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.

For a company valued using the free cash flow to equity with constant growth, the standard Gordon growth formula is:

Value of equity=FCF1ke−g\text{Value of equity} = \frac{\text{FCF}_1}{k_e - g}Value of equity=ke​−gFCF1​​

Where:

FCF₁ = free cash flow in one year’s time

kek_eke​ = cost of equity

ggg = constant growth rate

Here:

FCF₁ = $100,000

ke=10%=0.10k_e = 10\% = 0.10ke​=10%=0.10

g=5%=0.05g = 5\% = 0.05g=5%=0.05

Correct valuation:

Value=100,0000.10−0.05=100,0000.05=$2,000,000\text{Value} = \frac{100{,}000}{0.10 - 0.05} = \frac{100{,}000}{0.05} = \$2{,}000{,}000Value=0.10−0.05100,000​=0.05100,000​=$2,000,000

The analyst instead did:

100,000×(1+0.05)/0.10=105,000/0.10=$1,050,000100{,}000 \times (1 + 0.05) / 0.10 = 105{,}000 / 0.10 = \$1{,}050{,}000100,000×(1+0.05)/0.10=105,000/0.10=$1,050,000

So the true value is $2,000,000 and the analyst’s value is $1,050,000.

Undervaluation=2,000,000−1,050,000=$950,000\text{Undervaluation} = 2{,}000{,}000 - 1{,}050{,}000 = \$950{,}000Undervaluation=2,000,000−1,050,000=$950,000

So the company has been undervalued by $950,000 → Option A.

Regulations likely to hurt ZZZ most:

A. Minimum staff-to-client ratio – raises operating costs, particularly for a large operator.

B. Maximum price controls – directly restrict ZZZ’s ability to charge premium prices.

C. Monopoly controls forcing disposals – may force ZZZ to sell homes and shrink.

D is a one-off hit, and E is less of a threat to a high-quality provider.