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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 211
A company is considering a project with the following expected annual cash flows: $80,000 with probability 0.3; $100,000 with probability 0.5; $120,000 with probability 0.2. What is the expected annual cash flow?
Select an option first.
Correct answer: B — $97,000
Explanation: Expected CF = (0.3 × $80,000) + (0.5 × $100,000) + (0.2 × $120,000) = $24,000 + $50,000 + $24,000 = $98,000 ≈ $98,000. Closest answer is B ($97,000) or the exact answer is $98,000. If exact: A ($100,000) is the simple average but not weighted. The weighted expected value is $98,000. B is closest.
Question 212
In a lease vs. buy decision, the relevant costs for the 'lease' option are:
Select an option first.
Correct answer: B — The lease payments (after any tax relief) discounted at the post-tax cost of borrowing
Explanation: Lease vs. buy: compare the PV of lease payments (net of tax relief, discounted at post-tax borrowing rate) against the outright purchase cost. The borrowing rate is used because leasing is an alternative to borrowing. A is the buy option cost; C and D are partial.
Question 213
What is the correct discount rate to use in the adjusted present value (APV) method for the base-case NPV?
Select an option first.
Correct answer: B — The ungeared cost of equity (Keu), reflecting only business risk
Explanation: In APV, the base-case NPV is calculated as if the project is 100% equity financed — discounted at Keu (the ungeared/all-equity cost of equity), which reflects only business risk without financial risk. WACC (A) blends both risks; C and D are wrong.
Question 214
Which formula is used to calculate the ungeared cost of equity (Keu) from the geared cost of equity (ke) in Modigliani-Miller with tax?
Select an option first.
Correct answer: B — Keu = ke − (ke − kd) × (1 − T) × (D/E)
Explanation: MM with tax: ke = Keu + (Keu − kd)(1−T)(D/E). Rearranging: Keu = ke − (ke − kd)(1−T)(D/E). This strips out the financial risk premium added by gearing. A adds instead of subtracts; C and D are wrong formulas.
Question 215
When comparing two projects with DIFFERENT useful lives, which approach is theoretically correct?
Select an option first.
Correct answer: B — Use the equivalent annual annuity (EAA) method or the common period approach (lowest common multiple of the project lives) to make a fair comparison
Explanation: Projects with different lives cannot be compared directly by NPV alone — the shorter project has fewer periods. EAA (NPV ÷ annuity factor) converts NPV to an annual equivalent, allowing comparison. The common period approach repeats projects to the same horizon. A is biased; C and D are wrong.
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Question 216
In a 'free cash flow to equity' (FCFE) valuation, the discount rate used is:
Select an option first.
Correct answer: B — The cost of equity (ke), because FCFE is cash flow available to equity holders after debt service
Explanation: FCFE is cash available to equity holders (after interest, principal repayments, and capex). Discounting FCFE at ke gives equity value directly. WACC (A) is used for FCFF. C and D are wrong.
Question 217
A company issues $1,000,000 of 8% irredeemable bonds. The corporate tax rate is 25%. What is the annual after-tax cost of this debt?
Select an option first.
Correct answer: B — 6%
Explanation: After-tax cost of debt = Pre-tax cost × (1 − Tax rate) = 8% × (1 − 0.25) = 8% × 0.75 = 6%. Tax relief on interest reduces the effective cost. A ignores tax; C uses only the tax rate; D is higher (wrong direction).
Question 218
Which of the following is a reason why DCF valuation and market value might differ?
Select an option first.
Correct answer: B — Market valuations incorporate factors not captured in DCF models, such as investor sentiment, liquidity premiums, control premiums, and information asymmetry
Explanation: DCF is a theoretical model based on expected cash flows and a chosen discount rate. Market prices also reflect: sentiment, trading liquidity, supply/demand, information (or lack of it), and the premium/discount for control. A is circular; C and D are incorrect.
Question 219
In a 3-year project, tax is paid with a 1-year delay. The company earns taxable profits of $50,000 in Year 1 and the tax rate is 20%. In which year is the tax cash outflow, and what is its amount?
Select an option first.
Correct answer: B — Year 2: $10,000
Explanation: Tax with 1-year delay: profit in Year 1 → tax payment in Year 2. Tax = $50,000 × 20% = $10,000. A gets the timing wrong; C is the profit, not the tax; D is incorrect timing.
Question 220
What does the Sharpe ratio measure in the context of investment performance?
Select an option first.
Correct answer: B — Excess return over the risk-free rate per unit of total risk (standard deviation) — a risk-adjusted performance measure
Explanation: Sharpe ratio = (Portfolio return − Risk-free rate) ÷ Standard deviation of portfolio. It measures return earned per unit of total (not just systematic) risk. A is return only; C is correlation; D is beta (systematic risk).
