CCM Financial Analysis & Planning 2 — Questions and Answers
Question 1: A company has a current ratio of 1.8 and a quick ratio of 0.9. What does this discrepancy most likely indicate?
- The company has significant inventory relative to current assets (Correct answer)
- The company has excessive accounts receivable
- The company's long-term debt is too high
- The company's net income is declining
Correct answer: The company has significant inventory relative to current assets
A large gap between current and quick ratios indicates that inventory makes up a significant portion of current assets, since the quick ratio excludes inventory.
Question 2: Which budgeting approach starts each period with a zero base and requires managers to justify all expenditures?
- Incremental budgeting
- Zero-based budgeting (Correct answer)
- Activity-based budgeting
- Rolling budgeting
Correct answer: Zero-based budgeting
Zero-based budgeting (ZBB) requires every budget line item to be justified from scratch each period rather than adjusting prior-year figures.
Question 3: A project has an IRR of 14% and the company's WACC is 11%. What should management do?
- Reject the project because IRR exceeds WACC
- Accept the project because IRR exceeds WACC (Correct answer)
- Defer the project until IRR equals WACC
- Accept the project only if NPV is negative
Correct answer: Accept the project because IRR exceeds WACC
When IRR exceeds the cost of capital (WACC), the project creates value and should be accepted under the IRR decision rule.
Question 4: Contribution margin per unit is calculated as:
- Selling price minus total cost per unit
- Selling price minus variable cost per unit (Correct answer)
- Gross profit minus operating expenses per unit
- Net income divided by units sold
Correct answer: Selling price minus variable cost per unit
Contribution margin per unit equals the selling price minus variable cost per unit, showing how much each unit contributes toward covering fixed costs.
Question 5: A sensitivity analysis on a financial model primarily helps managers to:
- Calculate the exact future cash flows
- Understand how changes in key assumptions affect outcomes (Correct answer)
- Determine the optimal capital structure
- Eliminate all financial risk from a project
Correct answer: Understand how changes in key assumptions affect outcomes
Sensitivity analysis tests how much the output (e.g., NPV or profit) changes when individual input assumptions are varied, highlighting the most critical variables.
Question 6: Which financial statement links the income statement and balance sheet by explaining changes in equity?
- Statement of cash flows
- Statement of changes in equity (Correct answer)
- Statement of retained earnings
- Notes to financial statements
Correct answer: Statement of changes in equity
The statement of changes in equity reconciles opening and closing equity balances, incorporating net income, dividends, and other equity movements.
Question 7: Operating leverage measures the sensitivity of operating income to changes in:
- Interest rates
- Tax rates
- Sales volume (Correct answer)
- Capital expenditures
Correct answer: Sales volume
Operating leverage reflects how a given percentage change in sales volume amplifies the percentage change in operating income, driven by the proportion of fixed costs.
CCM Financial Analysis & Planning 2
A company has a current ratio of 1.8 and a quick ratio of 0.9.
What does this discrepancy most likely indicate?