Finance Concepts Quiz

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Questions and Answers

What are the advantages of issuing debentures over other sources of finance?

Debentures may have lower interest rates compared to bank loans and don’t require immediate repayment.

How do bank loans compare to debentures in terms of repayment frequency?

Bank loans are typically paid monthly while debenture interest is paid every six months.

What do the current ratio and acid test reveal about a firm's liquidity?

They provide insights into a firm's ability to cover short-term liabilities with its short-term assets.

Why is disclosing discontinued activities vital in financial statements?

It helps provide a more accurate prediction of future performance by highlighting non-recurring operations. Signup and view all the answers

What is one major drawback of flexible budgets in management accounting?

They can take a substantial amount of time to create and may rely on estimates which can be misleading. Signup and view all the answers

How does issuing bonus shares impact existing shareholders?

Issuing bonus shares does not dilute existing control as no funds leave the firm. Signup and view all the answers

What effect do high dividend yields typically have on a company's share price?

A good dividend yield can lead to an increase in share price. Signup and view all the answers

What are the negative implications of disclosing more financial figures?

It can complicate the financial statements, making them harder for readers to understand. Signup and view all the answers

What is a limiting factor in production?

A limiting factor is a resource that restricts the level of activity or quantity of output. Signup and view all the answers

Explain the concept of net present value (NPV).

Net present value is the difference between the present value of cash inflows and outflows, accounting for the time value of money. Signup and view all the answers

What is a significant drawback of using the payback method?

The payback method does not consider profits generated after the payback period. Signup and view all the answers

What does the internal rate of return (IRR) represent?

IRR is the percentage return an investment is expected to yield over its lifetime, requiring it to be greater than WACC to be profitable. Signup and view all the answers

What is one advantage of decreasing inventories?

Decreasing inventories reduces costs associated with storage, such as warehouse expenses and security. Signup and view all the answers

How does the average rate of return (ARR) measure profitability?

ARR focuses on profit relative to the initial investment, reflecting a firm’s primary objectives. Signup and view all the answers

What role does goodwill play in a company's valuation?

Goodwill is influenced by a firm's reputation, brand awareness, and its annual profits, often calculated as multiple times the annual profits. Signup and view all the answers

What is a primary use of share premium accounts?

Share premium accounts are used for issuing bonus shares and offsetting preliminary expenses for company formation. Signup and view all the answers

What is a disadvantage of using record cards for inventory management?

Record cards only show issues and do not track actual inventory used in production. Signup and view all the answers

What are the key steps in the budget preparation process?

Budget preparation involves identifying limiting factors, consulting departments for feedback, and producing a master budget. Signup and view all the answers

What is one significant advantage of using ICT in financial record-keeping?

It reduces the need for hiring a costly accountant by efficiently recording financial transactions. Signup and view all the answers

Identify a major disadvantage of implementing ICT for a small business.

The initial costs for hardware and software can be prohibitively high relative to their revenue. Signup and view all the answers

In evaluating a budget, why is it important for management to analyze variances?

It allows management to identify discrepancies and take remedial actions to correct them. Signup and view all the answers

What does a positive Net Present Value (NPV) indicate in project appraisal?

It suggests that the projected earnings exceed the anticipated costs, making the project financially viable. Signup and view all the answers

What is one key role of an auditor in a corporate governance framework?

To ensure accountability by evaluating the risk management processes during significant corporate decisions. Signup and view all the answers

How might the redemption of shares improve a company's Return on Capital Employed (ROCE)?

By reducing the number of shares, it increases the earnings attributed to each share, thereby improving ROCE. Signup and view all the answers

What is a risk associated with purchases on credit?

Irrecoverable debts may lead to lengthy and expensive court cases to collect payments. Signup and view all the answers

Why is understanding the gearing ratio important for a company?

It indicates the level of debt relative to equity, helping assess financial risk and stability. Signup and view all the answers

What might be a disadvantage of a merger in terms of ownership?

It may dilute ownership for existing shareholders if the merger involves issuing new shares. Signup and view all the answers

What is one potential outcome of improving earnings per share (EPS)?

Increasing net profit can significantly raise EPS, attracting investors and enhancing stock prices. Signup and view all the answers

Why might a company with a high gearing ratio struggle to raise additional capital?

High levels of debt can make lenders wary, increasing perceived investment risk. Signup and view all the answers

What is a potential benefit of maintaining consistent dividend payments?

It keeps shareholders satisfied and engaged, fostering loyalty and stability in ownership. Signup and view all the answers

How can variations in labor efficiency or material usage impact project costs?

Adverse variances may indicate inefficiencies or wastage, leading to increased project costs. Signup and view all the answers

What implication does a profitability index below 1 have for a project?

