Pass the CIMA Strategic F3 Questions and answers with Dumpstech

The pre-acquisition share prices are:

Company S: $5.00

Company T: $4.00

Shareholders in Company T want a 25% premium on the value of their shares, based on T’s current price:

Required value per T share=4.00×1.25=$5.00\text{Required value per T share} = 4.00 \times 1.25 = \$5.00Required value per T share=4.00×1.25=$5.00

Now value each offer using Company S’s pre-acquisition share price of $5:

A. 2 S shares for 1 T share

Value received = 2×5=$102 \times 5 = \$102×5=$10 → 150% premium (too high)

B. 1 S share for 1 T share

Value received = 1×5=$51 \times 5 = \$51×5=$5 →

Premium =5−44=25%= \frac{5 - 4}{4} = 25\%=45−4​=25% ✅

C. 1 S share for 2 T shares

That’s 0.5 S per T → 0.5×5=$2.500.5 \times 5 = \$2.500.5×5=$2.50 → actually a discount

D. 10 S shares for 4 T shares

That’s 2.5 S per T → 2.5×5=$12.502.5 \times 5 = \$12.502.5×5=$12.50 → huge premium (>200%)

Only offer B gives T’s shareholders exactly a 25% premium.

Correct answer: B – 1 share in Company S for 1 share in Company T.

A. The issue of bonds might limit the availability of debt finance in the future.

If the project is financed by a bond, gearing rises to 2:5, increasing financial risk and using up debt capacity. A rights issue instead reduces gearing to 1:5, preserving future borrowing capacity.

C. The rights issue will lead to less pressure on the operating cash flows of the programme.

Bond finance requires fixed interest payments (and eventual redemption), which must be met regardless of project cash flow variability. Equity raised via a rights issue has no mandatory interest and dividends are discretionary, so it places less strain on operating cash flows.

So the answer is:

Answer: A and C

Strategic reasons for a horizontal acquisition (same industry/level of value chain):

A Reduction of risk by building a larger portfolio – broader product / customer base in the same industry can reduce business risk → strategic.

C To achieve economies of scale – classic horizontal motive (sharing overheads, volume discounts, etc.).

E Reduction of competition – by acquiring a rival, the combined firm increases market power.

B is a financial motive (undervalued target), and D is a vertical integration motive.

Answer: A, C, E

Pre-acquisition standalone values:

ABB = $55m

BBA = $25m

Total pre-deal value = $80m.

After the acquisition, ABB (the combined business) is expected to generate post-tax cash flows of $10m per year in perpetuity. Cost of equity = 10%, and the firm is all-equity financed, so:

Post-acquisition value=100.10=$100m\text{Post-acquisition value} = \frac{10}{0.10} = \$100\text{m}Post-acquisition value=0.1010​=$100m

Synergy value = value of combined firm − sum of standalone values:

Synergy=100−80=$20m\text{Synergy} = 100 - 80 = \$20\text{m}Synergy=100−80=$20m

So the best estimate of the synergy from the acquisition is $20 million.

Working

Market value of equity E=6mE = 6mE=6m; debt D=4mD = 4mD=4m; so total V=10mV = 10mV=10m.

DV=410=0.4T=20%=0.20\frac{D}{V} = \frac{4}{10} = 0.4 \qquad T = 20\% = 0.20VD​=104​=0.4T=20%=0.20

Under Modigliani–Miller with tax, the relationship between ungeared cost of equity KuK_uKu​ and the after-tax WACC is:

WACC=Ku (1−TDV)\text{WACC} = K_u\,(1 - T \tfrac{D}{V})WACC=Ku​(1−TVD​)

So:

Ku=WACC1−TDV=11.04%1−0.20×0.4=11.04%0.92=12.00%K_u = \frac{\text{WACC}}{1 - T\frac{D}{V}} = \frac{11.04\%}{1 - 0.20 \times 0.4} = \frac{11.04\%}{0.92} = 12.00\%Ku​=1−TVD​WACC​=1−0.20×0.411.04%​=0.9211.04%​=12.00%

So the ungeared cost of equity is 12.00%.

Step 1 – Find TTT’s P/E ratio

Profit for the year (TTT) = $25m

Shares in issue = 100m → EPS = 25 / 100 = $0.25

Share price = $2.00

P/ETTT=2.000.25=8\text{P/E}_{TTT} = \frac{2.00}{0.25} = 8P/ETTT​=0.252.00​=8

Step 2 – Apply this P/E to YYY

Profit for the year (YYY) = $15m

Value of YYY’s equity = 15 × 8 = $120m

Shares in issue (YYY) = 200m

Price per YYY share=120200=$0.60\text{Price per YYY share} = \frac{120}{200} = \$0.60Price per YYY share=200120​=$0.60

✅ Answer: A. $0.60

All the options are debt with the same maturity, but convertible bonds include an equity conversion option for investors. Because of that option, the coupon rate at issue is usually lower than on straight bonds or bank loans. However, CIMA F3 emphasises that if the company’s share price is expected to rise significantly (as in this question, where the project should greatly improve the share price), holders are very likely to convert.

When conversion happens, the company settles the debt by issuing shares that, at that point, are worth much more than the original debt value. The effective total cost of finance (interest paid plus the value of equity given up) can end up higher than for ordinary bonds, leases, or bank loans over the full term.

Therefore, given the expectation of a strong future share price, the source of debt finance likely to be most expensive over the full term is:

C. Convertible bonds ✅