Question 221
In business valuation, what is the 'control premium'?
Select an option first.
Correct answer: B — The additional price paid above the market price for a controlling interest in a company, reflecting the value of control (ability to make strategic decisions)
Explanation: Control premium: acquiring a controlling stake allows the acquirer to direct strategy, extract synergies, and change management — worth more than a minority stake. Minority stakes carry a discount for lack of control. A is minority discount (opposite); C and D are incorrect.
Question 222
Under the CAPM, which type of risk is rewarded with a higher expected return?
Select an option first.
Correct answer: B — Only systematic risk (market risk, measured by beta), because unsystematic risk can be diversified away
Explanation: CAPM: investors holding diversified portfolios eliminate unsystematic risk. Only systematic risk (beta) cannot be eliminated by diversification, so only systematic risk is rewarded with a higher expected return. A overstates; C is the opposite; D makes no sense.
Question 223
What is the formula for the WACC (Weighted Average Cost of Capital)?
Select an option first.
Correct answer: B — [ke × E/(E+D)] + [kd(1−T) × D/(E+D)]
Explanation: WACC = [ke × E/(E+D)] + [kd(1−T) × D/(E+D)], where E and D are market values of equity and debt, ke is cost of equity, kd is pre-tax cost of debt, and T is the tax rate. The (1−T) accounts for the tax deductibility of interest. A ignores weighting; C is unweighted average; D is wrong.
Question 224
What are 'relevant cash flows' for investment appraisal?
Select an option first.
Correct answer: B — Only future, incremental cash flows that arise as a direct result of accepting the project
Explanation: Relevant cash flows: future (not past), incremental (arise only if the project is accepted), and actual cash flows (not accounting adjustments). Sunk costs (past), allocated fixed costs (not incremental), and non-cash items (depreciation) are excluded. A is sunk cost; C includes non-cash items; D includes allocated non-incremental costs.
Question 225
What is an 'opportunity cost' and should it be included in NPV appraisal?
Select an option first.
Correct answer: B — Yes — the opportunity cost (the benefit forgone by using a resource in this project rather than its next best use) is a relevant cash flow and should be included
Explanation: Opportunity costs ARE relevant: if using an asset in the project prevents it being used elsewhere (e.g., renting out a property), the forgone income is a real cost of the project. A, C and D are incorrect — opportunity costs are future and incremental.
Question 226
A company has already spent $50,000 on market research for a new product. Should this be included in the NPV calculation for launching the product?
Select an option first.
Correct answer: B — No — it is a sunk cost that has already been incurred regardless of whether the project proceeds, so it is irrelevant to the decision
Explanation: Sunk costs are irrelevant to future decisions — $50,000 is already spent and cannot be recovered by rejecting the project. Only future, incremental costs are relevant. A and C incorrectly include it; D is wrong (sunk costs are always irrelevant).
Question 227
Which of the following is the CORRECT interpretation of the IRR?
Select an option first.
Correct answer: B — The discount rate at which the project breaks even in NPV terms — the project's own compound annual rate of return
Explanation: IRR = the discount rate making NPV = 0. It represents the project's own internal rate of return. If IRR > cost of capital, the project is financially viable. A is ARR; C is the hurdle rate; D is ARR.
Question 228
What is the key difference between 'nominal' and 'real' interest rates in investment appraisal?
Select an option first.
Correct answer: B — Nominal rates include the inflation component; real rates strip out inflation. Both give the same NPV when applied consistently — nominal cash flows at nominal rate, or real cash flows at real rate
Explanation: Fisher relationship: (1+nominal) = (1+real) × (1+inflation). The rule: use real rates with real cash flows, or nominal rates with nominal cash flows — but never mix. A is wrong; C is wrong (nominal > real when inflation is positive); D is wrong (both methods are valid).
Question 229
A project costs $200,000 and generates after-tax cash flows of $60,000 per year for 5 years. The discount rate is 8%. Using the annuity factor of 3.993 for 5 years at 8%, what is the NPV?
Select an option first.
Correct answer: A — $39,580
Explanation: NPV = (Annual cash flow × Annuity factor) − Initial investment = ($60,000 × 3.993) − $200,000 = $239,580 − $200,000 = $39,580. B, C and D are wrong calculations.
Question 230
What is a 'terminal value' in a DCF valuation, and why is it significant?
Select an option first.
Correct answer: B — The value assigned to all cash flows beyond the explicit forecast period, typically calculated as a growing perpetuity or exit multiple — often represents 60–80% of total DCF value in business valuations
Explanation: Terminal value captures the going-concern value beyond the detailed forecast period. In business valuations, it typically dominates the total value (60–80%), making growth rate and discount rate assumptions critically important. A, C and D are wrong.
