E ratio of 12 and dividend cover of 2. Its profit before tax was $240.000 and it paid tax at 25%. It has 2 million $0. an ordinary dividend of $40. what is the current price of YH’s ordinary shares? $ t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 272 HD has earnings per share of $0.50 equity shares in issue. To the nearest $0.000 $0. Its share capital is 1 million $2 shares and its dividend is $0. YH has earnings per share of $1.01. The share is over-priced.000. to the nearest $0.

200 600 $0. has recently made profits after tax of $15m and has a market capitalisation of $120m.000 2. When valuing a private company.50 shares Profit after tax Dividends Cost of equity $5m $10.50 ordinary shares Share premium $1 preferred shares Reserves 5% bonds The ordinary shares are trading at $1. What is the value per share of BG to the nearest $0. BG’s P/E ratio is 15.5m $8. Issued share capital $0. The tax rate is 25%.4m 10% You are aware that -KJ. $m 1. it can be assumed that its value is 75% of an equivalent listed company. to the nearest $m? $ m . following its normal practice of retaining 80% of its earnings after tax . BG has nominal share capital of $0.CIMA F3 Question Bank (2015 syllabus) 275 9: Business valuations 61 YY is a listed company.01? $ 277 Co st I pyri ntu ght itio n2 015 Fir AS’s current P/E ratio is 14. based on a P/E valuation? $ m Use the following information to answer the next two questions MH is a private company with the following financial data. based on a P/E valuation. 279 What is the value of MH in $m. What is the market capitalisation of AS in $m. What is the current equity market capitalisation of YY in $m? $ 276 m The operating profit in BG’s latest set of accounts was $9. which is a listed company but otherwise similar in profile to MH.4m and its profit before tax was $8m. The following information is taken from its latest accounts. based on a P/E valuation? $ 278 m NB’s current P/E ratio is 10. What is the market capitalisation of NB in $m. It has just paid a dividend of $2m. It has just paid a dividend of $4m and has a dividend cover of 5. The bonds are currently trading at $103 per cent.400 500 6.90 and the preferred shares are not traded.25 shares with a value of $2m.

If the stock market is strong-form efficient.000 which she plans to invest on the local stock exchange. what will be the most likely proceeds from the share issue? $ 282 Rachel has been left a legacy of $50.20 Increase by $4. which of the following investment strategies should Rachel follow? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F     283 Study the financial press and invest in shares that appear to be undervalued. Share prices on a stock exchange are regularly observed to move when companies make announcements about the dividends they intend to pay out.65 1. It intends to list 25% of its 6 million shares.62 9 : B u s i n e s s v a l u a t i o n s 280 What is the value of MH in $m. to the nearest $m? $ 281 CIMA F3 Question Bank (2015 syllabus) m HG is about to undertake an initial public offering of its shares on the stock exchange. HG’s Finance Director has prepared the following schedule of equity valuations per share: Nominal value Net assets – book value Net assets – net realisable value Dividend valuation model $ 1. Which of the following best describes this form of market efficiency?     284 No efficiency Weak form efficiency Semi-strong form efficiency Strong form efficiency JW’s share capital consists of $0. Study the financial press for company announcements and invest in companies that have good growth prospects.5 million and a market capitalisation of $45 million. based on the dividend valuation model.25 shares with a nominal value of $2. Invest in three or four stable companies and hold the shares long-term. Invest in several different companies across a number of industry sectors.78 2.00 1. JW has just announced plans for a new investment that is expected to generate an NPV of $12 million. what will be the impact on the share price of JW?     No change Increase by $0. She understands that the stock exchange shows strong-form efficiency.30 Increase by $1.80 .10 Based on this data. Assuming strong form market efficiency.

AJ’s latest profits after tax are $700.      288 The cost of equity is difficult to establish with accuracy.000 during the year. What is the value of AJ. dividend cover of 2 and dividend yield of 5%.80.000.400 430 180 325 Sales Operating profits Depreciation Finance costs paid Tax ON repaid $300.60 per share. Co st I pyri ntu ght itio n2 015 Fir ST’s cost of equity is 11%.000. KJ. The model assumes shareholders have no control over the level of dividends. KJ intends to pay the new directors of AJ $100. What is the price of YE’s shares implied by this data to the nearest $0. which may not be true. who have taken no salary from the company but have drawn dividends. The model assumes that the dividend growth rate exceeds the discount rate. ON’s working capital fell by $210. Calculate ON’s free cash flow. $ m . based on a P/E valuation? $ 286 YE has earnings per share of $0. has made an offer for 100% of AJ’s share capital. Calculate the expected annual growth rate in dividends to the nearest 0. a larger company. ST has just paid a dividend of $0.000 on tangible assets to replace obsolete assets.CIMA F3 Question Bank (2015 syllabus) 285 9: Business valuations 63 AJ is jointly owned by its three directors. The model assumes that companies have sufficient earnings to maintain dividend growth levels. $000 6. The market price of ST’s shares is $6. The model assumes that retained earnings will be reinvested to earn a return equal to the cost of equity. as calculated by the dividend growth model.80. which may not be true.000 of debt during the year and spent $750. % 289 The following figures are taken from ON’s latest set of accounts.000 1. The tax rate is 25% and KJ is using a P/E ratio of 8 to value AJ.01%.01? $ 287 Which of the following are valid criticisms of the dividend valuation model? Select ALL that apply.

BX’s cost of capital is 13% and the number of shares in issue over the period has remained constant.1? $ .64 0.60 0. what is the market value per share of XG’s shares to the nearest $0. Goodwill Non-current tangible assets Current assets $0. Assuming a dividend has just been paid.64 9 : B u s i n e s s v a l u a t i o n s 290 CIMA F3 Question Bank (2015 syllabus) TR intends to pay a constant dividend of $0. with the dividend for 20X8 having just been paid.25 ordinary shares 6% $1 preferred shares Retained profits 8% bank loan Mezzanine debt Current liabilities $m 60 260 140 10 20 540 130 90 36 To the nearest $0. Using the dividend valuation model and the information above. what is the current market value of the shares. The cost of capital is 11%. to the nearest $0. XG has just paid a dividend of $0. which is also its cost of capital.71 0.75. 20X4 20X5 20X6 20X7 20X8 $ 0. what is the value of an ordinary share in FT using the net assets basis? t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F $ 292 BX has paid the following dividends over the last few years. what is the market value per share of BX’s shares to the nearest $? $ 293 XG looks to achieve constant growth of dividend each year. as well as retaining 40% of after-tax earnings for future investment.01.79 0. It can invest the funds it earns at 11%.01? $ 291 The following figures are taken from FT’s statement of financial position.84 on its $1 shares for the indefinite future.90 Using the dividend valuation model and the information above.

01? $ 298 MJ has 2 million $1 shares in issue. forecast post-tax earnings for NB would be predicted to be $20 million in the first year after the new investment and remain constant after that. The dividend in a year’s time is expected to be $0. What would be the market value per share of the remaining shares. GG is considering issuing $5 million worth of debt and using the proceeds to repurchase some of the share capital. What is the expected market price of MJ’s shares after the scrip issue? $ . The required return is 14%. What would be the valuation of NB’s equity according to Modigliani and Miller’s theory with tax if it issued the bond and undertook the investment? $ 297 m GG is all-equity financed and has 2 million shares in issue with a market value of $7. NB’s directors are considering raising this finance either in the form of a rights issue or an 8% bond.50 per share.2 million. Profits after tax are expected to be $150. what is the expected growth rate of dividends each year to the nearest 0.000 and the current market price of MJ’s shares is $3. LZ has 4 million shares in issue.CIMA F3 Question Bank (2015 syllabus) 294 9: Business valuations 65 The shares of CT have a market price of $1. by how much to the nearest $0.000. The project would be financed by an 8% bond. The board of CT wishes to increase dividends at a constant rate each year. MJ has accumulated reserves of $840.000 last year and some of its shareholders have indicated that they expect this dividend level to be maintained this year. However MJ is currently suffering from a temporary shortage of cash and its directors are considering offering shareholders a 1 for 20 scrip dividend. The cost of equity would rise to 15% but all earnings would continue to be paid out as dividends.01%? % 295 LZ is an all-equity financed company with a cost of capital of 14%. It is forecast to make constant post-tax profits of $2 million. LZ is considering a project that would cost $4 million and generate additional earnings before interest and tax of $1. The tax rate is 25%. The tax rate is 25%. It is considering raising $12 million to finance a new investment that will carry the same business risk as NB’s current operations.50. to the nearest $0. LZ pays all its profits out as dividends. MJ paid a dividend of $100.60. Assuming the market shows semi-strong efficiency. The tax rate is 20%. Using the dividend valuation model. Fir Excluding interest on the bond.01 would the market price per share increase when the project is announced? $ 296 Co st I pyri ntu ght itio n2 015 NB is an all-equity financed company with a cost of equity of 10%.12 per share.

Tangible assets Industry return on tangible assets Profit before tax Tax rate Weighted average cost of capital Cost of equity $120m 16% $36m 25% 10% 15% Using the Calculated Intangible Value method. $ m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .66 9 : B u s i n e s s v a l u a t i o n s 299 CIMA F3 Question Bank (2015 syllabus) The following data is available about HJ. calculate the value of HJ’s intangible assets.

Asset stripping is buying the share capital of a business and then selling off its assets. TD’s directors do not believe that the bid is in TD’s best interests and wish to take action before the bid is made.CIMA F3 Question Bank (2015 syllabus) 10: Mergers and acquisitions 67 Chapter 10: Mergers and acquisitions 300 If a company believes that it can raise its earnings per share by acquiring another company. Co st I pyri ntu ght itio n2 015 Fir C Coffee has made an offer to acquire M Milk. What is this type of acquisition called?     303 What is the main role of regulators in merger and acquisition activity?     304 Horizontal integration Vertical integration Diversification Market integration Deciding whether mergers and acquisitions should be allowed Intervening if a fair price is not being offered for the shares of the target company Intervening if the combined company is likely to have monopoly power Intervening to prevent directors of a target company frustrating a takeover bid LP intends to bid for TD. this is known as:     301 Bootstrapping Economy of scale Economy of integration Asset stripping Are the following statements TRUE or FALSE? A reverse takeover is the acquisition of a smaller company by a larger company. 302 True  False    C Coffee is a nationwide chain of coffee shops in Earland. M Milk is a chain of cafes based in Earland’s capital city. Which of the following courses of action can TD take before the bid is made?     Pacman White knight Refer the bid to the competition authorities Revalue non-current assets .

PV is using a proxy company to derive an appropriate discount rate to use when valuing the potential acquisition using a discounted cash flow approach.     JH’s earnings XV’s earnings JH’s P/E ratio XV’s P/E ratio .68 1 0 : M e r g e r s a n d a c q u i s i t i o n s 305 Which of the following benefits generated from a merger is a synergy from financial economics?     306 CIMA F3 Question Bank (2015 syllabus) Economies of scale Economies of vertical integration Economies of horizontal integration Bootstrapping Complete the sentence below by placing one of the following options in each of the spaces. An increase A decrease Higher Bootstrapping is Lower in value generated when a company acquires a company with a P/E ratio. 307 Which of the following best describes the role of competition authorities?     Approving mergers and takeovers Protecting the public interest by ensuring that competition is not undermined Ruling on whether competitive behaviour is ethical Advising the government on the operation of competition law t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 308 PV is planning to acquire a new subsidiary in a different market sector. Which of the following would not be used in a bootstrapping calculation? Select ALL that apply. Which of the following characteristics of the proxy should be the same as the potential subsidiary?     309 Strategic risk Operational risk Business risk Financial risk JH is valuing a possible acquisition XV using a bootstrapping calculation.

LP’s shareholders would be able to participate in the future growth of TH. PU has agreed to purchase TR at a cash price of $220 million and estimates that there will be synergistic benefits of $50 million arising from the acquisition. 313 How much can PU’s shareholders expect to gain from the takeover? $ 314 m How much can TR’s shareholders expect to gain from the takeover? $ m .CIMA F3 Question Bank (2015 syllabus) 310 69 Which of the following strategies could not be used as a defence when a hostile takeover bid has been received?     311 10: Mergers and acquisitions Pacman strategy White knight strategy Changing the company’s constitution to increase the % of votes required to approve a takeover Appeal to the competition authorities N Bank is about to take over Q Bank. PU has a market capitalisation of $750 million and a debt/equity ratio of 40%. TH’s gearing ratio would fall. Use the following data to answer the next two questions. TR is equity-financed and has a market capitalisation of $200 million. Both companies are of a similar size. TH’s directors wish to fund the acquisition by a share exchange. Which of the following would not be a synergistic benefit of N Bank purchasing Q Bank?     312 Reduction in staff costs due to elimination of duplicated functions Cash flow benefits due to shutting branches and disposing of property in places where branches are duplicated Greater profitability due to less competition in the banking sector Reduction of business risk due to diversification achieved through the acquisition Co st I pyri ntu ght itio n2 015 TH wishes to acquire LP and is deciding how best to finance the bid offer. TH’s earnings per share would rise. As part of the acquisition N Bank would take over all of Q Bank’s property portfolio and assume responsibility for all of Q Bank’s staff contracts. another retail bank which has been in financial trouble in recent years. Fir Which of the following would not be a consequence of funding the acquisition by a share exchange?     TH’s current shareholders would have their control diluted.

Which of the following are reasons why JK has offered to pay a higher price for MB’s shares? Select ALL that apply. The results are shown below. JK has to pay a premium to acquire a controlling interest. WB has valued PL in a number of different ways. PL is a listed company with 50 million $1 shares in issue. WB wishes to make the minimum offer possible but wants to make an offer that PL’s shareholders would be expected to accept. Valuation method Net assets (book value) Net assets (market value) Market capitalisation P/E ratio applied to forecast earnings for next year Value $m 400 450 600 700 What is the minimum price per share that WB should offer PL’s shareholders? $ 316 HJ is planning to acquire DL. cash flows are as follows: NPV of HJ’s cash flows without the acquisition NPV of DL’s cash flows without the acquisition NPV of the combined group’s cash flows with the acquisition t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F $m 200 50 280 What is the maximum price that HJ should offer for the equity of DL? $ 317 m JK is a listed company that is seeking to purchase the entire share capital of an unlisted company. after-financing. whereas the purchaser of the 5% shareholding used a net assets method. JK has offered to buy the shares at a price that is 25% higher than the price that 5% of MB’s share capital was sold for three months ago.     The cash flows of the combined group are likely to be higher than the sum of the cash flows of the two companies if they remain separate. The combined group will have lower diseconomies of scale.70 1 0 : M e r g e r s a n d a c q u i s i t i o n s 315 CIMA F3 Question Bank (2015 syllabus) WB is considering making a bid to buy the equity shares of PL. MB. . JK has used a cash flow method to value MB. The net present value of after-tax.

a manufacturer of mobile phones based in the same country. Which of the following are possible outcomes of the referral? Select ALL that apply. R. On the basis of these forecasts. HH has a P/E ratio of 12 and post-tax earnings of $8m. what is the maximum that HH should pay for the equity of JU? $ m . H Bank. On the day that the bid was announced. The combined group will use its increased market power to start a price war and force S out of business. HH’s directors have forecast that there would be synergies of $2m if the companies were combined and that the P/E ratio of the combined company would be 10. V Bank is forced to pay a higher price for the shares of H Bank. It has just made a bid for GT. The takeover is allowed to proceed. Which of the following are explanations why the rises in share price may have occurred? Select ALL that apply. S and T operate in the Eastern region of Earland. V Bank is required to give a guarantee that all H Bank’s branches will remain open. Synergies are forecast to be generated as a result of the takeover. A minority of the shareholders of R is opposed to the bid. Co st I pyri ntu ght itio n2 015 Fir Three bus companies. the smallest of the companies.      321 The combined group will undertake a rationalisation programme and cease operating on some socially necessary routes. The Minister for Business in Earland has asked the country’s competition authorities to investigate the takeover by V Bank of another retail bank. has just made a bid for T. the share prices of both companies rose. The combined group is forecast to have a higher Beta factor than either of the two companies by themselves. A majority of the directors of T are opposed to the bid. and JU has a P/E ratio of 9 and post-tax earnings of $6m. The combined group is believed to have a stronger competitive position than the two companies individually. The combined group will use its increased market power to charge higher prices. R. the largest of the three companies.CIMA F3 Question Bank (2015 syllabus) 318 10: Mergers and acquisitions 71 JD is a manufacturer of computers. HH is intending to take over JU.     319 The stock markets are weakly efficient. Which of the following issues are likely to be of concern to the competition authorities? Select ALL that apply.     320 The takeover is blocked.

where part of the consideration received by the owners is linked to the performance of the business after the sale A company having insufficient earnings to maintain dividend levels HE intends to purchase TW and is reviewing the post-acquisition value of the combined group using bootstrapping. and is considering raising cash from a debt issue or using a share exchange. HG is a geared company and the purchase consideration was a share-for-share exchange. HY currently has significant cash reserves but a gearing level that is higher than the industry average. Using a debt issue to provide cash rather than a share-for-share exchange is least likely to have the effect of:     323 Increasing GF’s earnings per share Increasing GF’s gearing Diluting GF’s shareholders’ control of the company Increasing GF’s cost of equity HG has taken over UP having paid a price that was above UP’s current market price. The method it will use will be:     Discounting future cash flows at an adjusted weighted average cost of capital Ungearing and regearing the cost of equity that is applied to returns to shareholders Applying the current price-earnings ratio of HE to the combined post-tax earnings of the new group Adjusting the combined market capitalisation of the two companies for the synergies that the acquisition will generate. . t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Which of the following would be the least suitable method of consideration for purchasing HY?     325 What is an earnout?     326 Cash offer. Which of the following are likely consequences of the takeover? Select ALL that apply. GF does not currently have surplus cash.72 1 0 : M e r g e r s a n d a c q u i s i t i o n s 322 CIMA F3 Question Bank (2015 syllabus) GF is looking to acquire RT and is deciding what consideration to use.     324 An increase in HG’s gearing An increase in HG’s share price A dilution of earnings of HG A reduction in the control of HG by its existing shareholders HY is contemplating a bid for the share capital of JI. funded by a rights issue Share for share exchange Debt for share exchange Valuation of a company using the price-earnings ratio A situation where a company has no suitable investments in which to invest excess earnings Sale of a business. funded from current cash balances Cash offer.

