Finance Concepts Quiz

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.

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.