ACCA Advanced Financial Management 1 â Questions and Answers
Question 1: A company invests $500,000 in a project generating annual cash flows of $120,000 for 6 years. Using a cost of capital of 10% and an annuity factor of 4.355, what is the approximate NPV?
- $22,600 (Correct answer)
- $72,600
- -$22,600
- $220,000
Correct answer: $22,600
NPV = $120,000 Ă 4.355 â $500,000 = $522,600 â $500,000 = $22,600, indicating the project adds value.
Question 2: Which statement best describes the Modified Internal Rate of Return (MIRR)?
- The rate that sets NPV to zero assuming reinvestment at the IRR
- The rate equating the terminal value of cash flows reinvested at the cost of capital to the initial investment (Correct answer)
- The arithmetic mean of annual project returns
- The IRR adjusted for the effects of inflation
Correct answer: The rate equating the terminal value of cash flows reinvested at the cost of capital to the initial investment
MIRR assumes cash inflows are reinvested at the cost of capital rather than the IRR, providing a more realistic measure of return.
Question 3: The Adjusted Present Value (APV) method of project appraisal differs from NPV because it:
- Discounts all cash flows at the WACC to incorporate financing effects
- Separates the base-case NPV (all-equity financed) from the present value of financing side-effects (Correct answer)
- Uses the equity beta to discount operating cash flows
- Ignores the interest tax shield when evaluating projects
Correct answer: Separates the base-case NPV (all-equity financed) from the present value of financing side-effects
APV splits the valuation into a base-case NPV (as if unlevered) plus the PV of financing benefits such as the tax shield on debt.
Question 4: When using CAPM to derive a project-specific discount rate using a proxy company's beta, which procedure is correct?
- Apply the proxy's geared equity beta directly to the new project
- Ungear the proxy company's equity beta, then regear it using the investing company's capital structure (Correct answer)
- Use the risk-free rate as the project discount rate to be conservative
- Average the proxy company's beta with the investing company's beta
Correct answer: Ungear the proxy company's equity beta, then regear it using the investing company's capital structure
The proxy's equity beta reflects its own gearing, so it must be ungeared to isolate business risk, then regeared to the investing firm's gearing before use in CAPM.
Question 5: A firm has asset beta (ungeared) of 0.80, a debt-to-equity ratio of 1:1 by market values, and a tax rate of 25%. What is the equity beta?
- 0.80
- 1.40 (Correct answer)
- 1.60
- 1.20
Correct answer: 1.40
Using the gearing formula: ÎČe = ÎČa Ă (Ve + Vd(1ât)) / Ve = 0.80 Ă (1 + 0.75) / 1 = 1.40.
Question 6: In real options analysis, a 'growth option' is best described as:
- The right to abandon a project if performance deteriorates
- The right to expand operations if early results prove favorable (Correct answer)
- The right to defer an investment decision to gather more information
- The right to switch inputs or outputs in response to price changes
Correct answer: The right to expand operations if early results prove favorable
A growth option gives management the flexibility to invest further and scale up operations if an initial project succeeds, creating additional value beyond the base NPV.
Question 7: Which of the following is the most significant limitation of the payback period as an investment appraisal technique?
- It is computationally complex and difficult to apply
- It ignores the time value of money and disregards cash flows occurring after the payback date (Correct answer)
- It requires detailed forecasts of future inflation rates
- It cannot distinguish between mutually exclusive projects of equal cost
Correct answer: It ignores the time value of money and disregards cash flows occurring after the payback date
The payback period ignores both the timing of cash flows (no discounting) and all cash flows beyond the payback point, meaning profitable long-term projects can be rejected.
ACCA Advanced Financial Management 1
A company invests $500,000 in a project generating annual cash flows of $120,000 for 6 years.
Using a cost of capital of 10% and an annuity factor of 4.355, what is the approximate NPV?