ACCA Financial Management and Investment 2 — Questions and Answers
Question 1: A company has a debt-to-equity ratio of 0.6, an equity beta of 1.4, and a tax rate of 25%. What is the asset (ungeared) beta?
- 0.95
- 1.05 (Correct answer)
- 0.88
- 1.12
Correct answer: 1.05
Asset beta = equity beta / [1 + (D/E)(1-T)] = 1.4 / [1 + 0.6 × 0.75] = 1.4 / 1.45 ≈ 1.05.
Question 2: Which technique adjusts a project's discount rate upward to account for political and country risk when appraising overseas investments?
- Adjusted Present Value (APV)
- Risk-adjusted discount rate (Correct answer)
- Certainty equivalent approach
- Monte Carlo simulation
Correct answer: Risk-adjusted discount rate
The risk-adjusted discount rate method adds a country risk premium to the base cost of capital to reflect additional sovereign and political risk.
Question 3: A bond with a face value of $1,000 pays a 6% annual coupon and matures in 5 years. If the required yield is 8%, what is its approximate market price?
- $920.15 (Correct answer)
- $1,000.00
- $1,082.00
- $960.07
Correct answer: $920.15
The bond trades at a discount because the coupon rate (6%) is below the required yield (8%), giving a price of approximately $920.
Question 4: Under CAPM, which type of risk is rewarded with higher expected returns?
- Total risk
- Unsystematic risk
- Specific risk
- Systematic (market) risk (Correct answer)
Correct answer: Systematic (market) risk
Only systematic risk, measured by beta, is rewarded under CAPM because unsystematic risk can be diversified away in a portfolio.
Question 5: A firm's shares trade at $50, expected dividend next year is $2.50, and dividends grow at 4% per year. What is the cost of equity using the Gordon Growth Model?
- 4%
- 5%
- 9% (Correct answer)
- 10%
Correct answer: 9%
Cost of equity = D1/P0 + g = $2.50/$50 + 0.04 = 0.05 + 0.04 = 9%.
Question 6: Which of the following best describes the Adjusted Present Value (APV) method?
- It discounts all cash flows at the WACC
- It separates base-case NPV from financing side effects (Correct answer)
- It uses a single risk-adjusted rate for all projects
- It replaces the IRR with a modified rate
Correct answer: It separates base-case NPV from financing side effects
APV = base-case NPV (as if all-equity) plus the NPV of financing side effects such as the tax shield on debt.
Question 7: A project has an initial investment of $500,000 and generates annual after-tax cash flows of $120,000 for 6 years. What is the payback period?
- 3.5 years
- 4.0 years
- 4.2 years (Correct answer)
- 5.0 years
Correct answer: 4.2 years
Payback = $500,000 / $120,000 = 4.17 years, approximately 4.2 years.
ACCA Financial Management and Investment 2
A company has a debt-to-equity ratio of 0.6, an equity beta of 1.4, and a tax rate of 25%.
What is the asset (ungeared) beta?