Strategic Financial Management Flashcards

Which capital budgeting technique calculates the discount rate at which the net present value of a project equals zero?

Answer: Internal Rate of Return (IRR)

The IRR is defined as the discount rate that makes the NPV of all cash flows from a project equal to zero.

Under the Modigliani-Miller theorem (without taxes), what is the effect of changing a firm's capital structure on its overall value?

Answer: It has no effect on the overall firm value

Modigliani-Miller (without taxes) states that in perfect capital markets, firm value is independent of its capital structure.

Which of the following best describes the Weighted Average Cost of Capital (WACC)?

Answer: The average return required by all providers of finance, weighted by their proportion of total capital

WACC blends the required returns of equity holders and debt holders, each weighted by their share of total capital, to reflect the firm's overall financing cost.

In the Capital Asset Pricing Model (CAPM), what does a beta (β) greater than 1 indicate?

Answer: The asset is more volatile than the market

A beta greater than 1 means the asset amplifies market movements, indicating higher systematic risk than the overall market.

Which working capital strategy involves maintaining minimal inventory and tight credit policies to reduce current assets?

Answer: Aggressive working capital strategy

An aggressive strategy minimizes current assets (low inventory, tight receivables) to reduce financing costs, accepting higher liquidity risk.

A company has a current ratio of 1.8 and a quick ratio of 0.9. What does this most likely indicate?

Answer: A significant portion of current assets is tied up in inventory

The large gap between the current ratio and quick ratio (which excludes inventory) indicates that inventory makes up a substantial part of current assets.

Which dividend policy theory argues that investors are indifferent between dividends and capital gains because they can create 'homemade dividends'?

Answer: Modigliani-Miller dividend irrelevance theory

Modigliani and Miller argued that in perfect markets, dividend policy is irrelevant because shareholders can replicate any dividend stream by selling shares.