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Free Questions › CPA › Business Analysis and Reporting
Free CPA Business Analysis and Reporting Practice Questions & Answers
500 exam-style Business Analysis and Reporting questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 61
A flexible budget differs from a static budget in that it:
Select an option first.
Correct answer: C — Is adjusted to the ACTUAL level of activity, isolating price and efficiency effects from volume effects
Explanation: A FLEXIBLE budget is restated for the ACTUAL activity level. Comparing actual results to a STATIC budget conflates VOLUME effects with PRICE and EFFICIENCY effects. The flexible budget separates them: the STATIC budget variance = the flexible budget variance + the sales volume variance.
Question 62
The just-in-time (JIT) philosophy aims to:
Select an option first.
Correct answer: A — MINIMISE inventory by producing only as needed — exposing and eliminating waste
Explanation: JIT minimises inventory, producing only what is needed when it is needed. Inventory is treated as WASTE that CONCEALS problems (defects, unreliable suppliers, long setups). Removing the buffer FORCES those problems into view. The trade-off: JIT is extremely vulnerable to supply chain disruption.
Question 63
The theory of constraints focuses on:
Select an option first.
Correct answer: B — Identifying and EXPLOITING the BOTTLENECK — since throughput is limited by the constraint
Explanation: THEORY OF CONSTRAINTS: a system's output is limited by its single tightest CONSTRAINT. Improving anything OTHER than the bottleneck yields NO increase in throughput. The five steps: identify the constraint, exploit it, subordinate everything to it, elevate it, then repeat.
Question 64
A company's WACC will typically:
Select an option first.
Correct answer: C — FIRST FALL as cheap debt is added, then RISE as financial distress costs increase — a U shape
Explanation: WACC typically follows a U-SHAPE. Adding cheap, tax-advantaged debt initially LOWERS WACC. Beyond a point, financial distress and bankruptcy risk raise BOTH the cost of debt AND the cost of equity, pushing WACC back up. The bottom of the U is the optimal capital structure.
Question 65
In a DCF valuation, using FCFF requires discounting at:
Select an option first.
Correct answer: B — The WACC — because FCFF is available to ALL capital providers (debt and equity)
Explanation: FCFF (free cash flow to the FIRM) is available to BOTH debt and equity holders, so it is discounted at the WACC, yielding ENTERPRISE value. FCFE (free cash flow to EQUITY) is discounted at the COST OF EQUITY, yielding EQUITY value directly. Mismatching the cash flow and the discount rate is a fundamental valuation error.
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Question 66
A company's CM ratio is 40% and fixed costs are $600,000. Break-even SALES are:
Select an option first.
Correct answer: C — $1,500,000
Explanation: Break-even in DOLLARS = Fixed costs / CM ratio = $600,000 / 0.40 = $1,500,000. Multiplying instead of dividing gives $240,000 (option A) — the intended trap.
Question 67
A multi-product firm's break-even point changes when the SALES MIX shifts, even if costs are unchanged, because:
Select an option first.
Correct answer: D — The WEIGHTED-AVERAGE CM ratio changes
Explanation: For a multi-product firm, break-even depends on the WEIGHTED-AVERAGE CM (or CM ratio), which is a function of the SALES MIX. Shifting toward lower-margin products RAISES the break-even point even with identical costs and prices. That mix sensitivity is a key exam point.
Question 68
A company has a margin of safety of 5% and a DOL of 8. A 5% decline in sales would reduce operating income by approximately:
Select an option first.
Correct answer: D — 40% — DOL of 8 magnifies the 5% sales decline eightfold
Explanation: %ΔEBIT = DOL × %ΔSales = 8 × (−5%) = −40%. And with a margin of safety of only 5%, that decline takes the company almost exactly to break-even. LOW margin of safety plus HIGH operating leverage is a genuinely dangerous combination.
Question 69
The relationship between DOL and the margin of safety is:
Select an option first.
Correct answer: B — INVERSE — DOL equals 1 / margin of safety percentage
Explanation: DOL = 1 / Margin of safety %. They are exact reciprocals. A margin of safety of 12.5% implies a DOL of 8. This elegant identity means the two measures are two views of the same underlying fragility.
Question 70
In capital budgeting, DEPRECIATION is relevant because it:
Select an option first.
Correct answer: A — Generates a TAX SHIELD — a cash INFLOW equal to depreciation × the tax rate
Explanation: Depreciation is NON-CASH, but it is TAX-DEDUCTIBLE — so it produces a DEPRECIATION TAX SHIELD = Depreciation × Tax rate, which IS a cash inflow. That is the only reason depreciation appears in a capital budgeting cash flow analysis at all.
