CIMA F3 Exam With Confidence Using Practice Dumps

Company B (all equity):

Cost of equity = asset return = Ku = 17%

Company A:

Gearing D:E = 1:2 → D/E = 0.5

Pre-tax cost of debt Kd = 7%

Tax rate T = 30%

Levered cost of equity with tax:

Ke=Ku+DE(1−T)(Ku−Kd)K_e = K_u + \frac{D}{E}(1 - T)(K_u - K_d)Ke​=Ku​+ED​(1−T)(Ku​−Kd​) Ke=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%K_e = 17\% + 0.5 \times 0.7 \times (17\% - 7\%) = 17\% + 0.5 \times 0.7 \times 10\% = 17\% + 3.5\% = 20.5\%Ke​=17%+0.5×0.7×(17%−7%)=17%+0.5×0.7×10%=17%+3.5%=20.5%

✅ Correct: A. 20.5%

B. Diversification into another product market will lower business risk

Diversifying into a different sector can reduce unsystematic (business-specific) risk, as cash flows from different industries may be less correlated.

C. Greater protection from transaction risk

Company A already has B$ exposures (manufacturing and a B$ loan). Acquiring Company B, which operates and earns in B$, can provide B$ inflows that help naturally hedge B$ outflows, reducing transaction risk.

D. Greater protection from translation risk

The acquisition adds net assets in B$, which can act as a balance sheet hedge against existing B$ liabilities (such as the B$ loan). On consolidation, this can reduce the volatility of reported equity due to exchange rate movements, i.e. translation risk.

Option A is weak: political risk in Country B is not reduced by owning more assets there. E is doubtful because Company B is in a different industrial sector, so classic production scale economies are unlikely to be a primary justification.