CIMA Financial Management and Risk 1 — Questions and Answers
Question 1: What does the 'weighted average cost of capital' (WACC) represent?
- The average interest rate on a company's bank loans
- The blended cost of all sources of finance, weighted by their proportion in the capital structure (Correct answer)
- The cost of issuing new equity shares
- The minimum return required on risk-free investments
Correct answer: The blended cost of all sources of finance, weighted by their proportion in the capital structure
WACC is the blended rate of return a company must earn on its assets to satisfy all its investors, weighted by each source's proportion in the capital structure.
Question 2: In capital investment appraisal, which method calculates the discount rate at which the net present value (NPV) of a project equals zero?
- Payback period
- Accounting rate of return
- Internal rate of return (IRR) (Correct answer)
- Profitability index
Correct answer: Internal rate of return (IRR)
The Internal Rate of Return (IRR) is the discount rate that makes the NPV of a project's cash flows equal to zero.
Question 3: Which type of risk cannot be eliminated through diversification in a portfolio?
- Specific (unsystematic) risk
- Systematic (market) risk (Correct answer)
- Business risk
- Credit risk
Correct answer: Systematic (market) risk
Systematic (market) risk affects all investments and cannot be eliminated through diversification, unlike unsystematic risk which is company-specific.
Question 4: A company has current assets of $500,000 and current liabilities of $200,000. What is its current ratio?
- 0.4
- 2.5 (Correct answer)
- 1.5
- 4.0
Correct answer: 2.5
The current ratio is calculated as current assets divided by current liabilities: $500,000 / $200,000 = 2.5.
Question 5: Which financial instrument gives the holder the right, but not the obligation, to buy an asset at a specified price on or before a specified date?
- Forward contract
- Futures contract
- Call option (Correct answer)
- Put option
Correct answer: Call option
A call option gives the holder the right, but not the obligation, to purchase an underlying asset at the strike price before or at expiration.
Question 6: What is 'working capital management' primarily concerned with?
- Long-term capital investment decisions
- Managing the day-to-day liquidity of current assets and current liabilities (Correct answer)
- Evaluating merger and acquisition opportunities
- Planning for retirement and pension fund obligations
Correct answer: Managing the day-to-day liquidity of current assets and current liabilities
Working capital management focuses on managing current assets (inventory, receivables, cash) and current liabilities to maintain day-to-day liquidity.
CIMA Financial Management and Risk 1
What does the 'weighted average cost of capital' (WACC) represent?