CPA CFE Finance 4

Question 1

What is the concept of the time value of money?

Accepted Answer

A dollar today is worth more than a dollar in the future because of its potential earning capacity, risk, and inflation

Answer

The time value of money recognizes that money available today can be invested to earn returns, making it more valuable than the same amount received in the future. This principle underlies discounting, compounding, and all of modern finance.

Question 2

What is a company's beta in the context of the Capital Asset Pricing Model?

Accepted Answer

A measure of the company's systematic risk relative to the market, indicating how sensitive its returns are to market movements

Answer

Beta measures a security's systematic risk relative to the overall market. A beta of 1 means the security moves with the market. Beta > 1 indicates greater sensitivity to market movements (more volatile), while beta < 1 indicates less sensitivity.

Question 3

What is the purpose of a interest rate swap?

Accepted Answer

To exchange fixed-rate interest payments for floating-rate interest payments (or vice versa) between two parties to manage interest rate risk

Answer

An interest rate swap allows two parties to exchange interest payment obligations — typically fixed for floating rate — on a notional principal amount. This helps manage interest rate exposure, reduce borrowing costs, or match assets and liabilities.

Question 4

In valuation, what is the enterprise value (EV) of a company?

Accepted Answer

The total value of the firm, calculated as market capitalization plus total debt minus cash and cash equivalents

Answer

Enterprise value represents the theoretical total cost of acquiring a company. It equals the market value of equity plus debt plus minority interest plus preferred equity minus cash. EV is used in valuation multiples (EV/EBITDA) and represents the value to all capital providers.

Question 5

What is the profitability index (PI) and how is it used in capital budgeting?

Accepted Answer

The present value of future cash flows divided by the initial investment; projects with PI greater than 1 should be accepted

Answer

The profitability index (benefit-cost ratio) is calculated as PV of future cash flows divided by the initial investment. A PI > 1 indicates the project creates value (same decision as NPV > 0). PI is particularly useful for ranking projects when capital is rationed.

CPA CFE Practice Test

CPA CFE Practice Test

CPA CFE Finance 4