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ACCA FM: Financial Management Practice Questions
45 original practice questions for ACCA Financial Management (FM), written for this site with full explanations. They are original questions in the style of the syllabus - not taken from any official exam. Use them to test coverage, then confirm details against ACCA's official materials.
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Working capital is defined as:
Correct answer: B. Working capital is current assets (inventory, receivables, cash) minus current liabilities (payables, overdrafts), representing the net resources tied up in day-to-day operations. Total assets less total liabilities is equity, non-current assets less long-term debt is not a standard measure, and cash plus inventory ignores receivables and all current liabilities. -
An aggressive working capital funding policy is one in which a company:
Correct answer: D. An aggressive policy pushes short-term finance further down the balance sheet, funding some permanent current assets with short-term sources; this is cheaper (short-term rates are usually lower) but riskier, because facilities may not be renewed. Large buffers describe a conservative investment policy, all-equity funding is a capital structure choice rather than a working capital policy, and using long-term finance for all current assets is the conservative funding approach. -
A company has inventory days of 60, receivables days of 45 and payables days of 40. Its cash operating cycle is:
Correct answer: A. The cash operating cycle is inventory days plus receivables days minus payables days: 60 + 45 - 40 = 65 days, the time between paying suppliers and collecting from customers. 145 days adds all three figures, 25 days subtracts receivables as well as payables (60 - 45 + 40 would also be wrong ordering), and 55 days has no basis in the calculation. -
Which combination of symptoms most clearly indicates overtrading (undercapitalisation)?
Correct answer: C. Overtrading occurs when a business grows faster than its long-term capital base: sales expand quickly, inventory and receivables balloon, and the growth is financed by stretching payables and the overdraft, so liquidity ratios deteriorate even while reported profits rise. Falling revenue with rising cash is the opposite situation, stable figures indicate equilibrium, and paying high dividends from surplus cash is a sign of excess liquidity, not undercapitalisation. -
A company uses 10,000 units of a component each year. The cost of placing an order is $25 and the annual cost of holding one unit is $2. Using the economic order quantity model, the EOQ is:
Correct answer: A. EOQ = square root of (2 x annual demand x order cost / holding cost per unit) = sqrt(2 x 10,000 x 25 / 2) = sqrt(250,000) = 500 units. 250 units results from forgetting the factor of 2 in the numerator (sqrt(125,000) is about 354, so 250 also fails that check), 1,000 units doubles the correct answer, and 125 units confuses the inputs; only 500 satisfies the formula. -
Which of the following actions would most directly reduce a company's receivables collection period?
Correct answer: C. An early settlement discount gives customers an incentive to pay sooner, directly shortening the average collection period, although the discount has a cost that should be evaluated. Extending credit terms lengthens the collection period, inventory buffers affect inventory days rather than receivables, and delaying supplier payments changes payables days, not receivables. -
A supplier offers a 2% discount for payment within 10 days instead of the normal 60 days. The approximate simple annual cost of refusing the discount is 2/98 x 365/50, roughly 15%. If the company can borrow on overdraft at 10% per year, it should:
Correct answer: D. Refusing the discount means paying 2% more for 50 extra days of credit, an annualised cost of about (2/98) x (365/50), roughly 15%. Financing the early payment on the overdraft costs only 10% per year, so taking the discount is worthwhile. The blanket claim that discounts reduce profit ignores this financing comparison, doing neither is not an available choice, and comparing 10% directly with the raw 2% ignores the time period, which is the whole point of annualising. -
The key difference between factoring and invoice discounting is that:
Correct answer: B. Factoring is a fuller service: the factor advances cash against invoices and usually takes over sales ledger administration and collection, which customers can see. Invoice discounting is a confidential loan against invoices, with the company continuing to run its own credit control. Bad debt protection depends on whether the arrangement is non-recourse, not on which product it is; both products are available domestically; and invoice discounting is a revolving finance arrangement, not a permanent sale of the whole book. -
Holding cash as a buffer against unexpected shortfalls or emergencies reflects which motive for holding cash?
