ACA Business Finance 4

Question 1

Which valuation method is most appropriate for valuing a going concern with stable, predictable cash flows?

Accepted Answer

Discounted cash flow (DCF) method

Answer

DCF valuation is most appropriate for going concerns as it explicitly considers the present value of future cash flows, capturing the timing and risk of cash generation over the entity's life.

Question 2

Interest rate risk can be hedged using:

Accepted Answer

Interest rate swaps

Answer

Interest rate swaps allow a company to exchange floating rate interest payments for fixed rate payments (or vice versa), effectively hedging the risk of interest rate movements.

Question 3

A convertible bond is attractive to investors because:

Accepted Answer

It gives the option to convert to equity, participating in upside

Answer

Convertible bonds offer downside protection (coupon payments) with upside potential (conversion to equity if the share price rises above the conversion price), making them attractive to investors.

Question 4

Which of the following would increase a company's operating leverage?

Accepted Answer

Increasing the proportion of fixed costs in the cost structure

Answer

Operating leverage increases when fixed costs form a higher proportion of total costs. Higher fixed costs mean that once they are covered, incremental revenue flows strongly to profit — but losses are amplified in downturns.

Question 5

Which of the following is consistent with a company having a high dividend payout ratio?

Accepted Answer

Mature, stable business with limited reinvestment needs

Answer

Mature businesses with stable cash flows and few high-return investment opportunities tend to return surplus cash to shareholders through high dividend payouts.

ACA ICAEW Practice Test

ACA ICAEW Practice Test

ACA Business Finance 4