Free Practice Questions for CIMA F3 Exam

For Company X: equity beta = 1.6, D/(D+E) = 50% ⇒ D = E, tax = 30%.

Ungear to get asset beta:

βa=βeEE+D(1−T)=1.6×11+1×0.7=1.6×11.7≈0.94\beta_a = \beta_e \frac{E}{E + D(1-T)} = 1.6 \times \frac{1}{1 + 1×0.7} = 1.6 \times \frac{1}{1.7} \approx 0.94βa​=βe​E+D(1−T)E​=1.6×1+1×0.71​=1.6×1.71​≈0.94

Re-gear for Company Y with 60% equity, 40% debt (D/V=0.4, E/V=0.6):

βe′=βaE+D(1−T)E=0.94×0.6+0.4×0.70.6=0.94×0.880.6≈1.38\beta_e' = \beta_a \frac{E + D(1-T)}{E} = 0.94 \times \frac{0.6 + 0.4×0.7}{0.6} = 0.94 \times \frac{0.88}{0.6} \approx 1.38βe′​=βa​EE+D(1−T)​=0.94×0.60.6+0.4×0.7​=0.94×0.60.88​≈1.38

CAPM ( rf=5%r_f = 5\%rf​=5%, rm=10%r_m = 10\%rm​=10% ):

Ke′=5%+1.38×(10%−5%)=5%+1.38×5%≈5%+6.9%=11.9%K_e' = 5\% + 1.38 × (10\%-5\%) = 5\% + 1.38×5\% \approx 5\% + 6.9\% = 11.9\%Ke′​=5%+1.38×(10%−5%)=5%+1.38×5%≈5%+6.9%=11.9%

When valuing an unlisted company using a P/E ratio from a similar listed company, we normally reduce the proxy P/E to reflect the extra risk and reduced attractiveness of the unlisted investment.

A. Relative lack of marketability – Unlisted shares are harder to sell and usually take longer to realise, so investors demand a higher return, i.e. a lower P/E. ✔

B. Lower level of scrutiny and regulation – Unlisted companies face less disclosure and governance requirements, so information risk is higher. Greater risk ⇒ lower valuation multiple ⇒ reduced P/E. ✔

C. Smaller and less established – Unlisted companies tend to be smaller, less diversified and less stable, so investors again expect a higher return, implying a lower P/E. ✔

D. Control premium not included – If the proxy P/E excludes a control premium but you are valuing a controlling stake, you would increase the P/E, not reduce it. ✘

E. Higher forecast earnings growth – Higher expected growth justifies a higher P/E, not a lower one. ✘

F. One-off profit item in latest earnings – This should be dealt with by adjusting the earnings, not by cutting the P/E multiple. ✘

So the three factors justifying a reduction in the proxy P/E are A, B and C.

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

Workings:

BBA remits BS40 million.

Withholding tax in country B = 25%:

Tax = 25% × 40 = BS10m

Net remitted = 40 − 10 = BS30m

Company AAB pays tax of 10% on cash received:

Tax = 10% × 30 = BS3m

Net after tax = 30 − 3 = BS27m

Exchange rate: A$1 = BS3 →

\text{AAB receives in A$} = \frac{BS27m}{3} = \text{A\$9m}

Issue price at 20% discount to $5 = $4 per share.

Amount to raise = 20m → new shares = 20m / 4 = 5m.

Existing shares = 20m → rights ratio = 5m : 20m = 1 : 4.

Answer: A. 1 new share for every 4 existing shares

A – Access to technical expertise: Q’s staff are leading experts and human capital is very valuable; acquiring this is a clear benefit.

D – Gain economies of scale: Both firms operate in the same technical service industry, so combining operations can reduce average costs and share overheads.

E – Improve EPS: Q has shown consistent earnings growth; if acquired at a reasonable price, this growth can enhance M’s earnings and potentially its EPS.

Diversification benefits (B) are limited because they are in the same industry, and intangible assets such as human capital are not strong collateral for borrowing (C).

Current KKA share price = $5.00

Cash offer: $5.75 per share

Premium = (5.75 − 5.00) / 5.00 = 0.75 / 5 = 15%

Bond offer: market value $90 bond for 15 KKA shares

Value per KKA share = 90 / 15 = $6.00

Premium = (6.00 − 5.00) / 5.00 = 1 / 5 = 20%

The highest premium is therefore 20% on the bond offer, i.e. option B.

A. Any opportunity to benefit from future exchange rate movements is lost.

True – a money market hedge locks in the effective exchange rate now, so you remove both downside risk and upside potential.

B. It can be tailored to match the size of the payment.

True – you can structure the borrowing/lending and FX transaction to exactly match the foreign currency amount due.

C. It manages transaction risk.

True – transaction risk (uncertainty in the home currency value of a known future foreign-currency cash flow) is what a money market hedge directly addresses.

D. It offers a significantly better outcome than a forward contract.

False – under interest rate parity, a money market hedge and a forward contract should give similar effective rates (ignoring spreads and costs).

E. It avoids the need to find immediate finance.

False – for a payable, you normally borrow or use cash now as part of the hedge, so it does not avoid immediate financing; it actually requires it.

✅ Answer to Q29: A, B, C

Approach A

Issue 10-year bond at 6% → net interest cost = 6.0%

Approach B

Borrow from bank at Libor + 2.5%

Enter 10-year swap. Market quote 4.0–4.2% vs Libor.

For a borrower wanting to pay fixed, it will pay the higher fixed rate (4.2%) and receive Libor.

Net cost under B:

Pay bank: Libor + 2.5%

Pay swap fixed: 4.2%

Receive from swap: Libor

Overall:

(Libor+2.5%)+4.2%−Libor=6.7%(\text{Libor} + 2.5\%) + 4.2\% - \text{Libor} = 6.7\%(Libor+2.5%)+4.2%−Libor=6.7%

So B costs 6.7% p.a. vs A at 6.0% p.a.

Difference = 0.7% per year, with Approach A cheaper.

Answer: A – Approach A is 0.7% a year less expensive.

Company X is an established, unquoted, specialist IT advisory firm with steady results, predictable dividends and cashflows. Company P is only buying 30% (a minority stake).

B. Dividend based using DVM – Very suitable because dividends are predictable and regular. For a minority stake, dividends are often the main measurable return, so a dividend valuation model is appropriate.

C. Cash based using free cash flow before interest – A DCF valuation based on free cash flow to the firm is also appropriate for a profitable, growing, going concern. You can value the whole business using FCFF and then take 30% of the equity value.

Asset-based (A) is less relevant for a specialist service company with relatively few tangible assets. P/E-based methods (D and E) are less ideal given there are few direct competitors, making comparables unreliable.