Correct answer: D. The precautionary motive is holding cash as a safety margin against unforeseen outflows or delays in receipts. The transactions motive covers cash needed for routine, predictable payments such as wages and suppliers, the speculative motive covers holding cash to exploit unexpected opportunities, and the dividend motive is not one of the recognised motives for holding cash. -
A project requires an investment of $300,000 and generates cash inflows of $75,000 per year. Its payback period is:
Correct answer: A. With constant annual inflows, payback = initial investment / annual inflow = 300,000 / 75,000 = 4 years. The other options do not follow from the figures: 3 years would need inflows of $100,000, 5 years would need $60,000, and 2.5 years would need $120,000 per year. -
A project has a positive net present value when discounted at the company's cost of capital. This means the project:
Correct answer: B. A positive NPV means the present value of expected inflows exceeds the outlay at the required return, so the project is expected to add that amount to shareholder wealth - the standard acceptance criterion. NPV says nothing about paying back within one year, a positive NPV implies the IRR is above (not below) the cost of capital, and rejection would only follow from a negative NPV. -
The present value of $1 receivable in two years at a discount rate of 10% is closest to:
Correct answer: C. The two-year discount factor at 10% is 1 / (1.10 x 1.10) = 1 / 1.21 = 0.826, so $1 in two years is worth about $0.826 today. $0.909 is the one-year factor (1/1.10), $1.210 is the compound factor for growing forwards rather than discounting back, and $0.800 would correspond to a rate of about 11.8%, not 10%. -
A project costs $110,000 and returns $40,000 per year for four years. The four-year annuity factor at 10% is 3.170. The project's NPV is closest to:
Correct answer: C. The present value of the inflows is 40,000 x 3.170 = $126,800, so NPV = 126,800 - 110,000 = $16,800. $50,000 is the undiscounted surplus (160,000 - 110,000), $126,800 is the present value of inflows before deducting the investment, and $36,800 does not follow from the calculation. -
The internal rate of return (IRR) of a project is the discount rate at which:
Correct answer: B. The IRR is the discount rate that makes NPV exactly zero; if the cost of capital is below the IRR, the project has a positive NPV. It has no direct link to payback, the cash flows themselves do not change with the discount rate (only their present values do), and the accounting rate of return is a profit-based measure unrelated to the IRR definition. -
Two mutually exclusive projects give conflicting rankings: Project A has the higher NPV, Project B the higher IRR. Which project should be chosen, and why?
Correct answer: A. When rankings conflict, NPV is theoretically superior: it measures the absolute wealth added and assumes reinvestment at the cost of capital, a more realistic assumption than the IRR's implicit reinvestment at the IRR itself. A higher percentage on a smaller or differently timed investment can add less total value, conflicting rankings do not make projects unacceptable (both may have positive NPVs), and payback ignores total value creation entirely. -
Which of the following should be included as a relevant cash flow in an NPV appraisal?