25.1 respectively. What will happen to the earnings per share of the combined group after the takeover?     329 Earnings per share will rise. KJ. as follows. From the viewpoint of YI. Co st I pyri ntu ght itio n2 015 Fir IK is negotiating to buy RT and has made a bid of $10 million. adding an earnout arrangement.5 million.  50% of operating profits for the three years if average annual operating profits exceed $3 million.01m. $ m . which of the following methods of consideration would be most suitable?     328 Cash offer Debt for share exchange Share for share exchange Earnout HG has bid for 100% of the share capital of LV. 0. The probabilities associated with these profit levels are 0.  45% of operating profits for the three years if average annual operating profits exceed $2. The directors see much of the value of KJ as being due to the strong business relations that its directors have built up with major customers and wish to retain this goodwill in the merged company. up to a maximum of $2.15 and 0. If average annual operating profits of RT exceed $2 million. up to a maximum of $3 million. The profits of both companies are expected to remain the same after the takeover and no synergies are expected from the takeover. and intends to use a share for share exchange as consideration for the purchase. The shares of HG are trading at a P/E ratio of 15 and the shares of LV are trading at a P/E ratio of 11.CIMA F3 Question Bank (2015 syllabus) 327 10: Mergers and acquisitions 73 The directors of YI are about to make a bid for a smaller company. Calculate the minimum consideration that IK will have to pay to the nearest $0. which RT’s directors have rejected.5 million. up to a maximum of $5 million. Earnings per share will remain the same We cannot tell from the information provided what will happen to earnings per share. IK has proposed an amended offer. Earnings per share will fall. additional consideration will be payable at the following rates:  40% of operating profits for the three years if average annual operating profits exceed $2 million.

The value of KH shares will be taken at their current market price. The purchase consideration will be half in new shares of KH and half in cash.00 per share with the suggested purchase consideration being one share in JK for every two shares in TY. Which of the following methods could not be used by JK to reduce dilution in earnings per share after the takeover?     Achieve synergies in TY’s operations Buy the shares for TY in cash rather than shares Sell off unprofitable parts of TY’s business Revalue TY’s non-current assets to a higher valuation . Annual earnings Number of shares in issue P/E ratio KH $10 million 25 million 10 MM $5 million 10 million 12 What is the share exchange element of the purchase consideration?     331 1 KH share for 2 MM shares 2 KH shares for 1 MM share 3 KH shares for 4 MM shares 4 KH shares for 3 MM shares Which of the following defences against a hostile takeover bid are open to the directors of the target company? Select ALL that apply. TY’s earnings per share is $0.96. JK has just made a takeover bid for TY at a price of $3.     Refer the bid to the competition authorities Refuse to pass on details of the bid to shareholders Launch a publicity campaign against the bid Issue a forecast of attractive future profits to persuade shareholders that the bid is too low Find an alternative buyer t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F  332 JK’s shares are being quoted at a market price of $6.15 and the current market price of its shares is currently $1.74 1 0 : M e r g e r s a n d a c q u i s i t i o n s 330 CIMA F3 Question Bank (2015 syllabus) KH has made an offer to buy the share capital of MM on a P/E ratio of 12.00 and a price-earnings ratio of 12. The following information is available about the two companies.

CK plans to acquire the share capital of ND.CIMA F3 Question Bank (2015 syllabus) 333 10: Mergers and acquisitions 75 The most recent results of LK are as follows.40 per share.000. by giving them a stake in the new company. total value $6 million. MD has agreed to buy 100% of LK’s share capital on a price/earnings ratio of 8. $ 334 Which of the following would not be an argument in favour of offering shares for a takeover rather than cash?     335 Co st I pyri ntu ght itio n2 015 Fir Which of the following are examples of poison pills in the context of mergers and acquisitions? Select ALL that apply.000 400 4. $000 5.50 per share. The target company issues additional shares to existing shareholders. A share offer may persuade the shareholders of the target company to sell.000 as a result of the takeover. The target company takes on large debts to make gearing too high to be attractive. Calculate the price per share offered by MD to the nearest $0. a share offer will not. A cash offer may result in a fall in earnings per share. to the nearest $0. The owners of the acquired company will not be subject to an immediate tax liability if the consideration is shares. total value $2 million CK’s after tax profit is $1. The nominal value of CK’s share capital is $0.25 shares in issue.5 million and ND’s after tax profit is $600.350 Operating profit Finance costs Profit before tax Tax Profit after tax Dividend Retained profits LK has 4 million $0. CK expects to achieve post-tax cost savings of $300. The terms of the offer are one share in CK for every two shares in ND.     336 The issue of loan capital to fund a cash offer may result in unacceptably high gearing.01? $ .600 900 3. The target company revalues assets to higher values to persuade shareholders that the bid is too low.01.700 350 3. The target company launches an advertising campaign denigrating the potential purchaser. What will be the expected earnings per share in the combined group after the acquisition. The nominal value of ND’s share capital is $0.

How many shares should UT issue to acquire YH? m 341 PS intends to acquire KL and pay a price that represents a higher P/E valuation than KL’s current valuation. There are no synergies arising from the acquisition.75 shares. How much would a holder of 1. The purchase consideration will consist of shares in PL. The takeover is expected to result in post-tax cost savings of $5 million. LE’s profit after tax is $16 million and MA’s profit after tax is $12 million. UT is prepared to offer a premium of 25% on YH’s current share price. Acquisition of which of the following businesses is most likely to provide the diversification that the directors require?     A company making complementary products A company making substitute products A company in a different industry sector A significant supplier t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 339 The directors of ID believe that the company’s current operations do not utilise fully the skills of its management and as a result the company is not fulfilling its potential. to the nearest $? $ 338 NQ’s directors believe that the company should lower the business risks that it faces by diversification. LE’s share capital consists of 40 million $1 shares and MA’s share capital consists of 30 million $0.76 1 0 : M e r g e r s a n d a c q u i s i t i o n s 337 CIMA F3 Question Bank (2015 syllabus) LE’s bid for the shares of MA has been accepted by the shareholders of MA. UT’s profit after tax is $31. LE’s share price is expected to change to reflect these savings but its P/E ratio is expected to remain at 12. YH’s profit after tax is $25 million and its price earnings ratio is 10. PS has a debt/equity ratio of 40%.000 shares in LE expect to gain from the takeover. As the stock market is efficient. To attract YH’s shareholders. but which lacks strategic focus and operational efficiency A company making complementary products A company with a similar customer profile UT is considering making an offer on a share-for-share exchange basis for 100% of the share capital of YH.25 million and its price-earnings ratio is 20. in order for its managers to be able to fulfil their potential?     340 A competitor that is operating below capacity A company operating in a different industrial sector with high growth potential. Which of the following would not be a consequence of the acquisition?     A reduction in the % stake in PS of PS’s existing shareholders A dilution of PS’s earnings per share A reduction in PS’s gearing Lower interest costs for PS . Which of the following should ID acquire. LE’s bid involves the exchange of 2 shares in LE for 3 shares in MA. UT has 50 million $1 shares in issue and YH has 20 million $1 shares in issue.

QS has 20 million $1 shares in issue and KB has 15 million $1 shares in issue. The purchase consideration will be in the form of two shares in MS for every three shares in LQ. The directors of both companies believe that the merger will result in $3 million synergies. MK’s shareholders want to maintain an interest in the combined company.CIMA F3 Question Bank (2015 syllabus) 342 10: Mergers and acquisitions 77 QS is considering making an offer for the share capital of KB. KB’s profit after tax is $9 million and its price earnings ratio is 15. GD has 15 million $1 shares in issue and KB has 20 million $1 shares in issue. What to the nearest 0.01 would be the dilution in earnings per share from the merger for the current shareholders of GD? $ 344 What is the value of the bid? $ 345 Co st I pyri ntu ght itio n2 015 Fir JK has made an offer for the share capital of WR. The offer is three new shares in QS for every four shares in KB. $ 346 m HW is considering making a takeover bid for MK and is planning to offer a debt for share exchange. By how much must pre-tax profit increase for the shareholders of MS not to suffer any earnings dilution? Give your answer to the nearest $0.00. QS’s profit after tax is $12. MK’s shareholders wish to defer a capital gain on the sale of shares. LQ’s profit after tax is $3.01% is the premium being offered to the shareholders of KB? % 343 The directors of GD are discussing with the directors of AQ the possibility of a merger between the two companies. m The shareholders of LQ have accepted a bid for their shares from MS. . The proposed terms of the merger are one share in GD for two shares in AQ. WR’s profit after tax is $8 million. The offer is three new shares in JK for every four shares in WR.5 million and its price-earnings ratio is 12. The tax rate is 25%. KB’s profit after tax is $6 million and its P/E ratio is 9. What to the nearest $0. JK has 80 million $1 shares in issue and WR has 30 million $1 shares in issue. share price $4. HW’s shareholders do not want to suffer a dilution of their control.1 million. JK’s profit after tax is $10 million and its priceearnings ratio is 16. MS’s profit after tax is $21 million and it has 15 million shares in issue. share price $2. The acquisition is expected to produce some synergies. GD’s profit after tax is $25 million and its price-earnings ratio is 18. In which of these circumstances would a debt for share exchange be least suitable?     HW has a higher gearing level than the industry average.40.8 million and it has 6 million shares in issue.

measured as (Debt/Debt+Equity) and using book values of ES. calculate the value of the synergies that will be generated by the combination of the two groups. True  False    . Calculate the number of shares in MJ that the shareholders of HS will receive as consideration. ES’s directors have estimated that the value of BU to the BS group. The market believes that the shareholders of HD will receive most of the benefits from the acquisition. After the offer was announced. taking into account post-acquisition synergies. WT’s post-tax earnings are $20 million and it has a P/E ratio of 9. is $4. The market price of MJ’s shares is $3.01% if it acquires BU? % 350 GY is planning to acquire WT. The market believes that the consideration that HD is offering for NW’s shares is too low. MJ currently has 30 million $0. ES currently has long-term debt of $3.50 shares in issue and HS currently has 5 million $1 shares in issue.8 million. Identify whether the following statements in relation to market opinion are true or false. HS’s shareholders have indicated that they require a 20% premium on the current market price of their shares.7 million.78 1 0 : M e r g e r s a n d a c q u i s i t i o n s 347 CIMA F3 Question Bank (2015 syllabus) MJ is considering acquiring HS using a share-for-share exchange. the market price of HD’s shares fell by 5% and the market price of NW’s shares rose. Using bootstrapping to calculate the value of the combined group.5 million. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F What will be the gearing ratio. to the nearest 0. $ 351 m HD has recently made a bid for NW and has offered the shareholders of NW 3 shares in HD for every 4 shares in NW. GY’s post-tax earnings are $45 million and it has a P/E ratio of 12. 348 What can be defined as ‘an investor acquiring a controlling interest in a company’s equity and where a significant percentage of the purchase price is financed by borrowings’?     349 Mezzanine finance Warrant finance Leveraged buyout Venture capital ES is considering raising $4 million of debt finance to fund the acquisition of BU.60 and the market price of HS’s shares is $6. share capital of $6 million and accumulated reserves of $5.

5 shares in NF. calculate the synergies that the combination will achieve. To the nearest $0. The directors of the two companies believe that the acquisition will generate $4 million synergies.4 shares in NF . The current share price of RV’s shares is $4. trading at $2. Which of the following offers is likely to be acceptable to the shareholders of NF and fulfil the requirements of the institutional shareholders of JL?     1 share in JL for every 2.90. it has 20 million $1 shares and earnings per share of $0. 354 Calculate the gain in wealth for the shareholders of QA if the bid is accepted. OR’s directors believe that it can maintain its current P/E ratio once it has acquired RV.3 shares in NF 1 share in JL for every 2.45 and the current market price of NF’s shares is $1.35 shares in NF 1 share in JL for every 2. it has share capital of 50 million $0. OR’s profit after tax is $36m. but are coming under pressure from JL’s institutional shareholders who wish JL to minimise the premium it pays for acquiring NF’s shares. Fir The directors of QA are planning to offer the shareholders of MV 8 QA shares for every 1 MV share. QA currently has 80 million $0. trading at $9.80 and MQ has 12 million shares in issue. MV currently has 5 million S1 shares in issue with a market price of $9.00.20. $ 355 Calculate the gain in wealth for the shareholders of MV if the bid is accepted. a company that JL wishes to acquire. $ 356 m m JL offered 1 of its shares for every 2.01.10 shares in issue with a market price of $1. JL’s directors are considering improving their offer. NF’s shareholders turned down this bid on the grounds that it undervalues NF as indicated by the current market price. what is the expected share price of the combined company after the merger? $ 353 OR has agreed to purchase all of RV’s shares for cash. The current market price of JL’s shares is $4. HW has 15 million shares. Co st I pyri ntu ght itio n2 015 QA is planning to make a bid for MV.25 shares in NF 1 share in JL for every 2. $ m Use the following information to answer the next two questions. Assuming OR’s directors are correct about the company’s maintaining its P/E ratio.CIMA F3 Question Bank (2015 syllabus) 352 10: Mergers and acquisitions 79 HW has made an offer for MQ on the basis of a one for four share exchange (one share in HW for four shares in MQ).00.00.30. They estimate that the combined company will be able to achieve synergies of $12 million.40.50 shares and its current share price is $9.

The directors of the merged company decided to sell off $5 million of surplus assets which they estimated could be sold without impacting upon the continuing profitability of the merged company. They estimate that the combined company will be able to achieve synergies of $8. $ m . The directors of XQ are planning to offer the shareholders of VZ one XQ share for every two VZ shares. $ m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 359 ML and FR recently merged.1m.00. The sale proceeds were used to make an investment with an expected net present value of $7 million.8 million. % 358 The directors of MN are planning to make a bid for DX. VZ currently has 8 million shares in issue with a market price of $2. The merger was by means of a share exchange with ML’s shareholders holding 60% of the shares of the merged company. The directors of MN estimate that the acquisition will result in synergistic benefits of $12 million. Calculate the increase in wealth of MN’s shareholders if the bid is accepted. MN currently has 20 million shares in issue at a current share price of $7. to the nearest 0.40.50 per DX share. Calculate the increase in wealth of FR’s shareholders to the nearest $0. Calculate the % share of the synergy gain that will accrue to the shareholders of VZ. XQ currently has 20 million shares in issue with a market price of $4. offering a cash offer of $4.10.1%. Prior to the merger the market capitalisation of ML was $25 million and the market capitalisation of FR was $15 million.30.80 1 0 : M e r g e r s a n d a c q u i s i t i o n s 357 CIMA F3 Question Bank (2015 syllabus) The directors of XQ are planning to make a bid for VZ. DX currently has 5 million shares in issue at a current share price of $4.

