CIMA F3 - Financial Strategy

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

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

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

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

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

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

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

That is exactly what option A states.

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

PBIT = $500,000

Existing interest = 5% × 300,000 = $15,000

Profit before tax = 500,000 − 15,000 = $485,000

Tax (30%) = 0.30 × 485,000 = $145,500

Earnings = 485,000 − 145,500 = $339,500

Shares = 250,000 ⇒ EPS = 339,500 / 250,000 ≈ $1.36

Share price = $8 ⇒ P/E ≈ 8 / 1.36 ≈ 5.9

Interest cover = PBIT / Interest = 500,000 / 15,000 ≈ 33.3 times

After the new debt and project:

New PBIT = 500,000 + 24,000 = $524,000

New interest = 15,000 + (3% × 200,000) = 15,000 + 6,000 = $21,000

Profit before tax = 524,000 − 21,000 = $503,000

Tax (30%) = 0.30 × 503,000 = $150,900

Earnings = 503,000 − 150,900 = $352,100

EPS = 352,100 / 250,000 ≈ $1.41

New share price = $8.50

New P/E ≈ 8.50 / 1.41 ≈ 6.0 (higher than before)

New interest cover = 524,000 / 21,000 ≈ 25.0 times (lower than before).

So:

Interest cover falls

P/E ratio rises

Correct option: B.

The assistant has discounted free cash flows to all investors at the WACC (10%). That gives the value of the business (enterprise value), not directly the value of equity.

For a geared company:

If you discount free cash flows to the firm (all investors) at the WACC, you obtain the total value of the firm (V).

To get equity value (E), you must then subtract the market value of debt (D):

E=V−DE = V - DE=V−D

Here, the company has a $6m 7% undated bond trading at par, so the market value of debt is $6m. That amount has not been deducted.

The other options are not errors:

The perpetuity discounting using 7.91.102×0.10\frac{7.9}{1.10^2 \times 0.10}1.102×0.107.9​ is correct for a constant cash flow from year 3 onward.

Using WACC (10%) is appropriate for FCFF.

Tax at 20% is already reflected in either the cash flows or the WACC; it is not “missing” as a separate line.

So the specific mistake is failing to deduct the $6m debt value, i.e. option D.

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

The Framework identifies six capitals: financial, manufactured, intellectual, human, social & relationship, and natural. From the options given, those that match are:

Manufactured ✅

Human ✅

Financial ✅

Answer: A, D, E

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

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

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

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

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

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

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

Answer: A. Bonds with warrants

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

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

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

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

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