Financial Management Flashcards

Which of the following best describes 'financial risk' in the context of a firm's capital structure?

Answer: Additional risk borne by equity holders due to the use of debt financing

Financial risk is the additional variability in equity returns that arises because fixed interest obligations must be met before equity holders receive any return.

A project costs $500,000 and generates net cash inflows of $125,000 per year. What is the payback period?

Answer: 4 years

Payback period = Initial investment / Annual cash inflow = $500,000 / $125,000 = 4 years.

Which of the following working capital strategies is considered the MOST aggressive?

Answer: Financing permanent current assets with short-term debt

Financing permanent (non-seasonal) current assets with short-term debt is aggressive because it exposes the firm to rollover risk and interest rate fluctuations.

The Modigliani-Miller theorem, WITHOUT taxes, states that:

Answer: A firm's value is independent of its capital structure

In a perfect capital market with no taxes, M&M Proposition I holds that firm value is unaffected by how it is financed.

Which ratio directly measures how effectively a firm collects its receivables?

Answer: Receivables turnover ratio

Receivables turnover = Net credit sales / Average accounts receivable, showing how many times receivables are collected in a period.

If a company's degree of combined leverage (DCL) is 4, what does this mean?

Answer: A 1% increase in sales leads to a 4% increase in EPS

DCL = DOL × DFL, and it measures the percentage change in EPS for a 1% change in sales; a DCL of 4 means EPS rises 4% for every 1% sales increase.

Which of the following is an example of a 'spontaneous' source of financing?

Answer: Accounts payable

Accounts payable arise automatically (spontaneously) from normal business operations as goods and services are purchased on credit.