BEC Financial Management and Capital Budgeting 2 — Questions and Answers
Question 1: Which of the following best describes a capital lease (finance lease)?
- A lease that transfers substantially all risks and rewards of ownership to the lessee (Correct answer)
- A short-term rental agreement with no balance sheet impact
- An operating expense treated as rent
- A lease cancelable at any time by either party
Correct answer: A lease that transfers substantially all risks and rewards of ownership to the lessee
A finance lease (capital lease) transfers substantially all the risks and rewards of ownership to the lessee, requiring capitalization on the balance sheet as an asset and liability.
Question 2: The optimal capital structure for a firm minimizes its:
- Weighted average cost of capital (WACC) (Correct answer)
- Total revenue
- Gross profit margin
- Accounts payable turnover
Correct answer: Weighted average cost of capital (WACC)
The optimal capital structure is the debt-to-equity mix that minimizes the firm's WACC, thereby maximizing the value of the firm and shareholder wealth.
Question 3: A company's current ratio is 1.8 and its quick ratio is 0.9. This difference most likely indicates:
- The company holds a significant amount of inventory (Correct answer)
- The company has excessive cash balances
- The company has very little long-term debt
- The company's accounts receivable are uncollectible
Correct answer: The company holds a significant amount of inventory
The gap between the current ratio and quick ratio arises because the quick ratio excludes inventory; a large difference signals that inventory is a major component of current assets.
Question 4: Which capital budgeting technique explicitly accounts for the time value of money?
- Net Present Value (NPV) (Correct answer)
- Payback period
- Accounting rate of return
- Break-even analysis
Correct answer: Net Present Value (NPV)
NPV discounts all future cash flows to their present value using the cost of capital, making it the technique that most rigorously incorporates the time value of money.
Question 5: A dividend payout ratio measures:
- The percentage of earnings paid to shareholders as dividends (Correct answer)
- The total dollar amount of dividends declared
- The growth rate of dividends over time
- The yield on the company's preferred stock
Correct answer: The percentage of earnings paid to shareholders as dividends
The dividend payout ratio is calculated as dividends per share divided by earnings per share, expressing the fraction of net income distributed to shareholders.
Question 6: Free cash flow (FCF) is best described as:
- Operating cash flow minus capital expenditures (Correct answer)
- Net income plus all non-cash charges
- EBITDA minus interest expense
- Revenue minus cost of goods sold
Correct answer: Operating cash flow minus capital expenditures
FCF represents the cash generated by operations after funding capital expenditures needed to maintain or grow the asset base, available to service debt and equity holders.
BEC Financial Management and Capital Budgeting 2
Which of the following best describes a capital lease (finance lease)?