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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 211
What is 'EBITDA' and why is it widely used by analysts?
Select an option first.
Correct answer: B — Earnings Before Interest, Tax, Depreciation and Amortisation — approximates operating cash flow and is widely used for: company comparisons across different capital structures, tax regimes, and accounting policies; leverage analysis (Net Debt/EBITDA); and as a basis for valuation multiples (EV/EBITDA)
Explanation: B is correct. EBITDA: removes the effects of financing (interest), taxes, and non-cash charges (D&A). Widely used in credit analysis and LBO modelling. Not a GAAP/IFRS measure — can be manipulated. Doesn't account for working capital or capex. A is wrong acronym. C is wrong. D: EBITDA ≠ free cash flow (ignores capex and working capital changes).
Question 212
What is a 'fairness opinion' in an M&A transaction?
Select an option first.
Correct answer: B — An independent opinion from an investment bank or financial adviser that the consideration offered in a merger or acquisition is fair from a financial point of view to the shareholders — typically obtained by the target board to support their recommendation
Explanation: B is correct. Fairness opinion: provided by an independent financial adviser (not the deal adviser who has a fee interest). Protects directors from fiduciary duty claims. States whether the offered consideration is within a 'fair' range based on DCF, comparable companies, and precedent transaction analysis. A is a solvency certificate. C is an audit opinion. D is regulatory clearance.
Question 213
What is the difference between 'book value' and 'market value' of equity?
Select an option first.
Correct answer: B — Book value is the accounting value of equity (total assets minus total liabilities per the balance sheet); market value is the current market capitalisation (share price × shares outstanding). Market value usually exceeds book value for profitable firms due to intangibles, growth prospects, and brand value
Explanation: B is correct. Book value: historical cost-based accounting equity. Market value: reflects investors' expectations of future cash flows, intangibles (brand, human capital), and growth. P/B > 1 for profitable firms; P/B < 1 can indicate distress or asset-heavy businesses where assets are undervalued. A and C are wrong. D: auditors certify financial statements, not market value.
Question 214
What is 'corporate governance' and why does it matter for finance?
Select an option first.
Correct answer: B — The system of rules, practices, and processes by which a company is directed and controlled — it matters for finance because weak governance increases agency costs, raises the cost of capital (investors demand a risk premium), and can lead to poor capital allocation and value destruction
Explanation: B is correct. Corporate governance: board structure, accountability, transparency, shareholder rights, audit quality. Good governance → lower cost of capital, better access to capital markets, higher valuations. UK: UK Corporate Governance Code ('comply or explain'). OECD Principles of Corporate Governance. A is operations management. C is accounting standards. D is takeover regulation.
Question 215
What is the 'principal-agent problem' in corporate finance?
Select an option first.
Correct answer: B — The conflict of interest arising when one party (agent — management) makes decisions on behalf of another (principal — shareholders) but their interests diverge — managers may prioritise salary, perks, job security, or empire-building over shareholder value maximisation
Explanation: B is correct. Principal-agent problem (Jensen and Meckling, 1976): shareholders can't perfectly monitor managers. Mitigation: performance-based pay (aligning incentives), board oversight, audit committee, activist investors, hostile takeovers (market for corporate control), and executive equity ownership. A is mathematical (wrong). C is a different conflict. D is a JV conflict.
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Question 216
What are 'executive share options' and how do they address agency problems?
Select an option first.
Correct answer: B — Rights given to executives to buy company shares at a fixed price (exercise price) in the future — if share price rises above the exercise price, the option is valuable. They align management interests with shareholders by rewarding share price performance
Explanation: B is correct. Executive share options (ESOs): align incentive of management with shareholders — executives only benefit if the share price rises (same goal as shareholders). Risks: executives may focus on short-term price boosting rather than long-term value, may time option exercises around information disclosure, and underwater options (price below exercise) provide no incentive. A is a competitor strategy. C is broader profit-sharing. D is wrong.
Question 217
What are 'long-term incentive plans' (LTIPs) and how do they differ from share options?
Select an option first.
Correct answer: B — Performance share plans where executive receives shares (not options) if pre-set performance targets (e.g., TSR vs peers, EPS growth) are met over a multi-year period (typically 3 years) — unlike options, executives receive real shares, and the awards are forfeited if performance targets are not met
Explanation: B is correct. LTIPs vs options: LTIPs deliver shares (not options), performance conditions apply (not just share price growth), executives can lose the award entirely if targets are missed. More aligned with long-term value than traditional options. A is a short-term bonus. C is pension. D is an option plan with long vesting.
Question 218
What is an 'accretive' vs 'dilutive' acquisition?
Select an option first.
Correct answer: B — An acquisition is EPS-accretive if the combined entity's EPS is higher than the acquirer's standalone EPS; EPS-dilutive if the combined EPS is lower. Accretion/dilution depends on the relative P/E ratios: buying a lower P/E target with shares is accretive
Explanation: B is correct. EPS accretion/dilution: if acquirer's P/E > target's P/E and paying with shares → combined EPS accretive. Cash acquisitions: depends on earnings yield vs after-tax cost of financing. Important: accretive doesn't mean value-creating (if overpaying, a deal can be accretive but NPV-negative). A is wrong. C and D are irrelevant to accretion.
Question 219
What is private equity (PE) and what are its main strategies?
Select an option first.
Correct answer: B — An asset class investing in companies that are not publicly listed — main strategies: venture capital (early-stage), growth equity (established growth companies), and buyouts (mature companies using leverage). PE firms aim to improve operations, grow the business, and exit profitably
Explanation: B is correct. PE: VC (start-ups, high risk), growth equity (profitable but capital-hungry), buyout/LBO (mature companies, operational improvement + leverage). Typical fund: 10-year closed-end, 2-and-20 fee structure. A restricts to public companies. C and D are different asset classes.
Question 220
What is carried interest in private equity?
Select an option first.
Correct answer: B — The share of profits (typically 20%) received by the general partner (GP) of a PE fund after returning the limited partners' capital and a preferred return (hurdle rate — typically 8%) — the primary performance incentive for fund managers
Explanation: B is correct. Carried interest: 20% of profits above hurdle. Mechanism: LPs get capital back + 8% preferred return → GP takes 20% of remaining profits. Only earned from successful investments. A is LBO debt interest. C is the management fee (2% p.a.). D is bond interest.
Question 221
What is project finance and how does it differ from corporate finance?
Select an option first.
Correct answer: B — A financing structure using a special purpose vehicle (SPV) that raises its own debt and equity — lenders are repaid from the project's cash flows alone (non-recourse or limited recourse). The sponsoring company's balance sheet is not directly at risk, unlike corporate finance where the company's full balance sheet backs the debt
Explanation: B is correct. Project finance: ring-fenced SPV, non-recourse. Common in infrastructure, energy, mining. Advantages: higher leverage, off-balance-sheet, risk allocation between sponsors, lenders, and offtakers (contracted revenues). A is too narrow. C and D are wrong.
Question 222
What is a debt-for-equity swap in financial restructuring?
Select an option first.
Correct answer: B — A transaction where debt holders exchange their debt claims for equity in the restructured company — used when a company cannot service its debt. The company's debt burden is reduced and lenders become shareholders. Original shareholders are typically diluted or wiped out
Explanation: B is correct. Debt-for-equity swap: distressed company restructuring. Lenders receive equity (usually majority), debt cancelled. Result: company deleveraged. Common in formal insolvency proceedings or negotiated out-of-court restructurings. A is an open market bond repurchase. C is an interest rate swap. D is wrong.
Question 223
What is post-merger integration (PMI) and why do many M&A deals fail to create value?
Select an option first.
Correct answer: B — The operational and cultural process of combining two merged organisations to realise planned synergies — many deals fail because: integration is harder and slower than expected, cultural clashes arise, key talent departs, IT systems are incompatible, and synergies are overestimated or the acquirer overpaid
Explanation: B is correct. PMI failure: research shows ~57% of mergers fail to create value. Key issues: integration complexity, cultural mismatch, customer churn, management distraction, winner's curse (overpaying). Best practice: 100-day integration plan, integration management office (IMO), talent retention bonuses, clear communication. A is legal. C is accounting. D is divestiture.
Question 224
What is return on invested capital (ROIC) and why is it important?
Select an option first.
Correct answer: B — NOPAT (net operating profit after tax) divided by invested capital (equity + net debt) — measures how efficiently a company generates profit from all invested capital. ROIC > WACC = value creation; ROIC < WACC = value destruction
Explanation: B is correct. ROIC = NOPAT / Invested capital. The key value creation test: if ROIC > WACC, every incremental £ of investment creates value. Drives decisions on: whether to grow, return cash, or restructure. A is a form of ROA. C is a revenue efficiency metric. D is ROE.
Question 225
What is the Altman Z-score?
Select an option first.
Correct answer: B — A financial formula combining five ratios that predicts the probability of corporate bankruptcy — Z > 2.99: low bankruptcy risk; 1.81–2.99: grey zone; < 1.81: high bankruptcy probability
Explanation: B is correct. Altman Z-score (1968): Z = 1.2(WC/TA) + 1.4(RE/TA) + 3.3(EBIT/TA) + 0.6(MVE/BVD) + 1.0(Rev/TA). Widely used in credit analysis and early warning systems. A is profitability analysis. C is an external rating. D uses only one dimension.
Question 226
What are agency costs of equity?
Select an option first.
Correct answer: B — Costs arising from the separation of ownership and control — shareholders (owners) delegate decisions to managers (agents) who may not always act in shareholders' best interests. Agency costs include: monitoring costs (audit, oversight), bonding costs (management pay structures), and residual loss (value destroyed by management decisions not in shareholders' interest)
Explanation: B is correct. Principal-agent problem (Jensen and Meckling, 1976): shareholders cannot perfectly monitor managers. Agency costs include: excessive executive pay, empire-building (over-acquisition), excessive perks, and under-investment. Mitigation: performance-based pay, board oversight, activist investors, and the threat of hostile takeover. A is investment management cost. C is issuance cost. D is dividends.
Question 227
What is 'mezzanine debt' in a capital structure?
Select an option first.
Correct answer: B — A layer of financing between senior debt and equity — typically subordinated, higher-yielding, and may include equity-linked features (warrants or conversion rights). Commonly used in LBOs and growth financings to fill the gap between senior debt capacity and equity
Explanation: B is correct. Mezzanine: sits in the 'middle' of the capital structure. Higher risk than senior debt → higher yield (cash + PIK — payment in kind). Often includes equity kickers (warrants). Used to maximise leverage in LBOs beyond what senior lenders provide. A is a size definition. C is a maturity. D is a government finance scheme.
Question 228
What is a preference share and how does it differ from an ordinary share?
Select an option first.
Correct answer: B — A hybrid security with preferential rights to a fixed dividend and priority over ordinary shares in liquidation — typically no voting rights. May be cumulative (unpaid dividends accumulate), convertible, or redeemable. Classified as debt under IAS 32 if mandatory dividends or redemption
Explanation: B is correct. Preference shares: fixed dividend (like debt characteristic), priority on winding up (before ordinary shares), typically no voting rights. Cumulative = missed dividends must be paid before ordinary dividends. Convertible = can convert to ordinary shares. A is a dual-class share. C is wrong. D is wrong.
Question 229
What is a dividend recap in private equity?
Select an option first.
Correct answer: B — A transaction where a PE-backed company takes on additional debt specifically to pay a large dividend to its equity holders (PE sponsors) — allows the PE sponsor to return capital to its investors without selling the company. Increases the company's financial risk
Explanation: B is correct. Dividend recap: PE sponsor causes the portfolio company to borrow more → pays cash dividend to the PE fund. Returns capital sooner (improves fund IRR) but loads the company with more debt. Controversial: company bears the increased risk while shareholders have already received the cash. A is a buyback. C is a capital reduction. D is a scrip dividend.
Question 230
What is a lock-up agreement in an IPO?
Select an option first.
Correct answer: B — An agreement by pre-IPO shareholders (founders, employees, PE investors) not to sell their shares for a specified period (typically 90–180 days) after the IPO — prevents a sudden flood of selling that could depress the newly listed share price
Explanation: B is correct. Lock-up: when the lock-up expires, there is often downward pressure on the share price as insiders may sell. Investment banks impose lock-ups to stabilise the post-IPO price and maintain investor confidence. A is a fundraising restriction. C is price stabilisation. D is a regulatory capital requirement.
Question 231
What is the greenshoe option (overallotment option) in an IPO?
Select an option first.
Correct answer: B — An option granted to the underwriting bank to sell up to 15% more shares than the original IPO size — used to stabilise the share price. If price rises: exercise greenshoe (buy at offer price, keep profit). If price falls: buy shares in the market to support price (cover the short position)
Explanation: B is correct. Greenshoe (named after the first company to use it): stabilisation mechanism. Over-allotment creates a short position. If stock rises: exercise greenshoe to cover. If stock falls: buy in market to support price. Limits post-IPO price volatility. A is wrong. C is wrong. D is wrong.
Question 232
What is the Merton model of credit risk?
Select an option first.
Correct answer: B — A structural credit risk model that views equity as a call option on the firm's assets — equity holders have the right to 'buy back' assets by repaying debt at maturity. If asset value < debt at maturity → default (option expires worthless). Uses Black-Scholes to price equity and derive implied default probability
Explanation: B is correct. Merton (1974): firm value = equity + debt. Equity = call option on firm value, strike = face value of debt, maturity = debt maturity. Default: V < D at maturity. Key outputs: implied default probability, credit spread. Extended to multi-period (KMV/Moody's Analytics). A is partially true but incomplete. C and D are wrong.
Question 233
What is vendor due diligence (VDD)?
Select an option first.
