IFA IFA Business Finance & Investment 1 — Questions and Answers
Question 1: What is the weighted average cost of capital (WACC)?
- The average interest rate on all bank loans
- The blended cost of all capital sources weighted by their proportion in the capital structure (Correct answer)
- The minimum return required on equity only
- The tax rate applied to interest payments
Correct answer: The blended cost of all capital sources weighted by their proportion in the capital structure
WACC is calculated by weighting the cost of each capital component (equity, debt) by its proportional share of total capital, representing the firm's overall financing cost.
Question 2: Which of the following is an example of equity financing?
- Issuing corporate bonds
- Taking a bank term loan
- Issuing new common stock (Correct answer)
- Entering a finance lease
Correct answer: Issuing new common stock
Issuing new common stock raises equity capital from shareholders without creating a repayment obligation, unlike debt instruments.
Question 3: What is a dividend policy and how does it affect shareholders?
- A company's strategy for setting employee bonuses
- The decision on how much of profits to distribute to shareholders versus retain in the business (Correct answer)
- A legal requirement to pay all profits to shareholders
- The schedule for paying interest on bonds
Correct answer: The decision on how much of profits to distribute to shareholders versus retain in the business
A dividend policy determines what portion of earnings is paid to shareholders as dividends and what is retained for reinvestment, directly affecting shareholder income and growth prospects.
Question 4: What is the primary purpose of a prospectus when a company issues new securities?
- To file the company's annual tax return
- To provide potential investors with material information about the offering and the company (Correct answer)
- To obtain a credit rating from rating agencies
- To apply for a bank loan
Correct answer: To provide potential investors with material information about the offering and the company
A prospectus is a formal legal document providing detailed information about the company, the securities being offered, and associated risks to enable informed investment decisions.
Question 5: What does 'leverage' mean in a business finance context?
- The amount of cash held in reserve
- The use of borrowed funds to amplify potential returns and risks (Correct answer)
- The ratio of current assets to current liabilities
- The market capitalization of the company
Correct answer: The use of borrowed funds to amplify potential returns and risks
Financial leverage involves using debt to finance assets, amplifying both potential returns on equity and the risk of losses if returns fall below the cost of debt.
Question 6: Which financial market instrument provides its holder with a fixed interest payment and return of principal at maturity?
- Common stock
- Preferred stock
- Corporate bond (Correct answer)
- Convertible note (before conversion)
Correct answer: Corporate bond
A corporate bond pays a fixed coupon (interest) at regular intervals and returns the face value (principal) to the holder at the maturity date.
IFA IFA Business Finance & Investment 1
What is the weighted average cost of capital (WACC)?