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Free ACCA Advanced Financial Management Practice Questions & Answers
400 exam-style Advanced Financial Management questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 181
What is 'merger control' (antitrust review) and which bodies conduct it?
Select an option first.
Correct answer: B — Regulators assess whether the combined firm would have significant market power that could harm competition — in the UK: the Competition and Markets Authority (CMA); in the EU: the European Commission; in the US: the DOJ and FTC
Explanation: B is correct. Merger control: if the combined entity would substantially lessen competition (UK test) or create a dominant position (EU test), the deal may be blocked or remedies required (divestitures, behavioural commitments). Large deals are subject to mandatory pre-completion notification. A is accounting. C is the stock exchange listing function. D is financial regulation.
Question 182
What is a 'rights issue' and how does it work?
Select an option first.
Correct answer: B — An offer of new shares to existing shareholders at a discount to the current market price, in proportion to their existing holdings — shareholders can take up their rights, sell them, or let them lapse
Explanation: B is correct. Rights issue: existing shareholders have the right (not obligation) to subscribe for new shares at the offer price (typically 20–30% below market price). The theoretical ex-rights price (TERP) is the blended price after the issue. Rights have value = TERP − offer price. A describes a placing. C is a buyback. D is a placing to institutions.
Question 183
What is the 'theoretical ex-rights price' (TERP)?
Select an option first.
Correct answer: B — The expected share price after a rights issue, calculated as: (Old shares × Current price + New shares × Issue price) / Total shares after the issue — it represents the diluted price if all rights are taken up
Explanation: B is correct. TERP = (N × P_old + 1 × P_issue) / (N+1) for a 1-for-N rights issue. It is a weighted average of the old market price and the (discounted) issue price. A is just the subscription price. C and D are wrong.
Question 184
What is the value of a right per new share in a rights issue?
Select an option first.
Correct answer: B — TERP − Issue price — the value attributable to each new share (or TERP − Current price for the loss/gain per existing share)
Explanation: B is correct. Value of right per new share = TERP − Subscription price. Value per existing share = (TERP − Current price) × shares held (this represents the dilution). A rights holder who sells receives the value of the right without subscribing. A and D are wrong. C gives a different metric.
Question 185
What is 'dilution' in the context of a share issuance?
Select an option first.
Correct answer: B — A reduction in earnings per share and ownership percentage of existing shareholders when a company issues new shares — occurs because more shares now share the same (or a proportionately smaller) profit and the same ownership is now a smaller fraction of the total
Explanation: B is correct. Dilution: financial dilution = EPS falls if the new capital does not immediately generate proportionate returns. Ownership dilution = existing shareholders' percentage ownership falls. A rights issue minimises dilution for those who exercise rights (they retain their pro-rata share). A and C are wrong. D is deleveraging.
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Question 186
What is a 'tender offer' in a takeover bid?
Select an option first.
Correct answer: B — An offer made by an acquirer directly to the target's shareholders to buy their shares at a specified price (typically at a premium) — bypassing the target's board, used in both friendly and hostile takeovers
Explanation: B is correct. Tender offer: acquirer invites shareholders to tender (sell) their shares at the offer price. A minimum acceptance condition is usually set (e.g., 51%). If the required level is not reached, the offer lapses. UK: regulated by the Takeover Panel / City Code. A is a loan. C is a bond buyback (different). D is a merger.
Question 187
What is a 'share buyback' (repurchase) and why do companies do it?
Select an option first.
Correct answer: B — A company purchasing its own shares from the market or shareholders — reasons include: returning surplus cash to shareholders, signalling that shares are undervalued, improving EPS (fewer shares in denominator), and adjusting capital structure
Explanation: B is correct. Share buyback: uses cash to reduce share count. EPS increases mechanically (same earnings, fewer shares). Signals management confidence. Tax-efficient alternative to dividends (in some jurisdictions). However, it reduces financial flexibility and may be done at inopportune times (near market peaks). A is an equity stake. C is a rights issue. D is an employee share plan.
Question 188
What is the 'Modigliani-Miller dividend irrelevance theorem'?
Select an option first.
Correct answer: B — In a perfect capital market (no taxes, no transaction costs, rational investors), dividend policy does not affect firm value because investors can create their own preferred income stream by selling shares (homemade dividends) if dividends are too low
Explanation: B is correct. MM dividend irrelevance: if a firm doesn't pay a dividend, shareholders can sell shares for cash (homemade dividend). In reality, taxes, information asymmetry (dividend signalling), and transaction costs mean dividend policy does affect value. A reverses the theorem. C and D are wrong under the MM framework.
