CFC Financial Management & Strategy 3 — Questions and Answers
Question 1: A company's operating leverage is high when:
- Fixed costs are a large proportion of total costs (Correct answer)
- Variable costs exceed fixed costs
- Debt financing dominates the capital structure
- Gross margin is below industry average
Correct answer: Fixed costs are a large proportion of total costs
High operating leverage means a large share of fixed costs, so small revenue changes produce amplified swings in operating income.
Question 2: Which ratio best measures how efficiently a company converts sales into free cash flow?
- Free cash flow margin (Correct answer)
- Current ratio
- Asset turnover ratio
- Times interest earned
Correct answer: Free cash flow margin
Free cash flow margin (FCF ÷ Revenue) shows the proportion of each revenue dollar that becomes free cash available to investors.
Question 3: When a financial controller evaluates a lease-versus-buy decision, the appropriate discount rate for the lease cash flows is typically the:
- After-tax cost of debt (Correct answer)
- WACC
- IRR of the project
- Risk-free rate
Correct answer: After-tax cost of debt
Lease payments are debt-like, contractual cash flows, so they are discounted at the firm's after-tax cost of debt.
Question 4: A company's Days Sales Outstanding (DSO) increased from 32 to 48 days. This most likely indicates:
- Slower customer collections or looser credit terms (Correct answer)
- Faster inventory turnover
- Improved liquidity position
- Higher profit margins
Correct answer: Slower customer collections or looser credit terms
Rising DSO signals customers are taking longer to pay, pointing to collection problems or deliberately extended credit policies.
Question 5: In a discounted cash flow valuation, the terminal value typically captures:
- Cash flows beyond the explicit forecast period (Correct answer)
- The liquidation value of tangible assets
- The present value of the first year's cash flow
- Accumulated depreciation on long-term assets
Correct answer: Cash flows beyond the explicit forecast period
Terminal value represents the present value of all cash flows expected after the discrete forecast horizon, often using a perpetuity growth model.
Question 6: Which financial instrument allows a company to lock in a future interest rate to hedge against rising borrowing costs?
- Interest rate swap (Correct answer)
- Currency forward
- Equity collar
- Credit default swap
Correct answer: Interest rate swap
An interest rate swap exchanges floating-rate payments for fixed-rate payments, effectively locking in a borrowing rate.
Question 7: A strategic acquisition is evaluated using synergies. If synergies fail to materialize, the acquirer most likely:
- Overpaid for the target, destroying shareholder value (Correct answer)
- Benefited from a lower purchase price
- Improved its return on invested capital immediately
- Reduced its weighted average cost of capital
Correct answer: Overpaid for the target, destroying shareholder value
When anticipated synergies do not occur, the premium paid over intrinsic value represents a transfer of wealth from acquirer shareholders to target shareholders.
CFC Financial Management & Strategy 3
A company's operating leverage is high when: