CIMA Updated F3 Exam Questions and Answers by eisa

Workings:

Z$ profit after tax = 10m

Tax rate in Z = 20%

Pre-tax profit in Z:

101−0.20=100.8=12.5m\frac{10}{1 - 0.20} = \frac{10}{0.8} = 12.5\text{m}1−0.2010​=0.810​=12.5m

Home country Y taxes at 50%, with full double tax relief → overall tax rate becomes 50% on pre-tax profits:

Net profit after all tax in Z$:

12.5×(1−0.50)=6.25m12.5 \times (1 - 0.50) = 6.25\text{m}12.5×(1−0.50)=6.25m

Exchange rate: Y$1 = Z$5 → convert:

6.255=1.25m\frac{6.25}{5} = 1.25\text{m}56.25​=1.25m

So expected profit in Y$ = 1.25m → A.

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.

G has effectively created an interest rate collar:

Buys a cap at 10% (protects against high rates).

Sells a floor at 8.5% (gives up benefit if rates fall too low, to reduce cost).

So:

A – True: G sacrifices gains from falling rates to help fund the cap.

B – True: the structure keeps G’s effective borrowing rate between 8.5% and 10%.

C – True: the main concern is rates rising above 10%, hence the cap.

D and E misinterpret the direction of the concern.

Workings (Modigliani & Miller with tax):

Current (unlevered) cost of capital ku=9%k_u = 9\%ku​=9%

Cost of debt kd=3%k_d = 3\%kd​=3%

Tax rate T=25%T = 25\%T=25%

Target D/E=1/2=0.5D/E = 1/2 = 0.5D/E=1/2=0.5

Formula with tax:

ke=ku+(ku−kd)(1−T)DEk_e = k_u + (k_u - k_d)(1-T)\frac{D}{E}ke​=ku​+(ku​−kd​)(1−T)ED​ ke=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%k_e = 9\% + (9\% - 3\%) \times 0.75 \times 0.5 = 9\% + 6\% \times 0.375 = 9\% + 2.25\% = 11.25\% \approx 11.3\%ke​=9%+(9%−3%)×0.75×0.5=9%+6%×0.375=9%+2.25%=11.25%≈11.3%

So the nearest option is 11.3% (C).