Correct answer: D. Relevant cash flows are future, incremental cash flows, which includes opportunity costs such as rent forgone because the project uses the warehouse. Market research already paid is a sunk cost, allocated overheads that do not change in total involve no incremental cash movement, and depreciation is an accounting entry rather than a cash flow (though tax effects of capital allowances, where applicable, would be relevant). -
A company's real cost of capital is 5% and expected general inflation is 4%. Using the Fisher relationship, the nominal (money) cost of capital is closest to:
Correct answer: A. The Fisher equation compounds rather than adds: (1 + nominal) = (1 + real) x (1 + inflation) = 1.05 x 1.04 = 1.092, so the nominal rate is 9.2%. Adding the rates gives the 9.0% approximation, which ignores the cross-term; 0.96% comes from dividing the factors instead of multiplying; and 5.0% is the real rate left unadjusted. Nominal cash flows should be discounted at this nominal rate. -
A major criticism of the payback method of investment appraisal is that it:
Correct answer: D. Payback measures only how quickly the outlay is recovered, so a project with large returns after the cutoff can be rejected in favour of one that merely repays quickly; basic payback also ignores the time value of money within the payback period. Its simplicity is actually its main attraction, it needs no special computation, and far from overweighting distant flows, it ignores them completely. -
An investment promises a constant cash inflow of $12,000 per year in perpetuity. At a discount rate of 8%, its present value is:
Correct answer: C. The present value of a level perpetuity is the annual cash flow divided by the discount rate: 12,000 / 0.08 = $150,000. $96,000 multiplies 12,000 by 8, $120,000 multiplies by 10 (equivalent to using a 10% rate), and $960,000 misplaces the decimal in the division. -
A rights issue is:
Correct answer: B. A rights issue invites existing shareholders to subscribe for new shares pro rata to their holdings, typically at a discount, which raises new cash while protecting them from dilution of control if they take up their rights. A public offer targets new investors, a bonus issue capitalises reserves and raises no cash, and convertible loan notes are debt, not an equity rights offer. -
A share trades at $5.00 cum-rights. A 1-for-4 rights issue is made at $3.00 per share. The theoretical ex-rights price (TERP) is:
Correct answer: D. TERP is the weighted average of the old shares and the new share: (4 x 5.00 + 1 x 3.00) / 5 = 23.00 / 5 = $4.60. $5.00 is the old cum-rights price, which must fall because the new shares are issued below it; $4.00 is a simple average of the two prices ignoring the 4:1 weighting; and $3.00 is the subscription price itself. -
Which statement correctly contrasts debt finance with equity finance?
Correct answer: B. Interest must be paid regardless of profits and is normally deductible for tax, while dividends are paid at the directors' discretion out of post-tax earnings. The other statements invert reality: interest obligations come before discretionary dividends, voting rights normally belong to ordinary shareholders rather than lenders, and in a liquidation debt ranks ahead of equity, which is why equity investors demand higher returns. -
Convertible loan notes are best described as:
Correct answer: C. Convertibles start life as debt and carry an option for the holder to exchange them for equity on set terms; the value of that option lets issuers offer a lower coupon than straight debt. They are not shares redeemable for cash on demand, an issuer cannot simply cancel debt without repaying it (repayment applies if conversion is not chosen), and preference shares are a different instrument entirely. -
Debt finance is generally cheaper for a company than equity finance because:
Correct answer: A. Lenders rank ahead of shareholders for income and capital and are often secured, so they accept a lower return, and tax relief on interest reduces the effective cost further. Comparing raw interest rates to dividend yields ignores capital growth in equity returns and does not hold universally, debt issues do carry arrangement fees, and most debt must be repaid or refinanced at maturity. -
When evaluating whether to lease an asset or to buy it with a bank loan, the cash flows of each option should be discounted at:
Correct answer: C. Lease-versus-buy is a financing decision between two low-risk, debt-like sets of cash flows, so the comparison uses the after-tax cost of borrowing as the discount rate. The project's IRR relates to the investment decision, which is made separately; the dividend growth rate is an input to equity valuation; and a CAPM equity return reflects business risk that is irrelevant to comparing two financing methods. -
Which of the following is a typical feature of a bank overdraft?