The % dividend on the convertible preference shares will be lower than the % interest on debt.     362    Co st I pyri ntu ght itio n2 015 Fir Venture capitalist funding generally consists of 100% equity finance to give the venture capitalist control of the company. to avoid taking control of the company. Debt interest is paid ahead of preference share dividends.CIMA F3 Question Bank (2015 syllabus) 11: Business reorganisations 81 Chapter 11: Business reorganisations 360 Which of the following are reasons for undertaking a sell-off? Select ALL that apply. Venture capitalist funding generally consists of 100% debt finance as equity is too risky. Venture capitalist funding generally consists of 100% debt finance to gain tax relief on interest. Venture capitalist funding consists of a mixture of equity and debt. Which of the following are reasons why a company might undertake a spin-off? Select ALL that apply. For which of the following reasons is a venture capitalist likely to prefer debt?     The venture capitalist will be forced to convert the preference shares into ordinary equity shares.     361 Which of the following are reasons why a management buyout of a subsidiary may be successful? Select ALL that apply.     364 Managers are more motivated Loss of inter-group synergies Managers can make changes quicker if they don’t need parent company approval The business is no longer involved in transfer pricing arrangements Which of the following explanations generally apply to venture capitalist funding of a management buyout?  363 Reduce the risk of a takeover Generate cash to overcome liquidity problems Dispose of a less profitable business Clarify the management structure Increase economies of scale Raise cash Reduce the risk of a takeover bid Comply with legal and regulatory requirements SS Co is seeking finance from a venture capitalist. but to gain the benefit of high returns on equity. Preference shares are less marketable than debt. The venture capitalist is considering whether the finance should take the form of debt or convertible preference shares. .

Which of the following valuation approaches is the seller likely to use when negotiating the selling price?     366 The directors of the LK group wish to dispose of one of its subsidiary companies. during the negotiation phase of the management buyout. and expects this division to generate higher profits than it did as a subsidiary of KJ. TH can apply economies of scope to KJ’s operations. Which of the following are explanations of why TH may be able to generate greater returns out of KJ? Select ALL that apply. There will be strategic synergies between TH and KJ. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Which of the following methods would not be an appropriate method for Sue and Jo to realise their investment?     368 Placing Management buy-out Private equity buy-in Trade sales MD is selling off an unprofitable subsidiary called KJ to TH. TH intends KJ to become a division of TH. There is a potential conflict of interest if. Diseconomies of scale will be higher. The directors of the subsidiary are interested in a management buy-out.     TH will apply a lower cost of capital to assess KJ’s cash flows. They now wish to realise the full value of their investment but will not be able to obtain a stock exchange listing. .82 1 1 : B u s i n e s s r e o r g a n i s a t i o n s 365 CIMA F3 Question Bank (2015 syllabus) DD is about to sell one of its divisions as it is making lower profits than the rest of the DD group. owning 100% of the share capital between them. the directors of the subsidiary company were to:     367 Net asset approach Discounted cash flow analysis at purchaser’s cost of equity Discounted cash flow analysis at DD’s weighted average cost of capital Discounted cash flow analysis at purchaser’s weighted average cost of capital Employ more staff Factor receivables Use surplus cash for a major investment with a positive present value Make a general provision against the value of assets Sue and Jo founded a new company a few years ago.

one from the bank. Calculate the net cash available to shareholders if HN did not continue as a going concern. $ 370 BN has agreed to sell an under-performing business unit to the managers of that business unit for $720 million. to the nearest $0.000. The inventory would have to be written down by 15% if disposed of on an immediate sale. A debt factor has valued trade receivables at $205. The remaining finance will consist of 2 loans of $160 million.CIMA F3 Question Bank (2015 syllabus) 369 11: Business reorganisations 83 HN has been struggling in recent years and its directors are currently deciding whether to continue in business. The following figures are taken from its latest accounts. $000 780 420 240 680 210 Non-current assets Inventory Trade receivables Trade payables Bank overdraft HN’s directors have valued its non-current assets and estimate that their realisable value is 75% of their book value. Co st I pyri ntu ght itio n2 015 Fir What is the minimum total equity value of the management buyout after 4 years. The managers have agreed a financing package for the management buyout with the bank and a venture capitalist.01m required to satisfy the venture capitalist? $ m . The managers have agreed to subscribe $100 million for share capital and the venture capitalist has agreed to subscribe $300 million for share capital. one from the venture capitalist. The venture capitalist expects a return of at least 20% on the equity portion of its investment over the first 4 years of the management buyout.

84 1 1 : B u s i n e s s r e o r g a n i s a t i o n s CIMA F3 Question Bank (2015 syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

CIMA F3 Question Bank (2015 syllabus) Answers to 1: Business objectives 85 Answers to chapter questions Chapter 1: Business objectives 1  Company Y has higher expected growth than Company X. for-profit entity 10  30. 5  Interest rates in the economy have risen. 2  5 times Interest cover = 3 5  P/E ratio = = Profit before interest.5 × 1. not-for-profit entities don’t.4% (4 × 0. 9  Public sector.95)/(20 × 0. 6  Equity shareholders 7  For-profit entities have financial objectives.25) = 30. here operating profit = 50/10 = 5 Interest payable Market valuation of shares Operating proft − Interest − Tax (8 × 10) (30 − 6 − 8) =5 4  Co st I pyri ntu ght itio n2 015 Fir Maximisation of the present value of future cash flows Shareholders will be more concerned about future cash flows than about profit maximisation in the present.4% . 8 The agency problem arises because managers have low accountability to shareholders and access to better information as shareholders.

000 ─ $100.5 ($200.07 12.000)/$200.86 A n s w e r s t o 1 : B u s i n e s s o b j e c t i v e s 11  CIMA F3 Question Bank (2015 syllabus) 13.60)/7.000)/$200.000 ─ $100. .20 × 100% = 13.000 ─ $100.9% 12  Profit before interest and tax 13  1.33 14  3. not-for-profit entity 19  25%:15% Operating profit margin: ($200.5 21  Variable costs are the highest proportion of its expenses.33 P/E ratio = Dividend payout ratio/Dividend yield = 12/9 = 1.60 – 7.000 ─ $50.000 ─ $50.1% Dividend yield = Dividend payout ratio/P/E ratio Dividend yield = 25/8 = 3.000 = 25% Profit before tax to revenue: ($200.000 = 2.07 Asset turnover = ROCE/Operating profit margin = 16/15 = 1.5% 18  Public sector.000 ─ $50.9% ((7.5 17 % Operating profit margin = ROCE/Asset turnover = 25/2 = 12.1% 15  40% Dividend payout ratio = Dividend yield × P/E ratio = 8% × 5 = 40% t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 16  1.000 = 15% 20  2.20) + 0.000)/$20.000 ─ $20.

1059 28 1.34/0. here R60.1427 0. here $505.04/1.000 × 1.05/1.26% 0.02/1.CIMA F3 Question Bank (2015 syllabus) Answers to 1: Business objectives 87 22 23 Import prices Increase  Decrease  Export prices    The € has depreciated and European buyers will find US goods to be more expensive.25 = $505.4/5.1427 26 0.1059 Co st I pyri ntu ght itio n2 015 Fir 9.834.800 .6081 27 0.6081 1.02)2 = 9.30) – 1 = 4.7491 30 R 60700 Exchange rate in a year’s time = 9.04) = 9.1400 × (1.7491 29 9.025)0.000/9.2) – 1 = 9.22% 4.800 × (1.03) = 0.05/1.7000 × (1.26 25 % 3√(0.06/1. 9.963 = 1.2000 × (1.22 24 % 4√(7.8865 Purchases = Y600.689.2500 × 0.8865 = R60.6200 × (1.700 31 $ 505800 Value of purchases = £280.04) = 0.

37  Interest rates fall. which is not an indication of profitability.88 A n s w e r s t o 1 : B u s i n e s s o b j e c t i v e s CIMA F3 Question Bank (2015 syllabus) 32  A charity 33  Yes. approximately $50. 38  A rise in the level of government borrowing  Greater demand for borrowing from businesses 16 39 % Dividend yield = Dividends/Market capitalisation = $400.000 Available facility = $1.  CH will have to demonstrate value for money.400.000 – 5.000 = $50. Interest rates are likely to rise.000 . It means getting the best use out of the money spent. . to counter the effect of inflation.5/4) – 1 = 4. looking at the input/output ratio.000) + (5.000 4.00 34 % 20X6 EPS = 200/50 = $4 20X9 EPS = 270/60 = $4.000.000/(1m × $2.000.000 × 90/360) = $950.50) = 0.000 – (10. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 36  Efficiency means doing things as quickly as possible.$950.50 Growth rate = 3√(4.000 – 4.000 of the facility would still be available for withdrawal. 16% 40  Earnings per share This will partly depend on the number of shares each company has issued.00% 35  The objectives of CH will be more difficult to define. O/D= 200.400.000. Efficiency does not necessarily mean doing things as quickly as possible.16.

67 Dividend per share = $2.40/12 = $0.5m/4m × $1.20/$0.05 = $0.67 42 25 % Earnings yield = Profits after tax/Market capitalisation = ($1.CIMA F3 Question Bank (2015 syllabus) 41 Answers to 1: Business objectives 89 1.50) = 25% Co st I pyri ntu ght itio n2 015 Fir .12 Earnings per share = $2.20 Dividend cover = $0.12 = 1.40 × 0.

48 49 r i F 50 True  False     Information can be omitted if it is subject to confidentiality constraints.90 Answers to 2: Sustainability & integrated reporting CIMA F3 Question Bank (2015 syllabus) Chapter 2: Sustainability and integrated reporting 43  Stakeholder Engagement 44  Improve quality of information available to providers of financial capital 45  Clarity  Comparability  Intellectual capitals 46 47 Capitals in integrated reporting can be defined as resources and relationships t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s Integrated reporting is part of sustainability reporting.  Accuracy  Ethical .

2% 57  The dividend objective only Dividend growth rate = 4√(1.15)/(5 × 2.500 = 19.1/0.29% Gearing = (6 × 1.2% 56 Co st I pyri ntu ght itio n2 015 Fir EBIT Finance cost ($2m × 25% × 8%) Profit before tax Tax Profit after tax 100% $ 400 400 80 320 ROE 100% = 320/2.16%.000 = 16% ROE 75% = 288/1.CIMA F3 Question Bank (2015 syllabus) Answers to 3: Financial strategy 91 Chapter 3: Financial strategy 51 Paying out a dividend Yes  No  Making a bonus issue   Yes  No    52 Raising new equity finance Raising new debt finance 53  Promotion of social objectives  Protection of customers from monopoly power 54  Harder Higher 55  Meet future needs  Maintain sufficient balances to be able to complete day-to-day transactions  100% equity . 75% equity – 19.8) – 1 = 8.62) = 52.7% 58  Making directors’ remuneration partly dependent on increases in share price  Investing in projects with a positive net present value 75% $ 400 40 360 72 288 .

92 A n s w e r s t o 3 : F i n a n c i a l s t r a t e g y 59  Transaction  Precautionary 60  Consideration for the sale of a business 61  New equity subscribed by the directors CIMA F3 Question Bank (2015 syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

66  Credit statement of profit or loss gain of $10.00 48.65 Loan $m 50. 80.89 = 80. liability or firm commitment that is attributable to a particular risk and could affect profit or loss Co st I pyri ntu ght itio n2 015 Fir Variability in cash flows and net investments in foreign operations are subject to separate hedging rules.89 1 April 20X4 31 March 20X5 Difference $m 80/1. The requirement is that the hedge must be highly effective.52 Hedge effectiveness = 1.50 100/1.61 1. 68  Maximum exposure to credit risk  Management of liquidity risk  Maturity analysis of financial liabilities  Sensitivity analysis to currency risk 69  Exposure to losses of goods in transit 70 $ (500) . IFRS 9 thereafter 65  Futures contracts require a margin deposit.6 62.48 1.65 60.6 80/1.4 63 % Investment $m $m 100/1.000 67  Changes in the value of assets or liabilities  Unrecognised firm commitment  Identified part of an asset.4% 64  IAS 39 up to 31 December 2017.CIMA F3 Question Bank (2015 syllabus) Answers to 4: Hedge accounting 93 Chapter 4: Hedge accounting 62  The hedge is expected to be at least 90% effective.52/1.

72 If a business is using hedge accounting in relation to a net investment in a foreign operation.94 A n s w e r s t o 4 : H e d g e a c c o u n t i n g 71 $ CIMA F3 Question Bank (2015 syllabus) 0 The two losses would cancel each other out. both the investment and the borrowing must be translated at closing rate at each year end and gains or losses on both items should be offset in other comprehensive income. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

2)] = $1.58 76 1.60) + (( 8 ) × $0.80 $0.35)] = $4.85 – $2.40 = $0.32) + (( ) × $0.58 1 10 Yield-adjusted price = 4+1 [(4 × $0.80 TERP = 1 4+1 74  [(4 × $4) + $3] = $3.85 Value of right = TERP – Issue price = $2. and shares with the benefits of rights will be more attractive than those without.80] = $4.00 $ TERP = 1 5+1 Co st I pyri ntu ght itio n2 015 Fir [(5 × $5) + 3.80 Value of right = TERP – Issue price = $4.00 77 1.40) + (2 × $3.80)] = $1.44 79 1 TERP = 4+1 [(4 × $1.10 5 1.50 × (1 – 0.10 $ 7 [(4 × $1.40] = $2.45 75  $0.45 TERP = 1 3+1 [(3 × $3) + $2.28 [(5 × $4.40) ] = $0.80 = $1.50) + (1. .CIMA F3 Question Bank (2015 syllabus) Answers to 5: Equity finance 95 Chapter 5: Equity finance 73  $3.44 80  $Nil 81  Issue price < Ex rights < Cum rights The issue price is less than the other prices to make the shares attractive.28 $ Yield-adjusted price = 78 1 4+1 4.80 – $3.

a company’s share price is likely to fall.000.   t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 85  1 for 2 TERP = $7 = 1 1 ??+1 ??+1 ((N × cum-rights price) + issue price) ((N × $8) + $5) 7(N+1) = 8N+5 7N+7 = 8N+5 N=2 86 The providers of equity finance face greater risk than the providers of debt finance. reserves will decrease by $500.96 A n s w e r s t o 5 : E q u i t y f i n a n c e 82  CIMA F3 Question Bank (2015 syllabus) $5.000 TERP = 1 ??+1 $2.000 × 0. because of greater uncertainty about their return and greater variability of their return. 87  88 $ Share capital will increase by $500.20 TERP = 1 3+2 [(3 × $4) + (2 × $2)] = $3.   Following a rights issue.00) = $2. 122500 200.000. As a result providers of equity finance will require a greater level of return on their investment than providers of debt.00= $5 million 83  $3.00 Issue proceeds = (10 million/4) × $2.000. the total value of a company’s ordinary shares is likely to fall.25 × $3.20 84 True False Following a rights issue. .00) + issue price) Issue price = ($2.80 × 5) – (4 × $3.80 = 1 ((N × cum rights price) + issue price) 4+1 ((4 × $3.50 × 0.7 = $122.500 The discount must be on market value as companies are not allowed to issue shares at a discount on nominal value.

60 3.75 91 ke = = 92 d1 +g P0 3(1.50 Cumulative number of shares applied for 000 500 1.30/(2/5)) = $0.CIMA F3 Question Bank (2015 syllabus) 89 14.80 3.70 cumulative number of applications exceeds 4 million.00 3.70 3.15) 150  + 0.300 9.70 = $14.200 1.300 9.8% 94 True False An increase in the dividend growth rate would result in a lower share price   An increase in the cost of equity would result in a lower share price.5% 93  VE 1 ) 2+1 9.7 × 0.900 At $3. therefore issue price is $3.   .900 $ 4.8m 90 $0.700 2.15 = 0. Proceeds = 4m × $3.8 $ Answers to 5: Equity finance 97 m Number of shares applied for at price 000 500 800 1.200 6.400 3.75  Value of right = Change in share price/Number of rights per share = ($0.14 = 9.70.8% g = bR g = 0.90 3.3% 9.600 3.173.300 2. or 17.5%  Co st I pyri ntu ght itio n2 015 Fir 17.500 4.3%    V  + kd (1 – t)  D    VE + VD   VE + VD  WACC = ke  8 = ke ( 2 )+5( 2+1 ke = 9.

40 ) 16.3 = 0.06 ke= 0.20 (1+0.1 (1 – 0.4 × 0.20 (1+0.6 99 ke = d0 [1+ g] P0 % +g g = 0.40 17. the dividend expected next year should be used in the calculation.5% (4.4) = 0.30 = 9.70 −0.2% . it is necessary to know the market value of shares.2 100 ke = d0 [1+ g] P0 % +g g = 0. 12.20) 14.12 = 0.20−0.12) + 0.168 ???? 16.04 = 0.8% 9.12 ke = 0.6% (4.176 ???? 17.8 98 d1 = 0.20 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F ke = P0 + g= + 0.40 4.3 97 ke = d P0 = % 0.40 (4.06) 2.06 = 0.00) 9. If a realistic cost of equity is to be calculated.142 ???? 14.3% % 1.98 A n s w e r s t o 5 : E q u i t y f i n a n c e 95 CIMA F3 Question Bank (2015 syllabus) If dividends are expected to grow.5 96 ke = d P0 = % 0.50 = 12.60 + 0.

067 ???? 6.50 = 0.171) 10.1% ke = 0.25 (1+??) (8.30 4. 105  The cost of debt capital would not change.  More investment projects would be worth undertaking.07) Co st I pyri ntu ght itio n2 015 Fir = $16.00) + ?? 8 × 0.60 (1+0. not the preferred shares.28)) – 1 = 17.07 (1.0 102 kpref = 103 + 0.04 ???? 4% 16.1 106 ke = d0 [1+ g] 0.  The share price would go up.2% d P0 = 0.08) = (0. 2.7 104 kpref = d P0 = % 0.20 = 0.12−0.45 g = (3√(0.45 (1+0.g 0.1% .7% The growth rate only applies to the ordinary shares.18 = 1.05 × 2 2.12−0.021 or 2.CIMA F3 Question Bank (2015 syllabus) 22.25 + 1.2 101 ke = d0 [1+ g] Answers to 5: Equity finance 99 % +g P0 0.171 = 0.19 g = 0.25g + 8g 9.222 ???? 22.08) 6.20 $ P0 = % d0 [1+ g] ke .25g = 0.18 = P0 % +g 1.

80 (1+0. 112  Underwriting 113  14.6 Rm = 12% For Y ke = 5 + (12 – 5) 1.g 0.2 Rm = 16.40 % 1.8% Using CAPM.00) − 0. for X ke = Rf + [Rm – Rf]β 16.2 1.00% ke = Rf + [Rm – Rf]β 15.00−1.05 = 0.2 = 5 + (Rm – 5) 1.4 = 14.8% .14 ???? 14% t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 111  Enhancing existing shareholders’ control over the company A listing is likely to mean that a company attracts a wider range of shareholders.100 A n s w e r s t o 5 : E q u i t y f i n a n c e CIMA F3 Question Bank (2015 syllabus) 107 21. which is likely to dilute the control of existing shareholders.4 = 13% 115  14.11−0.07) = (0.40 $ P0 = d1 ke .07) 14.6 = 6 + [Rm – 6]1.00 (1−0.8 Rm = 14% 114  13% ke = Rf + (Rm – Rf)β ke = 6% + (11% – 6%) 1.05) (6.0 108 ke = d0 [1+ g] P0 + g= 109  Introduction 110  Placing = $21.

0% Rm – Rf = excess return ke = 3% + (8%) 1.50 – ($4 × 0.CIMA F3 Question Bank (2015 syllabus) 116  Answers to 5: Equity finance 101 15.0% 117 Primary markets are where shares and bonds trade on an initial offering and secondary markets are where shares and bonds trade after their initial offering.7m Value per share = 12. 118  An underwriter 119  Make the shares attractive to existing shareholders  Safeguard against a fall in the market value during the offer period 120 A company is financed entirely by equity.7m = $4.66m/$4 × 0.15m/2.000 1.70 $000 8.70 Gain = $4.150 .95) = $0. The directors are concerned that current shareholders will object to the issue.660 12.50 . In order to ensure that the current shareholders gain all the benefits of the new project. using a new issue of shares to finance the project.50 Gain per share = $4. the issue price of each share must be greater than the market value of each share.95) = 2.490 2.50 Total gain = $0. as it will dilute the value of their shareholding. Co st I pyri ntu ght itio n2 015 Fir 121 $ 1000000 Existing market value 2m × $4 NPV Issue proceeds New value of company Number of shares = 2m + (2. It is about to invest in a project with a positive net present value.$4.00 = $0.5 = 15.50 × 2m = $1m 122 $ 0.

50 × 0.25 2.25 1.5 = $0.30 Price offered $ 2.102 A n s w e r s t o 5 : E q u i t y f i n a n c e CIMA F3 Question Bank (2015 syllabus) 123 4.50 2.25m = $0.50 Market value per share Existing market value/cost Gain No of shares Total gain Existing $ 3.9) = 7.30 Cumulative number of share bids received at price m 15 45 85 More than 50 million bids were received for a price of $2.5% 125 0.900 Existing market value 5m × $2.4m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Value per share = 25.4m = $3.5 124 % $000 12.30 or more.30 $ $000 80. .40 2.000 6.400 25.30 62.25m EPS = $0.000 5.4m 3m % gain to existing shareholders = (5m/5m + 3m) = 62.16 $ Earnings = (5m × $1.50 2.8m Share capital after rights issue = 5m × 1.25 = 6.8m + $0.000 86.50 NPV Issue proceeds New value of company Number of shares = 5m + (5.50 1.2m/$6.500 8.00 5m 5m New $ 3.50 2. Issue price = New value/current number of shares = $86m/20m = $4.000 Existing market value 20m × $4 NPV New value of company For gain to go to existing shareholders.4m/$2.9m/7.20)/7.16 126  50m @ $2. therefore shares are allocated at $2.30.

76 % Return = (6 % × 20/50) + (8% × 18/50) + (2% × 12/50) = 5.48.5 Yield-adjusted price = 3+1 [(3 × $0.50 (1+0.88 .g = 0.15−0.8) = 1.70 Number of shares required to finance new investment = $2m/($2.$2.$0.80 × 80%)] = $0.5m/5m = 0.76% . 128 As the number of shares held increases.40 = $0. Shareholders who take up the issue can buy 1 share at $2.80) + (( 10 ) × $0.02 Current EPS = $3.17 = $18.17 132  0 There is no risk premium.50 = $19.12) 0. in return for giving up the right to purchase each new share.25m New EPS = ($3. the level of unsystematic risk falls initially and then levels off and the level of systematic risk stays constant.72 . 129 $ 0.70 = $0.02 134 5. shareholders who take up their rights can expect to be financially in the same position as shareholders who sell their rights to the company.67 + $0.80 130  131 $ P0 = Amount raised d0 [1+ g] ke .72 Change in EPS = $0. 133 $ 0.48 Shareholders who sell their rights can make a profit of 4 × $0.5m + $1m)/5m + 1.67 However.00 × 0.CIMA F3 Question Bank (2015 syllabus) 127 Answers to 5: Equity finance 103 Assuming an efficient market. so the beta factor is zero.12 = $0. this is the ex-rights price Cum-rights price = $18.40 for every 4 shares they currently own and can therefore make a profit on each share purchased of $2. the level of portfolio risk falls initially and then levels off.25 m = $0.80 1 12.12 Co st I pyri ntu ght itio n2 015 Fir 19.

683 The current expected purchase price of the bond is therefore $93. preferred share.104 A n s w e r s t o 6 : D e b t f i n a n c e CIMA F3 Question Bank (2015 syllabus) Chapter 6: Debt finance 135 4.50 107.28 Or alternatively: 139 Year(s) Description 1-3 4 0 Interest Redemption & Interest Market value Cash flow $ 6 106 Discount Factor (4%) 2.66 . t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Year(s) Description 1-4 4 0 Interest Redemption Market value Cash flow $ 6 100 Discount Factor 4% 3.65 90. whereas the capital gain on a warrant is uncertain.30 136 Unsecured loan. the dividend on a preferred share is for a certain amount.30 $ Price per share $129/30 = $4.855 1 Present Value $ 16.170 0.855 1 Present Value $ 21.36 68.66 Present Value $ 25.30 93.775 0.28 The current expected market value of the bond is therefore $107. Year(s) Description 1-4 4 0 Interest Redemption Purchase price Cash flow $ 8 100 Discount Factor 10% 3.630 0. warrant  Interest on a loan has to be paid.78 85.28 94 $ Yield to maturity of similar bonds is 10%. therefore use 10% as the discount rate. 137  138 $ The rate of interest at which the total discounted value of future interest payments and capital repayments is equal to the current market value of the bond 107 Yield to maturity of similar bonds is 4% therefore use 4% as the discount rate.63 107.

therefore the net present value of the cash flow when discounted at 6% will be equal to zero.717 100 0.90 73.767 0.01) .792 Present Value $ (103.10 Present Value $ 38.673 = $9.666 Present Value $ (103.CIMA F3 Question Bank (2015 syllabus) Answers to 6: Debt finance 105 Alternatively: Year(s) Description 1-3 4 0 Interest Redemption Purchase price 9 140 Cash flow $ 8 108 Discount Factor 10% 2.60 104.673 0.2 % Year(s) Description Cash flow 0 1-4 Purchase Interest 8 (1-0.10 + $3.06.888 Discount Factor 7% 4.06) Y 84. which is a coupon rate of 9%.000 3.06/2.01)) × 3) = 5.840 Present Value $ (108.76 93.000 3.06) X 100 Discount Factor 6% 1.14 66.30 By interpolation: 3% + (($8.00) 22.66 % The yield to maturity is 6%.79 79. Interest paid = PV/Cumulative discount factor = $24.00 0 To achieve a NPV of zero the present value of the total interest paid has to be $108.683 Present Value $ 19.465 0.06 .20 (3.000 2.80 8.00 = $24. Year(s) Description 0 1-3 3 NPV Purchase Interest Redemption Cash flow $ (108.487 0.2% 88.00) 20. 141 105 $ Year(s) Description 1-6 6 0 Interest Redemption Purchase price 5.74 Discount Factor 6% 1.10 /($8.25) Redemption 142 4 NPV Co st I pyri ntu ght itio n2 015 Fir Cash flow $ 8 100 103 6 Discount Factor 3% 1.$84.

144 Year(s) Description 1-4 4 Market value Interest Redemption Cash flow $ 6 100 Discount factor 3% 3.993 0.106 A n s w e r s t o 6 : D e b t f i n a n c e 143 CIMA F3 Question Bank (2015 syllabus) 111 $ Yield to maturity of similar bonds is 3%.53))) = 7.683 Present value $ (900.80 4.00 36.3 145 Present value $ 399.10 1080 $ Yield to maturity of similar bonds is 8%.94 .080.000 6. Year(s) Description 1-5 5 Market value Interest Redemption Cash flow $ 100 1.00) 36. Year(s) Description 0 1-4 4 NPV Purchase Interest Redemption Cash flow $ 900 80 1.96 636. therefore use 3% as the discount rate.30 88.386 Present value $ (88.30 % Interest is 80/900 i.60 (12.000 Discount factor 8% 3.00 1.30 681.145 0.000 Discount factor 10% 1.04) Discount factor 10% 1.87 38.60 683.636 Present value $ (900.14 50.94/(4.508 By interpolation: 7% + (3% (4.e.000 3.000 7.024 0.8% Present value $ (88.000 3.00) 42.00 (21.888 Present value $ 22.94 + 12.037 0. 8·9% plus capital gain at maturity of $100 therefore discount initially at 10%.00) 253.717 0.80 111.53) By interpolation: 10% + (2% (36·6/(36·6 + 21.170 0.60 Discount factor 12% 1.04))) = 11·3% 7.681 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 11.00) 242.8 146 Year(s) Description 0 1-10 10 NPV Purchase Interest Redemption % Cash flow $ (88) 6 100 Discount factor 7% 1. therefore use 8% as the discount rate.

052 or 5.487 0.51 Operating profit will increase by $18.14 74.00) 5.00) 19.07 By interpolation: 7% + (3% (9.t] kd net = P0 = 9 (1−0.56/(7.000 2.56 + 2.38% 2.624 0.52))) = 8.000 Interest payable will increase by $140.3) 122 = 0.792 Present Value $ (95.08 Discount Factor 10% 1.4 150 kd net = 151  i[1 .56 By interpolation: 6% + (3% (7.02% 8.44 97.2) 105 = 8.25% 8.5) 4 NPV Co st I pyri ntu ght itio n2 015 Fir Cash flow $ (95.12 106.708 Present Value $ (95.240 0.00 5 NPV 107 % 10.3) 1 Conversion ( 4 × $280 × 1.00) 18.000 = = 2.t] P0 = % 11 (1−0.CIMA F3 Question Bank (2015 syllabus) 5.2 147 i[1 .000 3.000 2.20 – 0.000 Interest cover = Profit before interest payable $118.000 Discount Factor 9% 1.34 (2.00) 13.00 Discount Factor 6% 1.63 0.16 7.20/(9.2% % Year(s) Description 0 1-3 3 Purchase Interest Conversion 1 ( × $650) Discount Factor 7% 1.00) 12.52) .20 Present Value $ (110.3 149 Year(s) % Description 0 1-4 Purchase Interest 8(1 – 0.000 × 5% = $7.000 3.00) 5.00 130.0 148 Answers to 6: Debt finance Present Value $ (110.40 83.07))) = 10.60 105.51 Interest payable $47.751 9.465 0.816 Cash flow $ (110.

580 Present value of lease cost = $10.662 The asset should be purchased as the present value of the purchase cost is lower.000 Present value of lease cost = $18.108 A n s w e r s t o 6 : D e b t f i n a n c e CIMA F3 Question Bank (2015 syllabus) 152  The lessee receives capital allowances for the asset. 156  Purchased Cost of purchase: $80.621 Present Value $ (100.840 (56.000 0.000 Discount Factor 10% 1.759) = $121.000 *4.000 Leasing Year 0-9 Rental Net cash flow $ (12.791 Present Value $ (53.000 + ($18.170 0.000) Discount Factor 10% 6.000 × 0.000 ─ ($20.074) .000 × 5.000 × 3. 153  $10. 155  Leased t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Present value of purchase cost = $51.791 = $37.160) Lease Year 1-5 Rental Decision: Lease Net cash flow $ (14.000) 104.000) 25.621) = $38.460 Year Item 0 0-4 5 Cost of purchase Rentals Disposal value Net cash flow $ (100.108) Decision: Purchase 157  Leased Purchase Year 0 5 Purchase Residual value Net cash flow $ (81.000 Discount Factor 10% 1.910 The asset should be leased as the present value of the lease payments is lower.210 10.000) Discount Factor 10% 3.460 * Yr 1 – 4 Annuity factor + 1 154  Purchased Present value of purchase cost = $120.621 Present Value $ (81.250 6.000) 24.759 Present Value $ (81.000) 40.000 10.

053 = $103. 162  31 December 20X5 20X3: 32 × $2.05 = $94.000 Denominator = 5 × (5 + 1/2) = 15 Year 1: $60.000 . 164  The company’s cost of debt 165 $ 8000 Payments = $132.000 × (5/15) = $20.000 Decision: Purchase 160  The risk of changes in a bond’s return due to changes in interest rates over time 161  Interest is allowable for tax purposes.80 × 1.355 – 0.80 × 1.052 = $98.210 (93.000 = $60.  In the case of default.000 .$600.80 × 1. subordinated debtholders will be paid after statutory creditors.000 × $5 = $660.621 Present Value $ (100.08 20X4: 32 × $2.909) = $49.000 Year 2: $60. subordinated debtholders will be paid before shareholders.790) Decision: Purchase 159  Purchased Lease $14.000 × (3/15) = $8.000 Interest = $660.000 × (4/15) = $16.000 × (1+3.000) 6.72 163 Co st I pyri ntu ght itio n2 015 Fir  In the case of default.500 × (4.000 Purchase Residual value Discount Factor 10% 1 0.820 Purchase Year 0 5 Cash flow $ (100.000) 10.CIMA F3 Question Bank (2015 syllabus) 158  Answers to 6: Debt finance 109 Purchased Lease $20.78 20X5: 32 × $2.967 Purchase = $48.791) = $95.000 Year 3: $60.

708 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 168 78000 $ Year $ (40.5% = LIBOR + 1.LIBOR = 8% 171 Present Value $ (100.010)  Reduction in finance cost  Elimination of uncertainty about the levels of finance cost  Changing the profile of debt without changing the underlying instruments  8% Interest paid = LIBOR + 2% + 6% .000 × (4/10) × 0.000 Denominator = 4 × (4 + 1/2) = 10 Year 1: $30.000 Interest = $380.25 = $2.000 – 20.250 167 81000 $ Discount at after-tax cost of debt 12% (1 – 0.531 2.210 3.5% .25 * (100.25 3.000 × 4 = $380.000 × (3/10) × 0.5% Interest paid = 7% + LIBOR – 5.328 (81.25) = 9% Year $ (100.374)  LIBOR + 1.000 Year 2: $30.000* × 0.240) 23.000) 4.25 = $3.000) 40.000 × 0.323* Present Value $ (101.240 – 0.110 A n s w e r s t o 6 : D e b t f i n a n c e 166 CIMA F3 Question Bank (2015 syllabus) 2250 $ Payments = $95.25 64.917 1-3 2-4 169 170 Discount Factor 12% 2.772 0.000 .000 × 0.230 (78.000 0.000 × 0.842 0.000 – 16.000) 20.25 16.000) 0 2 3 4 Discount Factor 9% 1.000 = $30.088 11.$350.

