Pass the CIMA Strategic F3 Questions and answers with Dumpstech

In an MBO structure, senior bank debt has first claim on cash flows. Failure to pay interest on this debt can trigger default, covenants being breached, and potentially insolvency or loss of control.

Director bonuses (B) and dividends to the VC (C) are discretionary and can usually be postponed.

Inability to invest in new projects (D) is harmful for growth but less immediately threatening than defaulting on senior debt.

So the most critical cash use that must be covered is interest on bank debt.

A residual dividend policy pays dividends only after all positive-NPV projects are funded – typical for firms whose investors want growth rather than income.

C is a small listed company whose investors seek maximum capital growth → classic residual policy case.

Answer: C. Entity C

A scrip issue (bonus issue) is just slicing the same “pie” into more pieces – no new value is created.

Issue: 1 new share for every 4 existing → after the issue, each holder who had 4 shares will now have 5.

Total value before = 4 shares × $20 = $80.

After the issue, that $80 is spread over 5 shares:

Price after=805=$16\text{Price after} = \frac{80}{5} = \$16Price after=580​=$16

So the best estimate of the ex-scrip share price is $16.00.

Increase initially then decrease

This question tests understanding of the traditional theory of capital structure, a core topic within CIMA F3 under Cost of Capital and Capital Structure. The traditional view differs from Modigliani and Miller by arguing that there is an optimal capital structure where a company’s Weighted Average Cost of Capital (WACC) is minimised.

According to traditional theory, at low levels of gearing, introducing debt into the capital structure reduces WACC. This occurs because debt is generally cheaper than equity, largely due to lower risk for lenders and the tax deductibility of interest payments. Initially, equity holders do not perceive a significant increase in financial risk, so the cost of equity remains relatively stable. As a result, replacing some equity with cheaper debt lowers the overall WACC.

However, as gearing continues to rise beyond a certain point, the financial risk borne by both debt holders and equity holders increases substantially. Lenders demand higher interest rates to compensate for increased default risk, and shareholders require a higher return due to greater earnings volatility. This leads to rising costs of both debt and equity. Beyond the optimal gearing level, these rising costs outweigh the benefits of cheaper debt, causing WACC to increase.

CIMA F3 study guidance therefore concludes that under traditional theory, WACC:

Falls initially as gearing increases, and

Rises after the optimal capital structure is exceeded.

Since the directors are increasing gearing toward an industry average, the most appropriate description of WACC behaviour under traditional theory is that it will decrease initially and then increase.

Under IAS 39, a derivative such as a forward contract must always be measured at fair value in the statement of financial position. When that derivative is designated as a cash flow hedge of a highly probable forecast transaction and hedge accounting criteria are met, the effective portion of the gain or loss on the hedging instrument is recognised in Other Comprehensive Income (OCI), not in profit or loss.

Here, by 31 December 20X3 the forward contract (entered at nil cost) has a positive fair value of $10,000, so there is a gain of $10,000. Because the hedge has been correctly designated as a cash flow hedge, that gain is treated as part of the cash flow hedge reserve in equity via OCI. It will be recycled to profit or loss in a later period when the hedged transaction affects profit or loss (e.g. when the forecast foreign currency transaction occurs).

So for the year ended 31 December 20X3, the correct treatment is to recognise a $10,000 gain in OCI – answer D.

 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.

They need cash within 6 months and Divisions A and B are core. Options:

A. Sale of Division B – sells a core division; strategically undesirable.

B. Closure of a division – doesn’t raise cash, likely costs cash (redundancies, closure costs).

C. Management buy-out of Division C – disposes of a non-core asset, raises cash, and there is known management interest. ✅

D. Demerger of Division C – typically does not raise cash; it just separates ownership.

So the most suitable exit strategy is C.