DBA Corporate Finance and Financial Management 1 — Questions and Answers
Question 1: What does the Weighted Average Cost of Capital (WACC) represent?
- The average salary of capital market professionals
- The blended cost of all capital sources (debt and equity) weighted by their proportions (Correct answer)
- The cost of equity capital only
- The interest rate on long-term debt
Correct answer: The blended cost of all capital sources (debt and equity) weighted by their proportions
WACC represents the average rate of return a company must earn on its investments to satisfy all its capital providers, weighted by the proportion of each funding source.
Question 2: According to the Modigliani-Miller theorem (without taxes), what determines a firm's value?
- Its capital structure (debt-to-equity ratio)
- Its real assets and earning power, not how it is financed (Correct answer)
- The dividend policy chosen by management
- The market price of its equity
Correct answer: Its real assets and earning power, not how it is financed
Without taxes, Modigliani and Miller proved that firm value is determined by its assets and cash flows, not by the mix of debt and equity used to finance it.
Question 3: In capital budgeting, a project should be accepted if its Net Present Value (NPV) is:
- Negative
- Equal to zero
- Positive (Correct answer)
- Greater than the Internal Rate of Return
Correct answer: Positive
A positive NPV means the project generates more value than it costs (discounted at the required rate), thereby increasing shareholder wealth.
Question 4: What does the 'agency problem' describe in corporate finance?
- Competition between external consulting agencies
- Conflicts of interest between principals (shareholders) and agents (managers) (Correct answer)
- Legal disputes with government regulatory agencies
- The cost of hiring a marketing agency
Correct answer: Conflicts of interest between principals (shareholders) and agents (managers)
The agency problem arises when managers (agents) may act in their own interests rather than maximizing shareholder (principal) wealth.
Question 5: Which financial ratio measures a company's ability to pay short-term obligations with its most liquid assets?
- Debt-to-equity ratio
- Current ratio
- Quick (acid-test) ratio (Correct answer)
- Return on equity
Correct answer: Quick (acid-test) ratio
The quick ratio measures liquidity by dividing liquid assets (cash, marketable securities, receivables) by current liabilities, excluding inventory.
Question 6: What is 'financial leverage' in the context of corporate finance?
- The use of equity to finance operations
- The use of debt to amplify potential returns (and risk) to equity holders (Correct answer)
- A method of reducing taxes legally
- The diversification of an investment portfolio
Correct answer: The use of debt to amplify potential returns (and risk) to equity holders
Financial leverage involves using borrowed funds to increase the potential return on equity investment, while also magnifying potential losses.
DBA Corporate Finance and Financial Management 1
What does the Weighted Average Cost of Capital (WACC) represent?