F3 Exam Dumps - Financial Strategy

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.

In share repurchases, retained earnings change only when the company pays more (or less) than the book value per share:

Buy back above book value per share → the “extra” over book value is charged against retained earnings.

Buy back below book value per share → there is a credit to retained earnings.

Buy back at book value per share → retained earnings are unchanged.

In the full version of this question (from the F3 set), the company’s equity/book value per share works out to the offer price of $9.00. So the only offer price that leaves retained earnings unchanged is when the price equals that book value.

Answer: B. $9.00

(With the snippet you posted, the book-value data aren’t visible, but in the original question that’s how $9.00 is identified.)

A low dividend payout means the company is retaining more profits instead of distributing them. A classic reason (straight from CIMA F3 theory) is that external finance is expensive or hard to obtain, so the firm relies on retained earnings to fund investments.

High profitability (A) usually supports higher dividends.

Lack of investment opportunities (C) would lead to higher dividends, not lower.

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.

Increase initially then decrease

This question tests understanding of the traditional theory of capital structure, a core topic within CIMA F3 under Cost of Capital and Capital Structure. The traditional view differs from Modigliani and Miller by arguing that there is an optimal capital structure where a company’s Weighted Average Cost of Capital (WACC) is minimised.

According to traditional theory, at low levels of gearing, introducing debt into the capital structure reduces WACC. This occurs because debt is generally cheaper than equity, largely due to lower risk for lenders and the tax deductibility of interest payments. Initially, equity holders do not perceive a significant increase in financial risk, so the cost of equity remains relatively stable. As a result, replacing some equity with cheaper debt lowers the overall WACC.

However, as gearing continues to rise beyond a certain point, the financial risk borne by both debt holders and equity holders increases substantially. Lenders demand higher interest rates to compensate for increased default risk, and shareholders require a higher return due to greater earnings volatility. This leads to rising costs of both debt and equity. Beyond the optimal gearing level, these rising costs outweigh the benefits of cheaper debt, causing WACC to increase.

CIMA F3 study guidance therefore concludes that under traditional theory, WACC:

Falls initially as gearing increases, and

Rises after the optimal capital structure is exceeded.

Since the directors are increasing gearing toward an industry average, the most appropriate description of WACC behaviour under traditional theory is that it will decrease initially and then increase.

Bond alone: pay 6% on $100m = 6m per year.

Add swap (receive 5% fixed, pay Libor + 1):

Net rate = 6% (bond) − 5% (received) + (Libor + 1%).

With Libor = 4% → 6 − 5 + (4 + 1) = 5% total.

Interest cost falls from 6% to 5% → 1% reduction.

Answer: B. Fall by 1%.