Free Practice Questions for CIMA F3 Exam

In CIMA F3, finance leases are analysed as a form of debt financing and are compared directly with bank loans when evaluating long-term funding options. The syllabus (under Financing Decisions and Leasing vs Buying) explains that a finance lease is economically similar to borrowing to purchase an asset, because the lessee assumes substantially all the risks and rewards of ownership.

Option B is correct because one key advantage of a finance lease over a bank loan is that the lessor retains legal ownership of the asset, which provides strong security for the lender. As a result, the lessor’s risk is lower than that of a bank providing an unsecured or partially secured loan. CIMA F3 study guidance highlights that this reduced risk can allow the lessor to offer more favourable interest rates or financing terms than a conventional bank loan.

The other options are incorrect under current accounting and financial strategy principles:

A is incorrect because finance leases are not off-balance sheet. Under IFRS 16 (examined in F3), finance leases must be recognised on the statement of financial position, increasing both assets and liabilities and therefore affecting gearing.

C is incorrect because tax depreciation (capital allowances) normally remain with the legal owner, the lessor. These benefits are not “passed on” directly, although they may be reflected indirectly in lease pricing.

D is incorrect because maintenance is a feature of operating leases, not finance leases. In a finance lease, the lessee is responsible for maintenance and insurance.

Short-term rates slightly above long-term rates = mildly inverted yield curve.

A – This difference may reverse: Correct – the term structure can and does change over time.

B – Currency expected to strengthen long-term: Lower long-term rates imply lower expected long-term inflation, which is consistent with expectations of a stronger currency in the long run.

D – Interest rates are expected to fall: An inverted yield curve usually reflects market expectations that future short-term rates will be lower than today.

C is wrong because rates are not definite to fall, only expected to.

E is wrong: with short-term rates currently higher than long-term, a long-term borrower would not clearly “save” by borrowing short and refinancing; it also adds refinancing risk.

This is a fair value hedge of inventory.

Under fair value hedge accounting, both:

the change in fair value of the hedged item (inventory), and

the change in fair value of the hedging instrument (futures)

go to profit or loss.

Inventory: fair value rises from $400,000 to $480,000 → gain $80,000.

Futures: fair value becomes a $75,000 liability → loss $75,000.

Net effect in P&L: $80,000 – $75,000 = $5,000 gain.

Nothing goes to OCI for a fair value hedge.

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):

“Only pay a dividend once all positive NPV projects have been funded.” → Residual policy

Under a residual dividend policy, the firm first uses earnings to finance all projects with a positive NPV.

Whatever profit is left over (the “residual”) may be paid out as dividends.

So dividends are not the target; investment in value-adding projects is. That’s exactly what the statement describes.

“Investors prefer a predictable cash flow.” → Stable growth

A stable (or steadily growing) dividend policy aims to provide shareholders with a smooth, predictable stream of dividends.

Even if earnings are volatile, management tries to keep dividends level or with a modest regular increase.

This appeals to investors who value certainty of income, which is what the statement is referring to.

“May create volatile dividend movements.” → Constant payout ratio

With a constant payout ratio, the company always pays the same percentage of earnings as dividends (e.g. 40% of earnings every year).

If earnings go up and down, the dividend per share will also go up and down proportionally.

That leads to volatile dividend movements, which is exactly what the statement says.

So the final mapping is:

Residual policy → “Only pay a dividend once all positive NPV projects have been funded.”

Stable growth → “Investors prefer a predictable cash flow.”

Constant payout ratio → “May create volatile dividend movements.”

For a capital-intensive, fast-growing, owner-managed start-up with many investment opportunities, the most suitable policy is to retain earnings to finance all positive NPV projects first, and only pay dividends out of any leftover (residual) earnings. That’s exactly what a residual dividend policy does.

Advantages of a debt-funded cash offer vs a share exchange:

A. Shareholder control will remain with AB’s current shareholders.

B. More of the synergistic benefits will accrue to AB’s current shareholders.

D. EPS will increase (no dilution of equity; if synergies materialise, earnings are spread over the same number of shares).

Answer: A, B, D

CIMA F3 examines acquisition financing choices under Financial Policy Decisions and Mergers and Acquisitions, with a particular focus on how cash offers versus share exchanges affect shareholder wealth, control, gearing and earnings. The key issue from the perspective of Company AB’s shareholders is whether the method of financing enhances shareholder value without undermining the firm’s optimal capital structure.

A debt-funded cash offer involves Company AB raising debt to pay cash to the shareholders of Company DC. In contrast, a share exchange issues new equity, diluting existing ownership.

Option A is an advantage.

CIMA F3 highlights that a cash offer allows existing shareholders to retain control, because no new shares are issued. With a share exchange, ownership and voting power are diluted as DC’s shareholders become part-owners of the combined company.

Option B is an advantage.

Under a cash offer, all future synergies accrue to AB’s existing shareholders. F3 explains that with a share exchange, synergy benefits are shared with the target’s shareholders through their new equity stake. Therefore, a debt-funded cash offer concentrates the upside of synergies with the acquirer’s shareholders.

Option D is an advantage.

CIMA F3 notes that debt financing can lead to EPS growth, provided the return on the acquisition exceeds the cost of debt. Because no new equity is issued, earnings are spread over the same number of shares, and financial gearing magnifies returns to equity holders.

The remaining options are not advantages:

C (Gearing will increase) is a consequence, not an advantage. Since AB is already at its optimum capital structure, higher gearing increases financial risk.

E is incorrect; increasing WACC would reduce shareholder value, not enhance it.