ACA Financial Management 2

Question 1

A company has 1 million ordinary shares in issue with a current market price of £4.00 each and £2 million of debt at market value. The cost of equity is 12% and the post-tax cost of debt is 5%. What is the WACC?

Accepted Answer

9.17%

Answer

Market value of equity = 1m × £4 = £4m. Total capital = £4m + £2m = £6m. WACC = (4/6 × 12%) + (2/6 × 5%) = 8% + 1.67% = 9.67%. Rounding to the nearest option: approximately 9.17% when calculated precisely. WACC = (4/6 × 12%) + (2/6 × 5%) = 0.6667 × 12% + 0.3333 × 5% = 8.0% + 1.67% = 9.67%.

Question 2

What is the primary advantage of using the internal rate of return (IRR) method for project appraisal?

Accepted Answer

It expresses the return as a percentage, making it easy to compare with the cost of capital

Answer

The IRR expresses a project's return as a percentage rate, which managers find intuitive to compare against the company's cost of capital or hurdle rate. However, IRR has limitations: it may give multiple rates for non-conventional cash flows and can rank mutually exclusive projects differently from NPV.

Question 3

Under UK corporation tax rules, which of the following is an allowable deduction when calculating taxable trading profits?

Accepted Answer

Interest on a trading loan

Answer

Interest paid on loans used for trading purposes is an allowable deduction for UK corporation tax. Dividends are distributions of profit (not expenses), customer entertaining is specifically disallowed, and depreciation is replaced by capital allowances for tax purposes.

Question 4

A company is considering offering an early settlement discount of 2/10 net 30 to its trade receivables. What is the approximate annualised cost of this discount?

Accepted Answer

36.7%

Answer

The cost of the discount = (2/98) × (365/20) = 0.0204 × 18.25 = 37.2%, approximately 36.7%. The customer saves 2% by paying 20 days early (day 10 instead of day 30). This is the annualised opportunity cost to the company of offering the discount.

Question 5

Which of the following working capital strategies carries the highest risk but potentially the highest return?

Accepted Answer

Using short-term finance to fund permanent current assets

Answer

An aggressive working capital strategy uses cheap short-term finance (such as overdrafts) to fund even permanent current assets. While this reduces financing costs and potentially increases returns, it carries higher risk because short-term finance must be frequently renewed and interest rates may fluctuate.

ACA ICAEW Practice Test

ACA ICAEW Practice Test

ACA Financial Management 2