Free CIMA F3 Practice Exam with Questions & Answers | Set: 4

Applying hedge accounting will better match the gains/losses on hedging instruments with the underlying forecast revenues, reducing artificial volatility in reported profit. This makes the performance figures more representative and therefore easier for the market to analyse and value when the company lists.

Option D is weaker because hedge accounting is optional under IFRS, and A and C do not address the key issue of earnings volatility and future market valuation.

Current equity value = 10m × $3 = $30m

Issue price at a 40% discount: 3 × (1 − 0.40) = $1.80

New shares issued = 2.88 / 1.80 = 1.6m

Total shares after issue = 10 + 1.6 = 11.6m

Total value after project and issue (exam approach):

30 + 2.88 (cash raised) + 1 (NPV) = $33.88m

Ex-issue price = 33.88 / 11.6 ≈ $2.92

Gain/loss per existing share = 2.92 − 3.00 = −$0.08

Answer: B. Loss of $0.08

$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.

Against DDA

Fixed: ZZZ 10% vs DDA 10.5% → ZZZ cheaper by 0.5%

Floating: ZZZ rf+1 vs DDA rf+1.5 → ZZZ cheaper by 0.5%

ZZZ is better in both markets by the same margin → no comparative advantage, little reason for DDA to swap.

Against CCA

Fixed: ZZZ 10% vs CCA 9% → CCA cheaper by 1%

Floating: ZZZ rf+1 vs CCA rf+0.5 → CCA cheaper by 0.5%

CCA is cheaper in both, and also the one with greater advantage is fixed. There’s no natural “ZZZ better at one, CCA better at the other” pairing.

Against BBA ✅

Fixed: ZZZ 10% vs BBA 12% → ZZZ cheaper in fixed by 2%

Floating: ZZZ rf+1 vs BBA rf+0.25 → BBA cheaper in floating by 0.75%

So ZZZ has an advantage in fixed, BBA has an advantage in floating.

ZZZ wants floating, so it can:

Borrow fixed at 10% (where it is strong),

Enter a swap with BBA (who wants fixed but is strong in floating),

End up with an effective floating rate below rf+1.

Against AAB

Fixed: ZZZ 10% vs AAB 9.5% → AAB cheaper by 0.5%

Floating: ZZZ rf+1 vs AAB rf+0.75 → AAB cheaper by 0.25%

AAB is cheaper in both; no obvious mutual gain.

So the classical swap pairing is ZZZ with BBA → Option C.

 “The government of country X could refuse to grant visas to GHJ’s staff who need to move to country X.”

???? Method: Employ at least 80% local people in the production plant

Relying mainly on local employees reduces dependence on foreign staff and makes visa refusal less damaging and less likely politically.

 “The government of country X could introduce high taxes for outside companies which would make it difficult for GHJ to continue production in country X.”

???? Method: Take out a loan with a bank in country X

Local banks become important stakeholders. If high taxes threaten GHJ’s viability and ability to service the loan, the local bank has an incentive to lobby the government, reducing this political risk.

 “Local staff could find out how to make the product and use that knowledge to start a production plant of their own.”

???? Method: Import partly completed products from GHJ’s home country

Keeping key stages of production or core technology in the home country limits how much know-how local staff can copy.

 “The government of country X could refuse to renew visas for staff brought from GHJ’s home country.”

???? Method: Employ at least 80% local people in the production plant

Again, the more the operation depends on local staff, the less vulnerable it is to visa non-renewal and the more politically acceptable the operation is.

Interest on debt is treated as a tax-deductible expense, so it is deducted in arriving at profit before tax:

A – incorrect: security over assets doesn’t affect tax relief on interest.

B – incorrect: preference dividends are not tax-deductible.

C – incorrect: if it were deducted from post-tax profits there would be no tax relief.

D – correct: interest is deducted from pre-tax profits.

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).

NNN is financed by both equity and debt, and the directors specifically want the value of the equity. Valid approaches are:

A. Total earnings × P/E ratio – Correct

Using a suitable sector or market price–earnings multiple and multiplying by NNN’s earnings gives an estimate of the equity value directly.

B. Cash flow to all investors discounted at WACC less the value of debt – Correct

Discounting free cash flow to the firm (to all investors) at the WACC gives the enterprise value (debt + equity). Subtracting the market value of debt then leaves an estimate of the equity value.

C. Cash flow to all investors discounted at WACC – Not sufficient

This gives the total firm value, not just the equity. On its own, it doesn’t answer the question.

D. Cash flow to equity discounted at the cost of equity less the value of debt – Incorrect

Discounting cash flow to equity at the cost of equity already produces equity value. Subtracting debt again would be conceptually wrong (double counting).

E. Cash flow to equity discounted at the cost of equity – Correct

This is the standard free cash flow to equity (FCFE) valuation method and directly yields the value of equity.

So the appropriate methods here are A, B and E.