Correct answer: A. An overdraft is a fluctuating short-term facility: the company borrows only what it needs, pays interest on the balance actually drawn, and the bank can demand repayment at any time - the key risk of relying on it. Fixed terms with scheduled repayments describe a term loan, overdraft rates are usually higher than secured long-term borrowing because the bank's commitment is unsecured and flexible, and no debt converts to equity automatically. -
A young technology company with no profits, few tangible assets and an unproven product is seeking significant expansion finance. The most realistic source is:
Correct answer: B. Venture capitalists and business angels provide equity to high-risk, high-growth businesses in exchange for a stake and a planned exit, precisely because such companies lack the assets and track record lenders require. Banks have little security to lend against, public bond markets are closed to small unrated issuers, and trade credit is a short-term operating buffer, not expansion capital. -
A company's weighted average cost of capital (WACC) is most appropriate as the discount rate for a new project when:
Correct answer: D. WACC reflects the average risk and financing mix of the existing business, so it prices new projects correctly only when both stay broadly the same. A project in a different industry has different business risk and needs a risk-adjusted rate, and financing that materially changes gearing alters the capital structure assumptions behind the WACC - the marginal debt rate alone is never the right hurdle because the project also uses equity capacity. -
A company is financed by $600,000 of equity with a cost of 10% and $400,000 of debt with an after-tax cost of 6%. Its WACC is:
Correct answer: B. WACC weights each cost by its share of total capital: (600/1,000 x 10%) + (400/1,000 x 6%) = 6.0% + 2.4% = 8.4%. 8.0% is the unweighted average of 10% and 6%, 10.0% is the cost of equity alone, and 7.6% reverses the weights (0.4 x 10% + 0.6 x 6%). -
The risk-free rate is 3%, the expected market return is 8% and a share's beta is 1.2. Using the capital asset pricing model, the required return on the share is:
Correct answer: C. CAPM: required return = risk-free rate + beta x (market return - risk-free rate) = 3% + 1.2 x (8% - 3%) = 3% + 6% = 9.0%. 12.6% multiplies beta by the full market return and adds the risk-free rate (3 + 1.2 x 8), 8.0% adds the market premium without applying beta, and 9.6% is beta times the market return with no risk-free base. -
A share with an equity beta of 1.5 is best described as one whose returns:
Correct answer: D. Beta measures sensitivity to market movements: a beta of 1.5 means that when the market rises or falls, the share tends to rise or fall about 1.5 times as much, so it carries above-average systematic risk. A beta near zero would indicate returns unrelated to the market, a negative beta would indicate opposite movement, and a high beta means more risk, not less - only the risk-free asset has a beta of zero and no market risk. -
A share is priced at 400 cents. A dividend of 24 cents per share has just been paid, and dividends are expected to grow at 5% per year. Using the dividend growth model, the cost of equity is closest to:
Correct answer: A. Because the 24-cent dividend has just been paid, next year's dividend is 24 x 1.05 = 25.2 cents. Cost of equity = D1/P0 + g = 25.2/400 + 0.05 = 6.3% + 5.0% = 11.3%. 11.0% forgets to grow the dividend (24/400 + 5%), 6.3% is the dividend yield alone without growth, and 5.0% is the growth rate alone without the yield. -
Irredeemable loan notes pay interest of $8 per $100 nominal and trade at $80 per $100 nominal. The rate of corporation tax is 25%. The after-tax cost of this debt to the company is:
Correct answer: A. For irredeemable debt, the after-tax cost is the after-tax interest divided by the market price: 8 x (1 - 0.25) / 80 = 6 / 80 = 7.5%. 10.0% is the pre-tax cost (8/80) ignoring tax relief, 6.0% divides the after-tax interest by the nominal value of $100 instead of the market price, and 8.0% is simply the coupon rate on nominal value. -
As a company takes on progressively more debt, its cost of equity tends to rise because:
Correct answer: D. Gearing adds fixed interest charges ahead of shareholders, so equity earnings become more volatile and shareholders demand a higher return - this is financial risk, and it is why cheap debt does not reduce the WACC without limit. Lenders do not gain votes, tax relief continues while there are profits to relieve (though its value can be constrained in distress), and dividends remain discretionary at any gearing level. -
Under the capital asset pricing model, the risk premium in a share's required return compensates investors for:
Correct answer: B. CAPM assumes investors hold diversified portfolios, so company-specific (unsystematic) risk is diversified away and the market does not pay a premium for bearing it; only systematic, market-wide risk, measured by beta, is rewarded. Total risk therefore overstates what is priced, inflation is only one component of general market conditions reflected in the risk-free rate and market premium, and a specific event like auditor resignation is unsystematic risk. -
A company has earnings per share of 50 cents. A comparable listed company trades on a price/earnings ratio of 12. Using the P/E method, the estimated value per share is:
