F3 Exam Dumps - Financial Strategy

Two percentage adjustments are to be made to the proxy P/E ratio:

20% reduction because Company K is unlisted (unlisted companies usually trade at a discount).

15% increase because Company K has better growth prospects than the proxy (higher growth → higher P/E).

In exam-style CIMA F3 questions, unless stated otherwise, these adjustments are usually treated additively:

Net adjustment = +15% − 20% = −5%, i.e. a 5% decrease in the proxy P/E ratio.

So the total adjustment is a 5% decrease.

Key convertible bond points:

Investors accept a lower coupon on convertibles because they get the equity conversion option.

If converted, no new cash comes in: debt simply becomes equity.

On conversion, debt falls and equity rises, so gearing falls, not rises.

So:

A – False (convertible debt is usually cheaper, not more expensive).

B – False (no extra cash on conversion).

C – True (coupon is usually lower on convertibles).

D – False (conversion lowers gearing).

Answer Q73: C

Equity: 400m shares at $3 → $1,200m

Existing debt: $800m

New debt raised: $200m

Project NPV: $100m

Step 1 – Initial firm value:

= 1,200 + 800 = $2,000m

Step 2 – After raising $200m debt and investing in project:

Debt becomes = 800 + 200 = $1,000m

Firm value increases by NPV of 100 → new firm value = 2,000 + 100 = $2,100m

Wait – careful: raising debt also adds cash before investment, then project adds NPV:

After raising debt: 2,000 + 200 = 2,200

After investing in project with NPV 100: +100 → 2,300m total firm value

So final:

Firm value = 2,300m

Debt = 1,000m

Equity (by MV) = 2,300 – 1,000 = 1,300m

Step 3 – Gearing ratio (market value):

Gearing = Debt / (Debt + Equity)

= 1,000 / (1,000 + 1,300)

= 1,000 / 2,300 ≈ 43.48%

To avoid an immediate breach, the bank’s maximum gearing must be at least above 43.48%.

The lowest option that does this is 44%.

PBIT = $500,000

Existing interest = 5% × 300,000 = $15,000

Profit before tax = 500,000 − 15,000 = $485,000

Tax (30%) = 0.30 × 485,000 = $145,500

Earnings = 485,000 − 145,500 = $339,500

Shares = 250,000 ⇒ EPS = 339,500 / 250,000 ≈ $1.36

Share price = $8 ⇒ P/E ≈ 8 / 1.36 ≈ 5.9

Interest cover = PBIT / Interest = 500,000 / 15,000 ≈ 33.3 times

After the new debt and project:

New PBIT = 500,000 + 24,000 = $524,000

New interest = 15,000 + (3% × 200,000) = 15,000 + 6,000 = $21,000

Profit before tax = 524,000 − 21,000 = $503,000

Tax (30%) = 0.30 × 503,000 = $150,900

Earnings = 503,000 − 150,900 = $352,100

EPS = 352,100 / 250,000 ≈ $1.41

New share price = $8.50

New P/E ≈ 8.50 / 1.41 ≈ 6.0 (higher than before)

New interest cover = 524,000 / 21,000 ≈ 25.0 times (lower than before).

So:

Interest cover falls

P/E ratio rises

Correct option: B.

 A listing usually improves access to finance; it doesn’t make it harder to borrow.

 A stock exchange listing can enhance reputation, transparency and access to capital, which can improve the company’s credit rating, lowering the perceived risk to suppliers and lenders → B is correct.

 C may sometimes happen but isn’t a standard, expected consequence in the way B is.

 D is wrong – owners do not have to sell a majority or leave the board when listing.

 C – More cash = able to react quickly to unexpected investment opportunities.

 D – Cash buffer reduces the likelihood of liquidity problems in a downturn.

 E – If excess cash were returned, markets might read it as “no good growth opportunities”, so retaining avoids that negative signal.

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.