CIMA F3 Exam With Confidence Using Practice Dumps

We want methods that give the value of equity, not the value of the whole entity.

A. D₁ / (kₑ – g) → Gordon growth dividend model = value of equity (share value). ✅

B. Total earnings × P/E → market capitalisation = equity value. ✅

C. Free cash flows to all investors discounted at WACC → enterprise / firm value (equity + debt). ❌

D. Free cash flows to equity discounted at cost of equity → equity value. ✅

E. NCA + CA − CL → value of net assets before deducting long-term debt, i.e. value of the business to all capital providers, not just equity. ❌

So correct choices: A, B, D.

If the company switches from a residual dividend policy to a stable, growing dividend and increases its use of debt:

A. This does signal to the market that the company may be entering a more stable, mature growth phase – True.

B. A more stable dividend stream can attract a different type of investor (clientele effect) – True.

C. Directors still need to consider shareholder preferences; this statement is incorrect – False.

D. Retained earnings have an opportunity cost equal to the cost of equity and are generally not cheaper than debt – False.

E. More debt increases financial gearing and therefore financial risk – True.

Answer (200273):

Under traditional (pre–Modigliani & Miller) capital structure theory, there is an assumed inverse relationship between WACC and company value. The idea is:

As a firm moves towards its optimal capital structure, the WACC falls, and the total value of the firm (equity + debt) rises.

Beyond that optimal point, extra gearing increases financial risk, so the required return from both debt and equity goes up, causing WACC to rise and firm value to fall.

So, within this framework, if a company’s WACC increases, that means it has moved away from its optimal capital structure, and the value of the company will decrease.

Therefore, under traditional theory, an increase in WACC → decrease in company value, so the correct answer is B.