F3 Exam Dumps - Financial Strategy

ï‚· Covenants are mainly there to protect the lender (B),

ï‚· to impose financial discipline on the borrower (C), and

ï‚· if breached, they usually give the lender rights to call in the loan or renegotiate (D).

They are not designed simply to penalise the company (A) or eliminate tax (E).

Discursive_F0

When valuing lease finance you discount actual cash flows only.

The cash outflow is the lease payment itself.

Because the tax regime follows the accounting treatment, the lessee gets tax relief on:

the implied interest component of the lease, and

the depreciation (straight-line) charged on the leased asset.

These tax reliefs are cash inflows (reduced tax paid) and must also be included in the discounted cash-flow calculation. Interest and depreciation themselves are not cash flows; only their associated tax shields are.

Company A’s equity value at the launch date (end of 20X1) is the PV of a growing perpetuity of FCFE:

First FCFE (end of first year of operation, 20X2): $2m

Growth: 8%

Cost of equity: 12%

Value of Company A at end-20X1:

V=20.12−0.08=20.04=50 millionV = \frac{2}{0.12 - 0.08} = \frac{2}{0.04} = 50 \text{ million}V=0.12−0.082​=0.042​=50 million

Company V owns 40%:

Value of stake at sale=0.4×50=20 million\text{Value of stake at sale} = 0.4 \times 50 = 20 \text{ million}Value of stake at sale=0.4×50=20 million

It invests $15m at 1 Jan 20X0 and gets $20m at end-20X1 (≈ 2 years):

15(1+r)2=20⇒(1+r)2=2015=4315(1 + r)^2 = 20 \Rightarrow (1 + r)^2 = \frac{20}{15} = \frac{4}{3}15(1+r)2=20⇒(1+r)2=1520​=34​ 1+r=43≈1.1547⇒r≈15.47%1 + r = \sqrt{\frac{4}{3}} \approx 1.1547 \Rightarrow r \approx 15.47\%1+r=34​​≈1.1547⇒r≈15.47%

Nearest whole % = 16%

Answer: C. 16%

EBIT = 5

Interest @5% on 10m = 0.5 → PBT = 4.5

Tax 20% = 0.9 → Earnings = 3.6

EPS = 3.6 / 10m = 0.36

Price = 3.60 → P/E = 10

Next year:

Interest @6% = 0.6 → PBT = 4.4

Tax 20% = 0.88 → Earnings = 3.52

EPS = 3.52 / 10m = 0.352

Expected P/E = 9.5 → price = 0.352 × 9.5 = 3.344 (≈ 3.34).

Drop = 3.60 − 3.34 = 0.26 → % drop = 0.26 / 3.60 ≈ 7.2%.

Answer: A. Reduction of 7%

In a semi-strong form efficient market, share prices instantly adjust to all publicly available information. When the positive-NPV project is announced, its NPV is immediately reflected in the company’s value.

Answer Q35: B. Increase by the NPV of the project once the information has been announced

 Interest cover = PBIT / Interest = 20 / 5 = 4 times ≥ 3 ⇒ covenant met.

 Next year dividend per share = 0.04 × 1.10 = 0.044.

Total dividend = 0.044 × 200m = 8.8m.

Retained earnings = Earnings – Dividends = 12 – 8.8 = 3.2m < 3.5m ⇒ retained-earnings covenant breached only.

F Co is private, owned 60% by founder, 20% each by two children.

Needs a large amount of long-term finance within 3 months.

IPO rejected because it would take up to 12 months.

Venture Capitalist (VC) offers finance (debt + equity) but wants:

60% of equity

25% annual return

A board seat

Veto over all expenditure over a certain level.

Question: From the family’s perspective, which are advantages of using the VC?

Option-by-option

A. The cost of the finance – DISADVANTAGE

A required return of 25% and taking 60% of the equity is expensive; the family is giving up control and paying a high expected return. That’s not an advantage.

B. Changes in shareholding – DISADVANTAGE

Post-investment, the VC would own 60%, the family only 40% collectively. They lose control. That’s clearly a downside for them.

C. Veto on expenditure – DISADVANTAGE (for the family)

A VC veto on capital and revenue spend restricts management/family autonomy. While it may improve governance, it’s not an “advantage from the family’s perspective”.

D. Speed with which finance can be obtained – ADVANTAGE ✅

VC money can typically be arranged much faster than an IPO, which is crucial because the company needs funds within 3 months. This is explicitly given as a reason IPO is not suitable.

E. Experience of the Venture Capitalist with growing businesses – ADVANTAGE ✅

VCs often bring expertise, contacts, and strategic guidance in scaling businesses. From the family’s point of view, this support can increase the chances of successful expansion.

So the genuine advantages to the family are:

D (speed) and

E (experience).