4% .LIBOR = 6% 177 Companies can claim tax relief on interest paid on the bonds.90 and the interest cover covenant would be breached. compared with 1% less than KK for fixed rate finance).50 174 Co st I pyri ntu ght itio n2 015 Fir New finance cost = (50.6% = 0.2% Fixed Floating DD 7% LIBOR + 1% EE 6% LIBOR + 0.50 175 If the additional borrowing is undertaken.000.8% EE will pay LIBOR + 0. taking the borrowing and swap into account.4%.0.2% 173  KK 7% JJ LIBOR JJ has comparative advantage in floating rate finance (pays 1.5% .000 = 2. meaning that KK has comparative advantage in fixed rate finance. is 6% fixed.000 × 4%) = $340.0.5% less than KK.8% EE LIBOR + 0. ($200m × 0.1) = $20m Interest cover = $98m/$20m = 4. the interest cover would be 4.000 × 100 × 6%) + (1. it is not worth undertaking the swap and the companies will pay the rates quoted. 2.000/340. Bondholders must convert the bonds into shares on the conversion date. 178  Scrip bonds True  False    .5% + 4.2% = LIBOR + 0.2% each DD will pay 7% . Rate = LIBOR + 1.08) + ($40m × 0.4% 1% 0.6% Gain = 1% .2% = 6. 0.000 Interest cover = 850.9 176 The hedged rate. Since both have comparative advantage in the type of finance that they want.0.CIMA F3 Question Bank (2015 syllabus) 172  Answers to 6: Debt finance 111 DD 6.

$0. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Only the borrowing capacity of the individual company and its subsidiaries is considered.1) + ($4m/2) = $57m 180  The lease might give the organisation the chance to upgrade the asset during the terms of the lease. A finance lease is likely to be for a longer period of time.8m × 50/150 = $0.112 A n s w e r s t o 6 : D e b t f i n a n c e 179 $ 57 CIMA F3 Question Bank (2015 syllabus) m Payment = ($50m × 1. True  False    Interest on the loan by a willing third party would be allowable.2 m Debt : equity ratio = (30 + 8): 28 = 135.048 96 Saving in $ = €96.6m = $1.400 3.200 200 . not the whole group.7%. and the lessee is likely to be responsible for maintaining the asset.8 = $120.000 184 $ 1.144 2. Interest on TY loan = 6% × $30m = $1.8m Interest disallowed = $1. 182 Interest on the part of a loan that an independent third party would be prepared to lend the company is disallowable. 181  The lease is for most or all of the life of the asset.2m NH $000 3.  The organisation’s tax position may mean that it cannot benefit from the tax allowances that are available for purchasing the asset. 183 $ 120000 Interest costs without swap Interest costs with swap Saving YE €000 2.6m Allowable interest = $1.000/0.8m . so thin capitalisation rules apply.

5 4.5% MV equity = 5m × $3.25m MV of debt capital = 17.2= $16m Equity Debt WACC = (249/26) = 9.5 WACC = (247. Weight by market value of share and debt capital MV of share capital = 7.5 247. The return on equity will increase because of the greater level of financial risk.50 = $26.5/25) = 9.5m × $1.9 Ignore reserves.CIMA F3 Question Bank (2015 syllabus) Answers to 7: Capital structure 113 Chapter 7: Capital structure 9.5m × $3.25m Market value are equal. 189  The required return on equity increases.0 Equity Debt Cost 10. therefore 50% weighting for each 188  Falls initially then rises.9 185 % MV debt = $4m × 1.90% 9. Market value × Cost 200 49 249 .6 186 ke = d P0 % = 0.5 Market value × Cost 210 37.5 7.25 = $5m MV equity = 5m × $4= $20m Market value $m 20 5 25.125 or 12.50 = $26.58% 187  Co st I pyri ntu ght itio n2 015 Fir (50% × 14%) + (50% × 9%) Market value $m 16 10 26 Cost 12.

5m .5m Value per share = $48.85 Vg = Vu + TBc = $80m + ($45m × 0.114 A n s w e r s t o 7 : C a p i t a l s t r u c t u r e 190  CIMA F3 Question Bank (2015 syllabus) 9. 192  Minimum weighted average cost of capital 193 Affect  Not affect    Optimum level  No optimum level    Return on capital employed Default risk t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 194  A fall in the base rate of interest 195  The cost of debt varies according to the level of gearing. 196 Traditional Modigliani and Miller 197  198 $ The returns to shareholders become more variable.$45m = $48.85 .5m Value of equity = $93. 4.5% 191  BL Co has aimed to increase dividends by 5% per annum over the last few years.3) = $93.5%  V   + kd (1 – t)  D    VE + VD   VE + VD   WACC = ke  VE  2   1  +5    2 + 1  2 + 1 8 = ke  ke = 9.5m/10m = $4.

25 × 16) = $44m 204 12.keu= [keu – 6] 54 . the cost of debt eventually rises.25 4 keu = 60 keu = 15% 201 Co st I pyri ntu ght itio n2 015 Fir Under the traditional view of gearing.7)] = 10.4)] = 0.08 202 % kadj = keu[1 – tL] At 40% 11 = keu[1 – (0.25) = 12.90 199 115 % keg = keu + [keu – kd] VD [1 . 10.25 1(1−0.CIMA F3 Question Bank (2015 syllabus) 20.08% 203 $ 44 m Vg = Vu + TBc = 40 + (0.25) 18 = keu + [keu – 6] 2.22% At 70% kadj = 12.00 200 Answers to 7: Capital structure = 16 + [16 – 9] 1(1−0.14 (1 – ( )0.73% 44 . the weighted average cost of capital falls then rises and the value of the company rises then falls.3keu= [keu – 6] 2.22[1 – (0.73 % 16 kadj = keu[1 – tL] = 0.25 × 0. increasing gearing will mean that the cost of equity keeps rising.90% % keg = keu + [keu – kd] VD [1 .9 keu keu = 12.25 × 0.25) 18 .t] VE 15.3) 1 = 20.t] VE 1(1−0.

5882.3)] keu = 0.8 = 5.15/0.5)] = 10.  Investors are indifferent between personal and corporate gearing.37 207 % kadj = keu[1 – tL] 0.25( 1 )] = 11.15 – keu] = keu – 0.22% % change = 10.4% t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 5.4 206 keg = keu + [keu – kd] % VD [1 − t] VE 15(1−0.10] 25 11.15 = keu + [keu – 0.2L) 0.00 % kadj = keu[1 – tL] = 12 [1 – 0.108 = keu[1 – (0.17) L = 0.  Ordinary shares 210 211 11.22 10.33 + 0.17[1 – 0.116 A n s w e r s t o 7 : C a p i t a l s t r u c t u r e CIMA F3 Question Bank (2015 syllabus) 58.1168 kadj = 0.25 25 [0.10 = 3.25) 0.82% 13.8−10.82 205 % kadj = keu[1 – tL] 0.25 × 0.22 keu keu = 13.1168[1 – (0.25 × 0.00% 1+2 .2L = 1 – (0. 58.15 = 0.10 0.37% 208  A2 B4 C3 D1 209  Capital structure influences the weighted average cost of capital and the value of the entity.

8%)( 0.800 Substitute into kadj = keu[1 – tL] . equity $45m Earnings after interest = $8m .00 % Market value of company irrespective of gearing = $8m/0.75% Market value = $76m/0.45% 218 17.25 250 )] Substitute into kadj = keu[1 – tL] 216 $ 553 m Co st I pyri ntu ght itio n2 015 Fir Current cost of equity = 64/400 = 16% New cost of equity = 16% .93% = 12% + [(12% . 215  11. with kd being 8% 214  The cost of equity will rise as gearing increases.2% = 14% Cost of debt = 12/100 = 12% WACC under new gearing = (7/8 × 14%) + (1/8 × 12%) = 13.71 keg = keu + [keu – kd] % VD [1 − t] VE = 9 + ([9 – 4] × [(30 × 0.(0.24% = 11.53% [1 – ( 6.45 % kadj = keu[1 – tL] = 11 [1.7 3 Substitute into keg = keu + [keu – kd] )] VD [1 − t] VE .2 × 0.CIMA F3 Question Bank (2015 syllabus) 212  14.25 × 350 117 )] 1.71% .80/70] = 10.27% = 15% [1 – ( Answers to 7: Capital structure 0.16 = $50m Post the refinancing debt will be $5m.25)] = 10.1375 = $553m 217 10.65m Cost of equity = $7.65m/$45m = 17% 219 10. using the proxy company’s cost of equity of 15% 213  12.(7% × $5m) = $7.

WACC is assumed to be constant at all levels of gearing under this theory.14% keg = 10.5 3.25 Market value × Cost 2.1 = 0.7 50 ]) 14.2 × 0.11)) = 2.880 337.217.3 × $40m) Vu = $178m 11.75 = 6.38% Cost 12 6. 11.25% t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Market value $m 240 54 294 Equity Debt WACC = 294/3.2.14 .45 keu . 0.25 221 % Ignoring tax.14 + ([10.25) 1 ]) = 11.8r = 0.6] ×[ 224 2.4 (1−0.6] ×[ VE 30 (1−0.1/(0.05) 0.5 .14% 223 11.14 222 % Cost of irredeemable debt = (9/108) × 0.118 A n s w e r s t o 7 : C a p i t a l s t r u c t u r e CIMA F3 Question Bank (2015 syllabus) 220 178 $ m Vg = Vu + TBc $190m = Vu + (0.09 r = 0.217.8r + (0.72 0.7 + (4 × 0.38 keg = keu + [keu – kd] % VD [1 .t] 12 = keu + ([keu .5 = 9.72 3.25) 12 = keu + 0.7 = 1.45 keu keu = 10.1125.25% 9.

5 226 % Simple CAPM can be used.7 = 7.25) 80 )= 1.9 + 0.069 = 9.43% 7.6 (75+25 (1−0.35 ( ) = 0.4% 11.6.8 228 % Degear   75  = 1.2)) = 1.263 = 11.263 + − (1 t) V V  E D  β u = βg  VE Substitute in CAPM ke = Rf + [Rm – Rf]β = 3 + [7]1.25)  VE + VD (1 − t)  β u = βg  Regear VE βg = βu + (βu – βd) VD (1 − t) Substitute in CAPM VE Co st I pyri ntu ght itio n2 015 Fir = 0.069 ke = Rf + [Rm – Rf]β = 3 + [9-3]1. .8% 229  1. Gearing = (12 + 3 + 4)/((12 + 3 + 4) + (7 + 2 + 19)) = 40.3 and 1.43 225 Answers to 7: Capital structure 119 % As the preferred shares are irredeemable they are counted as part of equity and as the bank overdraft appears to be permanent.9 ( 20 (1−0.CIMA F3 Question Bank (2015 syllabus) 40. so the equity beta will be between 1. it is counted as part of debt. ke = Rf + [Rm – Rf]β = 4 + [9 – 4] 0.9  60+40 (1−0.5 KS’s debt/equity ratio lies between the ratios of ZW and XP.4 227 % Degear   60 = 1.5% 9.

5% 100 = 1.05 Substitute in CAPM 25 (1−0.923  100+40 (1−0.159 + 1.6 231 % Degear   100 = 1.25)  VE + VD (1 − t)  β u = βg  VE t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Substitute in CAPM ke = Rf + [Rm – Rf]β = 5 + [10 – 5]0.0% 9.2) 35 (1−0.2 ( ) = 0.05 + 1.5 233 % Gear βg = βu + (βu – βd) VD (1 − t) VE = 1.429 = 12.25) Substitute in CAPM ke = Rf + [Rm – Rf]β = 5 + [11 – 5]1.159 25 (1−0.159  60+40 (1−0.295 = 14.295 ke = Rf + [Rm – Rf]β = 4 + [12-4]1.3) 75 Substitute in CAPM = 1.7 ( ) = 1.6% 14.3 – 0.429 ke = Rf + [Rm – Rf]β = 2 + [9-2]1.3 + (1.3)  VE + VD (1 − t)  β u = βg  Regear VE βg = βu + (βu – βd) VD (1 − t) VE = 1.4 232 βg = βu + (βu – βd) % VD (1 − t) VE = 1.0 230 CIMA F3 Question Bank (2015 syllabus) % Degear   60 = 1.4% 14.923 = 9.3) 75 = 1.120 A n s w e r s t o 7 : C a p i t a l s t r u c t u r e 12.589 .589 = 14.

3) + βD  D = 1.25)) = 10.3) 70   V (1 − t)  55 45 (1−0.4% .3) 55+45 (1−0.46% WACC = (0.208 Co st I pyri ntu ght itio n2 015 Fir ke = Rf + [Rm – Rf]β = 4 + [11-4]1.23 – 0.15) Degear XR’s equity beta  121 30 (1−0.997  65+35 (1−0.208= 12.4 235 % Degear   65 = 1. 10.46%) + (0.3)  VE + VD (1 − t)   VE + VD (1 − t)  β u = βg  VE Regearing should then be done at JN’s gearing ratio.997 + 0.23 + (1.CIMA F3 Question Bank (2015 syllabus) 234  Answers to 7: Capital structure βg = 1.997 ( 22 (1−0.78 × 12.85 ( ) + 0.25) 78 )= 1.15 ( ) = 1.23   55+45 (1−0.22 × 4% × (1 – 0.25)  VE + VD (1 − t)  β u = βg  Regear VE βg = βu + (βu – βd) VD (1 − t) Substitute in CAPM VE = 0.4 ( ) = 0.

6m .96) + (16m × $1.122 A n s w e r s t o 8 : D i v i d e n d p o l i c y CIMA F3 Question Bank (2015 syllabus) Chapter 8: Dividend policy 236  The level of other liabilities 237  The value of equity depends on the investments that the firm has selected.6 million EPS $0.8/4 = €3. 238  A policy of no dividends gives shareholders greater control over management.60 × 10m = $6m EPS = $6m/(10m – 2m) = $0.  The company is using retained earnings rather than debt to finance projects with positive net present values.  Dividends need not be paid if a company makes a loss. 240 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 241  Cash $1.25) = 16m Gearing = (10 m × $0.9 × 0.96)/((10m × $0.6m Earnings = 0.4 242 % Number of shares = 20m – ($5m/$1. 246  Shareholder return is equal to dividends plus growth in the share price.75 Cash = $3m – (2m × 0.4% 243  Keeping cash to finance investments 244  In a tax regime where individuals pay more tax on dividends than capital gains 245  Shareholders will believe that PP lacks profitable opportunities for investing cash. 247 € 3600000 Maximum receipt = 20m × 0.70) = $1.75 32.25)) = 32. 239  Dissatisfied shareholders who sell their shares will be liable to transaction costs.

CIMA F3 Question Bank (2015 syllabus) 248 Answers to 8: Dividend policy  Using retained cash surpluses means directors can undertake investment projects without involving shareholders. Co st I pyri ntu ght itio n2 015 Fir . 249  A company should invest all available funds in projects that have positive net present values.  Using retained cash surpluses avoids possible changes of control that may result from a share issue. shareholders will prefer dividends. 123 Although using retained cash surpluses avoids transaction costs. If the tax rate on capital gains is higher. and only pay out dividends if no such projects are available. their cost is the cost of equity. The directors may have to ask shareholder approval at a general meeting if a new share issue rather than retained cash is used to fund investments.

30 + (($40m .124 A n s w e r s t o 9 : B u s i n e s s v a l u a t i o n s CIMA F3 Question Bank (2015 syllabus) Chapter 9: Business valuations 250  625c Dividend cover = Earnings per share Dividend per share ∴Dividend per share = Dividend yield = 50 = 20c 2.72 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 252  Weak form efficiency 253  Strong form efficiency 254  $2.70 / m CIV = ($70 million .5 Dividend per share Market price per share ∴Market price per share = 251 20 = 625c 0.(10% × $40 million)) × (0.72 $ New share price = $2.6m/5m) = $2.1) = $495 million 0.032 2.09 .60 255 $ 105 m Free cash flow = 240 + 60 – 20 – 75 – 45 – 55 = 105 256 $ 180 m Free cash flow = 360 + 85 – 120 – 80 – 65 = 180 257 CIV = ($50 million .40 + ($1.75/0.60 New share price = $2.$25m)/50m) = $2.(12% × $35 million)) × 258 $ 495 0.

26 Ex div value per share = $2.$0. 215 m Operating profit Interest Profit before tax Tax Depreciation Investment in non-current assets Investment in working capital $m 890 (150) 740 (185) 230 (500) (70) 215 .CIMA F3 Question Bank (2015 syllabus) 259  Answers to 9: Business valuations 125 Company BC has lower market capitalisation. which is not necessarily the same between the two companies.12 Value of shareholding = $2.26 .14 = $2. The share price will be influenced by the number of shares in issue. 260 A B C 261 $ 1 3 2 $50 m × 10 = $500m $60 m × 8 = $480m $70 m × 7 = $490m 530 Cum div value per share = 565/250 = $2.12 × 250 = $530 262 $ 210 Price = 340 – 60 – 70 = $210m 263  264 $ Co st I pyri ntu ght itio n2 015 Fir m Deduct interest but not dividends to arrive at the free cash flow and then discount at the company’s cost of equity.

Year 4 $m 480 0.5m = $7.000/1m = 0.126 A n s w e r s t o 9 : B u s i n e s s v a l u a t i o n s 265 $ CIMA F3 Question Bank (2015 syllabus) 4800 m Year 1 $m 340 0.5 50 = $367.84/0.04) 0.751 3.05 ) × 0.894m.788m Value of equity = 50% × $13.735 = $12.909 309 Discount factor Present value Year 2 $m 380 0.75) .900m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 267 $ 6448 Value of equity = 268 $ m (470+150)(1+0.783m.000 × 0.35 5.000 EPS = $160.830 Present value = $4.826 314 Year 3 $m 440 0.05) 0.348m Sum of cash flows = $13. so $6.000 = $160.926 370 Discount factor 8% Post year 4 cash flows = ( Year 2 $m 420 0. so $4.794 357 480 (1+0.08−0.857 360 Year 3 $m 450 0.800m 266 $ 6900 m Year 1 $m 400 0.04 = $6.25 269 Earnings in earnings per share calculation = Profit after tax – Preference dividends = ($240.05) 0.751 330 Year 4 $m 510 (1/0.25 270  The company’s growth prospects are poor.788m = $6.735 353 .16 P/E ratio = 0.16 = 5.$20.448m 7.14−0.15−0.1) × 0.05 367.35 Value of equity = Value per share = 35(1+0.

25 277 $ 280 m Earnings = $4m × 5 = $20m Market capitalisation= $20m × 14 = $280m .25 Profit after tax = $8m × 0.80 Price = P/E ratio × EPS = $0.50) × $1.800m 276 $ 11.90 = $3.40 × 2 = $0.20 Earnings per share = Dividend per share × Dividend cover = $0.000 273 $ 3.000m/$0.500.40 Price = P/E ratio × EPS = $0.80 × 12 = $9.80/20% = $9.25 = 6.75 = $6m Market capitalisation = $6m × 15 = $90m Market price per share = $90m/(2m/0.60 Market capitalisation = 1m × $9.000 275 $ 3800 m Market capitalisation = (1.10 × 4 = $0.39/12% = $3.20 274 $ 9600000 Co st I pyri ntu ght itio n2 015 Fir Earnings per share = Dividend per share × Dividend cover = $0.CIMA F3 Question Bank (2015 syllabus) 271 $ Answers to 9: Business valuations 127 9.40 × 8 = $3.60 = $9.25) = $11.00 272 $ 6500000 Earnings as a % of share price = Dividend yield × Dividend cover = 4% × 3 = 12% Share price = $0.00 Earnings as a % of share price = Dividend yield × Dividend cover = 4% × 5 = 20% Share price = $1.600.25 Market capitalisation = 2m × $3.

285 $ 5000000 Need to use sustainable profits. which are $700. Valuation = 6m × 0. 284  No change If the stock market is strongly efficient.5 × (120/15) × 0.02) 0. 283  Semi-strong form efficiency The stock market is responding to a public announcement.000.5 = 0. as market will expect dividend payments.75) = $625.150.2 g= 10% × 0.1−0.128 A n s w e r s t o 9 : B u s i n e s s v a l u a t i o n s 278 CIMA F3 Question Bank (2015 syllabus) 100 $ m Earnings = $2m/(1 – 0.8) = $10m Market capitalisation= $10m × 10 = $100m 279 63 $ m Value = Profit after tax × P/E ratio × Private co adjustment = 10.4 (1 +0.000 .000 Valuation = $625.000 – ($100.000 × 0.10 = $3.5 – 8. $107m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 281 3150000 $ Use dividend model. it will have already anticipated JW’s expansion plans.1m.2 = 2% P0 = d0 [1 + g] ke − g = 8.4)/10.75 = $63m 280 107 $ m Growth rate in calculation = bR r = 10% b= (10.000 282  Invest in several different companies across a number of industry sectors.25 × $2.02 = $107.000 × 8 = $5.

which may not be true.CIMA F3 Question Bank (2015 syllabus) 286 Answers to 9: Business valuations 129 8.00% 289 $ 485 Co st I pyri ntu ght itio n2 015 Fir m Free cash flow = 1.0882g g = 2.84/0.10 .25)) = $3.10 Valuation = 260 + 140 – 20 – 130 – 90 – 36 = $124m Valuation per share = ($124m/(10/0.00 $ Dividend per share = EPS/Dividend cover = $0.0882 + 0. which may not be true.40/0.0882g + g % 0.  The model assumes that retained earnings will be reinvested to earn a return equal to the cost of equity. The model assumes that the discount rate exceeds the dividend growth rate.0218 = 1.64 0.  The model assumes that companies have sufficient earnings to maintain dividend growth levels.60 (1+??) 6.400 + 430 – 180 – 325 – 300 – 750 + 210 = $485m 290 $ 7. The model assumes dividend levels are determined by shareholder expectations.40 Market price per share = Dividend per share/Dividend yield = $0. the issue of control is irrelevant.00 287  The cost of equity is difficult to establish with accuracy.11 = P0 +g 0.64 291 $ 3. 2.80/2 = $0.00 288 ke = d0 [1 + g] 0.11 = $7.80 +g 0.05 = $8.11 = 0.

13−0.9 $ Growth rate = bR = 0.044 6.075g = 0.6 (1+0.75 (1+0.044 P0 = d0 [1 + g] ke − g = 0.8) + $1.700 320 3.075g 1.130 A n s w e r s t o 9 : B u s i n e s s v a l u a t i o n s 292 CIMA F3 Question Bank (2015 syllabus) 28 $ Growth rate = 4√(0.075 + 0.9/0.6) – 1 = 10.11 = 0.11−0.14)/4m = $3.94 Current market price per share = ($2m/0.704 .$3.4 × 0.2m) Interest ($4m × 0.1067) 0.14 – g = 0.05 294 = $11.51 .57 = 0. P0 = 293 d0 [1 + g] ke − g = 0.60 = 0.94 $000 3.704m/0.79) – 1 = 13.9 % t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F P0 = d0 [1 + g] ke − g $1.57 Profit before interest and tax (($2m/0.92% exceeds the cost of capital. using a geometric progression The growth rate over the last year of (0.065 g = 6.044) 0.14−?? 0.51 Increase in market price = $4.05% 295 $ 0.12 (1+??) 0.67%.380 676 2.9/0.1067 = $28 11. so cannot be used in the calculation.15)/4m = $4.08) Profit before tax Tax Profit available for distribution New market price per share = ($2.

8m Assuming this is a perpetuity and discounting at WACC Value of intangibles = $16.33 299 $ 126 m Current pre-tax profit generated from intangibles = $36m – (16% × $120m) = $16.50 = $7m Market value per share after the scrip issue = $7m/(2m × 1.33) = $8.25/1.33 Co st I pyri ntu ght itio n2 015 Fir Company value will be unchanged Market capitalisation before the scrip issue = 2m × $3.25 × $12m) = $203m Value of equity = $203m .25m .25 × 5m) = $16.44 Vg = Vu + TBc Vu = 2m × $7.50) = 1.25m Veg = $16.1 = $200m Vg = Vu + TBc = $200m + (0.50 = $15m Vg = $15m + (0.25)/0.33m Market price per share = $11.8m (1 – 0.1 = $126m .44 298 $ 3.05) = $3.$12m = $191m 297 $ 8.$5m = $11.25m Number of shares = 2m – ($5m/7.CIMA F3 Question Bank (2015 syllabus) 296 $ 191 Answers to 9: Business valuations 131 m Value of NB if it remains ungeared = $20m/0.

.132 A n s w e r s t o 1 0 : M e r g e r s a n d a c q u i s i t i o n s CIMA F3 Question Bank (2015 syllabus) Chapter 10: Mergers and acquisitions 300  Bootstrapping 301 A reverse takeover is the acquisition of a smaller company by a larger company. Asset stripping is buying the share capital of a business and then selling off its assets. 307  Protecting the public interest by ensuring that competition is not undermined 308  Business risk 309  JH’s earnings  XV’s P/E ratio 310  Changing the company’s constitution to increase the % of votes required to approve a takeover 311  Reduction of business risk due to diversification achieved through the acquisition 312  TH’s earnings per share would rise. True  False    302  Horizontal integration 303  Intervening if the combined company is likely to have monopoly power t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 304  Revalue non-current assets 305  Bootstrapping 306 Bootstrapping is an increase in value generated when a company acquires a company with a lower P/E ratio.

CIMA F3 Question Bank (2015 syllabus)

313

$

30

Answers to 10: Mergers and acquisitions

133

m

Gain = 200 + 50 – 220 = $30m

314

$

20

m

Gain = 220 – 200 = $20m

315

$

12

Price per share = 600/50 = $12

316

$

80

m

Offer price = 280 – 200 = $80m

317

318

319

Co
st I pyri
ntu ght
itio
n2
015

The cash flows of the combined group are likely to be higher than the sum of the cash
flows of the two companies if they remain separate.

JK has to pay a premium to acquire a controlling interest.

Synergies are forecast to be generated as a result of the takeover.

The combined group is believed to have a stronger competitive position than the two
companies individually.

The takeover is blocked.

The takeover is allowed to proceed.

Fir

The competition authorities will not intervene to regulate the price to be paid and are more
likely to insist that some branches are disposed of, because the combined group may be seen as
having excessive market power if all the branches remain open.

320

The combined group will undertake a rationalisation programme and cease operating on
some socially necessary routes.

The combined group will use its increased market power to start a price war and force S
out of business.

The combined group will use its increased market power to charge higher prices.

134 A n s w e r s t o 1 0 : M e r g e r s a n d a c q u i s i t i o n s

CIMA F3 Question Bank (2015 syllabus)

321
64

$

m

Value of HH = $8m × 12 = $96m
Value of combined group = (8 + 6 + 2) × 10 = $160m
Maximum payment = 160 – 96 = $64m

322

Diluting GF’s shareholders’ control of the company

323

A dilution of earnings of HG

A reduction in the control of HG by its existing shareholders

Debt for share exchange

324

A debt for share exchange would increase gearing levels, which are already high, further.

t
h
5
g
1
i
0
r
2
y
p ion
o
C uit
t
n
I
t
s
r
i
F
325

Sale of a business, where part of the consideration received by the owners is linked to
the performance of the business after the sale

326

Applying the current price-earnings ratio of HE to the combined post-tax earnings of the
new group

327

Earnout

This should encourage KJ’s directors to join the combined company, and gives them an
incentive to contribute to its future performance.

328

Earnings per share will rise.

If a company buys another company with a lower P/E ratio by means of a share exchange, the
EPS will rise if total profits stay the same.

329

$

10.00

m

The probabilities add to less than 1 (0.5), so there is a possibility that no extra consideration will
be payable.

CIMA F3 Question Bank (2015 syllabus)

330

Answers to 10: Mergers and acquisitions

135

3 KH shares for 4 MM shares
KH
$10 million
25 million
$0.40
10
$4.00

Annual earnings
Number of shares in issue
Earnings per share
P/E ratio
Share price

MM
$5 million
10 million
$0.50
12
$6.00

Total purchase consideration = $6.00 × 10m = $60m
Consideration to be paid in new KH shares = $60m × 0.5 = $30m
Number of new shares to be issued $30m/$4 = 7.5m
10m shares, therefore offer is 3 KH shares for 4 MM shares

331

Launch a publicity campaign against the bid

Issue a forecast of attractive future profits to persuade shareholders that the bid is too low

Find an alternative buyer

Directors can lobby the competition authorities but they cannot refer the bid themselves. Not
passing on details of the bid breaches their duty of transparency to shareholders.

332

333

$

7.40

EPS = 3.7m/4m = $0.925
Offer price = $0.925 × 8 = $7.40

334

Co
st I pyri
ntu ght
itio
n2
015

Fir

Revalue TY’s non-current assets to a higher valuation

A cash offer may result in a fall in earnings per share, a share offer will not.

A share offer may result in a fall in earnings per share.

335


336

$

The target company issues additional shares to existing shareholders.
The target company takes on large debts to make gearing too high to be attractive.

0.17

Number of CK shares pre-acquisition = 6m/0.5 = 12m
Number of shares in ND = 2m/0.4 = 5m
Number of shares issued in CK = 5m/2 = 2.5m
Total number of shares in CK after the acquisition = 14.5m
Earnings = 1.5 + 0.6 + 0.3 = $2.4m
Earnings per share = 2.4/14.5 = $0.17

40 × 9 = $3.40 Premium = ($22.60 .25 = $312.40 Share price KB = $0.$14.5625 .50 Market value of YH’s shares = $25m × 10 = $250m Market value of shares to be issued to YH shareholders = $250m × 1.60 Offer 3 shares in QS = $7.80 = 1.50 EPS KB = 6/15 = $0. but which lacks strategic focus and operational efficiency t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 25 340 m Market value of UT’s shares = $31.25 % EPS QS = $12.5m Number of shares to be issued = $312. 342 56.50 .$4.80 Gain = 1.5m/20m = $0.55 New share price = $0.40 LE share price = $0.50 4 shares in KB = $3.80 = $1.55 × 12 = $6.25m × 20 = $625m Market value per share = $625m/50m = $12.800 338  A company in a different industry sector 339  A company operating in a different industrial sector with high growth potential.80 Number of new shares = (2/3) × 30 m = 20m New share capital = 40m + 20m = 60m Earnings = S16m + $12m + $5m = $33m EPS = $0.625 × 12 = $7.000 × $1.50 × 3 = $22.5m/$12.40 = 0.136 A n s w e r s t o 1 0 : M e r g e r s a n d a c q u i s i t i o n s CIMA F3 Question Bank (2015 syllabus) 337 1800 $ LE EPS = 16/40 = $0.40)/$14.50 = 25m 341  Lower interest costs for PS The acquisition will have no impact on interest costs.60 × 4 = $14.625 Share price QS = $0.60 Increase in share price = $6.40 × 12 = $4.

6m . which may already be excessive. 10000000 347 Value of consideration = 5m × $6 × 1.40 = $26.48 Existing EPS = $25m/15m = $1.40 m Co st I pyri ntu ght itio n2 015 Fir Number of shares issued to acquire LQ = 6m × 2/3 = 4m New number of shares = 15m + 4m = 19m Total earnings required to avoid dilution = 19m × $1.5m Value of bid = 22.8m Increase in post-tax earnings required = $26. A debt for share exchange would increase gearing.60 = $10m 348  Leveraged buyout Venture capitalists may use this method.CIMA F3 Question Bank (2015 syllabus) 343 $ Answers to 10: Mergers and acquisitions 137 0.8m = $1.75 = $2.125 × 16 = $2 No of JK shares to be issued = 30m × ¾ = 22.12 344 $ 45 m JK EPS = $10m/80 = $0.60 Dilution = $1.8m/0. but it is not a definition of venture capital.60 .125 JK share price = $0. .4 MS EPS = $21m/15m = $1.$24.48 = $0.6m Combined earnings = $21m + $3.8m Increase in pre-tax profit required = $1.12 Profits of merged company = $25m + $9m + $3m = $37m Number of shares = 15m + 20m/2 = 25m EPS of merged company = $37m/25m = $1.8m = $24.4m 346  HW has a higher gearing level than the industry average.2m = 36m No of shares = 36m/$3.5m × $2 = $45m 345 $ 2.$1.

30 = $27.40 × 20m) = $44m Value using OR’s P/E ratio = $44m × 12.25 349 CIMA F3 Question Bank (2015 syllabus) % New debt = $3.$534m = $16m True  False    .5) = 31.5m New gearing = 7.6m Number of shares = 15m + (12/4)m = 18m Market price per share = $178.92 HW current market value = 15m × $9. The market believes that the consideration that HD is offering for NW’s shares is too low.72 = 12.5m + $4m = $7.72 OR P/E ratio = 9/0.6/18 = $9.5m New equity = S6m + $5.20 = $84m Value post merger = $450m + $84m = $534m OR EPS = $36m/50m = 0. 352 $ 9.25% 350 $ 60 m Value GY = $45m × 12 = $540m Value WT = $20m × 9 = $180m Pre-acquisition value = $540m + $180m = $720m Post-acquisition value = ($45m + $20m) × 12 = $780m Synergy gains = $780m .6m Value post merger = $147m + $27.5/(7.6m + $4m = $178.8m = $16.5 + 16.$720m = $60m 351 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F The market believes that the shareholders of HD will receive most of the benefits from the acquisition.80 = $147m MQ current market value = 12m × $2.5 PAT after merger = $36m + ($0.5 = $550m Synergies = $550m .138 A n s w e r s t o 1 0 : M e r g e r s a n d a c q u i s i t i o n s 31.92 353 $ 16 m OR current market value = 50m × $9 = $450m RV current market value = 20m × $4.7m + $4.