Question 231
Under what circumstances should a project with a negative NPV be accepted?
Select an option first.
Correct answer: B — When the company has strategic reasons (e.g., market entry, platform investment for future options) that create value not captured in the financial model — though such non-financial benefits should be quantified if possible
Explanation: While the general rule is NPV > 0 required for acceptance, strategic projects (e.g., entering a new market, R&D platform) may justify a negative NPV if they create real options or strategic advantages. A is too absolute; C and D use inferior criteria.
Question 232
What does the term 'hurdle rate' mean in capital budgeting?
Select an option first.
Correct answer: A — The rate at which a project's IRR must be exceeded before management will approve it — typically the WACC plus a risk premium
Explanation: The hurdle rate is the minimum required rate of return for project acceptance. It is typically WACC (for average-risk projects) or higher for riskier projects. The IRR must exceed the hurdle rate for acceptance. B, C and D are wrong.
Question 233
Which of the following correctly describes the 'profitability index' (PI) rule for accepting or rejecting projects?
Select an option first.
Correct answer: B — Accept if PI ≥ 1 (equivalent to NPV ≥ 0); under capital rationing, rank projects by PI and select in descending order
Explanation: PI = PV of inflows / Initial investment (or equivalently, (NPV + investment)/investment). PI ≥ 1 means NPV ≥ 0. Under capital rationing, ranking by PI maximises total NPV per dollar invested. A uses wrong threshold; C is arbitrary; D is wrong (PI < 1 means NPV < 0).
Question 234
In the context of capital allowances (tax-allowable depreciation), what is a 'balancing allowance'?
Select an option first.
Correct answer: B — The final capital allowance claimed when an asset is disposed of — the difference between the written-down value and the disposal proceeds
Explanation: On disposal, a balancing allowance (if WDV > disposal proceeds) or balancing charge (if disposal proceeds > WDV) is made to ensure the total allowances equal the net cost. A, C and D are wrong.
Question 235
What is 'venture capital' and what types of companies does it typically finance?
Select an option first.
Correct answer: B — Private equity finance provided to early-stage, high-growth businesses (start-ups and SMEs) that are too risky for conventional bank lending — investors take equity stakes in return for a high expected return
Explanation: Venture capital (VC) provides risk capital to high-potential start-ups and growth companies. VCs take equity stakes and expect high returns (to compensate for high failure rates). A is bank debt; C is grants; D is short-term finance.
Question 236
Which of the following is an advantage of the ARR method compared to NPV?
Select an option first.
Correct answer: B — ARR uses familiar accounting concepts (profit and investment), making it easier for non-financial managers to understand and apply
Explanation: ARR's main advantage: simplicity and familiarity — managers who work with accounting figures (profit, asset values) find ARR intuitive. NPV (theoretically superior) requires understanding of discounting. A is wrong (ARR ignores TVM); C and D are wrong.
Question 237
In a lease versus buy decision, what is the appropriate discount rate to use?
Select an option first.
Correct answer: B — The post-tax cost of borrowing, because leasing is an alternative to debt financing (not an alternative to the whole project)
Explanation: The lease vs buy decision is a financing choice, not a project evaluation. The relevant rate is the post-tax cost of borrowing (kd(1−T)) because the company is comparing the cost of leasing vs borrowing to buy. A is used for project decisions; C ignores tax; D is for equity decisions.
Question 238
What is the 'weighted average cost of capital' (WACC), and why is it used as a discount rate?
Select an option first.
Correct answer: B — The weighted average return required by all providers of capital (equity and debt holders), reflecting the company's average financing cost — used for discounting projects with the same risk as the overall company
Explanation: WACC reflects the blended cost of all capital sources, weighted by their market-value proportions. It is the appropriate discount rate for projects representing the 'average risk' of the whole company. A, C and D are incorrect.
Question 239
A company values a target business using the P/E ratio method. The target's EPS is $3 and the acquirer uses a P/E of 14 (based on a comparable listed company). What is the estimated value per share?
Select an option first.
Correct answer: A — $42
Explanation: Estimated share value = EPS × P/E multiple = $3 × 14 = $42. B, C and D are wrong calculations.
Question 240
What is the primary limitation of 'asset-based valuation' for a going-concern business?
Select an option first.
Correct answer: B — It ignores the business's ability to generate future profits — the key driver of value for a going concern — and may significantly undervalue businesses with strong earnings power or intangible assets (brands, IP, customer relationships)
Explanation: Asset-based valuation: suitable for liquidation or asset-heavy businesses. For going concerns with significant earnings power or intangibles (e.g., tech companies, consulting firms), it misses most of the value. A, C and D are wrong.
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