You’re on a roll
Create a free account to save your ACCA progress, track your accuracy by topic, and pick up right where you left off.
Free Questions › ACCA › Financial Management
Free ACCA Financial Management Practice Questions & Answers
400 exam-style 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 301
What are 'financial distress costs' and how do they affect the optimal capital structure?
Select an option first.
Correct answer: B — Direct costs (e.g., legal/administration in bankruptcy) and indirect costs (e.g., loss of customers, key staff, suppliers tightening credit) that arise as gearing increases and default risk rises, limiting the optimal level of debt
Explanation: Financial distress costs (bankruptcy costs): as gearing rises, risk of default rises, and distress costs increase. These offset the tax shield benefit, giving an optimal gearing level where tax shield PV = distress cost PV. A, C and D are unrelated.
Question 302
What is the 'pecking order theory' of financing?
Select an option first.
Correct answer: B — Companies prefer internal funding (retained earnings) first, then debt if needed, and issue new equity only as a last resort
Explanation: Pecking order theory (Myers & Majluf): managers prefer internal finance (no information asymmetry issues), then debt (small signal to market), and avoid equity issuance (signals shares are overvalued). A reverses debt-equity preference; C is the static trade-off theory; D is wrong.
Question 303
Under the 'trade-off theory' of capital structure, what is the optimal gearing level?
Select an option first.
Correct answer: B — Where the marginal tax benefit of debt equals the marginal financial distress cost
Explanation: Trade-off theory: balance the PV of interest tax shields against the PV of financial distress costs. Optimal gearing: dVtax/d(D) = dVdistress/d(D) — where the marginal tax benefit equals the marginal distress cost. A is no-gearing (ignores tax shield); C ignores distress; D is arbitrary.
Question 304
What is 'dividend irrelevance theory' (Modigliani-Miller)?
Select an option first.
Correct answer: B — In a perfect capital market (no taxes, transaction costs, or information asymmetry), dividend policy is irrelevant to firm value — investors can create 'home-made dividends' by selling shares
Explanation: MM dividend irrelevance: in perfect markets, shareholders can replicate any dividend policy by buying/selling shares ('home-made dividends'). The total return (dividend + capital gain) is unchanged by dividend policy. A, C and D reflect 'dividend relevance' arguments.
Question 305
What is the 'clientele effect' in dividend theory?
Select an option first.
Correct answer: A — Companies attract investors who prefer their particular dividend policy, meaning changing dividend policy may lose existing investors and attract new ones
Explanation: The clientele effect: different investors prefer different dividend policies based on their tax position and income needs. A company that changes its dividend policy risks alienating its existing investor base. B, C and D are incorrect.
Get the full ACCA question bank — free
Drop your email and we'll send you fresh ACCA practice questions, fully worked solutions and exam-deadline reminders. No spam — unsubscribe in one click.
Want to save your score and take a full mock exam? Create a free account →
Question 306
What is meant by 'signalling' in dividend theory?
Select an option first.
Correct answer: B — Dividend changes signal management's view of future prospects — dividend increases signal confidence in future earnings; cuts signal deterioration
Explanation: Signalling theory: because management has information shareholders do not (information asymmetry), dividend changes are interpreted as signals. A sustained increase signals confidence; an unexpected cut often leads to a sharp share price fall. A, C and D are incorrect.
Question 307
Which of the following is a real-world market imperfection that makes dividend policy relevant?
Select an option first.
Correct answer: B — Taxes (different tax rates on dividends vs. capital gains), transaction costs, and information asymmetry make dividend policy potentially relevant to shareholder wealth
Explanation: In the real world, taxes (dividends taxed differently from capital gains), transaction costs (home-made dividends have costs), and signalling (information asymmetry) all make dividend policy relevant — contrary to MM perfect market assumptions. A, C and D describe the perfect market assumptions.
Question 308
What is the 'scrip dividend' (stock dividend)?
Select an option first.
Correct answer: B — An alternative to a cash dividend whereby shareholders receive additional shares instead of cash, conserving the company's cash
Explanation: A scrip dividend allows the company to retain cash while still rewarding shareholders with equity. Shareholders receive shares equivalent in value to the cash dividend they would have received. A, C and D are incorrect or describe different dividend types.
Question 309
What is the formula for calculating 'interest cover'?
Select an option first.
Correct answer: B — Earnings before interest and tax (EBIT) ÷ Interest expense
Explanation: Interest cover = EBIT ÷ Interest expense. It measures how many times operating profit covers interest payments. A uses net profit (after interest — circular); C mixes EBITDA and debt; D uses revenue (wrong).
Question 310
In the context of the CAPM, what is the 'security market line' (SML)?
Select an option first.
Correct answer: B — The straight line plotting expected return against beta for all assets, with intercept Rf and slope (Rm − Rf) — the graphical representation of CAPM
Explanation: The SML: E(R) = Rf + β(Rm − Rf). It plots the expected return for any asset given its beta. Assets above the SML are underpriced (buy); below are overpriced (sell). A, C and D are unrelated graphs.