Question 71
The after-tax cash flow from an operating cash inflow of $100,000 at a 25% tax rate is:
Select an option first.
Correct answer: B — $75,000
Explanation: After-tax operating cash flow = Pre-tax cash flow × (1 − t) = $100,000 × 0.75 = $75,000. Cash INFLOWS are taxed; cash OUTFLOWS provide a tax shield. Depreciation is added separately as a tax shield only.
Question 72
A project's terminal cash flow typically includes:
Select an option first.
Correct answer: C — Salvage value NET OF TAX, plus RECOVERY of working capital
Explanation: TERMINAL cash flow = after-tax salvage proceeds + RECOVERY of net working capital originally invested. If the asset is sold ABOVE book value, tax is paid on the gain; if BELOW, a tax benefit arises. Forgetting the working capital recovery is a common omission.
Question 73
An increase in NET WORKING CAPITAL at the start of a project is:
Select an option first.
Correct answer: B — A cash OUTFLOW at time zero, RECOVERED at the end of the project
Explanation: Additional working capital (inventory, receivables) required to run the project is a cash OUTFLOW at inception, and it is RECOVERED (an inflow) when the project ends and those balances are liquidated. It is NOT depreciated and NOT tax-affected.
Question 74
In a replacement decision, the tax effect of selling the old asset BELOW its book value is:
Select an option first.
Correct answer: C — A tax BENEFIT (a cash inflow) — the loss is deductible
Explanation: Selling below book value produces a LOSS, which is TAX-DEDUCTIBLE — generating a cash INFLOW equal to the loss × the tax rate. This is why the disposal PROCEEDS and TAX EFFECT are relevant even though the book value itself is sunk.
Question 75
The equivalent annual annuity is used to compare projects with:
Select an option first.
Correct answer: A — UNEQUAL LIVES — converting each NPV into an equivalent annual cash flow
Explanation: When comparing MUTUALLY EXCLUSIVE projects with UNEQUAL LIVES, comparing raw NPVs is misleading (a longer project has more time to accumulate value). The EQUIVALENT ANNUAL ANNUITY converts each NPV into a comparable per-year figure. The alternative is a replacement-chain analysis over a common horizon.
Question 76
The PROFITABILITY INDEX ranking may differ from NPV ranking because PI:
Select an option first.
Correct answer: A — Measures value per DOLLAR INVESTED, favouring smaller projects — while NPV measures TOTAL dollar value
Explanation: PI measures NPV per dollar invested, so it can favour small, efficient projects over larger ones that create more TOTAL value. With UNLIMITED capital, NPV is the correct criterion. With CAPITAL RATIONING, PI maximises the total NPV achievable from a limited budget.
Question 77
A company applies overhead using a predetermined rate. Actual overhead exceeds applied overhead. Overhead is:
Select an option first.
Correct answer: C — UNDERAPPLIED — the shortfall is typically charged to COGS (or prorated if material)
Explanation: When ACTUAL overhead EXCEEDS APPLIED, overhead is UNDERAPPLIED — not enough cost was charged to production. The balance is closed to COGS (increasing it) if immaterial, or PRORATED across WIP, finished goods and COGS if material.
Question 78
In ABC, a BATCH-level cost driver would be:
Select an option first.
Correct answer: C — NUMBER OF SETUPS
Explanation: ABC uses a HIERARCHY of drivers: UNIT-level (labour hours, machine hours); BATCH-level (setups, purchase orders, inspections); PRODUCT-level (design changes, product specifications); FACILITY-level (rent, plant management). Recognising the LEVEL is what makes ABC more accurate than a single volume-based rate.
Question 79
A FACILITY-level cost in ABC is:
Select an option first.
Correct answer: A — Difficult to allocate meaningfully to products — often treated as a period cost or allocated arbitrarily
Explanation: FACILITY-level costs (plant rent, general plant management) sustain the facility as a whole and bear NO causal relationship to individual products. Any allocation is essentially arbitrary. Many ABC implementations therefore leave them unallocated, treating them as period costs — which preserves the integrity of the product cost figures.
Question 80
The four-variance analysis of overhead separates:
Select an option first.
Correct answer: B — VARIABLE spending, VARIABLE efficiency, FIXED spending (budget), and FIXED VOLUME
Explanation: FOUR-VARIANCE overhead analysis: (1) VOH spending; (2) VOH efficiency; (3) FOH budget (spending); (4) FOH volume. The two-variance approach collapses these into a controllable (budget) variance and a volume variance.
Question 81
A favourable materials PRICE variance combined with an unfavourable QUANTITY variance may indicate:
Select an option first.
