ACCA Financial Management and Investment 5

Question 1

A company evaluates a lease-versus-buy decision. Which discount rate should be used to discount the after-tax lease payments?

Accepted Answer

The after-tax cost of borrowing

Answer

Lease payments are similar to debt obligations, so the after-tax cost of borrowing is the appropriate rate to discount them in a lease vs. buy analysis.

Question 2

Transaction exposure in foreign exchange management refers to:

Accepted Answer

The risk arising from existing contractual obligations in foreign currency

Answer

Transaction exposure arises from already-committed foreign currency transactions such as receivables, payables, and loan repayments.

Question 3

Which capital budgeting method is most appropriate when comparing projects with unequal useful lives?

Accepted Answer

Equivalent Annual Annuity (EAA) or Equivalent Annual Cost (EAC)

Answer

EAA converts each project's NPV into an equivalent annual figure, enabling fair comparison of projects with different time horizons.

Question 4

A company's WACC is 10%. A new project has a beta of 1.5, the risk-free rate is 4%, and the market risk premium is 6%. Should the project be evaluated at the WACC?

Accepted Answer

No, use the project's own risk-adjusted rate of 13%

Answer

The project-specific rate = Rf + β(Rm - Rf) = 4% + 1.5 × 6% = 13%; using WACC would understate the required return for this higher-risk project.

Question 5

Which of the following best explains why dividends may be irrelevant in a perfect capital market (Modigliani-Miller dividend irrelevance theory)?

Accepted Answer

Investors can create homemade dividends by selling shares

Answer

In a perfect market, investors can replicate any desired income stream by selling shares ('homemade dividends'), making the firm's dividend policy irrelevant to its value.

ACCA - Association of Chartered Certified Accountants Practice Test

ACCA - Association of Chartered Certified Accountants Practice Test

ACCA Financial Management and Investment 5