ACCA SP Advanced Financial Management 2

Question 1

A company wishes to acquire a target firm. Which of the following valuation approaches uses the present value of future free cash flows?

Accepted Answer

Discounted cash flow (DCF) valuation

Answer

DCF valuation estimates the intrinsic value of a firm by discounting projected free cash flows to equity (or free cash flows to firm) at the appropriate cost of capital (WACC or Ke).

Question 2

Which of the following best describes an 'interest rate swap'?

Accepted Answer

An agreement between two parties to exchange interest payments (fixed for floating) on a notional principal

Answer

An interest rate swap is a derivative where two parties exchange interest payment streams — typically one party pays a fixed rate and the other pays a floating rate (e.g., SONIA) on the same notional principal.

Question 3

The 'weighted average cost of capital' (WACC) should be used as the discount rate when:

Accepted Answer

The project maintains the company's existing capital structure and business risk

Answer

WACC is appropriate as a discount rate when the proposed project is of similar risk to the company's existing activities and does not change the capital structure materially.

Question 4

Under pecking order theory, firms prefer to finance new investments using:

Accepted Answer

Retained earnings first, then debt, then new equity

Answer

Pecking order theory (Myers & Majluf) argues firms prefer internal financing first (retained earnings), then debt, and finally new equity as a last resort, to minimise information asymmetry costs.

Question 5

A 'credit default swap' (CDS) is best described as:

Accepted Answer

A derivative providing insurance against a borrower defaulting on a debt

Answer

A CDS is a derivative contract where the protection buyer pays a premium and the protection seller compensates the buyer if a specified credit event (e.g., default) occurs on the reference entity.

ACCA Strategic Professional Practice Test

ACCA Strategic Professional Practice Test

ACCA SP Advanced Financial Management 2