ACCA AS Financial Management — Questions and Answers
Question 1: Net present value (NPV) is calculated as:
- The sum of undiscounted future cash flows minus initial investment
- The sum of present values of future cash flows minus the initial investment (Correct answer)
- Annual profit divided by initial investment
- The payback period expressed in present value terms
Correct answer: The sum of present values of future cash flows minus the initial investment
NPV = Sum of discounted future cash inflows − Initial investment. A positive NPV indicates the investment earns more than the cost of capital, adding value to the firm.
Question 2: The internal rate of return (IRR) is:
- The discount rate that maximises NPV
- The discount rate at which NPV equals zero (Correct answer)
- The average accounting return over the project's life
- The required rate of return set by the company
Correct answer: The discount rate at which NPV equals zero
IRR is the discount rate that makes the NPV of a project exactly zero. If IRR > cost of capital, the project is acceptable; if IRR < cost of capital, reject.
Question 3: Which of the following is a limitation of the payback period as an investment appraisal method?
- It is too complex to calculate
- It ignores cash flows arising after the payback period (Correct answer)
- It requires a cost of capital to be specified
- It is not suitable for comparing projects of different sizes
Correct answer: It ignores cash flows arising after the payback period
Payback ignores all cash flows occurring after the payback period is reached, meaning it can favour short-term projects over more profitable long-term ones.
Question 4: The weighted average cost of capital (WACC) represents:
- The return required by equity shareholders only
- The average after-tax cost of all long-term financing, weighted by market values (Correct answer)
- The cost of new debt only
- The risk-free rate plus a market risk premium
Correct answer: The average after-tax cost of all long-term financing, weighted by market values
WACC is the blended cost of all sources of capital (equity and debt), each weighted by its proportion of total capital at market value. It is used as the discount rate for investment appraisal.
Question 5: Working capital management involves balancing:
- Long-term debt and equity
- The levels of current assets and current liabilities to maintain liquidity and profitability (Correct answer)
- Capital expenditure and revenue expenditure
- Dividend policy and retained earnings
Correct answer: The levels of current assets and current liabilities to maintain liquidity and profitability
Working capital management aims to optimise current assets (inventory, receivables, cash) and current liabilities (payables, overdraft) to maintain sufficient liquidity while maximising profitability.
Question 6: The operating cycle (cash conversion cycle) measures:
- The time from paying for raw materials to collecting cash from customers (Correct answer)
- The number of days it takes to repay long-term debt
- The duration of a capital expenditure project
- The time taken to complete one production run
Correct answer: The time from paying for raw materials to collecting cash from customers
The cash conversion cycle = inventory days + receivable days − payable days. It measures the net time a business's cash is tied up in working capital.
ACCA AS Financial Management
Net present value (NPV) is calculated as: