Section 1: Foundations of Financial Management (15 Questions)

1. Question: What is the primary goal of a financial manager in a corporation?
   • Answer: The primary goal is to maximize shareholder wealth, which is reflected in the firm’s stock price.
2. Question: What are the three main financial statements used in financial analysis?
   • Answer: The Income Statement (profit and loss), the Balance Sheet (assets, liabilities, and equity), and the Statement of Cash Flows.
3. Question: What is the difference between accounting profit and cash flow?
   • Answer: Accounting profit includes non-cash items like depreciation, while cash flow represents the actual cash coming into and going out of the business.
4. Question: What is the formula for the Current Ratio, and what does it measure?
   • Answer: Current Ratio = Current Assets / Current Liabilities. It is a liquidity ratio that measures a company’s ability to meet its short-term obligations.
5. Question: What is the Time Value of Money (TVM) concept?
   • Answer: The idea that a dollar today is worth more than a dollar in the future because of its potential earning capacity.
6. Question: How is the future value (FV) of a single cash flow calculated?
   • Answer: FV=PV∗(1+r)n, where PV is the present value, r is the interest rate, and n is the number of periods.
7. Question: What is the difference between compounding and discounting?
   • Answer: Compounding is the process of calculating future value by earning interest on interest. Discounting is the process of finding the present value of a future sum.
8. Question: What is an annuity, and how is it different from a perpetuity?
   • Answer: An annuity is a series of equal payments at fixed intervals for a limited period. A perpetuity is a stream of equal payments that continues forever.
9. Question: What does a firm’s beta measure?
   • Answer: Beta is a measure of a stock’s systematic risk, or its volatility relative to the overall market. A beta of 1 means the stock moves with the market, a beta > 1 means it’s more volatile, and a beta < 1 means it’s less volatile.
10. Question: What is the Efficient Market Hypothesis (EMH)?
    • Answer: The EMH states that security prices fully reflect all available information. This implies it is impossible to consistently “beat the market” based on publicly available information.
11. Question: What is the relationship between risk and return?
    • Answer: There is a direct relationship: higher risk is associated with the potential for higher returns. Investors demand greater compensation for taking on more risk.
12. Question: What is the difference between the primary market and the secondary market?
    • Answer: The primary market is where new securities are sold for the first time. The secondary market is where existing securities are traded between investors.
13. Question: What is the formula for the Debt-to-Equity Ratio, and what does it indicate?
    • Answer: Debt-to-Equity Ratio = Total Debt / Total Equity. It is a leverage ratio that measures the proportion of a company’s financing that comes from debt versus equity.
14. Question: What is the Quick Ratio and why is it sometimes a better measure of liquidity than the Current Ratio?
    • Answer: Quick Ratio = (Current Assets – Inventory) / Current Liabilities. It excludes inventory because inventory can be difficult to convert into cash quickly.
15. Question: Define Free Cash Flow (FCF).
    • Answer: FCF is the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. It’s the cash available to all investors.

Section 2: Valuation and Capital Budgeting (15 Questions)

