B. Acy Bachelor of Accountancy Corporate Finance and Financial Management 2 — Questions and Answers
Question 1: Which of the following represents the Modigliani-Miller proposition in a world with no taxes?
- A firm's value increases as it adds more debt
- A firm's value is independent of its capital structure (Correct answer)
- Equity financing is always cheaper than debt financing
- Dividends increase firm value
Correct answer: A firm's value is independent of its capital structure
MM Proposition I (no taxes) states that firm value is unaffected by capital structure because investors can replicate any leverage ratio through homemade leverage.
Question 2: A company has the following data: Sales = $2,000,000; Variable costs = $1,200,000; Fixed costs = $400,000. What is the contribution margin ratio?
- 40% (Correct answer)
- 60%
- 30%
- 70%
Correct answer: 40%
Contribution margin = Sales - Variable costs = $800,000; Contribution margin ratio = $800,000 / $2,000,000 = 40%.
Question 3: Which type of lease requires the lessee to recognize both an asset and a liability on the balance sheet?
- Operating lease under old GAAP only
- Finance (capital) lease (Correct answer)
- Short-term lease
- Month-to-month lease
Correct answer: Finance (capital) lease
A finance lease (formerly called a capital lease) requires the lessee to record a right-of-use asset and a corresponding lease liability under both old and new GAAP (ASC 842).
Question 4: The internal rate of return (IRR) rule states that a project should be accepted when:
- IRR is less than the cost of capital
- IRR equals the payback period
- IRR exceeds the required rate of return (hurdle rate) (Correct answer)
- IRR is negative
Correct answer: IRR exceeds the required rate of return (hurdle rate)
A project adds value when its IRR exceeds the hurdle rate (cost of capital), meaning the project earns more than the minimum required return.
Question 5: Which ratio measures a company's ability to meet short-term obligations using only its most liquid assets (excluding inventory)?
- Current ratio
- Quick (acid-test) ratio (Correct answer)
- Cash ratio
- Debt-to-equity ratio
Correct answer: Quick (acid-test) ratio
The quick ratio = (Cash + Marketable securities + Receivables) / Current liabilities, excluding inventory as it is the least liquid current asset.
Question 6: Financial leverage amplifies which of the following for common shareholders?
- Only gains, never losses
- Both gains and losses (Correct answer)
- Only losses, never gains
- Operating risk only
Correct answer: Both gains and losses
Financial leverage magnifies both positive and negative outcomes for equity holders because fixed debt payments must be met regardless of operating performance.
Question 7: A firm repurchasing its own shares in the open market will most likely cause which of the following?
- Earnings per share (EPS) to decrease
- Return on equity (ROE) to decrease
- Earnings per share (EPS) to increase (Correct answer)
- Total assets to increase
Correct answer: Earnings per share (EPS) to increase
A share buyback reduces the share count, so the same total earnings are spread over fewer shares, increasing EPS.
B. Acy Bachelor of Accountancy Corporate Finance and Financial Management 2
Which of the following represents the Modigliani-Miller proposition in a world with no taxes?