CIMA F3 - Financial Strategy

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

The company is deciding between:

Selling the business via a Management Buyout (MBO), or

Selling to an external private equity (PE) buyer.

From the original company’s viewpoint, an advantage of an MBO is:

The buyers are the existing management team. Relationships already exist, and there’s usually more trust and alignment.

Post-divestment, the original company may still trade with the divested unit (e.g., as a supplier or customer). Cooperation tends to be better with a familiar internal team than with an external PE house whose primary focus is financial returns.

Why the others are wrong:

B. Enhanced big data opportunities – unrelated to the divestment method.

C. Improved relationships with MBO team in the event of a sale to PE – logically inconsistent; if sold to PE, it’s not an MBO.

D. Higher price due to synergistic benefits – PE typically looks for financial engineering and operational improvements, not classic corporate synergies. You are more likely to see synergy premia when selling to a trade buyer, not in an MBO.

So the key pro-MBO argument here is better cooperation post divestment → A.

Comprehensive and Detailed Step-by-Step Explanation (Based on CIMA F3: Financial Strategy Principles)

In CIMA F3, the characteristics of fixed–income securities such as bonds are covered extensively under Financial Instruments, Cost of Capital, and Debt Finance. A key concept taught is that some bond features are contractually fixed for the entire life of the bond, whereas others fluctuate according to market dynamics.

A fixed-rate bond is one where the coupon rate remains the same throughout the bond’s life. According to F3 learning materials, the coupon rate is established at issuance and does not change, regardless of interest rate movements in the market. Therefore, the coupon rate is fixed (A is correct).

The nominal value (also called par value or face value) is another element explicitly stated in debt contracts. The nominal value is the base amount upon which coupon interest is calculated, and it does not fluctuate over the life of the bond. It is only repaid at maturity. Thus, nominal value remains unchanged (D is correct).

Furthermore, the amount payable on maturity is predetermined in the bond indenture and is equal to the nominal (par) value unless the bond is a special type like a convertible or index-linked bond. Standard fixed-rate corporate bonds repay par value at maturity, so this amount does not change. Therefore, the redemption amount remains constant (E is correct).

In contrast, the yield varies with changes in market interest rates and investor demand. Higher market rates reduce bond prices and increase yields, and vice versa. Therefore, yield is not constant. Likewise, market value also fluctuates due to interest rate changes, risk perceptions, and market expectations. Hence, both (B) and (C) are incorrect.

CIMA F3 explains that the Dividend Growth Model (DGM) is only suitable where dividends are stable, predictable, and capable of being forecast with reasonable confidence. It is therefore weak when applied to young, unlisted, high-risk companies, especially those with uncertain future cash flows.

A. No established dividend payment pattern – ✔ Correct

Company B has made losses in its first three years and has not paid dividends. CIMA F3 explicitly states that the dividend growth model is unsuitable where there is no dividend history, because the model relies on extrapolating future dividends from past patterns.

B. Uses future projected dividends – ✘ Incorrect

This is not a weakness, but a fundamental feature of the dividend growth model. All valuation models are forward-looking, and CIMA F3 does not consider this a limitation.

C. Growth rate difficult to determine – ✔ Correct

The business operates in a unique, high-risk sector, and future earnings and dividends are highly uncertain. CIMA F3 highlights that the DGM is extremely sensitive to the assumed growth rate, making it unreliable when growth cannot be estimated with confidence.

D. Time value of money ignored – ✘ Incorrect

The dividend growth model explicitly discounts future dividends, meaning it fully incorporates the time value of money, a core principle taught in F3.

E. Cost of capital difficult to estimate – ✔ Correct

As an unlisted company, Company B has no observable beta or market data. CIMA F3 stresses that estimating the cost of equity for private, high-risk businesses is problematic, reducing the reliability of DGM outputs.

We need to raise $45m with minimum dilution, so choose the highest price at which there is sufficient demand.

Demand at or above each possible offer price:

$5.00 → 5m shares → $25m (insufficient)

$4.75 → (2 + 5) = 7m shares → 7 × 4.75 = $33.25m (insufficient)

$4.50 → (3 + 2 + 5) = 10m shares → 10 × 4.50 = $45m (exactly enough)

$4.25 or $4.00 would raise more than $45m but require issuing more shares → more dilution.

So the best price that still raises $45m is $4.50.

Answer: A – $4.50

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

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

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

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

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

So the total adjustment is a 5% decrease.

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

In a merger of two listed companies in the same industry, CIMA F3 highlights several typical post-merger outcomes:

A. Increase in customer base – The combined entity now serves the customers of both legacy firms, usually increasing total customer reach and market share.

C. Decrease in employee motivation due to internal changes – Mergers often create uncertainty, restructuring, cultural clashes and role changes, which can reduce morale and motivation, at least in the short term.

D. Changes to supplier relationships owing to internal changes – A larger merged company often renegotiates supply contracts, consolidates suppliers or changes volumes, so relationships and terms are likely to change.

E. Cost savings from synergistic benefits and economies of scale – This is one of the main motives for mergers: eliminating duplication, spreading fixed costs, consolidating operations, and gaining purchasing power.

Option B (competition authorities step in to stop a potential price monopoly) is not something that will necessarily or likely occur after the merger; it may happen in some extreme cases and typically occurs before completion, so it’s not treated as a standard outcome.

So the most appropriate outcomes are: A, C, D and E.

$2 million is recognised in profit or loss and $5 million is recognised in other comprehensive income.

This is a cash flow hedge of variable interest payments.

Under IFRS 9, the net swap settlements (the “interest leg”) are taken to profit or loss to adjust the interest expense on the borrowing → $2m in P&L.

The change in fair value of the swap that is an effective hedge of future cash flows is recorded in OCI → total gain on swap is $2m (cash received) + $5m (closing FV asset) = $7m; we’ve already put $2m in P&L, so the remaining $5m goes to OCI as a cash flow hedge reserve.