F3 Exam Dumps : Financial Strategy

In CIMA F3’s coverage of short-term financing, commercial paper (CP) is identified as a very cost-effective funding source for large, high-credit-quality companies. CP is an unsecured, short-term promissory note, typically issued for periods up to 270 days, making it ideal for a 6-month funding need. Because it is issued directly into the money markets by strong credits, the interest cost is usually lower than overdrafts or short-term bank loans, which include a bank’s margin.

The scenario states that the company is large, listed, has an “excellent credit rating”, minimal default risk and already has a commercial paper programme. This matches the textbook profile of a company for which CP is the cheapest source of short-term borrowing.

Treasury bills (C) are issued by governments, not companies, so they are an investment vehicle, not a borrowing method here. Bank overdrafts (A) are flexible but generally expensive and better for fluctuating day-to-day needs. A 6-month term loan (B) tends to involve higher arrangement fees and interest margins than CP. Therefore, option D is the most cost-effective choice.

Current values (before project):

Equity = 1,100

Debt = 500

Firm value = 1,600

Project cost = 200; NPV = +10.

After the project:

Financed by rights issue (equity only)

Equity = 1,310 → increase of 210

But shareholders have to inject 200 cash themselves.

Net gain in shareholder wealth = 210 − 200 = 10

Financed by bond issue (all debt)

Equity = 1,150 → increase of 50

No new equity cash is put in by shareholders.

Net gain in shareholder wealth = 50

This equals: project NPV (10) + tax shield on extra debt (0.20 × 200 = 40).

Financed by mix of debt & equity at existing D/E

Equity = 1,260 → increase of 160

New equity raised ≈ 137 (since extra debt is 63, total 200).

Net gain = 160 − 137 = 23 (NPV 10 + extra tax shield ≈ 13).

The company’s objective is maximisation of shareholder wealth, so it should choose the financing that gives the highest net increase, which is the bond issue (all debt) with a gain of $50m to equity holders.

This is exactly what Modigliani & Miller with corporate tax predicts: increasing gearing creates value for shareholders via the interest tax shield.

Answer: B. $50 million if financed by debt