00 = $45m Value post merger = $96m + $45m + $12m = $153m Number of shares in issue = 80m + (5m × 8) = 120m QA shareholders have 80/120 (2/3) of merged group.8m Number of shares in issue = 20m + (8m/2) = 24m Share price = $112.34 shares for each JL share.8m Share of total gain = $2.8m = 31.$96m = $6m 355 $ 6 m MV current market value = $45m Value post merger = $153m Number of shares in issue = 120m MV shareholders have 40/120 (1/3) of merged group. but JL’s shareholders want JL to pay the minimum premium. The shareholders of NF will not accept exchanging more than 2.$16m = $2.8 % XQ current market value = 20m × $4.3 shares in NF Ratio of prices = 4.CIMA F3 Question Bank (2015 syllabus) 354 $ Answers to 10: Mergers and acquisitions 6 139 m QA current market value = 80m × $1. 357 31.8% .00 = $16m Value post merger = $88m + $16m + $8.8m .40 = $88m VZ current market value = 8m × $2.8m = $112. value $18.8m/$8. value = $153m × 2/3 = $102m Gain = $102m .$45m = $6m 356  Co st I pyri ntu ght itio n2 015 Fir 1 share in JL for every 2.20 = $96m MV current market value = 5m × $9.8m/24m = $4. value = $153m × 1/3 = $51m Gain = $51m .70 VZ shareholders hold 4m shares.90 = 2.34.45/1.8m Gain = $18.

5m = $153m Increase in wealth = $153m .8m t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .5m MN’s shareholders’ value = $175.$22.140 A n s w e r s t o 1 0 : M e r g e r s a n d a c q u i s i t i o n s 358 $ 7 CIMA F3 Question Bank (2015 syllabus) m MN current market value = 20m × $7.5m Cash paid to DX shareholders = 5m × $4.5m Value post merger = $146m + $20.8 m Value of merged group = $25m + $15m + $7m = $47m Share of FR’s shareholders = 40% × $47m = $18.50 = $22.5m .30 = $146m DX current market value = 5m × $4.$146m = $7m 359 $ 3.5m + $9m = $175.10 = $20.8m Gain = $18.$15m = $3.8m .

so Total equity value = $622.000 370 $ 829. but to gain the benefit of high returns on equity.44 m VC investment will need to grow by 20% each year to satisfy its requirement.08/0.CIMA F3 Question Bank (2015 syllabus) Answers to 11: Business reorganisations 141 Chapter 11: Business reorganisations 360  Generate cash to overcome liquidity problems  Dispose of a less profitable business  Managers are more motivated  Managers can make changes quicker if they don’t need parent company approval 362  Venture capitalist funding consists of a mixture of equity and debt.44m . 361 369 $ Co st I pyri ntu ght itio n2 015 Fir 257000 Cash available = (75% × 780) + (85% × 420) + 205 – 680 – 210 = $257.75 = $829. to avoid taking control of the company.204 = $622. 363  Reduce the risk of a takeover bid  Comply with legal and regulatory requirements 364  Debt interest is paid ahead of preference share dividends.08 Venture capitalist investment = 300/(300 + 100) = 75% of equity. so after 4 years = $300m × 1.  There will be strategic synergies between TH and KJ. 365  Discounted cash flow analysis at purchaser’s weighted average cost of capital 366  Make a general provision against the value of inventory 367  Placing 368  TH can apply economies of scope to KJ’s operations.

142 A n s w e r s t o 1 1 : B u s i n e s s r e o r g a n i s a t i o n s CIMA F3 Question Bank (2015 syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

143 Pilot Paper Fir Cop s t In yrig (2015 Syllabus) h tu t n2 015 itio .

144 CIMA F3 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

145 CIMA Pilot Paper (2015 Syllabus) Paper F3 Financial Strategy Time allowed: 90 minutes Co st I pyri ntu ght itio n2 015 Fir All questions are compulsory and MUST be attempted .

A steady increase in earnings is MOST likely to be a financial objective of:     A charity A public listed company A public sector enterprise A ‘not-for-profit’ company Modigliani and Miller’s 1963 Theory of Capital Structure with Tax assumes that:     the cost of equity remains constant regardless of gearing level. companies can borrow at zero cost. a company is liable to tax but not its shareholders. or an identified portion of an asset. liability or firm commitment that is attributable to a particular risk and could affect profit or r i F 3 4 loss. an unrecognised . financial distress does not carry any cost. .146 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) CIMA F3 ALL questions are compulsory and MUST be attempted 1 In which THREE of the following circumstances is a scrip dividend most likely to be preferable to a normal dividend?      For a bank wishing to increase its capital adequacy ratios To retain cash in the business to finance investment For a company facing liquidity problems To reward shareholders after many years of not declaring a dividend To split the shares in order to make them more marketable A fair value hedge is defined in IAS 39: Financial Instruments: Recognition and Measurement as: 2 Place the words below to complete the following statement. cash flow asset or liability derivative fair value firm commitment A hedge of the exposure to changes in highly probable t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s of a recognised .

The college operates within very tight budgetary cash constraints.      7 In which of the following situations is a residual dividend policy most likely to be appropriate?     8 Number of students enrolled Cost of providing tuition Student achievement level Student satisfaction with facilities Cash deficit avoided A large publicly listed company A small family-owned private company where the majority of the shareholders use dividend income to pay household expenses A small company listed on a small company stock exchange and owned by investors seeking maximum capital growth on their investment In a tax regime where individuals pay less tax on income than on capital gains Which of the following best describes the role of competition authorities?     To ensure that new businesses can grow and become successful despite high levels of competition To promote fair and ethical competitive behaviour To prevent monopoly situations developing in essential service industries To ensure healthy levels of competition and safeguard public interest . Complete the following sentence: If this plan is carried out. interest cover would then be and therefore the interest cover covenant with Bank A would  Select an option from the drop down box: Option 1 be breached Option 2 not be breached 6 A public sector college receives government sponsorship for certain courses which teach skills which are needed locally in the form of a fixed fee for each student completing such courses to a satisfactory level. Co st I pyri ntu ght itio n2 015 Fir Which THREE of the following would be the MOST important in a value for money review of this college by the government.CIMA F3 Pilot paper questions (2015 syllabus) 5 147 A company has:  Profit before interest and tax of $120 million  A borrowing of $300 million at 5% interest from Bank A with an interest cover covenant (based on profit before interest and tax) of 5 The company plans to borrow an additional $100 at 5% interest from Bank B without an interest cover covenant to finance the repurchase of shares.

5% fixed against Libor. Which of the following is the MOST likely consequences of this plan?     10 The company would become more vulnerable to a hostile takeover bid. Shareholder wealth would decrease by the value of cash paid as a special dividend. The company would become less able to respond promptly to new business opportunities. What is the best explanation of why convertible preference shares are considered to reduce the risk to Bank A?     Lower gearing throughout the life of the convertible preference shares Debt interest is paid ahead of preference share dividends Greater interest cover due to higher profit before tax and interest Preference dividends can be waived if there is insufficient cash available t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 11 A UK company:  Enters into a 3 year borrowing with bank A at a floating rate of Libor plus 2%.5% fixed 2. A company has bank borrowings with Bank A. making it clear to investors that this is a one-off event. but also respond to other information about the company immediately it becomes publicly available. Libor 12 3. The hedged borrowing rate. The directors of the company wish to accept additional finance offered by a venture capitalist. is Complete the above sentence by placing one of the following options into the highlighted box. The share price would rise due to the signalling effect of the special dividend.5% fixed 2% fixed 5.148 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 9 CIMA F3 A company plans to return surplus cash to shareholders by paying a special dividend.0% fixed Libor plus 2% Share prices quoted on a stock exchange are observed to reflect historical share price information and other historical information about a company. Bank A has asked that the venture capitalist's finance is structured in the form of convertible preference shares rather than a borrowing in order to reduce risk to Bank A. The company is funded by a mix of debt and equity and there are no unused bank facilities. taking both the borrowing and swap into account. Which of the following best describes the form of market efficiency?     Weak form Semi-weak form Strong form Semi-strong form . and  In order to fix the interest rate for the 3 years. simultaneously enters into an interest rate swap with bank B at 3.

the company has:    5 million $1 shares in issue Market share price (cum rights) of $4. shareholders who sell their Select an option from the drop down box: Option 1 better off than Option 2 worse off than Option 3 in the same position as 15 A company adopts the Global Reporting Initiative (GRI) and issues an annual sustainability report in accordance with the guidelines.15 for each share held. If the market is efficient and the share price moves to reflect this information on the day that the project is announced.80 each of the basis of 1 new share for every 5 shares held. 1 million share will be issued at $2.48 increase $0.CIMA F3 Pilot paper questions (2015 syllabus) 13 149 A company has 100 million $1 ordinary shares in issue and the current share price is $2. Any shareholder who does not wish to take up their rights will be able to sell them to the company at $0. what is the theoretical movement in the share price on that day?     14 No change $0.24 increase $0. no further disclosure is required Where information is unavailable. The day after the announcement of the project and rights issue.64 increase A company wishes to raise $4 million from a rights issue to finance a new project. these should be explained Information may only be omitted if it is subject to either legal prohibitions or confidentiality constraints .80 Co st I pyri ntu ght itio n2 015 Fir Assuming an efficient market. The project has a return equal to the company’s Weighted Average Cost of Capital. it is sufficient to state that this is the case Where information is omitted due to confidentiality constraints.40. Under the rights issue. A proposed new project requires an initial investment of $40 million and is expected to have an Internal Rate of Return of 20% and Net Present Value of $24 million. Which of the following statements relating to incomplete disclosure is correct?     Where legal restrictions prohibit. shareholders who take up their rights can expect to the financially  rights to the company.00 Theoretical ex-rights price (TERP) of $3.

300 (that is.300) A$ interest rate is 3% a year B$ interest rate is 5% a year What is the best estimate of the A$ value that the company will obtain for the B$300 receipt in 2 years’ time?     19 A$222 A$235 A$240 A$405 The following data relates to a company Operating profit Depreciation and amortisation Finance charges paid Capital expenditure to sustain operations Tax paid Repayment of borrowings Equity dividend paid The best estimate of free cash flow for equity is:     $40 million $70 million $90 million $120 million $million 200 70 15 90 45 50 30 . Which of the following characteristics of the proxy company should be the same as the subsidiary company?     17 Which THREE of the following strategies are MOST likely to enhance shareholder wealth?      18 Foreign exchange risk Product risk Financial risk Business risk Investment in projects with a positive Net Present Value Increasing the rate of dividend growth Enhancing brand reputation and recognition Increasing director bonuses Moving profitable operations to low tax regimes A company uses currency A$ as its functional currency but will receive payment in respect of foreign income of B$300 in 2 years’ time. A$ 1 = B$1. t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Foreign exchange data:    A$/B$ spot is currently 1.150 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 16 CIMA F3 A parent company is planning to dispose of a subsidiary company that operates in a different market sector to the rest of the group. The parent company is using a proxy company to derive an appropriate discount rate to use for valuing the subsidiary company using a discounted cash flow approach.

Some of the new business units are making losses and have failed to achieve the synergistic benefits expected.04% = 10% × �1 − �280�� 27 10. Which THREE of the following are most likely to be motives for ABC to hold surplus cash?      23 Speculative Value for money Transaction Economies of scale Precautionary A company has:       A geared cost of equity of 12% An ungeared cost of equity of 10% A WACC of 9. True False 21 YY is valuing a potential acquisition target.84% = 12% × �1 − � �� 280 . According to Modigliani and Miller’s theory with tax. WACC would move to:     83 9.30% = 12% × �1 − �280�� 83 7. company ZZ. Which of the following items of data would be used in a bootstrapping valuation calculation?      22 YY’s earnings ZZ’s earnings YY’s P/E ratio ZZ’s P/E ratio ZZ’s debt Co st I pyri ntu ght itio n2 015 Fir Company ABC has achieved rapid growth by acquiring new business units.25% Market value of equity of $210 million Market value of debt of $70 million A tax rate of 30% The company plans to raise $20 million of debt and use these funds to repurchase shares. using a bootstrapping approach. True/False On conversion date.75% = 10% × �1 − � �� 280 27 9. the ordinary shareholders of the company have the option to choose whether or not the bonds should be converted into shares The bondholder can normally claim tax relief on interest paid on the bond up to conversion Place one of the following options in each of the boxes highlighted above.CIMA F3 Pilot paper questions (2015 syllabus) 20 151 The following statements in respect of convertible bonds issued by a company are either true or false. The cash flows of ABC vary considerably from month to month.

20 5 0 0 0 2.60 Number of share bids received at that price t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 5 35 55 44 25 Which of the following options shows how the shares will be allocated?     Number of shares issued at each price (millions) Number of shares issued at each price (millions) Number of shares issued at each price (millions) Number of shares issued at each price (millions) 2. Interested parties were invited to bid for shares in the range $2.60 0 0 0 25 Price offered .40 2.30 2.152 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 24 A division of a company is being sold.60 per share.50 0 0 50 25 2.30 35 0 0 0 2.20 to $2. The results are as follows: Price offered $ 2.20 2. Which of the following valuation approaches is likely to be the most useful to the seller when negotiating the sales price?     25 Bootstrapping Asset basis Discounted cash flow analysis discounted at the seller’s WACC Discounted cash flow analysis discounted at the seller’s cost of equity Which of the following could be used as defence on receipt of a hostile takeover bid?     26 CIMA F3 Poison pill strategy Change the Articles of Association to increase the percentage of shareholder votes required to approve a takeover White Knight strategy Declare a special dividend 50 million ordinary shares are to be offered to the general public by tender offer.50 2.40 10 50 0 0 2.

0. a company that also operates retail stores in this region. NN is in the process of acquiring QQ.20 0.000 . NN would take over all staff contracts and ownership of the store properties owned by QQ.50 1. The impact of this plan on the cash balance and earnings per share is: Earnings per share ($) After the share repurchase Co st I pyri ntu ght itio n2 015 Fir Cash ($ million) Before the share repurchase 2.00 0.600 4.20 Complete the table above by placing one of the following options in each of the highlighted boxes.18 29 0.00 A carpet retail outlet has produced the following forecast data for the next 6 month (183 day) period to show its bank.50 each. Sales and purchases can be assumed to arise evenly over the period.22 0.000. The agreed overdraft facility is $900. The company has an overdraft balance of $100.000.000 In the previous 6 months.200 4.080.CIMA F3 Pilot paper questions (2015 syllabus) 27 153 NN operates a number of retail stores in a particular region of the country.000 No. Sales revenue (cash sales) Purchases (60 days credit) Other costs (settled immediately) $000 8. the bank account would not be overdrawn Yes. NN and QQ have highly positively correlated cash flow streams because they operate in the same business sector and location. Which THREE of the following would be MOST likely to be synergistic benefits to NN of purchasing QQ?      28 Cost savings due to economies of scale in purchasing activities Reduction in staff costs due to elimination of duplicated administration roles Cash benefit by sale and leaseback of retail store property acquired Enhanced profit due to reduced competition in the region Diversification due to owning a larger portfolio of retail outlets A listed company has 10 million $0. Post-acquisition NN would become the largest retailer in the region.50 shares in issue. As part of the purchase agreement. The company is planning to repurchase 1 million of these shares at a price of $1.200. would the overdraft facility be adequate?     Yes. the overdrawn facility would be exceeded by approximately $180.000 and on 60 day credit terms. the overdraft facility would be exceeded by approximately $1. (183 day) period to the forecast the purchases were also $4. If all suppliers were to suddenly withdraw credit at the end of month 6.50 2. approximately $510.000 of the overdraft facility would still be available for drawdown No.

154 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 30 Which of the following statements is consistent with Modigliani and Miller’s dividend irrelevancy theory?     31 CIMA F3 A policy of steady growth in dividend is preferable to a residual dividend policy Shareholder return can be measured as the aggregate of dividends plus growth in share price The share price is NOT affected by a dividend payment Shareholder wealth can be maximised by retaining a high percentage of earnings Complete the statement below by placing one of the following options in each of the highlighted spaces. AA is funded by a combination of ordinary shares and fixed rate bank borrowings denominated in A$. which has A$ as its currency. Which THREE of the following should AA consider disclosing in its financial statements according to IFRS 7 Financial Instruments: Disclosures?      Capital management policy Credit risk management policy Aged debtor analysis The impact of adverse exchange rate movements on reported profit Business recovery risk policy . AA is a company which manufactures vacuum cleaners and sells them to retail outlets in its home country. equity controlling noncontrolling a lender an investor borrowings A leveraged buyout occurs when typically a private equity firm. Sales are on 90 day terms. AA sources most goods and services locally buy also imports some large value items from a neighbouring country which has N$ as its currency. It has no surplus cash. acquires a interest in a company’s equity and where a significant percentage of the purchase price is financed through t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 32 .

CIV = [ $40 million – (11% × $30 million) ] × 0.35 0. what is the best prediction of the dividend for the current financial year?     $36 million $44 million $49 million $61 million . Based on the forecast data above and assuming the financial objectives are achieved.12 0.CIMA F3 Pilot paper questions (2015 syllabus) 33 155 Company ABC is using the Calculated Intangible Value (CIV) company valuation method to value its intangible assets.65 Company AQ is purchasing a foreign company. Relevant data:      Average profit before tax for ABC is $40 million Industry average return on tangible assets is 11% ABC’s tangible assets are $30 million Corporate income tax is 35% ABC has a WACC of 10%. AQ wishes to finance the new subsidiary with maximum possible gearing. cost of debt of 8% and cost of equity of 12% Complete the following CIV calculation by placing the numbers into the boxes below. Co st I pyri ntu ght itio n2 015 Which of the following is most likely to reduce the optimum gearing level for the new subsidiary?     35 Fir Thin capitalisation rules Political risk The extent to which the foreign company tax rate is lower than the parent company tax rate Parent company dividend policy A wholly equity financed company’s financial objectives are:   To achieve earnings growth of 4% a year.10 34 0. Consideration for TT will include sufficient funds to enable TT’s directors to repay TT’s borrowings in full. The company forecasts free cash flow of $110 million and earnings of $80 million in the current financial year. which will be set up as a subsidiary. and To meet on invested funds of 9%.10 / 1. TT.12 1.

