CFC Financial Management & Strategy 5 — Questions and Answers
Question 1: A CFO is considering a share repurchase versus a cash dividend of equal size. Which statement about the tax treatment is most accurate in the US?
- Repurchases may be tax-advantaged for shareholders since gains are deferred until shares are sold (Correct answer)
- Cash dividends are always tax-free for individual investors
- Share repurchases trigger immediate ordinary income tax for all shareholders
- Both are taxed identically under current US federal law
Correct answer: Repurchases may be tax-advantaged for shareholders since gains are deferred until shares are sold
Share repurchases allow shareholders to choose when to sell, deferring capital gains tax, whereas dividends create an immediate taxable event for all recipients.
Question 2: A company's cash conversion cycle (CCC) is 45 days. Management wants to reduce it. Which action would be most effective?
- Negotiating longer payment terms with suppliers (Correct answer)
- Shortening the credit terms offered to customers
- Increasing inventory safety stock levels
- Accelerating capital expenditure payments
Correct answer: Negotiating longer payment terms with suppliers
CCC = DIO + DSO − DPO; extending Days Payable Outstanding (DPO) by getting longer supplier terms directly reduces the CCC.
Question 3: Which financial metric is most useful for comparing the operating performance of two companies with different capital structures?
- EBITDA margin (Correct answer)
- Return on equity (ROE)
- Earnings per share (EPS)
- Net profit margin
Correct answer: EBITDA margin
EBITDA margin excludes interest (and thus leverage effects), allowing operating performance comparison across firms with differing debt levels.
Question 4: A breakeven analysis shows a company's fixed costs are $500,000, price per unit is $50, and variable cost per unit is $30. What is the breakeven quantity?
- 25,000 units (Correct answer)
- 10,000 units
- 16,667 units
- 50,000 units
Correct answer: 25,000 units
Breakeven = Fixed Costs ÷ Contribution Margin per unit = $500,000 ÷ ($50 − $30) = $500,000 ÷ $20 = 25,000 units.
Question 5: When a controller applies sensitivity analysis to a valuation model, the output is best described as:
- The change in NPV resulting from varying one input at a time while holding others constant (Correct answer)
- A probability distribution of possible NPV outcomes
- The set of scenarios that yield a positive NPV
- The expected NPV weighted by scenario probabilities
Correct answer: The change in NPV resulting from varying one input at a time while holding others constant
Sensitivity analysis isolates the effect of changing one variable (e.g., growth rate or discount rate) while keeping all other assumptions fixed.
Question 6: A firm is evaluating two mutually exclusive projects with different lives. The most rigorous method to compare them is:
- Equivalent Annual Annuity (EAA) method (Correct answer)
- Comparing their undiscounted payback periods
- Selecting whichever project has the higher IRR
- Using the project with the larger initial NPV
Correct answer: Equivalent Annual Annuity (EAA) method
The EAA converts each project's NPV into an annual figure, making projects with different lifespans directly comparable on a per-year basis.
Question 7: A financial controller is asked to assess whether a proposed merger creates value. Which approach directly measures the incremental value of the deal?
- Calculating the present value of expected synergies minus the acquisition premium paid (Correct answer)
- Comparing the acquirer's P/E ratio before and after the deal
- Reviewing the target's historical revenue growth
- Analyzing the combined entity's pro forma EPS accretion
Correct answer: Calculating the present value of expected synergies minus the acquisition premium paid
True M&A value creation = PV of synergies − premium paid; EPS accretion can be misleading if it results from financial engineering rather than real economic gain.
CFC Financial Management & Strategy 5
A CFO is considering a share repurchase versus a cash dividend of equal size.
Which statement about the tax treatment is most accurate in the US?