Free Practice Questions for CIMA F3 Exam

Relevant cash flows for a lease–or–buy decision (discounting at post-tax cost of borrowing) are:

A. Tax relief on tax depreciation allowances – relevant for the buy option.

B. Bank loan payments – not relevant; financing flows are excluded when using the borrowing rate as discount rate.

C. Maintenance payments – here, maintenance is paid by the lessee under the lease, and would also be paid if the asset is bought; since it is the same under both options, it is not a differential cash flow.

D. Lease payments – relevant cash outflows under the lease option.

E. Tax relief on the book depreciation – relevant where tax relief is given on book depreciation (here, under the finance lease).

Therefore, the three relevant cash flows from the list are:

Answer (200259):

A, D, E\boxed{A,\ D,\ E}A, D, E​

 A. The shareholder can choose whether to take the cash or not.

With a repurchase, shareholders can decide to sell (take cash) or keep their shares. A one-off dividend forces all shareholders to receive cash.

 C. It means that the company will be able to pay lower total dividends in the future.

After a buyback there are fewer shares in issue. If the company keeps the same dividend per share, the total dividend outlay falls – good for future cash flow and flexibility.

 E. It will not create an expectation for future increased dividends.

A large one-off dividend may be interpreted as a permanent increase, creating pressure to maintain higher payouts. A buyback is seen as a more one-off, discretionary event, so it avoids that expectation.

 B is wrong: a repurchase reduces, not increases, shares in issue.

 D is not an advantage relative to a dividend – both methods return cash that shareholders can spend as they wish.

Working

Market value of equity E=6mE = 6mE=6m; debt D=4mD = 4mD=4m; so total V=10mV = 10mV=10m.

DV=410=0.4T=20%=0.20\frac{D}{V} = \frac{4}{10} = 0.4 \qquad T = 20\% = 0.20VD​=104​=0.4T=20%=0.20

Under Modigliani–Miller with tax, the relationship between ungeared cost of equity KuK_uKu​ and the after-tax WACC is:

WACC=Ku (1−TDV)\text{WACC} = K_u\,(1 - T \tfrac{D}{V})WACC=Ku​(1−TVD​)

So:

Ku=WACC1−TDV=11.04%1−0.20×0.4=11.04%0.92=12.00%K_u = \frac{\text{WACC}}{1 - T\frac{D}{V}} = \frac{11.04\%}{1 - 0.20 \times 0.4} = \frac{11.04\%}{0.92} = 12.00\%Ku​=1−TVD​WACC​=1−0.20×0.411.04%​=0.9211.04%​=12.00%

So the ungeared cost of equity is 12.00%.

Founder of Company C owns 52% and wants to keep control.

A share-for-share exchange means issuing new shares → dilutes the founder’s holding and may reduce control.

A cash offer financed by borrowing does not issue new shares → founder’s percentage holding (and control) is preserved.

That is exactly what option A states.

Answer: A. A share-for-share exchange would result in a significant change in control… whereas a cash offer would not.

A – Shareholders who want cash can sell into the repurchase.

B – Fewer shares in issue → higher EPS for remaining shareholders.

C – Reduces surplus cash that might attract predators.

Equity: $30m

Debt: $35m at 5% interest, redeemable in 5 years

They require 30% p.a. compound on the equity and no dividends are paid.

Equity value required in 5 years

Future value=30×1.35=30×3.71293≈$111.39m\text{Future value} = 30 \times 1.3^5 = 30 \times 3.71293 \approx \$111.39\text{m}Future value=30×1.35=30×3.71293≈$111.39m

Debt cash flows

Annual interest: 35×5%=$1.75m35 \times 5\% = \$1.75\text{m}35×5%=$1.75m → over 5 years: 1.75×5=$8.75m1.75 \times 5 = \$8.75\text{m}1.75×5=$8.75m

Principal repaid in year 5: $35m

Total due to venture capitalists

111.39+8.75+35=$155.14m (approx)111.39 + 8.75 + 35 = \$155.14\text{m (approx)}111.39+8.75+35=$155.14m (approx)

Answer: A. $155.14 million

Verified Answer: = B

CIMA F3 compares different forms of long-term finance, including preference shares and bonds/Eurobonds, focusing on control, tax treatment, gearing impact, and flexibility.

Statement B captures a key advantage of preference shares from the company’s perspective: if profits are poor, preference dividends can be omitted or deferred, especially when they are cumulative. Although unpaid dividends accumulate, non-payment does not normally constitute default in the same way as missing an interest payment on a bond. For a Eurobond, failure to pay interest when due would place the company in default, triggering legal and reputational consequences. This extra flexibility is exactly why preference shares might be favoured over bonds.

Statement A is misleading: Eurobonds are often unsecured, and security (or lack of it) is not a defining difference versus preference shares.

Statement C is incorrect in this context: redeemable cumulative preference shares are typically treated as a financial liability under IFRS (like debt), so they would generally increase gearing, not reduce it.

Statement D is clearly wrong as dividends are not tax-deductible, whereas bond interest normally is. Therefore, the best justification for issuing preference shares rather than a Eurobond is B.

Current PBIT = $25m

Existing debt = $60m at 5% → interest = 0.05 × 60 = $3m

Current interest cover = 25 / 3 = 8.3 times (as stated).

New borrowing: $20m at 10% → extra interest = 0.10 × 20 = $2m

Total interest after borrowing = 3 + 2 = $5m

PBIT in first year is unchanged at $25m, so:

New interest cover=255=5 times\text{New interest cover} = \frac{25}{5} = 5 \text{ times}New interest cover=525​=5 times

Loan covenant requires minimum cover of 4 times. New cover (5x) is above this, so covenant is not breached.

Correct answer: D – Interest cover would reduce to 5 times and the covenant would NOT be breached.