Business Finance Flashcards

The payback period method's main weakness is that it:

Answer: Ignores cash flows occurring after the payback period

Payback ignores all cash flows after the payback point and does not account for the time value of money, potentially favouring short-term projects at the expense of value-creating long-term investments.

Foreign exchange transaction risk arises from:

Answer: Changes in exchange rates on specific foreign currency transactions

Transaction risk is the risk that exchange rate movements between deal date and settlement date will affect the sterling value of a specific foreign currency transaction.

Which of the following is a use of funds (application of funds)?

Answer: Purchase of new machinery

A purchase of new machinery is an application (use) of funds — cash flows out. Sources of funds include new share issues, retained profit, loans; uses include asset purchases and debt repayment.

In a leveraged buyout (LBO), the acquisition is primarily financed by:

Answer: A large amount of debt secured against the target's assets

An LBO involves acquiring a company using a high proportion of debt (often secured on the target's assets and cash flows), with the intention of repaying debt from the acquired business's future cash flows.

A zero coupon bond is characterised by:

Answer: Paying no periodic interest; issued at a discount and redeemed at par

Zero coupon bonds pay no periodic coupon; they are issued at a deep discount to par value, and the return to the investor is the difference between purchase price and redemption value at maturity.

The Altman Z-score is used to:

Answer: Predict the probability of corporate financial distress or bankruptcy

Altman's Z-score combines several financial ratios into a single score to predict the likelihood of corporate bankruptcy; a score below a threshold indicates high distress risk.