ACA Business Finance 3

Question 1

The pecking order theory of capital structure suggests companies prefer:

Accepted Answer

Retained earnings first, then debt, then equity as a last resort

Answer

Pecking order theory (Myers & Majluf) suggests firms prefer internal financing (retained earnings), then external debt, and finally new equity, due to asymmetric information and signalling effects.

Question 2

A company with a quick ratio of less than 1 indicates:

Accepted Answer

Its current liquid assets cannot cover current liabilities

Answer

A quick ratio below 1 means liquid current assets (excluding inventory) are less than current liabilities, suggesting potential short-term liquidity pressure.

Question 3

Duration in bond analysis measures:

Accepted Answer

The weighted average time to receive cash flows, reflecting price sensitivity to interest rate changes

Answer

Duration measures the weighted average time to receive a bond's cash flows and also approximates the percentage price change for a given change in interest rates (interest rate sensitivity).

Question 4

Which of the following is a non-cash item that is added back to profit when calculating operating cash flow?

Accepted Answer

Depreciation

Answer

Depreciation is a non-cash charge that reduces profit but does not involve a cash outflow; it is therefore added back to profit when calculating operating cash flows under the indirect method.

Question 5

Enterprise value (EV) is typically calculated as:

Accepted Answer

Market capitalisation plus net debt (debt minus cash)

Answer

Enterprise value represents the total value of the business to all capital providers: EV = market capitalisation + total debt − cash and cash equivalents.

ACA ICAEW Practice Test

ACA ICAEW Practice Test

ACA Business Finance 3