CIMA F3 - Financial Strategy

Company A’s equity value at the launch date (end of 20X1) is the PV of a growing perpetuity of FCFE:

First FCFE (end of first year of operation, 20X2): $2m

Growth: 8%

Cost of equity: 12%

Value of Company A at end-20X1:

V=20.12−0.08=20.04=50 millionV = \frac{2}{0.12 - 0.08} = \frac{2}{0.04} = 50 \text{ million}V=0.12−0.082​=0.042​=50 million

Company V owns 40%:

Value of stake at sale=0.4×50=20 million\text{Value of stake at sale} = 0.4 \times 50 = 20 \text{ million}Value of stake at sale=0.4×50=20 million

It invests $15m at 1 Jan 20X0 and gets $20m at end-20X1 (≈ 2 years):

15(1+r)2=20⇒(1+r)2=2015=4315(1 + r)^2 = 20 \Rightarrow (1 + r)^2 = \frac{20}{15} = \frac{4}{3}15(1+r)2=20⇒(1+r)2=1520​=34​ 1+r=43≈1.1547⇒r≈15.47%1 + r = \sqrt{\frac{4}{3}} \approx 1.1547 \Rightarrow r \approx 15.47\%1+r=34​​≈1.1547⇒r≈15.47%

Nearest whole % = 16%

Answer: C. 16%

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

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

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

Verified Answer: = C

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

CIMA F3 explains warrants as equity-linked sweeteners often attached to debt issues (such as bonds) to make them more attractive, allowing the issuer to reduce the coupon rate. This aligns directly with statement A, which is therefore correct: warrants are indeed used to “sweeten” a bond and drive down the interest rate.

Statement B is also correct: a warrant gives the holder the right, but not the obligation, to subscribe for a company’s ordinary shares at a fixed exercise price on or before a specified future date. This is a core definition in the F3 syllabus under hybrid and derivative instruments.

Statement D reflects the idea that warrants can be costly to existing shareholders. If the share price in future is well above the exercise price, new shares will be issued at what is effectively a discount, diluting existing shareholders’ value. This is a recognised downside in CIMA discussions of equity-linked incentives.

Statement C is the incorrect one. Warrants are typically detachable and tradeable, but they are not normally redeemable by the issuer at nominal share value at the discretion of the holder. They’re exercised into shares or sold in the market, not “sold back” to the company for par. Hence C is NOT correct.

Questions no: 199044

PBIT = $1.1m

Debt = $2m at 5% → interest = $0.1m

Profit before tax = 1.1 – 0.1 = $1.0m

Tax at 20% = 0.2m → Earnings after tax = $0.8m

Earnings yield = Earnings ÷ Market value of equity = 10%:

0.8=0.10×MV⇒MV=0.80.10=$8m0.8 = 0.10 \times \text{MV} \Rightarrow \text{MV} = \frac{0.8}{0.10} = \$8\text{m}0.8=0.10×MV⇒MV=0.100.8​=$8m

Shares in issue = 4m → share price:

Price=84=$2.00\text{Price} = \frac{8}{4} = \$2.00Price=48​=$2.00

Answer: C: $2.00

Given currently:

Cost of equity ke=10%k_e = 10\%ke​=10%

Post-tax cost of debt = 4%

WACC = 7.6%

Gearing D/(D+E)=40%D/(D+E) = 40\%D/(D+E)=40%

Tax 20%

New gearing after raising more debt: 50%.

Under Modigliani & Miller with tax (no distress costs):

Cost of debt remains constant as gearing changes (until very high levels of debt). So

➜ F is TRUE, A is FALSE.

As gearing increases, the tax shield on debt becomes larger, so WACC falls.

➜ B (WACC will decrease below 7.6%) is TRUE, E is FALSE.

Higher gearing increases financial risk borne by shareholders, so cost of equity rises with more debt.

➜ C (cost of equity will increase above 10%) is TRUE, D is FALSE.

So the correct set is B, C and F.

Net book value of equity = $20m

Net realisable value of equity = $25m

Free cash flow to equity = $3.5m indefinitely

Cost of equity (ke) = 10%

Value from FCFE (perpetuity):

Vequity=3.50.10=35mV_{\text{equity}} = \frac{3.5}{0.10} = 35\text{m}Vequity​=0.103.5​=35m

A reasonable minimum is the break-up / net realisable value = $25m.

A reasonable maximum is the going-concern DCF value = $35m.

Answer: A. Minimum $25.0m, maximum $35.0m

In CIMA F3, the Calculated Intangible Value (CIV) method is used to estimate intangible value by comparing a business’s profits to what would be expected from its tangible asset base, typically relying on normalised, sustainable earnings and an assumption of continuing returns. This scenario has three features that reduce CIV validity. First, the business owns freehold property whereas the industry norm is to lease (A). CIV depends on a “normal” tangible asset base and the return on those tangibles; a non-standard capital structure in tangibles can distort the benchmark return and the computed “excess earnings,” so adjustments would be required. Second, significant profits are forecast only for three years with negligible profits thereafter (B). CIV implicitly assumes excess earnings are sustainable (often capitalised as a continuing benefit), so a short-lived profit window undermines the idea of capitalising excess returns into a continuing intangible value. Third, the business has not yet made a profit (C), which weakens CIV because it typically uses observed/established earnings to compute excess returns; early-stage forecasts add significant estimation risk. CIV can be applied to unlisted companies (so D is not a limitation), and the fact that software IP is not in the accounts is exactly why an intangible valuation approach is considered (so E is not a limitation).

This is the appropriate, code-compliant defence: communicate with shareholders, explain the company’s prospects (including use of cash for an acquisition) and why the bid undervalues the firm. The other options either breach takeover-code norms or are not well-justified.

Quick explanation:

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

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

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

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

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

✅ Correct: A, C, E