Correct answer: C. The P/E method multiplies earnings per share by the benchmark ratio: 0.50 x 12 = $6.00 per share. $24.00 divides the ratio by the EPS (12 / 0.50), $12.00 is the P/E ratio itself expressed in dollars, and $0.42 divides EPS by the ratio (0.50 / 12). In practice a discount is often applied when valuing an unquoted company against a listed comparator. -
A share is expected to pay a dividend of 20 cents in one year, dividends are expected to grow at 5% per year thereafter, and shareholders require a return of 10%. Using the dividend growth model, the share's value today is:
Correct answer: D. P0 = D1 / (Ke - g) = 20 / (0.10 - 0.05) = 20 / 0.05 = 400 cents = $4.00. $2.00 ignores growth and divides by the full 10% (20/0.10), $1.33 adds the growth rate to the required return instead of subtracting it (20/0.15), and $6.00 does not follow from the model. -
The main weakness of valuing a going-concern business using the book value of its net assets is that book values:
Correct answer: C. A going concern is worth the cash and profits it will generate, and much of that value sits in intangibles that never appear on the balance sheet, so an asset-based figure usually serves only as a floor or a liquidation reference. Book values can be above or below market values depending on the asset, property companies are actually where asset bases work best, and balance sheets contain historical figures - the criticism is that they say too little about future profits, not too much. -
A listed company's market capitalisation is calculated as:
Correct answer: A. Market capitalisation is the equity market's valuation of the company: share price times the number of shares in issue. Total assets minus current liabilities is a balance sheet measure of capital employed, profit times payout ratio gives the total dividend rather than a company value, and nominal share capital plus retained earnings is book equity, which routinely differs from market value. -
An investor is valuing a small minority shareholding in an unquoted company that pays steady dividends. The most suitable valuation approach is:
Correct answer: B. A minority holder cannot direct strategy, distribute assets or set the dividend policy; what they actually receive is the dividend stream, so the dividend valuation model fits best. Asset-based approaches suit control situations or liquidation, which a minority cannot force, and valuing the entire business's cash flows presumes a level of control a small stake does not confer - that approach belongs to majority acquisitions. -
A German company agrees today to sell goods to a US customer, with payment of $500,000 due in three months. The risk that the euro value of this receipt changes because of exchange rate movements before payment is:
Correct answer: B. Transaction risk is the exposure on individual foreign currency transactions between agreeing a price and settling it - exactly the position described. Economic risk is the longer-term effect of exchange rates on a business's competitive position and value, translation risk arises when consolidating foreign operations' figures into group statements, and interest rate risk concerns borrowing and deposit rates, not currency. -
Which situation gives rise to translation risk?
Correct answer: A. Translation risk is an accounting exposure: the reported value of foreign net assets moves with exchange rates when consolidated, even though no cash flow occurs at that point. Waiting for a foreign invoice to be paid is transaction risk, long-term competitive erosion is economic risk, and a rising floating rate is interest rate risk. -
A company hedges a future foreign currency payment using a forward exchange contract. The essential feature of this hedge is that the company:
Correct answer: C. A forward contract is a binding agreement to exchange a set amount at a set rate on a set date: the outcome is certain whichever way the spot rate moves, which is both its strength (certainty) and its cost (no upside). Walking away or paying a premium for a right without obligation describes a currency option, and exchanging principal now with a reversal later describes a swap arrangement, not a forward. -
To hedge a foreign currency receivable due in three months using a money market hedge, a company would:
Correct answer: D. The money market hedge for a receivable manufactures the exchange today: borrow the present value of the receivable in the foreign currency, convert at today's spot rate (investing the proceeds at home), and let the customer's payment repay the foreign loan, eliminating rate risk. Buying the foreign currency today would double the exposure rather than hedge it, doing nothing leaves the position unhedged, and lending foreign currency is the hedge for a payable, not a receivable. -
A company with a large floating-rate loan fears that interest rates will rise. Which arrangement directly addresses this risk?
Correct answer: A. By paying fixed and receiving floating on a swap with a notional matching the loan, the floating receipts offset the loan's floating interest, leaving a net fixed cost - the standard protection against rising rates. Selling currency receivables addresses exchange risk, not interest rate risk; enlarging the floating facility increases the exposure; and share buybacks are a capital management action with no hedging effect.
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