1 38 0. The directors of the subsidiary company are interested in purchasing the subsidiary company by means of a management buy-out.8% Gearing (D/D+E) of 40% Corporate income tax rate of 30% The risk free rate is 2% and the market risk premium is 3%.2 Bond with warrants attached Revolving credit bond Redeemable bond Equity bond Convertible bond The directors of a company wish to dispose of one of its subsidiary companies.7 1. the directors of the subsidiary company were to:     employ more staff in the subsidiary’s administration office accept projects with high Net Present Values delay a revaluation of assets sell and leaseback office buildings .156 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 36 CIMA F3 A bond:     has a nominal value of $300 million.8 Pre-tax cost of debt of 3. 0. There is a potential conflict of interest if. during the negotiation phrase of the management buy-out. The company’s debt beta is: t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Place one of the following options in the highlighted box above. pays interest of $15 million twice a year in arrears. is trading at $103 per $100 nominal on 1 July 20X1.8 Which THREE of the following are types of bonds issued by a company?      39 0. and is redeemable at par on 31 December 20X1 How much must the issuer pay to the bondholders on 31 December 20X1?     37 $15 million $300 million $309 million $315 million A company has:     Equity beta of 1.

based upon a pre-agreed formula relating to the financial performance of a business. through an earn-out arrangement?     41 Management bonus incentive payment Contractual payment on redundancy Incentive payment to salespersons Consideration for the sale of a business Complete the above share portfolio risk chart by placing one of the following options in each of the highlighted boxes.CIMA F3 Pilot paper questions (2015 syllabus) 40 Which of the following payments would be made. Which of the following sources of finance is most likely to be suitable?     43 157 Convertible bond Commercial paper Private placement of bonds Retained earnings A company is evaluating the decision whether to lease an asset or to buy it outright using newly borrowed funds. Beta value Systematic risk Number of shares held Unsystematic risk Average time to maturity Co st I pyri ntu ght itio n2 015 Fir 42 A long-established unlisted medium sized company requires 10 year funding and wishes to reduce its dependence on bank finance. Which of the following is the BEST discount rate to use for the evaluation?     Pre-tax cost of debt Post-tax cost of debt Cost of equity WACC .

Time Net operating cash flow (NOCF) Tax on NOCF New equipment Tax relief on new equipment 0 1 2 3-5 6+ 250 250 250 250 250 – – (75) (75) (75) (200) – – – – – – 50 15 – . Click on the TWO grid squares that contain an error. What does this information tell us about the difference between Company HH and Company GG?     45 Company HH has lower growth prospects Company HH has a higher share price Company HH’s shareholders are exposed to greater risk Company HH has a higher market capitalisation Company A is planning to sell wholly owned subsidiary B on 1 January 20X1 and is preparing a valuation for B as at that date using a discounted cash flow method. Tax depreciation allowances can be claimed over 4 years on a straight line basis in respect of this equipment  The corporate income tax rate is 30%.158 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 44 CIMA F3 Companies GG and HH operate in the same industry. Tax is paid a year in arrears  Assume all cash flows arise at the end of the year unless stated otherwise  B has a financial year end of 31 December t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F The trainee accountant has produced the following analysis of forecast project cash flows to be used in the valuation. Additional information:  B’s net operating cash flow is forecast to be $250 million in the year to 31 December 20X1 and is expected to remain at this level every year in perpetuity  New equipment costing $200 million will need to be paid for on 1 January 20X1. They have the same level of earnings buy Company HH has a higher P/E ratio. All figures are in $ million.

 EE would pay tax of 10% on cash received from FF.53 million 4 million x 85% x 90% / 2 C E$ 3. ST currently has gearing (debt/debt+equity) of 40% and would fund any cash offer by raising additional debt finance. whose functional currency is E$. FF has F$ 4 million of surplus cash EE wishes to use these funds to pay a special dividend to its shareholders. whose functional currency is F$. EE has a foreign subsidiary. Both companies are of a similar size.15 million 4 million x 75% x 85% x 90% B E$ 1.CIMA F3 Pilot paper questions (2015 syllabus) 46 159 EE is a company located in country E. Structuring the bid offer for the acquisition of VZ as a cash offer funded by debt rather than a share exchange is MOST likely to have the effect of:     Diluting ST shareholders’ control Lowering ST’s gearing (debt/debt+equity) Enabling VZ’s shareholders to participate in future growth in ST Increasing ST shareholders’ earnings per share .12 million 4 million x 85% x 90% × 2     47 Option A Option B Option C Option D Co st I pyri ntu ght itio n2 015 Fir Company ST wishes to acquire company VZ and is considering how best to structure the bid offer. E$ 1 = F$ 2. FF. The maximum level of special dividend that could be paid by EE is approximately: Option Value of dividend Workings A E$ 1.06 million 4 million x 85% x 90% D E$ 6. in country F. Tax regime:  FF has already paid 25% corporate income tax on profits and would need to pay withholding tax of 15% on any cash remitted to the parent company. The exchange rate is reasonably stable and today.

worth a total of $184. $ . Mr A and Mr B still own 100% of the share capital in the company and wish to realise the full value of their investment in the coming year.160 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) CIMA F3 48 Earnings for the year ($ million) 100 160 200 Company AAA Company BBB Company CCC P/E ratio 12 10 7 Rank the companies in order of market value by placing them into the highlighted boxes below. Which THREE of the following exit strategies could Mr A and Mr b consider?      51 Management buy-out Trade sale Initial public offering Spin-off Private equity buy-in A company declares a dividend of $0.80 at the cum div market price. Company CCC Company AAA Company BBB Options: Highest value Lowest value 49 A company currently has:     WACC of 12% Corporate income tax rate of 30% 400 million $1 ordinary shares in issue Current market share price of $2. The company has grown extremely quickly but is not yet sufficiently large to be able to obtain a listing on the local stock exchange. Mr A holds 120 shares in a company. What is the theoretical ex div value of Mr A’s shares? Give your answer to 2 decimal places.60 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F The company announces a 1 for 4 rights issue at a discount of 20% to the current share price to finance a project that has a yield of 15%. The yield adjusted TERP is: $ 50 (give your answer to 2 decimal places) Mr A and Mr B established a new company five years ago.09 per share.

00 a share  Reinvest the funds raised immediately in a project with an Internal Rate of Return (IRR) equal to WACC Show how this plan is likely to affect gearing and the share premium account by placing one of the available options in each of the following boxes: Gearing (debt/debt+equity) Share premium account Increase Stay the same Decrease 53 Data for private company MM: Assets (book value) Assets (realisable value) Liabilities (excluding borrowings) Borrowings (book value) Borrowings fair value) Equity (book value) Co st I pyri ntu ght itio n2 015 Fir A company wishes to purchase MM. $ million 250 300 90 60 70 100 The minimum purchase price for MM’s equity on an asset valuation basis is: $ 54 million (round your answer to the nearest whole number) A rights issue is to be used to raise $100 million. The funds are required to finance a new project. Which THREE of the following are affected by the choice of discount at which shares are issued?      Wealth of a typical shareholder Cost of underwriting Value raised Number of shares issued Earnings per share .CIMA F3 Pilot paper questions (2015 syllabus) 52 161 A company has gearing of 50% (debt/debt+equity) and plans to:  Issue $1.00 ordinary shares under a rights issue at a 20% discount to the current market price of $2.

. RS has 50% gearing (debt/debt+equity) and a market capitalisation of $300 million. The results are shown below: t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F Valuation method Net assets (book value) Net assets (market value) P/E ratio applied to forecast earnings for next year Market capitalisation Value of XX in $ million 250 420 580 500 Note that net assets are defined here as assets less all liabilities except borrowings. W should offer shareholders at least: $ per share. RS’s shareholders and lenders can expect to gain from the deal as follows. Place one of the following options in each of the highlighted boxes below. 0 5 15 Gain (in $ million) RS’s shareholders RS’s lenders 56 Company W is considering making a bid to buy the equity shares of company XX.162 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 55 CIMA F3 Company RS has agreed to purchase company TS at a cash price of $120 million and estimates that there will be synergistic benefits of $30 million arising from the purchase. XX is a listed company with 100 million shares in issue. W has valued the acquisition target in a number of different ways. Give your answer to the nearest whole number. TS is wholly equity financed and has a market capitalisation of $110 million.

Details of the export order are as follows: Date Action 1 December 20X1 The company accepted an export order.6% 20. The company’s first export order was received in 20X1 and a forward contract was taken out to hedge the A$ value of the order. 1 February 20X2 Goods delivered and invoice raised. The latest annual report lists growth in earnings per share as a financial objective. The expected gross profit on the order fell by $10 to $100 due solely to movements in the spot rate. When converted at spot. the export sale showed an exported gross profit of $100. How would the use of cash flow hedge accounting have affected the financial statements for the year ended 31 December 20X1? Place one of the following options in each of the highlighted boxes. To date. Profit before tax in respect of the export sale plus forward contract No hedge accounting $10 loss 58 Co st I pyri ntu ght itio n2 015 Fir Cash flow hedge accounting applied $ nil $90 profit $100 profit The following data has been taken from the annual reports of a single company: Year ended 31 December Earnings ($million) Number of shares in issue at the end of the year (million) 20X1 120 100 20X2 160 150 20X3 180 150 20X4 210 150 The company issued 50 million new shares by means of a rights issue on 3 January 20X2. The compound average annual growth rate in earnings per share achieved between 20X1 and 20X4 is approximately:     5.3% 5. all sales and purchases have been in A$. No hedge accounting was applied.5% . 31 December 20X1 The forward contract showed a loss on revaluation of $10.5% 25.CIMA F3 Pilot paper questions (2015 syllabus) 57 163 A company is located in country A and uses the A$ as the functional currency.

164 P i l o t p a p e r q u e s t i o n s ( 2 0 1 5 s y l l a b u s ) 59 CIMA F3 The following statements in respect of finance leases are either true or false. Give your answer to the nearest whole number. after-financing cash flows for each company and the combined group are as follows: NPV of Y’s cash flows without the acquisition NPV of Z’s cash flows without the acquisition NPV of the combined group YZ’s cash flows with the acquisition Value (in $ million) 100 40 170 The maximum price that Y should offer for the equity of Z is: t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F $ million. Under a finance lease. The net present value (NPV) of after-tax. an unprofitable lessee can still benefit from tax depreciation allowances passed on by the lessor Place one of the options below in each of the highlighted boxes above. True/False A bank can offer a low rate of interest on a finance lease than on a bank loan because the lease is supported by an asset. True 60 False Company Y is acquiring company Z. .

165 CIMA Pilot Paper (2015 Syllabus) Paper F3 Financial Strategy Answers Co st I pyri ntu ght itio n2 015 Fir .

shareholders who take up their rights can expect to the financially better off than shareholders who sell their rights to the company. is 5. interest cover would then be 6.5% fixed. 12  Semi-strong form 13  $0. liability or firm commitment that is attributable to a particular risk and could affect profit or loss. To retain cash in the business to finance investment. 3  A public listed company 4  financial distress does not carry any cost. 10  Debt interest is paid ahead of preference share dividends 11 The hedged borrowing rate. For a company facing liquidity problems t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .0 and therefore the interest cover covenant with Bank A would not be breached 6    Cost per student of providing tuition Student achievement level Cash deficit avoided 7  A small company listed on a small company stock exchange and owned by investors seeking maximum capital growth on their investment.166 P i l o t p a p e r a n s w e r s ( 2 0 1 5 S y l l a b u s ) CIMA F3 1    2 A hedge of the exposure to changes in highly probable fair value of a recognised asset or liability. taking both the borrowing and swap into account. 8  To ensure healthy levels of competition and safeguard public interest. 5 If this plan is carried out.24 increase 14 Assuming an efficient market. For a bank wishing to increase its capital adequacy ratios. or an identified portion of an asset. 9  The company would become less able to respond promptly to new business opportunities. an unrecognised firm commitment.

CIMA F3 Pilot paper answers (2015 Syllabus) 15  Where information is omitted due to confidentiality constraints.04% = 10% × �1 − � �� 280 24  Discounted cash flow analysis discounted at the seller’s WACC 25  White Knight strategy 27 False . these should be explained. the ordinary shareholders of the company have the option to choose whether or not the bonds should be converted into shares The bondholder can normally claim tax relief on interest paid on the bond up to conversion False Fir Cop st I yri ntu ght itio n2 015 21   ZZ’s earnings YY’s P/E ratio 22    Speculative Transaction Precautionary 23  9. 16  Business risk 17    Investment in projects with a positiveNet Present Value Enhancing brand reputation and recognition Moving profitable operations to low tax regimes 18  A$222 19  $70 million 167 20 True/False On conversion date.

40 50 2. 28 After the share repurchase Cash ($ million) 2. 32    33 CIV = [ $40 million – (11% × $30 million) ] × 34  Thin capitalisation rules 35  $44 million Credit risk management policy Aged debtor analysis The impact of adverse exchange rate movements on reported profit 0. Reduction in staff costs due to elimination of duplicated administration roles.10 .20 0.22 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s 29 r i F 30 Before the share repurchase  No.50 0 2.65 / 0. 31 A leveraged buyout occurs when an investor.50 Earnings per share ($) 0. acquires a controlling interest in a company’s equity and where a significant percentage of the purchase price is financed through borrowings.20 0 2.00 0. Enhanced profit due to reduced competition in the region.30 0 2.000. the overdraft facility would be exceeded by approximately $ 180.168 P i l o t p a p e r a n s w e r s ( 2 0 1 5 S y l l a b u s ) CIMA F3 26  Price offered 27 Number of shares issued at each price (millions) 2.  Shareholder return can be measured as the aggregate of dividends plus growth in share price.60 0    Cost savings due to economies of scale in purchasing activities. typically a private equity firm.

53 million 0 1 2 3-5 6+ 250 250 250 250 250 – – (75) (75) (75) (200) – – – – – – 50 15 – . 169 $315 million 41 Co st I pyri ntu ght itio n2 015 Fir Unsystematic risk Systematic risk Number of shares held 42  Private placement of bonds 43  Post-tax cost of debt 44  Company HH has a higher market capitalisation. 40  Consideration for the sale of a business. 45 Time Net operating cash flow (NOCF) Tax on NOCF New equipment Tax relief on new equipment 46  (Option B) E$ 1.CIMA F3 Pilot paper answers (2015 Syllabus) 36  37 The company’s debt beta is: 0.6 38    Bond with warrants attached Redeemable bond Convertible bond 39  delay a revaluation of assets.

170 P i l o t p a p e r a n s w e r s ( 2 0 1 5 S y l l a b u s ) 47  CIMA F3 Increasing ST shareholders’ earnings per share 48 Highest value Company BBB Company CCC Lowest value Company AAA 49 $ 50    51 $ 2.60 Management buy-out Trade sale Private equity buy-in 174.00 t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F 52 Gearing (debt/debt+equity) Decrease Share premium account Increase 53 $ 54    150 million Cost of underwriting Number of shares issued Earnings per share 55 Gain (in $ million) 56 RS’s shareholders 20 RS’s lenders 0 $ 5 per share .

an unprofitable lessee can still benefit from tax depreciation allowances passed on by the lessor False $ 70 Co st I pyri ntu ght itio n2 015 Fir million .3% 59 True/False 60 A bank can offer a low rate of interest on a finance lease than on a bank loan because the lease is supported by an asset. True Under a finance lease.CIMA F3 Pilot paper answers (2015 Syllabus) 171 57 Profit before tax in respect of the export sale plus forward contract $10 loss No hedge accounting $ nil Cash flow hedge accounting applied 58  5.

172 P i l o t p a p e r a n s w e r s ( 2 0 1 5 S y l l a b u s ) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F CIMA F3 .

CIMA F3 Question Bank (2015 syllabus) Maths tables & Formulae 173 Maths tables & Formulae Co st I pyri ntu ght itio n2 015 Fir .

174 M a t h s t a b l e s & F o r m u l a e CIMA F3 Question Bank (2015 syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .

CIMA F3 Question Bank (2015 syllabus) Maths tables & Formulae 175 Co st I pyri ntu ght itio n2 015 Fir .

176 M a t h s t a b l e s & F o r m u l a e CIMA F3 Question Bank (2015 syllabus) t h 5 g 1 i 0 r 2 y p ion o C uit t n I t s r i F .