ACA Financial Management — Questions and Answers
Question 1: A UK company is evaluating a project with an initial investment of £100,000 and expected net cash flows of £30,000 per year for 5 years. If the cost of capital is 10%, what is the approximate net present value (NPV)?
- £13,724 (Correct answer)
- £50,000
- £30,000
- −£13,724
Correct answer: £13,724
NPV = PV of cash inflows − Initial investment. Using the annuity factor for 5 years at 10% (3.7908): PV = £30,000 × 3.7908 = £113,724. NPV = £113,724 − £100,000 = £13,724. A positive NPV indicates the project adds value.
Question 2: Which of the following sources of finance would typically have the lowest cost to a UK company?
- Ordinary share capital
- Preference shares
- Secured bank loan (Correct answer)
- Unsecured overdraft
Correct answer: Secured bank loan
A secured bank loan typically has the lowest cost because the lender's risk is reduced by the security (collateral), and interest payments are tax-deductible in the UK (reducing the effective cost). Equity is more expensive because shareholders bear the highest risk and require a higher return.
Question 3: What does the weighted average cost of capital (WACC) represent?
- The cost of the company's most expensive source of finance
- The average return required by all of the company's investors, weighted by market value (Correct answer)
- The interest rate on the company's bank loan
- The dividend yield on ordinary shares
Correct answer: The average return required by all of the company's investors, weighted by market value
WACC is calculated by weighting the cost of each source of finance (equity, debt, preference shares) by its proportion in the company's capital structure at market values. It represents the minimum return a project must generate to satisfy all providers of capital.
Question 4: Under the UK Corporate Governance Code, what is the primary role of the audit committee?
- Setting executive remuneration
- Overseeing the integrity of financial reporting and the effectiveness of internal and external audit (Correct answer)
- Appointing the CEO
- Managing day-to-day operations
Correct answer: Overseeing the integrity of financial reporting and the effectiveness of internal and external audit
The UK Corporate Governance Code requires listed companies to establish an audit committee responsible for monitoring the integrity of financial statements, reviewing internal controls, overseeing the relationship with the external auditor, and reviewing the effectiveness of internal audit.
Question 5: A company has earnings before interest and tax (EBIT) of £200,000 and interest charges of £50,000. What is the interest cover ratio?
- 4 times (Correct answer)
- 2.5 times
- 3 times
- 5 times
Correct answer: 4 times
Interest cover = EBIT ÷ Interest charges = £200,000 ÷ £50,000 = 4 times. This ratio measures how many times over the company can cover its interest payments from operating profits. A higher ratio indicates lower financial risk.
Question 6: Which of the following best describes the payback period method of investment appraisal?
- The time taken for cumulative net cash flows to equal the initial investment (Correct answer)
- The total profit generated by the investment over its life
- The internal rate of return on the investment
- The discounted value of all future cash flows
Correct answer: The time taken for cumulative net cash flows to equal the initial investment
The payback period measures how long it takes for the cumulative cash inflows from a project to repay the original investment. While simple to calculate and understand, it ignores the time value of money (unless discounted payback is used) and cash flows after the payback point.
ACA Financial Management
A UK company is evaluating a project with an initial investment of £100,000 and expected net cash flows of £30,000 per year for 5 years.
If the cost of capital is 10%, what is the approximate net present value (NPV)?