It suggests that the project's costs outweigh its benefits, indicating it may not be a wise investment. Signup and view all the answers

Study Notes

2 Mark Questions

Limiting Factor: A factor of production that restricts the level of activity or output.
Provision: A liability of uncertain timing or amount.
Net Present Value (NPV):
- Pros: Accounts for the time value of money (inflation).
- Cons: Cost of capital estimation can be challenging, potentially leading to inaccuracies.
Payback Method:
- Pros: Simple calculation, easily understood by managers and non-accountants.
- Cons: Ignores profits beyond the payback period.
Average Rate of Return:
- Pros: Focuses on profit, a primary objective for firms.
- Cons: Doesn't consider the time value of money (inflation).
Internal Rate of Return (IRR):
- Definition: The percentage return an investment is expected to yield over its lifetime.
- Profitability Condition: Must be greater than the Weighted Average Cost of Capital (WACC) for profitability.
- Pros: Allows comparison of projects with different lifespans.
- Cons: Complex calculation, potentially not easily understood by non-accountants.
Profitability Index:
- Pros: Facilitates comparison of returns from different-sized projects.
Decrease in Inventories:
- Pros: Reduced storage costs (warehousing, security).
- Cons: Potentially limited inventory availability, affecting large order fulfillment.
Decrease in Trade Payables:
- Pros: Potential improvement in credit rating, aiding future credit acquisition.
- Cons: Reduced short-term liquidity for other business needs.
Purchase of Shares in Another Company:
- Motivations: Anticipated increase in share price, gaining control over suppliers or other companies.
Issue Additional Shares:
- Purpose: Raising capital, reducing gearing ratio.

4 Mark Questions

Budget Preparation Process:
- Identify limiting factors (e.g., production).
- Consult with departments for realistic figures.
- Develop a master budget (comprehensive income forecast).
Factors Determining Goodwill:
- Goodwill is tied to annual profits (often multiples of annual profits, e.g., 3x).
- Firm reputation and brand awareness contribute to goodwill.
Marginal vs. Absorption Costing:
- Marginal Costing: Matches costs to periods; potentially more accurate profit reporting (prudence concept); lower inventory valuation.
- Absorption Costing: Matches costs to products; helpful for product profitability analysis (matching concept).
Record Card:
- Pros: Clear tracking of receipts, issues, and running balance, reduces theft risk; indicates low inventory and reorder needs.
- Cons: Tracks issues, not inventory use in production; requires constant updates.
Share Premium Account Uses:
- Bonus share issuance.
- Paying premiums for share redemption.
- Writing off preliminary expenses during company formation.

12/6 Mark Questions

Use of ICT (Information and Communication Technology):
- Financial:
  - Pros: Streamlines financial transactions, reduces accountant costs.
  - Cons: High initial hardware/software costs, potential for equipment obsolescence, staff training needs, maintenance expenses.
- Technical:
  - Pros: Automated record-keeping, reduces errors, faster financial statements.
  - Cons: Unnecessary for simple operations; potential data loss due to system failure.
- Human:
  - Pros: Potential workload reduction, positive experience.
  - Cons: Difficulty understanding/implementing, frustration for those unfamiliar with ICT.
Budget as a Forecasting, Planning, and Control Tool:
- Pros: Direct management control over relevant budget items, assists in forecasting, aids in planning and coordinating across departments, variance analysis can drive remedial actions.
- Cons: Forecasting can be imprecise, some costs are outside management control, some figures (e.g., rent) are relatively stable, hence budget preparation might not be worthwhile.
Project Appraisal:
- NPV: Positive NPV generally indicates a profitable project.
- ARR: Compare ARR to cost of capital (discount factor); higher ARR is better.
- Payback Period: Ensure the payback is within the expected project lifespan.
- Gearing Ratio: Avoid excessive gearing levels (e.g., +/-50%).
- Profitability Index: Increase in index shows more favorable project.
Standard Costing Evaluation: Analyze variances (labor efficiency/rate, material usage/price) and determine drivers.
Auditor Role: Focuses on leadership, effectiveness, accountability, relations with shareholders and remuneration.
- Case for Auditors: justify alternative corporate governance approaches.
- Case against Auditors: Can be expensive or add non-significant value.
Share Redemption Evaluation:
- Pros: Can improve Return on Capital Employed (ROCE); reduce future dividend payouts.
- Cons: Worsens gearing ratio; may discourage future investments; reduces company liquidity.
Credit Purchases Evaluation:
- Pros: Potential for increased sales and market share.
- Cons: Risk of bad debts, potential for legal issues related to debt collection.
Merger Evaluation:
- Pros: Diversification, expansion, economies of scale, potential for higher profits.
- Cons: Goodwill costs; diluted ownership if shares exchanged; worsening liquidity if paid in cash.
Improving Earnings Per Share (EPS): Increase profit, reduce interest, lower taxation, reduce outstanding shares.
Gearing Ratio Evaluation: Assess the advantages/disadvantages of utilizing debt financing (higher interest reduces profit).
Dividend Payments Evaluation:
- Pros: Maintain shareholder satisfaction, positive signalling.
- Cons: Reduced cash available, potential impact on short-term cash flow and liquidity, lower overall liquidity.
Debentures Evaluation:
- Pros: Potentially lower interest rates compared to bank loans.
- Cons: Possible asset forfeiture as collateral, larger interest payments.
Liquidity Performance Evaluation:
- Evaluate cash levels, current ratio, acid-test ratio; analyze comparisons between periods.
Disclosing Discontinued Activities:
- Pros: Increased transparency.
- Cons: Complicates financial statements.
Flexible Budgets:
- Pros: Facilitates better decision-making; allows comparison of different activity levels, meaningful variance analysis.
- Cons: Time-consuming development; reliance on estimates/assumptions.
Issuing Bonus Shares vs. Final Dividends:
- Bonus Shares: No cash outflow.
- Final Dividends: No dilution of current shares, may result in higher valuations if dividends are attractive.

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Description

Test your understanding of essential finance concepts including Net Present Value, Payback Method, and Rate of Return. This quiz explores benefits and drawbacks of various financial metrics used in decision-making. Perfect for students in finance classes or professionals brushing up on key topics.