Question 311
What does a high 'gearing ratio' imply about a company?
Select an option first.
Correct answer: B — High financial risk — the company has a high proportion of debt, meaning large fixed interest commitments which amplify earnings volatility and increase default risk
Explanation: High gearing: more debt → larger fixed interest payments → greater financial risk. If earnings fall, the fixed interest burden becomes harder to meet. A, C and D are not what high gearing implies.
Question 312
Which of the following factors would DECREASE a company's beta?
Select an option first.
Correct answer: C — Reducing gearing by repaying debt
Explanation: Lower gearing reduces financial risk, which reduces the equity beta. β_equity = β_asset × [1 + (1−T)(D/E)], so lower D/E reduces β_equity. A, B and D all increase beta (more systematic risk).
Question 313
What is the main assumption of the 'dividend growth model' (Gordon Growth Model) when used to estimate the cost of equity?
Select an option first.
Correct answer: B — Dividends grow at a constant rate (g) forever, allowing the formula P₀ = D₁/(ke − g) to be derived and rearranged for ke
Explanation: Gordon Growth Model assumption: constant perpetual growth rate g. From P₀ = D₁/(ke − g), we can derive ke = D₁/P₀ + g. A, C and D violate the model's assumptions.
Question 314
A company's shares are priced at $10, with a dividend of $0.60 just paid and expected growth of 5%. What is the cost of equity using the dividend growth model?
Select an option first.
Correct answer: A — 11.3%
Explanation: ke = D₁/P₀ + g = (0.60 × 1.05)/10 + 0.05 = 0.63/10 + 0.05 = 6.3% + 5% = 11.3%. B uses D₀ instead of D₁ (0.60/10 + 5% = 11%); C and D are wrong calculations.
Question 315
What is 'systematic risk' measured by in CAPM?
Select an option first.
Correct answer: B — Beta (β) — the measure of a security's sensitivity to market movements
Explanation: Beta measures systematic (market) risk: how much a stock moves when the market moves. β = cov(ri, rm)/var(rm). Standard deviation (A and C) measures total risk; D is the risk premium, not the risk measure.
Question 316
What is the impact of REDUCING the tax rate on a company's WACC?
Select an option first.
Correct answer: B — WACC increases (or the tax shield benefit decreases) because the after-tax cost of debt rises as tax relief is worth less
Explanation: kd(after-tax) = kd(pre-tax) × (1−T). Lower T → higher after-tax cost of debt → WACC increases (less benefit from the debt tax shield). A is the effect of increasing tax; C and D are wrong.
Question 317
What is a 'zero-coupon bond'?
Select an option first.
Correct answer: B — A bond that pays no periodic interest (coupon); instead, it is issued at a deep discount to face value and redeemed at face value, with the return being the capital gain
Explanation: Zero-coupon bonds: no periodic interest; issued below face value; return is the difference between issue price and face value at maturity. A (no principal) contradicts bond definition; C is a low-coupon bond; D is a convertible.
Question 318
What is the 'yield to maturity' (YTM) of a bond?
Select an option first.
Correct answer: B — The discount rate at which the present value of all future cash flows (coupon payments + repayment of principal) equals the current market price
Explanation: YTM is the IRR of the bond — the discount rate equating PV of all future cash flows to the current market price. It reflects the total return an investor earns if the bond is held to maturity. A is the coupon yield; C is market price; D is the coupon rate.
Question 319
What is the relationship between bond prices and interest rates?
Select an option first.
Correct answer: B — They move in opposite directions — when market interest rates rise, bond prices fall, and vice versa
Explanation: Inverse relationship: if rates rise, newly issued bonds offer higher coupons, making existing bonds (with lower coupons) less valuable. Their price must fall to equalise yields. A reverses the relationship; C and D are wrong.
Question 320
What is the definition of 'currency risk' (foreign exchange risk)?
Select an option first.
Correct answer: B — The risk that exchange rate movements adversely affect the value of foreign currency transactions, assets, or liabilities
Explanation: Currency (FX) risk arises when exchange rates change, affecting the home-currency value of foreign receipts, payments, assets, or liabilities. A is inflation risk; C is credit risk; D is political/country risk.
Question 321
What is a 'forward exchange rate'?
Select an option first.
Correct answer: B — An agreed exchange rate for a currency transaction that will take place at a specified future date, used to hedge currency risk
Explanation: A forward exchange rate is contractually agreed today for a transaction in the future (e.g., 3 months forward). It locks in the rate, eliminating the uncertainty of the future spot rate. A is the current rate; C is a forecast; D is fixed/official rates.
Question 322
What is the 'interest rate parity' theory?
Select an option first.
Correct answer: B — The forward exchange rate reflects the difference in interest rates between two countries — currencies with higher interest rates trade at a forward discount to compensate
Explanation: Interest rate parity (IRP): forward rate/spot rate = (1 + interest rate home)/(1 + interest rate foreign). Higher interest rate countries have their currency at a forward discount. A is unrealistic; C is purchasing power parity (different theory); D is untrue.
Question 323
What is purchasing power parity (PPP)?
Select an option first.
Correct answer: B — The theory that exchange rates between countries adjust over time to reflect differences in their inflation rates — countries with higher inflation see their currency depreciate
Explanation: PPP: if Country A has higher inflation than Country B, Country A's currency will depreciate to maintain equal purchasing power for identical goods. A is the law of one price (different concept); C ignores inflation; D is the gold standard.
Question 324
What is an 'interest rate swap'?
Select an option first.
Correct answer: B — An arrangement between two parties to exchange interest payments — typically swapping a fixed-rate obligation for a floating-rate one (or vice versa), to manage interest rate risk or achieve cheaper borrowing
Explanation: Interest rate swaps allow companies to change their exposure from fixed to floating (or vice versa), or to exploit comparative advantages in different credit markets. A, C and D are unrelated.
Question 325
What is 'transaction exposure' in foreign exchange risk management?
Select an option first.
Correct answer: B — The risk arising from agreed foreign currency transactions (existing contracts) where the exchange rate may change before settlement
Explanation: Transaction exposure: real cash flows at risk from agreed (committed) FX transactions not yet settled. Translation exposure (A) is accounting risk from consolidating foreign subsidiaries. C is competitive risk; D is interest rate-FX linkage.
Question 326
Using CAPM, if a company has β = 0.8, Rf = 4%, and Rm = 10%, what is the required return on equity?
Select an option first.
Correct answer: A — 8.8%
Explanation: ke = Rf + β × (Rm − Rf) = 4% + 0.8 × (10% − 4%) = 4% + 0.8 × 6% = 4% + 4.8% = 8.8%. B only uses β × Rf; C uses β × Rm; D is just Rm − 2%.
Question 327
A company has the following capital structure (at market values): Equity $6m, Debt $4m, Tax rate 25%, kd = 6%, ke = 12%. What is the WACC?
Select an option first.
Correct answer: D — 8.7%
Explanation: WACC = [12% × 6/10] + [6%(1−25%) × 4/10] = [12% × 0.6] + [4.5% × 0.4] = 7.2% + 1.8% = 9.0%. Answer B ($9%) is correct. Let me recheck: ke weight = 6/(6+4) = 0.6; kd(after-tax) = 6% × 0.75 = 4.5%; kd weight = 4/10 = 0.4. WACC = 7.2% + 1.8% = 9.0%. B is correct.
Question 328
According to MM Proposition II (with no tax), what happens to the cost of equity (ke) as gearing increases?
Select an option first.
Correct answer: C — ke increases proportionally to offset the benefit of cheaper debt, keeping WACC constant
Explanation: MM (no tax) Prop II: as debt/equity ratio rises, ke increases: ke = Keu + (Keu − kd) × D/E. The increase in ke exactly offsets the effect of cheaper debt, leaving WACC unchanged. A and D are wrong; B is the WACC result, not the ke result.
Question 329
What is the Modigliani-Miller formula for the cost of equity in a geared firm (with tax)?
Select an option first.
Correct answer: B — ke = Keu + (Keu − kd)(1 − T)(D/E)
Explanation: MM with tax: ke = Keu + (Keu − kd)(1 − T)(D/E). As gearing rises, ke rises but less steeply than without tax (because debt interest is tax-deductible, the financial risk added per unit of gearing is lower). A is ungeared; C and D are wrong formulas.
Question 330
A company's ungeared cost of equity is 12% and its pre-tax cost of debt is 8%. Tax rate is 25%. If D/E = 0.5, what is the geared cost of equity using MM (with tax)?
Select an option first.
Correct answer: B — 12% + (12% − 8%) × 0.75 × 0.5 = 13.5%
Explanation: ke = Keu + (Keu − kd)(1−T)(D/E) = 12% + (12% − 8%) × 0.75 × 0.5 = 12% + 4% × 0.375 = 12% + 1.5% = 13.5%. A is ungeared (no adjustment); C and D are wrong calculations.
More free ACCA topics
Management Accounting401
Financial Accounting400
Corporate and Business Law400
Performance Management400
Financial Reporting400
Strategic Business Reporting400
Advanced Financial Management400
Advanced Performance Management400
Advanced Taxation400
Business and Technology300
Taxation300
Audit and Assurance300
Strategic Business Leader300
Advanced Audit and Assurance296
Ten questions in
- The ones you miss are saved as a drill you can repeat
- Your place is kept, on this device and any other
- A streak, if that is the thing that gets you back tomorrow
Every question on this page stays free and open either way.