CA Financial Management 5 — Questions and Answers
Question 1: Which of the following scenarios would most likely trigger a firm to issue equity rather than debt?
- The firm's stock price is at a historic low
- The firm's debt ratio is already near its industry maximum (Correct answer)
- Interest rates in the market have recently declined
- The firm has a large amount of unused tax loss carryforwards
Correct answer: The firm's debt ratio is already near its industry maximum
When a firm's leverage is near the ceiling of its target or industry norm, issuing additional debt increases financial risk and borrowing costs, making equity the preferred choice.
Question 2: Which type of risk CANNOT be eliminated through diversification?
- Unsystematic risk
- Firm-specific risk
- Idiosyncratic risk
- Systematic risk (Correct answer)
Correct answer: Systematic risk
Systematic risk (market risk) affects all securities and cannot be diversified away; only unsystematic (firm-specific) risk is eliminated through portfolio diversification.
Question 3: A firm uses the 'percentage of sales' method for financial forecasting. If sales are projected to grow from $1M to $1.2M and accounts receivable are currently $100,000 (10% of sales), projected accounts receivable will be:
- $100,000
- $110,000
- $120,000 (Correct answer)
- $130,000
Correct answer: $120,000
Accounts receivable remain at 10% of sales; 10% × $1,200,000 = $120,000.
Question 4: Which of the following is an advantage of leasing over purchasing an asset outright?
- The lessee retains full ownership rights
- Lease payments are never tax deductible
- Leasing typically requires a smaller initial cash outlay (Correct answer)
- Leasing always results in lower total cost over the asset's life
Correct answer: Leasing typically requires a smaller initial cash outlay
Leasing conserves cash by avoiding a large upfront purchase price, which is especially valuable for firms with limited capital or uncertain long-term needs for the asset.
Question 5: In a net present value (NPV) analysis, if the NPV of a project is exactly zero, the firm should:
- Reject the project because it adds no value
- Accept the project because it exactly earns the required return (Correct answer)
- Request additional capital from investors before proceeding
- Perform only a payback period analysis before deciding
Correct answer: Accept the project because it exactly earns the required return
An NPV of zero means the project returns exactly the required rate of return (WACC), making it acceptable — it neither creates nor destroys value.
Question 6: Which of the following best describes 'float' in the context of cash management?
- The difference between the book balance and the bank balance due to outstanding checks and deposits in transit (Correct answer)
- The firm's short-term investment in marketable securities
- The credit line available from a commercial bank
- The excess cash held above the minimum required balance
Correct answer: The difference between the book balance and the bank balance due to outstanding checks and deposits in transit
Float is the difference between the cash balance on the firm's books and the balance shown by the bank, arising from checks written but not yet cleared or deposits not yet credited.
Question 7: Which of the following is a key assumption of the Efficient Market Hypothesis (EMH)?
- Investors have different access to information depending on wealth
- Transaction costs are always zero for institutional investors only
- All relevant information is rapidly and fully reflected in security prices (Correct answer)
- Past price patterns can reliably predict future prices
Correct answer: All relevant information is rapidly and fully reflected in security prices
EMH assumes that prices incorporate all available information quickly, meaning no investor can consistently earn abnormal returns by trading on that information.
CA Financial Management 5
Which of the following scenarios would most likely trigger a firm to issue equity rather than debt?