CIMA F3 Exam With Confidence Using Practice Dumps

Let’s walk it through carefully.

1. Current earnings and EPS

EBIT = 5m

Current interest (5% × 10m) = 0.5m

Profit before tax = 5.0 − 0.5 = 4.5m

Tax (20%) = 0.9m

Earnings = 4.5 − 0.9 = 3.6m

Shares = 10m → EPS₀ = 3.6 / 10 = 0.36

Current share price = 3.60 → current P/E = 3.60 / 0.36 = 10 (matches the question context).

2. Earnings next year with higher interest

New interest rate = 6% → interest = 10m × 6% = 0.6m

Profit before tax = 5.0 − 0.6 = 4.4m

Tax (20%) = 0.88m

Earnings = 4.4 − 0.88 = 3.52m

EPS₁ = 3.52 / 10m = 0.352

3. New share price using new P/E

Expected P/E next year = 9.5

Price1=EPS1×P/E1=0.352×9.5=3.344\text{Price}_1 = \text{EPS}_1 \times \text{P/E}_1 = 0.352 \times 9.5 = 3.344Price1​=EPS1​×P/E1​=0.352×9.5=3.344

4. Percentage reduction in share price

Current price = 3.60

New price ≈ 3.344

Drop = 3.60 − 3.344 = 0.256

% reduction=0.2563.60≈7.1%≈7%\%\ \text{reduction} = \frac{0.256}{3.60} \approx 7.1\% \approx 7\%% reduction=3.600.256​≈7.1%≈7%

So the closest option is A. Reduction of 7%.

This question examines loan covenant compliance, a topic covered in CIMA F3 under Debt Finance, Financial Risk, and Dividend Policy. Loan covenants are contractual restrictions imposed by lenders to protect their interests. Breaching a covenant can trigger penalties or loan repayment demands, so directors must assess compliance carefully using projected financial information.

The company has two covenants:

Interest cover must not fall below 4 times

Retained earnings for the year must not fall below $5.00 million

Step 1: Interest Cover Covenant

CIMA F3 defines interest cover as:

From the projections:

EBIT = $25.00 million

Interest = $3.20 million

Since 7.8 > 4, the company meets the interest cover covenant.

Step 2: Retained Earnings Covenant

Earnings after tax are projected at $15.26 million.

The most recent dividend per share is $0.10, and dividends are planned to increase by 8%:

With 100 million shares in issue:

Retained earnings for the year:

Since $4.46 million < $5.00 million, the company breaches the retained earnings covenant.

Conclusion (CIMA F3 Interpretation)

Interest cover covenant: Complied with

Retained earnings covenant: Breached

Under CIMA F3 guidance, directors must recognise that even when profitability appears strong, dividend policy can cause covenant breaches if distributions are excessive.