In CIMA F3, the valuation of a target in an acquisition using P/E multiples is based on the principle that the maximum price a bidder should pay is the value of the target to the bidder, i.e. the value of the target’s earnings when capitalised at the bidder’s P/E ratio if post-acquisition performance is expected to match the bidder’s. When tax is involved, the profits used must be after tax earnings, because the P/E ratio is defined as:

P/E=Market Value of EquityEarnings after tax\text{P/E} = \frac{\text{Market Value of Equity}}{\text{Earnings after tax}}P/E=Earnings after taxMarket Value of Equity​

Step 1 – Convert pre-tax profit to earnings

Company F’s pre-tax profit = $300m.

Corporate tax rate = 30%.

EarningsF=300×(1−0.30)=300×0.70=$210m\text{Earnings}_F = 300 \times (1 - 0.30) = 300 \times 0.70 = \$210\text{m}EarningsF​=300×(1−0.30)=300×0.70=$210m

Step 2 – Apply Company E’s P/E ratio (bootstrapping effect)

Because both firms have similar risk and E believes it can “bootstrap” F’s earnings so that the market values F on E’s P/E of 15:

Value of F to E=EarningsF×P/EE=210×15=$3,150m\text{Value of F to E} = \text{Earnings}_F \times \text{P/E}_E = 210 \times 15 = \$3,150\text{m}Value of F to E=EarningsF​×P/EE​=210×15=$3,150m

This represents the combined value of F’s earnings once integrated into E and re-rated at the higher multiple. Under F3 principles, this figure is the maximum price E should be willing to pay; paying more would destroy value for E’s shareholders because the purchase price would exceed the value created by the acquisition.

Therefore, the maximum offer price to F’s shareholders is:

$3,150 million\boxed{\$3,150\ \text{million}}$3,150 million​

A company has a 5.25% fixed-rate loan and wants to swap it to variable using a swap quoted:

4.50% – 4.55% in exchange for Libor

(Libor currently 4%)

To turn its fixed loan into a synthetic floating-rate loan, the company needs to:

Receive fixed (to offset part of the 5.25% it pays on the loan), and

Pay Libor (to end up with variable cost).

From the swap quote, if the company wants to receive fixed, it gets the lower rate: 4.50% (the bank’s bid rate).

Cash flows:

Pay 5.25% fixed on the loan

Receive 4.50% fixed on the swap

Pay Libor (4.00%) on the swap

Net cost:

5.25%−4.50%+4.00%=0.75%+4.00%=4.75%5.25\% - 4.50\% + 4.00\% = 0.75\% + 4.00\% = 4.75\%5.25%−4.50%+4.00%=0.75%+4.00%=4.75%

✅ Answer to Q28: B. 4.75%

Company X is an established, unquoted, specialist IT advisory firm with steady results, predictable dividends and cashflows. Company P is only buying 30% (a minority stake).

B. Dividend based using DVM – Very suitable because dividends are predictable and regular. For a minority stake, dividends are often the main measurable return, so a dividend valuation model is appropriate.

C. Cash based using free cash flow before interest – A DCF valuation based on free cash flow to the firm is also appropriate for a profitable, growing, going concern. You can value the whole business using FCFF and then take 30% of the equity value.

Asset-based (A) is less relevant for a specialist service company with relatively few tangible assets. P/E-based methods (D and E) are less ideal given there are few direct competitors, making comparables unreliable.

According to Modigliani and Miller with tax, the value of a levered firm is:

VL=VU+Tc×DV_L = V_U + T_c \times DVL​=VU​+Tc​×D

where TcT_cTc​ is the corporate tax rate and DDD is the market value of debt. With corporate income tax, interest is tax-deductible, so increasing debt creates a tax shield and increases total firm value.

Initially:

Debt = 40

Equity = 60

Total value = 100

Tax rate = 20%.

If the company increases debt and uses the proceeds to buy back shares until debt equals equity, then:

New structure: D=ED = ED=E

Total firm value rises because Tc×DT_c \times DTc​×D increases.

The extra value (PV of the additional tax shield) accrues to shareholders, even though the accounting market value of equity after the buyback may fall in absolute terms; shareholders have also received cash from the buyback, so their total wealth increases.

Business risk (and therefore asset beta) is unchanged; however equity beta would rise, not fall, because of higher financial leverage. Therefore the only correct statement is that the plan would increase shareholder wealth – answer C.

Current revenue = $300m at $2.00/kWh → units = 300/2 = 150m kWh

New price cap = $1.50; demand rises 10% → units = 150m × 1.10 = 165m kWh

New revenue = 165m × $1.50 = $247.5m

Costs remain $200m → new profit = 247.5 − 200 = $47.5m profit

✅ Answer: A. $47.5 million profit

The parent wants to sell a loss-making subsidiary, with two options:

Trade sale to an external buyer

Management Buyout (MBO) – where the subsidiary’s existing management team buys it.

Both offer the same price, so we compare non-price factors.

With an MBO:

The existing management are the buyers. So instead of fearing job losses or big changes, they benefit directly.

That makes them supportive, not hostile.

Therefore, the parent company is more likely to avoid a hostile reaction from key management – this is a clear advantage of choosing an MBO over a trade sale.

Why not the others?

A. Raise the cash more quickly – MBOs often need complex financing (private equity, bank debt), which can actually slow things down versus a straightforward trade sale.

C. Focus on core competencies – that’s a benefit of divesting in general, not specific to MBO vs trade sale.

D. Retain the knowledge of key management – in an MBO, management usually leave with the business, so the parent loses their knowledge, not retains it.

A scrip (or bonus) issue capitalises reserves: an amount is transferred from retained earnings to share capital.

Effects:

Retained earnings decrease (transfer out).

Share capital increases by the same amount.

Total equity (book value of equity) is unchanged (it’s just a reclassification).

Number of shares increases, so with unchanged earnings, EPS decreases.

That matches exactly the effects listed, so the transaction is a scrip dividend.

Interest on debt is treated as a tax-deductible expense, so it is deducted in arriving at profit before tax:

A – incorrect: security over assets doesn’t affect tax relief on interest.

B – incorrect: preference dividends are not tax-deductible.

C – incorrect: if it were deducted from post-tax profits there would be no tax relief.

D – correct: interest is deducted from pre-tax profits.

Negatives for the bank:

A. Advanced, custom-made tech equipment – poor resale value and high obsolescence risk, weak security.

C. Premises on a long-term lease and not fully fitted out – limited asset security; further capital outlay still needed.

E. Essential ongoing R & D – continuing cash demands and uncertainty of returns.

Positives, so not negatives:

B. Continuing profitability and net cash generation – good for servicing debt.

D. Founders’ personal investment – shows commitment and loss-sharing; strengthens equity base.

Residual dividend policy → dividends are not a good reflection of underlying performance → rules out A.

Highly cyclical earnings and capital structure not matched by listed peers make simple P/E comparison (D) unreliable.

Net asset value (C) rarely captures earnings potential for a going concern.

A discounted cash flow approach using free cash flows and a cost of equity derived from a proxy company (adjusted for gearing) is most appropriate.

Answer: B: Discounted cash flow analysis at WACC based on free cash flow to equity.

(Conceptually: FCFE discounted at cost of equity.)