Correct answer: A — The purchase of CHEAPER, LOWER-QUALITY materials that produced more waste — an interdependence between variances
Explanation: Variances are INTERDEPENDENT. A favourable PRICE variance achieved by buying cheap, inferior material often causes an UNFAVOURABLE QUANTITY (usage) variance from breakage and rework — and may also produce an unfavourable LABOUR efficiency variance. Evaluating purchasing on price alone creates exactly this dysfunction.
Question 82
The 'management by exception' principle means investigating:
Select an option first.
Correct answer: D — Only variances that are SIGNIFICANT — by size, by percentage, or by trend
Explanation: MANAGEMENT BY EXCEPTION concentrates attention on SIGNIFICANT variances, whether by absolute size, percentage of standard, or persistent TREND. Investigating every trivial variance wastes resources. Note that FAVOURABLE variances also warrant investigation — they may signal a lax standard or a quality problem.
Question 83
A company's ROI is 20% (margin 10%, turnover 2.0). To raise ROI to 25% by improving TURNOVER alone, turnover must become:
Select an option first.
Correct answer: B — 2.5
Explanation: ROI = Margin × Turnover. Currently 10% × 2.0 = 20%. To reach 25% with margin held at 10%, turnover must be 25% / 10% = 2.5. Turnover improves by reducing the ASSET base (better working capital management) or increasing sales from the same assets.
Question 84
Residual income's principal weakness compared with ROI is that it:
Select an option first.
Correct answer: B — Is an ABSOLUTE dollar figure, making it hard to compare divisions of DIFFERENT SIZES
Explanation: RI cures ROI's underinvestment problem — but because it is an ABSOLUTE dollar amount, a large division will almost always report higher RI than a small one, regardless of relative efficiency. That makes cross-division comparison difficult. EVA is a refinement of RI addressing accounting distortions.
Question 85
EVA differs from residual income principally by:
Select an option first.
Correct answer: B — ADJUSTING accounting figures (e.g. capitalising R&D, adding back the LIFO reserve) to better reflect ECONOMIC reality
Explanation: EVA is RI with ACCOUNTING ADJUSTMENTS designed to convert GAAP figures into ECONOMIC ones — capitalising R&D and marketing spend that build long-term value, adding back the LIFO reserve, treating operating leases as debt. The goal is to stop managers being penalised for value-creating investments that GAAP expenses.
Question 86
A negative EVA means the division:
Select an option first.
Correct answer: B — Earned LESS than the cost of the capital it employs — even if accounting profit was positive
Explanation: NEGATIVE EVA means the division failed to cover its CAPITAL CHARGE — it destroyed value, even if it reported an accounting PROFIT. This gap between accounting profit and economic profit is the entire reason EVA exists. It does not automatically mean closure; it means the capital is not earning its keep.
Question 87
A dual-rate transfer pricing system charges:
Select an option first.
Correct answer: A — The SELLING division at market price and the BUYING division at variable cost — with the difference eliminated in consolidation
Explanation: DUAL-RATE transfer pricing credits the SELLER at a price that motivates it to transfer (market or full cost plus) while charging the BUYER a price that motivates the right decision (variable cost). The difference is eliminated on consolidation. It preserves goal congruence at the cost of some complexity.
Question 88
A company's beta is 1.4, the risk-free rate is 4%, and the market return is 10%. The cost of equity is:
Select an option first.
Correct answer: A — 12.4%
Explanation: CAPM: Re = Rf + β(Rm − Rf) = 4% + 1.4 × (10% − 4%) = 4% + 1.4 × 6% = 4% + 8.4% = 12.4%. Note the MARKET RISK PREMIUM is (Rm − Rf) = 6%, not Rm. Multiplying beta by the full 10% gives 18% — a common error.
Question 89
An ASSET beta (unlevered beta) differs from an EQUITY beta because it:
Select an option first.
Correct answer: B — REMOVES the effect of FINANCIAL LEVERAGE — isolating business risk
Explanation: An EQUITY (levered) beta reflects BOTH business risk AND financial leverage. UNLEVERING it removes the leverage effect, isolating the ASSET (business) beta. To value a division, you take a comparable company's equity beta, UNLEVER it, then RELEVER it at your own capital structure — the pure-play method.
Question 90
A pure-play approach to estimating a division's cost of capital uses:
Select an option first.
Correct answer: B — Comparable SINGLE-BUSINESS companies' betas, unlevered and relevered to the division's capital structure
Explanation: Using the PARENT'S WACC for every division systematically over-invests in risky divisions and under-invests in safe ones. The PURE-PLAY method finds comparable single-business companies, UNLEVERS their betas to isolate business risk, and RELEVERS at the division's target structure.
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