ACCA - Association of Chartered Certified Accountants Financial Management and Investment Questions and Answers — Questions and Answers
Question 1: A company has an inventory holding period of 45 days, a receivables collection period of 60 days, and a payables payment period of 30 days. What is the length of the company's cash operating cycle?
- 135 days
- 105 days
- 75 days (Correct answer)
- 15 days
Correct answer: 75 days
The cash operating cycle measures the time between paying for raw materials and receiving cash from customers. The formula is: Inventory Days + Receivables Days - Payables Days. In this case, it is 45 + 60 - 30 = 75 days.
Question 2: When evaluating mutually exclusive projects, which of the following statements best describes a key advantage of using the Net Present Value (NPV) method over the Internal Rate of Return (IRR) method?
- NPV is a percentage measure, making it easier to compare projects of different sizes.
- NPV directly measures the absolute increase in shareholder wealth. (Correct answer)
- IRR always provides a single, unambiguous decision rule, unlike NPV.
- NPV is easier to calculate as it does not require the company's cost of capital.
Correct answer: NPV directly measures the absolute increase in shareholder wealth.
The primary objective of financial management is to maximize shareholder wealth. NPV calculates the absolute monetary gain from a project in today's terms, directly aligning with this goal. IRR is a relative (percentage) measure and can sometimes give conflicting rankings with NPV for mutually exclusive projects, especially those of different scales or with unconventional cash flows.
Question 3: A company announces a 1-for-4 rights issue at a subscription price of $2.50 per share. The current market price of the company's shares is $3.10. What is the theoretical ex-rights price per share?
- $2.65
- $2.80
- $3.00
- $2.98 (Correct answer)
Correct answer: $2.98
The theoretical ex-rights price (TERP) is the weighted average price of the shares after the rights issue. To calculate it: consider a holding of 4 existing shares. The value of 4 existing shares = 4 * $3.10 = $12.40. The cost of 1 new share = 1 * $2.50 = $2.50. The total value of the 5 shares after the issue is $12.40 + $2.50 = $14.90. The theoretical price per share is $14.90 / 5 = $2.98.
Question 4: Which of the following is a critical underlying assumption when using a company's existing Weighted Average Cost of Capital (WACC) to evaluate a new investment project?
- The business risk of the new project is similar to the company's existing operations. (Correct answer)
- The project will be financed entirely by new equity.
- The project is expected to have a higher Internal Rate of Return (IRR) than existing projects.
- The company's tax rate is expected to decrease as a result of the new project.
Correct answer: The business risk of the new project is similar to the company's existing operations.
Using the existing WACC as a discount rate is only appropriate if the new project does not alter the company's overall risk profile. This means the project should have similar business risk to the company's current activities and be financed in a way that maintains the current capital structure. If a project is significantly riskier or less risky, a project-specific discount rate should be used.
Question 5: A private company has reported post-tax earnings of $5 million. A comparable publicly listed company has a P/E ratio of 12. Analysts suggest that a 20% discount should be applied to the P/E ratio to reflect the lower marketability and higher risk of the private company's shares. Using the P/E ratio method, what is the estimated value of the private company?
- $60 million
- $12 million
- $48 million (Correct answer)
- $50 million
Correct answer: $48 million
First, the P/E ratio of the comparable company must be adjusted for the private company discount. The adjusted P/E ratio is 12 * (1 - 0.20) = 9.6. Then, this adjusted ratio is applied to the private company's earnings to find its value: Valuation = Earnings * Adjusted P/E = $5 million * 9.6 = $48 million.
Question 6: A UK company has recently made a large sale to a customer in the United States, with payment of $1.5 million due in 90 days. The company is concerned that the GBP/USD exchange rate may move unfavourably before the payment is received. What type of foreign exchange risk is the company primarily exposed to?
- Transaction risk (Correct answer)
- Translation risk
- Economic risk
- Liquidity risk
Correct answer: Transaction risk
Transaction risk is the risk that exchange rate fluctuations will change the value of future cash flows from existing contractual obligations. In this case, the company has a specific, contracted receivable in a foreign currency, and its value in the home currency (GBP) is uncertain. Translation risk relates to converting foreign subsidiary financial statements, and economic risk relates to long-term effects on a company's competitive position and market value.
ACCA - Association of Chartered Certified Accountants Financial Management and Investment Questions and Answers
A company has an inventory holding period of 45 days, a receivables collection period of 60 days, and a payables payment period of 30 days.
What is the length of the company's cash operating cycle?