MEM Financial Management for Engineers 2 — Questions and Answers
Question 1: What is the primary purpose of a pro forma financial statement?
- To record historical transactions accurately
- To project future financial performance (Correct answer)
- To comply with SEC reporting requirements
- To calculate current tax obligations
Correct answer: To project future financial performance
Pro forma financial statements are forward-looking projections used for planning, fundraising, or evaluating the financial impact of decisions.
Question 2: Which capital structure theory suggests that an optimal debt-equity mix minimizes WACC and maximizes firm value?
- Modigliani-Miller theorem (no taxes)
- Trade-off theory (Correct answer)
- Pecking order theory
- Market timing theory
Correct answer: Trade-off theory
The trade-off theory holds that firms balance the tax benefits of debt against the costs of financial distress to find an optimal capital structure.
Question 3: An engineering manager evaluates two projects with identical NPVs. Project A has a 2-year payback; Project B has a 5-year payback. Which is generally preferred?
- Project B, because longer payback indicates more revenue
- Project A, because shorter payback reduces risk and improves liquidity (Correct answer)
- Neither, because NPV is the only relevant metric
- Project B, because more time allows for better returns
Correct answer: Project A, because shorter payback reduces risk and improves liquidity
Shorter payback periods reduce exposure to uncertainty and improve cash flow availability, making Project A preferable when NPVs are equal.
Question 4: What does a positive EVA (Economic Value Added) indicate?
- The company has positive net income
- The company is creating shareholder value above its cost of capital (Correct answer)
- The company has more assets than liabilities
- The company's stock price is rising
Correct answer: The company is creating shareholder value above its cost of capital
Positive EVA means a firm earns returns exceeding its cost of capital, indicating true economic profit and value creation for shareholders.
Question 5: In financial analysis, what does 'sensitivity analysis' examine?
- How employee morale affects financial results
- How changes in key assumptions affect project outcomes (Correct answer)
- The sensitivity of customers to price changes only
- How regulatory changes impact audit results
Correct answer: How changes in key assumptions affect project outcomes
Sensitivity analysis tests how much a project's NPV or other metrics change when individual input variables (like sales volume or cost) are varied.
Question 6: Which depreciation method results in higher depreciation expense in early years of an asset's life?
- Straight-line depreciation
- Double declining balance depreciation (Correct answer)
- Units of production depreciation
- Sum-of-years digits (both B and D)
Correct answer: Double declining balance depreciation
The double declining balance method applies twice the straight-line rate to the declining book value, front-loading depreciation expense.
MEM Financial Management for Engineers 2
What is the primary purpose of a pro forma financial statement?