CPA CFE Finance 2

Question 1

What is the primary purpose of financial leverage?

Accepted Answer

To amplify returns to equity holders by using debt financing, which increases both the potential upside and downside

Answer

To reduce the company's total debt

Answer

To eliminate all financial risk

Answer

To avoid paying interest on borrowed funds

Question 2

What is the internal rate of return (IRR) of a project?

Accepted Answer

The discount rate that makes the net present value of the project's cash flows equal to zero

Answer

The project's profit margin

Answer

The project's accounting rate of return

Answer

The cost of capital used to evaluate the project

Question 3

In portfolio theory, what does diversification achieve?

Accepted Answer

It reduces unsystematic (company-specific) risk but cannot eliminate systematic (market) risk

Answer

It eliminates all investment risk

Answer

It increases the expected return without changing risk

Answer

It guarantees a minimum return on the portfolio

Question 4

What is the dividend discount model (DDM) used for?

Accepted Answer

Estimating the intrinsic value of a stock based on the present value of expected future dividends

Answer

Calculating the tax on dividend income

Answer

Determining the company's dividend payout ratio

Answer

Setting the company's dividend policy

Question 5

Under the pecking order theory of capital structure, what is the preferred order of financing?

Accepted Answer

Internal funds (retained earnings) first, then debt, then external equity as a last resort

Answer

External equity first, then debt, then internal funds

Answer

Debt first, then internal funds, then equity

Answer

All sources of financing are equally preferred

Question 6

What is the payback period method of capital budgeting, and what is its main limitation?

Accepted Answer

It measures the time to recover the initial investment; its main limitation is that it ignores the time value of money and cash flows after the payback period

Answer

It calculates NPV; its limitation is complexity

Answer

It measures the accounting rate of return; it has no limitations

Answer

It calculates IRR; its limitation is multiple solutions