Pass the CIMA CIMA Strategic F3 Questions and answers with CertsForce

Correct answer: C – Net asset based valuation using replacement cost best suits a capital-intensive company with reliable tangible asset values and highly uncertain future earnings/cash flows.

Explanation (concise):

To value the equity of BNM appropriately, HJK can use:

D. Share price × number of shares in issue

This is simply the market capitalisation, i.e. the current market value of equity.

A. Cash flows of $24 million discounted at the cost of equity

Discounting cash flows available to equity holders (free cash flow to equity) at the cost of equity is a standard equity valuation approach under CIMA F3.

E. Cash flows of $30 million (= $40 million net of tax at 25%) discounted at WACC minus the value of debt

Here, $30m is effectively FCFF = EBIT × (1 – T). Discounting FCFF at WACC gives the value of the firm; subtracting the value of debt then gives the equity value.

Option B double counts retained profits (already reflected in the share price), and option C is based on the wrong cash flow definition for equity valuation.

C – Correct: only valuing three years of forecast cash flows ignores the continuing value of the business, so the valuation is understated.

D – Correct: based on typical CIMA F3 treatment, the forecast FX path should reflect expected weakening of the foreign currency (often due to higher inflation), but the assistant’s rates instead imply a strengthening B$, so the FX forecasts are inconsistent.

E – Correct: the assistant has effectively valued the business (entity value) by discounting cash flows to all providers of finance. To arrive at equity value, the B$5m of debt should be deducted.

A is incorrect because multiplying by an exchange rate quoted as AS per B$ is the right approach. B is incorrect because cash flows to all investors are appropriately discounted at WACC, not at the cost of equity.

Before announcement:

Equity = 4m shares × $4.0 = $16m

Debt = $7m

Gearing = 7 / 16 = 43.75% → already above 40%.

After additional $2m debt and higher share price:

Debt = 7 + 2 = $9m

Equity = 4m × $4.2 = $16.8m

Gearing = 9 / 16.8 ≈ 53.6% → even further above the 40% ceiling.

So the gearing objective is exceeded both before and after, and gearing rises.

The question asks for advantages to the acquiring company (ADC/ABC) of using shares rather than cash to pay for DEF.

C. It incentivises DEF to continue creating value for the combined group

If DEF’s shareholders (and possibly managers) receive shares in ADC, they now own part of the combined business. That aligns their interests with ADC’s existing shareholders and encourages them to help grow the value of the group.

E. The risk of poor future performance of the acquisition is shared with the DEF company shareholder.

If ADC pays with shares, DEF’s shareholders share in both the upside and downside. If the acquisition underperforms, the fall in value is shared instead of all the risk resting on ADC’s original shareholders. That’s an advantage for ADC.

F. It preserves liquidity

Paying with shares means ADC does not need to use up cash or raise new debt. This preserves cash balances and borrowing capacity, which is a clear advantage.

Why not the others?

A (sharing benefits of future growth with DEF shareholders) is actually a cost from ADC’s existing shareholders’ viewpoint – they give away more of the upside.

B dilution of ownership is also a disadvantage, not an advantage.

D a tax saving for ABC – the tax impact is usually more relevant for sellers or when using debt, not typically a direct advantage of share consideration to the acquirer.

Venture capitalists typically exit by:

Flotation/IPO (B)

Trade sale to another company (C)

Sale back to the original owners/management (D)

Liquidation (A) is a failure scenario, not a planned exit, and raising long-term debt (E) is not an exit at all.

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.

Cash flows:

Years 1–3: 100, 100, 100

From year 4: grow at 2% forever. Cost of capital = 12%.

PV of years 1–3:

PV1−3=1001.12+1001.122+1001.123≈240\text{PV}_{1-3} = \frac{100}{1.12} + \frac{100}{1.12^2} + \frac{100}{1.12^3} \approx 240PV1−3​=1.12100​+1.122100​+1.123100​≈240

Terminal value at end of year 3:

Year 4 CF = 100×1.02=102100 \times 1.02 = 102100×1.02=102

TV3=1020.12−0.02=1020.10=1,020\text{TV}_3 = \frac{102}{0.12 - 0.02} = \frac{102}{0.10} = 1{,}020TV3​=0.12−0.02102​=0.10102​=1,020

PV of terminal value:

PV(TV)=1,0201.123≈726\text{PV(TV)} = \frac{1{,}020}{1.12^3} \approx 726PV(TV)=1.1231,020​≈726

Total value ≈ 240+726=966240 + 726 = 966240+726=966.

So the value is $966 million → Option A.