Pass the CIMA CIMA Strategic F3 Questions and answers with CertsForce

Competition authorities focus primarily on market structure and competition, not on whether the bid is generous or on employment promises. Their concern is: Will this merger substantially lessen competition?

In food retailing, a key issue is local market concentration – for example, a single group owning too many supermarkets in particular towns or regions. A classic remedy is for the bidder to divest overlapping outlets so that effective competition remains.

B. Agreeing to dispose of specified outlets which overlap geographically directly addresses the competition authority’s main concern and is the standard structural remedy used in practice.

A (more cash) is irrelevant to competition issues.

C (job guarantees) is mainly a political/employment concern, not an antitrust one.

D (promise to pass on cost savings) is difficult to monitor and enforce and is normally viewed as less credible than structural remedies.

So the action most likely to persuade the competition authorities is B.

Zero NPV project → total shareholder wealth should be unchanged if rights are used or sold, not wasted.

A – Exercising all rights: shareholders put cash in, get extra shares; wealth unchanged.

C – Selling all rights: they don’t invest but receive the rights’ value in cash; wealth unchanged.

E – Part exercise, part sell: combination of A and C, still no loss of wealth.

Letting rights lapse (B or part-lapse in D) destroys value → those are not wealth-neutral.

A spin-off/demerger normally involves separating a division or subsidiary and giving its shares to the existing shareholders. It doesn’t in itself raise finance (A), it doesn’t introduce new shareholders to the core entity (B), and it does not inherently increase takeover risk (D). Its main advantage is that it allows the market to value the demerged business separately, revealing its “true” value – C is correct.

In CIMA F3, equity valuation using P/E multiples is based on earnings available to ordinary shareholders (i.e. profit after interest and tax). The syllabus emphasises that when valuing a potential takeover target, you should (1) derive maintainable post-tax earnings and then (2) apply a P/E multiple that reflects prices actually paid in comparable acquisitions, not just average stock-market multiples.

Calculate maintainable earnings:

Profit before interest and tax (PBIT) = $5m

Less interest on 10% bonds: 10% × $10m = $1m

Profit before tax = $4m

Tax at 20% = $0.8m

Earnings for equity = $3.2m

Select the appropriate P/E multiple:

F3 explains that “takeover P/Es” are usually higher than sector trading P/Es, reflecting the control premium. Here we have:

Overall market P/E = 20

Retail sector P/E = 10

Recent retail takeovers P/E = 13

For a takeover valuation we use the 13× multiple from recent sector takeovers.

Compute equity value:

Equity value=3.2m×13=41.6m\text{Equity value} = 3.2\text{m} \times 13 = 41.6\text{m}Equity value=3.2m×13=41.6m

Debt’s market value (90% of $10m) is not added here because the P/E method already gives the equity value.

So, a reasonable expected equity value in a takeover is $41.6 million.

Relevant cash flows:

Finance lease option

Lease payments: 2,200 (cost)

Tax relief on interest element of lease: (200)

Tax relief on accounting depreciation: (400)

Tax relief on full lease payment (550) is NOT relevant – tax law says relief is only on interest and depreciation.

Maintenance (100) is incurred under both options → irrelevant.

Net PV cost of leasing:

2,200−200−400=1,6002,200 - 200 - 400 = 1,6002,200−200−400=1,600

Bank loan (buy) option

Initial asset cost is financed by the bank loan, so the financing inflow and the purchase outflow cancel. We focus on ownership-related flows:

Salvage value at end: (20) (benefit)

Tax relief on tax depreciation allowances: (450)

Maintenance 100 again occurs under both options → irrelevant.

Net PV cost of buying:

2,000 (asset cost)−20−450=1,5302,000\ (\text{asset cost}) - 20 - 450 = 1,5302,000 (asset cost)−20−450=1,530

(Effectively the trainee’s PVs imply a net cost of 1,530 for bank loan/own, versus 1,600 for lease.)

Difference in cost:

1,600−1,530=701,600 - 1,530 = 701,600−1,530=70

So the bank loan is $70,000 less expensive than the finance lease → Option C.

Debt becomes more attractive when:

Corporate tax increases → larger tax shield on interest.

Bond yields decrease → lower pre-tax cost of debt.

So the combination that makes a bond issue more attractive is higher tax and lower yields.

The mechanics of the DVM calculation are fine:

D1=500,000×1.08=540,000D_1 = 500,000 × 1.08 = 540,000D1​=500,000×1.08=540,000

Required return = 15% + 3% = 18%

Value = D1/(ke−g)=540,000/(0.18−0.08)D_1 / (k_e − g) = 540,000 / (0.18 − 0.08)D1​/(ke​−g)=540,000/(0.18−0.08).

The conceptual problem is assuming dividends can grow at 8% indefinitely when earnings only grow at 6%; over time dividends cannot consistently grow faster than earnings.

Delta: 12% fixed or rf + 3% floating

Kappa: 15% fixed or rf + 4% floating

Delta’s advantage:

Fixed: 3% better (15 − 12)

Floating: 1% better (rf+4 − (rf+3))

Comparative advantage is in fixed; total potential gain from a swap = 3% − 1% = 2%, shared equally → 1% saving each.

So:

Delta (wants floating): (rf + 3%) − 1% = rf + 2%

Kappa (wants fixed): 15% − 1% = 14%

So D: Delta pays rf + 2%, Kappa pays 14%.