C214 Financial Management Practice Questions - Set 3 - Part 1

Correct Answer: To distribute cash to shareholders or reinvest in the company

Free cash flow (FCF) represents the cash that remains after funding capital expenditures and can be distributed to shareholders or reinvested in the business.

Correct Answer: Accounts payable

Spontaneous accounts, such as accounts payable, automatically vary with sales and are directly related to daily business operations.

Correct Answer: To meet additional funding needs beyond internal growth

Discretionary funding is needed when a company’s growth exceeds what it can finance internally, requiring additional external funding.

Correct Answer: A bond that is not backed by specific assets

Unsecured bonds are not backed by specific collateral, making them riskier compared to secured bonds, which are backed by assets.

Correct Answer: To lock in a fixed exchange rate and eliminate risk

Hedging foreign exchange risk ensures predictable cash flows by locking in an exchange rate, thus reducing the risk of fluctuating currency values.

Correct Answer: Interest payments are tax-deductible

Issuing bonds allows companies to take advantage of tax-deductible interest payments, lowering the overall cost of capital compared to issuing equity.

Correct Answer: The combined effect of operating and financial leverage on profits

Degree of combined leverage (DCL) reflects the total impact of both operating and financial leverage on a firm’s profitability.

Correct Answer: The bond will sell at a premium

If the coupon rate is higher than the market interest rate, the bond will sell at a premium because it offers a higher return than the market.

Correct Answer: It indicates higher risk and higher returns

A higher beta value in the CAPM indicates that the stock is more volatile and riskier compared to the overall market, leading to potentially higher returns.

Correct Answer: Risk that can be eliminated through diversification

Idiosyncratic risk is specific to a single company or industry and can be reduced or eliminated by diversifying investments across multiple assets.

Correct Answer: The time it takes to convert sales into cash

The cash cycle measures the time from the purchase of inventory to the collection of cash from sales, indicating how quickly a company can generate cash from its operations.

Correct Answer: The value of future cash flows discounted to today’s value

Present value (PV) is the current worth of future cash flows, discounted at a specific rate to account for the time value of money.

Correct Answer: It decreases CFO

An increase in accounts receivable means that sales have been made but cash has not yet been received, reducing the company’s cash flow from operations.

Correct Answer: The principle that money gains value over time through interest or dividends

The time value of money reflects the idea that money today can grow over time through investments, interest, or dividends, making it more valuable than the same amount in the future.

Correct Answer: Risk-free rate and market risk premium

CAPM includes the risk-free rate, market risk premium, and beta to calculate the expected return on a stock.

Correct Answer: Par value

The par value is the bond’s face value, which is typically the amount that will be repaid to the bondholder at maturity.

Correct Answer: The company will generate excess cash

If projected sales growth is less than the sustainable growth rate, the company generates excess cash because internal resources are sufficient to support the growth.

Correct Answer: Balance sheet

The balance sheet shows a company’s financial position at a specific point in time, detailing its assets, liabilities, and shareholders' equity.

Correct Answer: They move in opposite directions

Bond prices and market interest rates have an inverse relationship—when market interest rates rise, bond prices fall, and vice versa.

Correct Answer: Cross-sectional analysis

Cross-sectional analysis involves comparing a firm’s financial ratios with those of competitors or industry averages to evaluate relative performance.