Free CIMA F3 Practice Exam with Questions & Answers | Set: 10

Current:

Revenue = $450m at $2.50/kWh → units = 450 / 2.5 = 180m kWh

Costs = $250m → Profit = $200m

After cap: price = $2.00, demand up 15%:

New volume = 180 × 1.15 = 207m kWh

New revenue = 207 × 2.00 = $414m

Costs unchanged = $250m → New profit = 414 − 250 = $164m

Answer: B. $164.00 million profit

A – Quality of current management: affects risk of default and how well the business is run.

B – Current gearing ratio: shows how much existing leverage there is and the risk of over-gearing.

E – Interest cover on existing debt: key indicator of the firm’s ability to service interest payments.

EPS (C) and dividend cover (D) are more relevant to equity investors than to new long-term lenders.

The market yield of 8% is a before-tax return to investors. For the company, interest payments reduce taxable profit, so the after-tax cost of debt is:

Cost of debt=Yield×(1−tax rate)\text{Cost of debt} = \text{Yield} \times (1 - \text{tax rate})Cost of debt=Yield×(1−tax rate)

This makes the company’s cost of debt lower than the 8% market yield.

Holding excess cash increases equity (retained earnings) without necessarily increasing profits proportionately. This dilutes returns to shareholders, so ROE falls. Liquidity actually increases, and vulnerability to takeover may fall, not rise.

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

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.

The question asks for advantages to the acquiring company (ADC/ABC) of using shares rather than cash to pay for DEF.

C. It incentivises DEF to continue creating value for the combined group

If DEF’s shareholders (and possibly managers) receive shares in ADC, they now own part of the combined business. That aligns their interests with ADC’s existing shareholders and encourages them to help grow the value of the group.

E. The risk of poor future performance of the acquisition is shared with the DEF company shareholder.

If ADC pays with shares, DEF’s shareholders share in both the upside and downside. If the acquisition underperforms, the fall in value is shared instead of all the risk resting on ADC’s original shareholders. That’s an advantage for ADC.

F. It preserves liquidity

Paying with shares means ADC does not need to use up cash or raise new debt. This preserves cash balances and borrowing capacity, which is a clear advantage.

Why not the others?

A (sharing benefits of future growth with DEF shareholders) is actually a cost from ADC’s existing shareholders’ viewpoint – they give away more of the upside.

B dilution of ownership is also a disadvantage, not an advantage.

D a tax saving for ABC – the tax impact is usually more relevant for sellers or when using debt, not typically a direct advantage of share consideration to the acquirer.

Given (current): Debt:Equity = 20:80, tax = 25%, equity beta = 1.20, asset beta = 1.01.

Check/ungear beta (matches table):

βa=βeEE+D(1−T)=1.20×8080+20×0.75=1.01\beta_a = \beta_e \frac{E}{E + D(1-T)} = 1.20 \times \frac{80}{80 + 20×0.75} = 1.01βa​=βe​E+D(1−T)E​=1.20×80+20×0.7580​=1.01.

Re-gear for new structure D:E = 30:70:

βe′=βaE+D(1−T)E=1.01×70+30×0.7570=1.01×92.570≈1.33\beta_e' = \beta_a \frac{E + D(1-T)}{E} = 1.01 \times \frac{70 + 30×0.75}{70} = 1.01 \times \frac{92.5}{70} \approx 1.33βe′​=βa​EE+D(1−T)​=1.01×7070+30×0.75​=1.01×7092.5​≈1.33

CAPM with rf=3%r_f = 3\%rf​=3%, rm=10%r_m = 10\%rm​=10%:

Ke′=3%+1.33×(10%−3%)≈3%+9.3%=12.3%K_e' = 3\% + 1.33 × (10\%-3\%) \approx 3\% + 9.3\% = 12.3\%Ke′​=3%+1.33×(10%−3%)≈3%+9.3%=12.3%