CIMA F3 - Financial Strategy

IFRS 7 requires detailed disclosures of financial instrument risks, specifically:

Credit risk – exposure to counterparties failing to meet obligations.

Market risk – currency, interest rate, and other price risks.

Liquidity risk – ability to meet obligations as they fall due.

Business risk and enterprise risk are broader strategic concepts, not the focus of IFRS 7.

✅ Answer: A, C, and E

Workings (Modigliani & Miller with tax):

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

Cost of debt kd=3%k_d = 3\%kd​=3%

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

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

Formula with tax:

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

So the nearest option is 11.3% (C).

PBIT = $4m

Interest on loan = 10% × $10m = $1m

Profit before tax = $3m

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

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

Equity value = $2.4m × 10 = $24m

Answer: D. $24 million

Company B (all equity):

Cost of equity = asset return = Ku = 17%

Company A:

Gearing D:E = 1:2 → D/E = 0.5

Pre-tax cost of debt Kd = 7%

Tax rate T = 30%

Levered cost of equity with tax:

Ke=Ku+DE(1−T)(Ku−Kd)K_e = K_u + \frac{D}{E}(1 - T)(K_u - K_d)Ke​=Ku​+ED​(1−T)(Ku​−Kd​) Ke=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%K_e = 17\% + 0.5 \times 0.7 \times (17\% - 7\%) = 17\% + 0.5 \times 0.7 \times 10\% = 17\% + 3.5\% = 20.5\%Ke​=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%

✅ Correct: A. 20.5%

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

Ungear to get asset beta:

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

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

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

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

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

Practical considerations for dividend/retention policy of a high-risk exploration company facing volatile profits and major investment needs:

A. Timing and size of cash flows needed for the new investment – crucial for deciding how much to retain vs. pay out – Relevant.

B. Fluctuating projected profits – affects ability to sustain dividends – Relevant.

C. Legislation and regulation on distributable profits – always a hard constraint on dividends – Relevant.

D. Dividend policies of mature multinationals – not a practical constraint for a small, high-risk explorer – Not key.

E. Interest rates and tax savings on debt – less relevant where debt finance is unlikely to be available – Not key.

Answer (200289):

For tax planning and compliance, transfer prices between group companies must follow the arm’s length principle: intra-group prices should be those that would be charged between independent parties in comparable circumstances.

Option D explicitly states this – same price as would be charged to independent supermarkets in that foreign country.

Options B and C suggest manipulating prices based on tax rates, which risks breaching transfer pricing rules. Thin capitalisation (A) is about debt levels, not intra-group pricing. So D is the key factor.

Company X is an established, unquoted, specialist IT advisory firm with steady results, predictable dividends and cashflows. Company P is only buying 30% (a minority stake).

B. Dividend based using DVM – Very suitable because dividends are predictable and regular. For a minority stake, dividends are often the main measurable return, so a dividend valuation model is appropriate.

C. Cash based using free cash flow before interest – A DCF valuation based on free cash flow to the firm is also appropriate for a profitable, growing, going concern. You can value the whole business using FCFF and then take 30% of the equity value.

Asset-based (A) is less relevant for a specialist service company with relatively few tangible assets. P/E-based methods (D and E) are less ideal given there are few direct competitors, making comparables unreliable.

In CIMA F3, rights issues and post-issue valuation are taught under the learning outcomes relating to financing decisions, equity issuance, and shareholder value analysis. The Theoretical Ex-Rights Price (TERP) represents the price a share should trade at immediately after the rights issue when the “value dilution” and “value added” of the project are taken into account.

According to the financial strategy principles taught in F3, the TERP is calculated by adding:

The current market value of equity,

The cash raised from the rights issue, and

The net present value (NPV) of the investment project,

then dividing by the total number of shares after the issue. This reflects the CIMA F3 view that share prices should adjust to reflect both new financing inflows and future economic benefits associated with positive-NPV projects.

Step-by-step application of the F3 method

(1) Current shareholders’ equity value:

(2) Rights issue price:

Rights issued at a 10% discount:

(3) Number of new shares issued:

(4) Total shares after issue:

(5) Total value after issue and project:

Add value of cash raised and NPV:

(6) TERP formula:

Rounded to two decimal places:

This calculation follows the CIMA F3 principle that positive-NPV projects increase shareholder wealth, and therefore must be added to the total post-issue company valuation before dividing by the enlarged share capital.

ï‚· Indonesia has higher inflation, so its currency is expected to depreciate, not appreciate.

A: Wrong – says appreciate.

B: Correct – FTT receives a currency likely to fall in value, so it has transaction risk.

 C: Correct – invoicing in FTT’s home currency shifts/reduces its own currency risk.

 D: Incorrect – that’s more about business/operational risk, not translation risk.

 E: Correct – if FTT also pays out Indonesian currency (e.g. imports from Indonesia), receipts and payments can naturally hedge each other.