16. Question: What are the two types of cash flows an investor receives from a typical corporate bond?
    • Answer: Periodic coupon payments (interest) and the face value (principal) at maturity.
17. Question: What is the relationship between a bond’s price and market interest rates?
    • Answer: They have an inverse relationship. As market interest rates rise, the value of existing bonds with lower coupon rates falls, and vice versa.
18. Question: How is the value of a stock determined using the Dividend Discount Model (DDM)?
    • Answer: The DDM values a stock as the present value of all of its future expected dividend payments.
19. Question: What does a P/E (Price-to-Earnings) Ratio tell an investor?
    • Answer: It measures how much an investor is willing to pay for a dollar of a company’s earnings. A high P/E ratio may indicate that investors expect high future growth.
20. Question: What is capital budgeting?
    • Answer: The process of planning and managing a firm’s long-term investments, such as new projects or equipment.
21. Question: What is Net Present Value (NPV)?
    • Answer: The difference between the present value of a project’s future cash inflows and the present value of its cash outflows. A positive NPV indicates a profitable project.
22. Question: What is the Internal Rate of Return (IRR)?
    • Answer: The discount rate at which the Net Present Value (NPV) of a project’s cash flows equals zero. It represents the project’s expected rate of return.
23. Question: What is the main drawback of using the Payback Period method for capital budgeting?
    • Answer: It ignores the time value of money and all cash flows that occur after the payback period.
24. Question: What is the cost of capital for a firm?
    • Answer: The weighted average cost of all the different sources of capital used to finance the firm’s assets, including debt and equity.
25. Question: What is the Weighted Average Cost of Capital (WACC)?
    • Answer: The average rate of return a company is expected to pay to all its security holders, including debt and equity holders. It’s used as the discount rate for evaluating new projects.
26. Question: What is the difference between the cost of debt and the cost of equity?
    • Answer: The cost of debt is the interest rate a company pays on its borrowings. The cost of equity is the return a company’s equity investors require.
27. Question: What is the Gordon Growth Model, and what is its main limitation?
    • Answer: A version of the DDM that assumes dividends will grow at a constant rate forever. Its limitation is that it’s only applicable to firms with stable, predictable growth.
28. Question: How does the market price of a bond change if its coupon rate is greater than the market interest rate?
    • Answer: The bond will sell at a premium (above its face value).
29. Question: What is stock valuation?
    • Answer: The process of estimating the intrinsic value of a stock, often to determine whether it is undervalued or overvalued by the market.
30. Question: When making a capital budgeting decision, which is generally the preferred method between NPV and IRR, and why?
    • Answer: NPV is generally preferred because it measures the direct increase in firm value in dollars, whereas IRR provides a percentage return which can lead to conflicts when comparing projects of different scales.

Section 3: Financial Decisions and Working Capital (15 Questions)

31. Question: What is working capital?
    • Answer: Working capital is the difference between a firm’s current assets and its current liabilities. It represents the funds available for day-to-day operations.
32. Question: What is the Cash Conversion Cycle (CCC)?
    • Answer: A metric that measures the number of days it takes for a company to convert its investments in inventory and other resources into cash flows from sales.
33. Question: What are the three components of the Cash Conversion Cycle?
    • Answer: Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) – Days Payable Outstanding (DPO).
34. Question: What are two common strategies for a firm to manage its working capital more efficiently?
    • Answer: Speeding up collections from customers (reducing DSO) and slowing down payments to suppliers (increasing DPO).
35. Question: What is the Capital Structure of a firm?
    • Answer: The mix of debt and equity used to finance its assets.
36. Question: What is the main argument of the Modigliani-Miller Theorem?
    • Answer: In a perfect market (no taxes, no bankruptcy costs), a firm’s value is irrelevant to its capital structure. In reality, taxes and bankruptcy costs make capital structure relevant.
37. Question: What is the Trade-Off Theory of Capital Structure?
    • Answer: This theory suggests that a firm’s optimal capital structure is a trade-off between the tax benefits of debt and the costs of financial distress (like bankruptcy costs).
38. Question: What is a dividend policy?
    • Answer: A company’s plan for how it will distribute earnings to shareholders, whether through cash dividends, stock dividends, or a mix of both.
39. Question: What is a stock dividend?
    • Answer: A dividend paid to shareholders in the form of additional shares of stock rather than cash. It does not affect the firm’s total value but increases the number of shares outstanding.
40. Question: What is retained earnings?
    • Answer: The portion of a company’s net income that is not paid out as dividends to shareholders but is retained by the company to reinvest in its business.
41. Question: What is the difference between a stable dividend policy and a residual dividend policy?
    • Answer: A stable dividend policy aims to pay a consistent, predictable dividend. A residual dividend policy pays out whatever is left over after funding all worthwhile capital investments.
42. Question: What is Agency Theory in financial management?
    • Answer: It studies the conflicts of interest that can arise between a firm’s management (the agent) and its owners (the principal), especially regarding financial decisions.
43. Question: What is a line of credit?
    • Answer: An agreement between a bank and a company that provides a maximum amount of money the company can borrow at any time over a set period. It’s a key tool for managing working capital.
44. Question: How does an increase in sales impact a firm’s financing needs?
    • Answer: An increase in sales typically leads to a need for more spontaneous financing (e.g., increased accounts payable) and discretionary financing to fund the growth in assets.
45. Question: What is the Plowback Ratio?
    • Answer: The percentage of earnings that a company retains and reinvests in the business rather than paying out as dividends. It is also known as the retention ratio.