Question 189
What is the 'dividend signalling hypothesis'?
Select an option first.
Correct answer: B — A change in dividends signals management's view of the firm's future prospects — an increase signals confidence in future earnings; a cut signals difficulties. Because management knows more than investors (information asymmetry), dividend changes convey credible information
Explanation: B is correct. Signalling: dividends are 'sticky' (managers reluctant to cut) — so an increase is a credible signal of management optimism. A cut is taken very negatively by the market. Share buybacks are generally less binding commitments and carry a different (though related) signal. A is MM theorem. C overstates. D is partly right but ignores the different commitments.
Question 190
What is the 'clientele effect' in dividend policy?
Select an option first.
Correct answer: B — Different groups of investors (clienteles) prefer different dividend policies based on their tax positions and income needs — high-tax-rate investors prefer capital gains (low dividends); pension funds and income-seeking investors prefer high dividends. Changing dividend policy attracts different investors
Explanation: B is correct. Clientele effect (MM extension): tax positions and income needs differ across investors. Once established, changing dividend policy may cause transaction costs as the old clientele sells and a new clientele buys. Argues for consistency in dividend policy. A is management preference. C ignores investor preferences. D is wrong.
Question 191
What is a 'special dividend' and when might it be paid?
Select an option first.
Correct answer: B — A one-time cash payment to shareholders above and beyond the regular dividend — paid when the company has excess cash from: an asset sale, windfall profits, or a decision to return surplus capital. Unlike a buyback, it is distributed equally per share
Explanation: B is correct. Special dividend: non-recurring, often large. Signals that the management does not see opportunities to invest the excess cash at an adequate return (returns the cash to shareholders). Different from a regular dividend — doesn't signal a long-term commitment. A restricts to founders (wrong). C restricts to preference (wrong). D is wrong.
Question 192
What is a 'scrip dividend' (stock dividend)?
Select an option first.
Correct answer: B — A dividend paid in the form of new shares rather than cash — shareholders receive additional shares instead of a cash payment. Conserves the company's cash while still rewarding shareholders
Explanation: B is correct. Scrip dividend: no cash leaves the company. Shareholders receive more shares. EPS diluted (more shares, same earnings — though earnings grow as cash is retained). Tax treatment may differ from a cash dividend. Companies sometimes offer a choice: cash or scrip. A is a combination (wrong). C and D are wrong.
Question 193
What is 'dividend cover' and what does a ratio of 2 mean?
Select an option first.
Correct answer: B — Earnings per share divided by dividend per share — a cover of 2x means the company earned twice the dividend, suggesting the dividend is well-supported and there is scope for future increases
Explanation: B is correct. Dividend cover = EPS ÷ DPS = 2x → company retains half its earnings (dividend payout ratio = 50%). High cover = safe dividend, capacity for growth. Low cover (< 1) = paying out more than earned (unsustainable). A inverts the ratio to give dividend yield (approximately). C and D use wrong measures.
Question 194
What is the 'Dividend Discount Model' (DDM)?
Select an option first.
Correct answer: B — A model for valuing a share by discounting all expected future dividends at the required rate of return: P₀ = D₁/(Ke−g) for constant growth. It is the basis of the Gordon Growth Model for share valuation
Explanation: B is correct. DDM: present value of all future dividends. If dividends grow at constant rate g: P₀ = D₁/(Ke−g). Assumptions: constant growth, Ke > g. Used to estimate Ke: Ke = D₁/P₀ + g. A is dividend policy analysis. C contradicts the model's foundation. D: while preference shares have fixed dividends and suit the model, DDM applies to ordinary shares too.
Question 195
What is 'free cash flow yield' and how is it used?
Select an option first.
Correct answer: B — Free cash flow per share divided by the share price — a higher free cash flow yield suggests a company is generating more cash relative to its price, often indicating an undervalued or cash-generative company
Explanation: B is correct. FCF yield = FCF per share / Share price. Used to compare companies' valuation relative to their cash generation. A company with a high FCF yield relative to peers may be undervalued. Preferred by value investors. A is dividend yield. C is a price-to-book variant. D is a price-to-sales variant.
Question 196
What is 'financial gearing' (leverage) and how is it measured?
Select an option first.
Correct answer: B — The proportion of debt in a company's capital structure, typically measured as: (1) debt-to-equity (D/E) ratio; or (2) debt-to-capital (D/(D+E)); or (3) interest cover (EBIT/interest) as an earnings-based measure
Explanation: B is correct. Gearing measures: D/E (balance sheet gearing), D/(D+E) (capital gearing), interest cover (income statement gearing). High gearing: higher financial risk but potential for higher returns to equity (leverage effect). A is an asset ratio. C is an asset/liability ratio. D is net profit margin.
