CIMA F3 Exam With Confidence Using Practice Dumps

When valuing an unlisted company using a P/E ratio from a similar listed company, we normally reduce the proxy P/E to reflect the extra risk and reduced attractiveness of the unlisted investment.

A. Relative lack of marketability – Unlisted shares are harder to sell and usually take longer to realise, so investors demand a higher return, i.e. a lower P/E. ✔

B. Lower level of scrutiny and regulation – Unlisted companies face less disclosure and governance requirements, so information risk is higher. Greater risk ⇒ lower valuation multiple ⇒ reduced P/E. ✔

C. Smaller and less established – Unlisted companies tend to be smaller, less diversified and less stable, so investors again expect a higher return, implying a lower P/E. ✔

D. Control premium not included – If the proxy P/E excludes a control premium but you are valuing a controlling stake, you would increase the P/E, not reduce it. ✘

E. Higher forecast earnings growth – Higher expected growth justifies a higher P/E, not a lower one. ✘

F. One-off profit item in latest earnings – This should be dealt with by adjusting the earnings, not by cutting the P/E multiple. ✘

So the three factors justifying a reduction in the proxy P/E are A, B and C.

Two percentage adjustments are to be made to the proxy P/E ratio:

20% reduction because Company K is unlisted (unlisted companies usually trade at a discount).

15% increase because Company K has better growth prospects than the proxy (higher growth → higher P/E).

In exam-style CIMA F3 questions, unless stated otherwise, these adjustments are usually treated additively:

Net adjustment = +15% − 20% = −5%, i.e. a 5% decrease in the proxy P/E ratio.

So the total adjustment is a 5% decrease.

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.