Correct answer: B — A due diligence report commissioned by the seller, prepared by independent advisers, and made available to potential buyers — used in auction processes to speed up timelines, reduce the number of separate buyer DD exercises, and standardise information. Buyers may still conduct confirmatory DD
Explanation: B is correct. VDD: seller-controlled DD. Benefits: faster process, seller manages sensitive disclosures, reduces target management distraction. Common in PE auction sales. A is buy-side DD. C is management information (not independent). D is a regulatory filing.
Question 234
What is drag-along and tag-along rights in PE shareholder agreements?
Select an option first.
Correct answer: B — Drag-along: majority shareholders can force minority shareholders to sell in a buyout (enables a clean 100% sale). Tag-along: minority shareholders can sell alongside the majority in a transaction (protects minority from being left with an unknown new majority owner)
Explanation: B is correct. Drag-along: majority drags minority into a sale. Tag-along: minority tags alongside majority. Both are contractual rights in shareholder agreements protecting different parties' interests. A is a veto right. C is a blocking right. D is a dividend preference.
Question 235
What is return on equity (ROE) and what are its three drivers (DuPont)?
Select an option first.
Correct answer: B — Profit after tax divided by total equity — DuPont decomposition: ROE = Net profit margin × Asset turnover × Financial leverage (equity multiplier). Identifies whether ROE is driven by profitability, efficiency, or leverage
Explanation: B is correct. ROE = PAT/Revenue × Revenue/Assets × Assets/Equity = margin × turnover × leverage. This decomposition identifies the three distinct drivers. A uses pre-tax profit and wrong denominator. C uses revenue. D uses EBIT.
Question 236
What is a fairness opinion in an M&A transaction?
Select an option first.
Correct answer: B — An independent opinion from a financial adviser that the consideration offered in a merger or acquisition is fair from a financial point of view to shareholders — typically obtained by the target board to support their recommendation and protect directors from fiduciary duty claims
Explanation: B is correct. Fairness opinion: from an independent financial adviser (not the deal adviser with a fee interest). States whether the consideration is within a 'fair' range based on DCF, comparable companies, and precedent transactions. Protects directors from shareholder lawsuits. A is a solvency certificate. C is an audit opinion. D is regulatory clearance.
Question 237
What is warranty and indemnity (W&I) insurance in M&A?
Select an option first.
Correct answer: B — Insurance covering financial losses from breaches of warranties given by the seller in the SPA — the insurer pays the buyer if a warranty claim arises. Allows sellers a clean exit and enables competitive auction processes by removing sellers' ongoing liability for warranty breaches
Explanation: B is correct. W&I insurance (buy-side): increasingly common in PE deals. Seller offers clean exit (no post-completion warranty exposure). Insurer conducts its own DD. Enables sellers to give stronger reps and warranties (backed by insurance) and buyers to make more competitive bids. A is deal abort insurance. C is D&O insurance. D is FX insurance.
Question 238
What is accretive vs dilutive acquisition?
Select an option first.
Correct answer: B — An acquisition is EPS-accretive if combined EPS is higher than the acquirer's standalone EPS; EPS-dilutive if combined EPS is lower. Accretion/dilution depends primarily on relative P/E ratios: buying a lower P/E target with shares is typically accretive
Explanation: B is correct. EPS accretion/dilution: if acquirer P/E > target P/E and paying with shares → accretive (lower-cost earnings acquired). Cash acquisition: depends on earnings yield vs after-tax financing cost. Important caveat: EPS accretion ≠ value creation. A deal can be accretive but NPV-negative if the acquirer overpaid. A is wrong. C and D are irrelevant.
Question 239
What is management equity participation in a PE-backed company?
Select an option first.
Correct answer: B — An arrangement where the management team co-invests alongside the PE sponsor and participates in equity returns — typically structured as 'sweet equity' (shares that participate disproportionately above a hurdle). Aligns management interests with investor objectives of generating high returns
Explanation: B is correct. Management equity: typically 5–20% of equity pool. Sweet equity: management shares kick in above a hurdle (e.g., above 1× the original investment). Strong alignment: management only benefits significantly from the same events that create returns for the PE sponsor. A is a bonus scheme. C is a broad ESOP. D is wrong.
Question 240
What is corporate governance and why does it matter for the cost of capital?
Select an option first.
Correct answer: B — The system of rules, practices and processes by which a company is directed and controlled — strong governance reduces agency costs, lowers the cost of capital (investors demand a smaller risk premium for better-governed firms), and improves capital allocation. UK: UK Corporate Governance Code ('comply or explain')
Explanation: B is correct. Corporate governance: board structure, accountability, transparency, shareholder rights, audit quality. Good governance → lower cost of capital, better market access, higher valuations. Poor governance → higher risk premium demanded by investors. A is operations management. C is accounting standards. D is takeover regulation.
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