CME Financial Management & Budgeting 3 — Questions and Answers
Question 1: Which budgeting approach ties resource allocation directly to measurable outcomes and performance metrics?
- Incremental budgeting
- Activity-based budgeting
- Performance-based budgeting (Correct answer)
- Flexible budgeting
Correct answer: Performance-based budgeting
Performance-based budgeting links spending explicitly to achieving defined results or outcomes rather than to inputs or activities.
Question 2: A manager notices a favorable price variance but an unfavorable efficiency variance for direct materials. What does this most likely mean?
- Materials were purchased cheaply but more was used than standard (Correct answer)
- Materials were expensive but less was consumed than planned
- Both price and usage were better than budget
- The standard itself was set incorrectly
Correct answer: Materials were purchased cheaply but more was used than standard
A favorable price variance means actual cost per unit was below standard; an unfavorable efficiency variance means more material was consumed than the standard allowed.
Question 3: When computing a company's weighted average cost of capital (WACC), which component is adjusted for taxes?
- Cost of equity
- Cost of preferred stock
- Cost of debt (Correct answer)
- Cost of retained earnings
Correct answer: Cost of debt
Interest on debt is tax-deductible, so the after-tax cost of debt [Kd × (1 − tax rate)] is used in the WACC calculation.
Question 4: A company is evaluating two mutually exclusive projects. Project A has a higher NPV; Project B has a higher IRR. Which should be selected and why?
- Project B, because a higher IRR always means greater value creation
- Project A, because NPV directly measures added shareholder value in dollar terms (Correct answer)
- Either project, since NPV and IRR always agree on mutually exclusive choices
- Project B, because IRR is independent of the discount rate
Correct answer: Project A, because NPV directly measures added shareholder value in dollar terms
For mutually exclusive projects, NPV is the preferred criterion because it measures the absolute increase in firm value, whereas IRR can give conflicting signals.
Question 5: Under activity-based costing (ABC), overhead is allocated based on:
- A single plant-wide rate tied to direct labor hours
- The cost drivers that actually cause overhead costs to vary (Correct answer)
- Total revenue of each product line
- Senior management's judgment about product profitability
Correct answer: The cost drivers that actually cause overhead costs to vary
ABC assigns overhead costs using multiple cost drivers that reflect the actual consumption of resources by each activity.
Question 6: If a company's accounts receivable days (DSO) increases from 30 to 45 days, what is the most direct financial implication?
- The company is collecting cash faster from customers
- More cash is tied up in receivables, reducing liquidity (Correct answer)
- Profitability automatically improves due to higher sales
- Inventory turnover will increase proportionally
Correct answer: More cash is tied up in receivables, reducing liquidity
A rising DSO means customers are taking longer to pay, which ties up working capital and reduces available cash.
Question 7: Which financial statement directly shows whether a company generated or consumed cash from its day-to-day operations?
- Balance sheet
- Income statement
- Statement of cash flows (Correct answer)
- Statement of retained earnings
Correct answer: Statement of cash flows
The operating section of the cash flow statement reconciles net income to actual cash generated or consumed by core business operations.
CME Financial Management & Budgeting 3
Which budgeting approach ties resource allocation directly to measurable outcomes and performance metrics?