CIMA F3 Business valuation: practice questions with answers

Question 1

Morden plc has just paid a dividend of $0.42 per share. Dividends are expected to grow at 4% a year indefinitely, and shareholders require a return of 10% a year. Using the dividend valuation model, what is the theoretical ex-dividend value of one Morden plc share?

1. A $4.37
2. B $7.00
3. C $7.28
4. D $7.57

Show the answer

Answer: C. P0 = d0 x (1 + g) / (ke - g) = $0.42 x 1.04 / (0.10 - 0.04) = $0.4368 / 0.06 = $7.28

Question 2

The managers of a division of Harwell plc are planning a management buyout (MBO), backed by a private equity firm. Which of the following is a typical feature of the financing of an MBO?

1. A High gearing, including mezzanine debt, with an equity ratchet that increases management's stake if performance targets are met
2. B Finance raised mainly through an initial public offering of shares in the new company
3. C Low gearing, because lenders will not lend against the assets or cash flows of the business
4. D The private equity firm provides only debt and takes no equity stake in the new company

Show the answer

Answer: A. In a typical MBO the managers contribute a small amount of equity, a private equity firm provides most of the equity, and the rest is senior debt plus mezzanine finance (unsecured or second-ranking debt, often with warrants). An equity ratchet increases the managers' share of equity if performance targets are met. Investors plan an exit, such as a trade sale or IPO, within a few years.

Question 3

When valuing a target company, which statement best describes the use of the replacement cost of its net assets?

1. A It gives the minimum price the seller should accept, because it shows what the assets would raise if sold piecemeal
2. B It includes internally generated brands and goodwill, so it is the most complete measure of value
3. C It values the business by discounting its expected future cash flows at a risk-adjusted rate
4. D It estimates what the bidder would spend to set up an equivalent business itself, so it can indicate a maximum price, although it excludes goodwill

Show the answer

Answer: D. Asset-based valuations can use book value, realisable value (what the assets would raise on disposal, often a seller's minimum) or replacement cost (what it would cost to acquire equivalent assets, often a buyer's upper limit for the tangible business). Their weakness is that they ignore the value of the business as a going concern, including intangible assets such as brands, know-how and customer relationships.

Question 4

Analysts believe the stock market is semi-strong form efficient. When would you expect the share price of a target company to react to a takeover bid?

1. A Gradually over several weeks after the announcement, as analysts study the offer document
2. B Before any announcement, because prices already reflect all private information
3. C Only when the acquisition is completed and the consideration is paid
4. D When the bid is publicly announced, adjusting quickly to reflect the new information

Show the answer

Answer: D. Under the efficient market hypothesis: weak form prices reflect all past price information; semi-strong form prices reflect all publicly available information; strong form prices reflect all information, including private information. Most evidence supports semi-strong efficiency in major markets, so target share prices jump on announcement. Price rises before an announcement usually reflect leaks or speculation, which is why insider dealing is illegal.

Question 5

Denby Co, a fast-growing company with a short trading record, plans to join a stock market to raise $12 million. It is choosing between the exchange's main market and its growth market for smaller companies. Which statement best describes the growth market compared with the main market?

1. A It is unregulated, so the company will have no duty to publish financial information after admission
2. B Admission requirements are less demanding and costs are lower, but the shares are usually less liquid and attract fewer large institutional investors
3. C Its shares are usually more liquid, because more large institutional investors trade on growth markets
4. D It is open only to companies whose shares are already listed on the main market

Show the answer

Answer: B. Many exchanges run a second-tier or growth market (for example a junior or alternative investment market) for smaller, younger companies. Typical features: no or shorter minimum trading record, no or a lower minimum free float, a nominated adviser in place of a full sponsor, and lower admission and ongoing costs. Disadvantages are lower liquidity, a smaller investor base and often a lower valuation. Some companies later move up to the main market.

Question 6

Garsdale Co, a large private company, plans to obtain a stock market quotation through Hawes plc, a much smaller listed company. Hawes plc will buy all of Garsdale Co's shares and pay by issuing so many new shares that Garsdale Co's former owners will hold about 85% of the enlarged Hawes plc. What is this transaction called?

1. A A management buy-in
2. B A demerger
3. C A reverse takeover
4. D An introduction

Show the answer

Answer: C. In a reverse takeover a listed company acquires a (usually larger) unlisted company and pays with so many new shares that the unlisted company's owners end up controlling the enlarged listed group. It is a way for the private company to obtain a listing without a full IPO. Stock exchanges usually treat it like a new listing: the listed company's shareholders must approve the deal and the enlarged group must meet the admission requirements again.