ACA Business Finance 1

Question 1

The weighted average cost of capital (WACC) is used in capital budgeting to:

Accepted Answer

Discount future cash flows when the project has the same risk as the company

Answer

WACC represents the average cost of all financing sources, weighted by their market value proportions. It is appropriate as a discount rate when the project mirrors the company's existing risk profile.

Question 2

Which of the following is a feature of debt finance compared to equity finance?

Accepted Answer

Interest is tax-deductible

Answer

Interest payments on debt are tax-deductible, creating a tax shield that reduces the effective cost of debt. Dividends on equity are not tax-deductible.

Question 3

The internal rate of return (IRR) of a project is the discount rate at which:

Accepted Answer

Net present value equals zero

Answer

IRR is the discount rate that makes the NPV of a project's cash flows equal to zero. A project is acceptable if its IRR exceeds the cost of capital.

Question 4

Which capital structure theory suggests that an optimal capital structure exists that maximises firm value by balancing tax benefits of debt against financial distress costs?

Accepted Answer

Trade-off theory

Answer

Trade-off theory posits that firms balance the tax shield benefits of debt against the costs of financial distress; the optimal capital structure occurs where marginal benefit equals marginal cost.

Question 5

A rights issue involves:

Accepted Answer

Offering existing shareholders the right to buy new shares at a discount

Answer

A rights issue offers existing shareholders the right (but not obligation) to purchase additional shares at a discounted price, typically in proportion to their existing holdings.

ACA ICAEW Practice Test

ACA ICAEW Practice Test

ACA Business Finance 1