Question 197
What is the 'leverage effect' (financial gearing impact on ROE)?
Select an option first.
Correct answer: B — When a firm earns a return above its cost of debt, using debt magnifies the return on equity — but when returns fall below the cost of debt, losses are also magnified. This asymmetry is the double-edged nature of financial leverage
Explanation: B is correct. Leverage effect: ROE = ROA + (ROA − Kd) × (D/E). If ROA > Kd, gearing boosts ROE. If ROA < Kd, gearing depresses ROE below what it would be without debt. This is the fundamental risk-return trade-off of financial leverage. A is only true when ROA < Kd. C is wrong — leverage increases variability. D is too extreme.
Question 198
What is 'operating gearing' (operational leverage) and how does it affect risk?
Select an option first.
Correct answer: B — The proportion of fixed costs in a company's total cost structure — high operating gearing means large fixed costs relative to variable costs. Small changes in revenue cause large changes in operating profit, increasing business (operating) risk
Explanation: B is correct. Operating gearing: DOL (degree of operating leverage) = % change in EBIT / % change in sales. High fixed costs → high DOL → earnings volatile with sales. Capital-intensive industries (airlines, manufacturers) have high operating gearing. A is financial gearing. C is equity ratio. D is operating margin.
Question 199
What is the 'optimal capital structure' according to the trade-off theory?
Select an option first.
Correct answer: B — The capital structure that maximises firm value by balancing the tax benefits of debt (interest tax shield) against the costs of financial distress — a firm's optimal structure is where the marginal benefit of the tax shield equals the marginal cost of financial distress
Explanation: B is correct. Trade-off theory: V_levered = V_unlevered + PV(tax shield) − PV(financial distress costs). The optimal point varies by firm type: stable cash flow firms (e.g., utilities) can support more debt; volatile/high-growth firms should use less debt. A and C are extreme. D is arbitrary.
Question 200
What are 'agency costs of debt' and how do they arise?
Select an option first.
Correct answer: B — Conflicts between shareholders and debt holders — shareholders may take excessive risk (asset substitution), reject positive NPV projects if the gains accrue mainly to debt holders (underinvestment), or pay excessive dividends to strip assets. Debt holders anticipate these actions and charge higher rates or impose covenants
Explanation: B is correct. Agency costs of debt: asset substitution (risk shifting), underinvestment (debt overhang), dividend payment strategies (asset stripping). These costs reduce firm value and increase the cost of borrowing. Covenants (restrictions on dividends, additional debt, asset sales) and monitoring costs (required financial reporting) are mechanisms to address them. A is a management cost. C is the explicit cost of debt. D is a separate cost.
Question 201
What is a 'bond covenant' and what types exist?
Select an option first.
Correct answer: B — Contractual restrictions placed on the borrower in a bond indenture (loan agreement) to protect lenders — positive covenants (actions the borrower must take: maintain insurance, provide financial statements) and negative covenants (restrictions: cap on additional debt, limits on dividends, asset sale restrictions)
Explanation: B is correct. Covenants: positive (affirmative) = things the borrower must do. Negative (restrictive) = things the borrower must not do. Financial covenants: maintain minimum interest cover or maximum leverage ratio. Breach = event of default → lenders can demand immediate repayment. A is a payment schedule. C is credit rating. D is priority (seniority).
Question 202
What is the difference between 'senior' and 'subordinated' (junior) debt?
Select an option first.
Correct answer: B — In a liquidation or default, senior debt holders are paid in full before subordinated debt holders receive anything — senior debt has priority and therefore lower risk and lower yield; subordinated debt has more risk and demands higher yield
Explanation: B is correct. Priority in insolvency: secured senior debt > unsecured senior debt > subordinated (junior) debt > equity (preference then ordinary). Mezzanine debt is a form of subordinated debt. Higher risk = higher required yield. A partially overlaps but isn't the defining feature (unsecured senior can exist). C is partially right but not the definition. D is wrong.
Question 203
What is 'mezzanine debt' in a capital structure?
Select an option first.
Correct answer: B — A layer of financing between senior debt and equity in the capital structure — it is typically subordinated, higher-yielding, and may have equity-linked features (warrants or conversion rights). Commonly used in LBOs and growth financings where the firm needs more leverage than senior lenders will provide
Explanation: B is correct. Mezzanine: sits in the 'middle' of the capital structure. Higher risk than senior debt → higher yield (cash and PIK — payment in kind). Often includes equity kickers (warrants) to compensate lenders for subordinated risk. Commonly used to 'fill the gap' between senior debt capacity and equity in LBOs. A is a size definition. C is a maturity. D is a government finance scheme.
Question 204
What is 'convertible debt' and what are the benefits to the issuer?
Select an option first.
Correct answer: B — A bond or loan that gives the holder the right to convert into equity at a predetermined price (conversion price) — benefits to issuer: lower coupon than straight debt (holder pays for conversion option), enables equity issuance at a premium to current price, and can reduce bankruptcy risk if converted
Explanation: B is correct. Convertible bond: lower interest cost (option value reduces required coupon). If share price rises above conversion price, holders convert — debt becomes equity, deleveraging the balance sheet. Risk: dilution of existing shareholders on conversion. A is mandatory convertible (different). C is distress conversion. D is perpetual debt.
Question 205
What are 'warrants' attached to debt instruments?
Select an option first.
Correct answer: B — Options giving the holder the right to purchase shares in the issuing company at a fixed price (exercise price) for a fixed period — attached to bonds or preference shares to make them more attractive, effectively lowering the required coupon
Explanation: B is correct. Warrants: call options on the company's shares. If share price rises above exercise price, the warrant has value. Issuer benefit: reduces the coupon required (holders pay for the option). Unlike convertibles, warrants are exercisable alongside the bond (bond remains outstanding after exercise). A is a coupon. C is a put option (different). D is a credit default swap.
Question 206
What is the 'net debt position' of a company?
Select an option first.
Correct answer: B — Total debt (short-term + long-term) minus cash and cash equivalents — indicates the company's overall leverage position. Net cash = more cash than debt (negative net debt)
Explanation: B is correct. Net debt = Interest-bearing debt − Cash. A company with net cash position has no net leverage. Net debt/EBITDA is a common leverage metric for credit analysis. A is only short-term debt. C gives a different ratio. D gives EBIT minus interest = EBT.
Question 207
What is 'goodwill impairment' and what triggers it?
Select an option first.
Correct answer: B — A write-down of goodwill when the value of the acquired business (cash-generating unit) has fallen below its carrying value — tested at least annually under IFRS 3. Impairment reduces goodwill on the balance sheet and creates a non-cash charge in profit or loss
Explanation: B is correct. IFRS 3 / IAS 36: goodwill not amortised (unlike under US GAAP, which uses a simplified impairment model). Annual impairment test compares carrying amount to recoverable amount (higher of value in use and fair value less costs to sell). If carrying > recoverable → impairment loss (non-cash, P&L). A is wrong — IFRS doesn't amortise goodwill. C and D are wrong.
Question 208
What is 'value-based management' (VBM)?
Select an option first.
Correct answer: B — A management philosophy that focuses on maximising long-term shareholder value — uses value-creating metrics like EVA (Economic Value Added), CFROI (Cash Flow Return on Investment), or TSR (Total Shareholder Return) as primary performance measures, aligning management incentives with shareholder wealth creation
Explanation: B is correct. VBM: introduced by firms like McKinsey (Value = Free Cash Flow/WACC) and Stern Stewart (EVA). Key principle: only invest if return > cost of capital. Incentive alignment: bonuses tied to EVA or TSR rather than accounting profit. A focuses on short-term (wrong). C and D have different objectives.
Question 209
What is 'benchmarking' in financial performance assessment?
Select an option first.
Correct answer: B — Comparing a company's performance metrics against those of industry peers, best-in-class companies, or industry averages — enables relative performance assessment. Types: financial benchmarking (margins, returns), operational benchmarking (efficiency), and strategic benchmarking (competitive positioning)
Explanation: B is correct. Benchmarking: external comparison context. Without benchmarking, absolute metrics may be misleading (a 10% ROE looks different in a high-ROE vs low-ROE industry). Types: peer group benchmarking (same industry), cross-industry (best practice), temporal (own company over time). A is budgeting. C is intangible valuation. D is risk management.
Question 210
What is a 'balanced scorecard' approach to performance measurement?
Select an option first.
Correct answer: B — A strategic performance management framework that measures performance across four perspectives: financial, customer, internal business processes, and learning & growth — moves beyond purely financial metrics to capture leading indicators of future performance
Explanation: B is correct. Balanced scorecard (Kaplan and Norton, 1992): financial perspective (ROE, EPS growth), customer (satisfaction, retention, market share), internal processes (quality, cycle time, innovation), and learning & growth (employee satisfaction, training, information systems). A is an averaging technique. C is credit analysis. D is M&A screening.
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