Finance Quiz: Free Cash Flow & Capital Cost

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Questions and Answers

What is the formula for calculating Free Cash Flow (FCF)?

FCF = EBIT + Depreciation + Taxes + Capital Expenditures - Change in Working Capital

FCF = EBIT + Amortization - Taxes - Capital Expenditures - Change in Working Capital

FCF = EBIT - Amortization - Taxes + Capital Expenditures + Change in Working Capital

FCF = EBIT + Depreciation - Taxes - Capital Expenditures - Change in Working Capital (correct)

Which of the following statements about Free Cash Flow (FCF) is correct?

FCF is the cash available for distribution to investors after accounting for capital expenditures. (correct)

FCF is the same as the accounting statement of cash flow.

FCF includes cash from financing activities.

FCF only accounts for cash from operating activities.

In the provided weekly data, what is the net cash flow for both weeks?

€80

€60 (correct)

€39

€52

What does the cost of capital represent for a company?

The minimum return a company must earn to satisfy its investors. Signup and view all the answers

Which component is NOT included in the calculation of Free Cash Flow?

Operating Expenses Signup and view all the answers

Which of the following accurately describes the difference between FCF and the Accounting Statement of Cash Flow?

FCF emphasizes cash available for reinvestment, whereas the Accounting Statement details cash movements. Signup and view all the answers

What is the effect of a change in accounts payable on net cash flow in the provided weeks?

It increases net cash flow in Week 1. Signup and view all the answers

How is the change in receivables described in both weeks?

A decrease of €60 in Week 1 and €20 in Week 2. Signup and view all the answers

What is the main purpose of the cost of equity?

To determine the return required by shareholders for their investment risk Signup and view all the answers

Which component is NOT included in the Capital Asset Pricing Model (CAPM) formula?

Company's profit margin Signup and view all the answers

What does a higher beta indicate about a company's stock?

Greater risk and higher cost of equity Signup and view all the answers

Why is the cost of debt generally lower than the cost of equity?

Interest payments on debt are tax-deductible Signup and view all the answers

What does WACC stand for, and what does it represent?

Weighted Average Cost of Capital; overall cost of financing for the company Signup and view all the answers

Which of the following correctly reflects systematic risk?

Affects the entire market and is measured by beta Signup and view all the answers

How does equity financing impact a company's obligations?

Equity financing has no repayment obligation Signup and view all the answers

Which of the following statements about the risk-return tradeoff is true?

Investors require higher returns for assuming higher risks Signup and view all the answers

Which of the following correctly describes an advantage of using WACC?

It provides a comprehensive view of a firm's financing costs. Signup and view all the answers

What is one of the key challenges in calculating WACC?

Accurately estimating inputs such as beta and market risk premium. Signup and view all the answers

In the scenario provided, what is the proportion of debt in the capital structure?

33% Signup and view all the answers

Why is it important to understand a firm's WACC when making investment decisions?

It serves as the benchmark for project acceptance, only accepting returns above WACC. Signup and view all the answers

What is the after-tax cost of debt calculated in the example?

4.2% Signup and view all the answers

How is WACC applied in valuation models?

It is used as the discount rate in discounted cash flow (DCF) models. Signup and view all the answers

Which statement best describes the impact of excessive debt on a firm's finances?

It increases financial risk, including bankruptcy risk. Signup and view all the answers

What does a WACC of 8.09% suggest about potential projects?

All projects should yield a return of at least 8.09% to create value. Signup and view all the answers

What is a common mistake when considering mid-year cash flows?

Assuming they do not need adjustments Signup and view all the answers

What assumption is inherent in the concept of perpetuities?

Constant cash flows and discount rates Signup and view all the answers

What decision is indicated when the Net Present Value (NPV) is greater than zero?

Accept the project Signup and view all the answers

In the formula for Net Present Value (NPV), what does the term $C_t$ represent?

Cash flow at time $t$ Signup and view all the answers

What is a key application of Time Value of Money (TVM) in finance?

Valuation of bonds Signup and view all the answers

What does the abbreviation WACC stand for?

Weighted Average Cost of Capital Signup and view all the answers

Which statement accurately defines the Time Value of Money (TVM)?

The idea that €1 today is worth more than €1 in the future due to its potential earning capacity. Signup and view all the answers

What is the role of the discount rate in the Present Value formula?

It accounts for the opportunity cost of capital. Signup and view all the answers

If a company expects to receive €10,000 in 5 years with a discount rate of 8%, what is the Present Value?

Approximately €6,805 Signup and view all the answers

What is the Future Value of an investment of €5,000 at an annual interest rate of 10% for 3 years?

Approximately €6,655 Signup and view all the answers

Which of the following accurately describes cash flows?

Cash flows can be categorized as either inflows or outflows occurring over time. Signup and view all the answers

What interpretation can be made from the Present Value calculation of €10,000 in 5 years being valued at €6,805 today?

The future cash flow has a determined worth based on current investment potential. Signup and view all the answers

Which factor is NOT considered a key parameter in evaluating cash flows?

Expense Ratio Signup and view all the answers

What is the purpose of the discount rate in the NPV formula?

To assess the risk of the cash flows Signup and view all the answers

How is the present value of an annuity calculated?

By using the formula that incorporates the cash flow per period, discount rate, and number of periods Signup and view all the answers

If an investment has a negative NPV, what does it indicate?

The investment does not create value Signup and view all the answers

What characterizes a perpetuity?

It provides equal cash flows indefinitely Signup and view all the answers

What mistake can affect the accuracy of TVM calculations?

Using an incorrect discount rate Signup and view all the answers

What is the main application of TVM in retirement planning?

To find out how much to save today to meet future goals Signup and view all the answers

In the context of an annuity, what does 'C' represent in the present value formula?

Cash flow per period Signup and view all the answers

How is the NPV affected if cash flows increase while the discount rate remains unchanged?

NPV will increase Signup and view all the answers

Study Notes

Corporate Finance

Corporate finance involves two key missions: ensuring sufficient funds for expansion and meeting obligations, and generating a return for investors at least equal to their required rate.
€1 today is not equivalent to €1 in the future due to the time value of money.
Higher risk generally implies a higher expected return.
Understanding cash inflows and outflows is critical for liquidity and solvency.
The cost of capital determines the average rate of return needed to satisfy investors.
Guidelines exist for deciding whether a project or investment adds value for shareholders.
Equity and debt are used for long-term financing.

Balance Sheet

Assets represent a firm's investments.
- Current assets are short-term assets (e.g., cash, accounts receivable, inventory).
- Fixed assets are long-term assets (e.g., property, plant, equipment; intangible assets such as goodwill, patents, trademarks).
Liabilities and equity represent the sources of financing used to acquire assets.
- Current liabilities are obligations due within one year.
- Long-term liabilities are obligations due in more than one year.
- Shareholders' equity represents the difference between a firm's assets and liabilities.

Key Financial Concepts

Solvency-liquidity perspective focuses on a firm's short-term obligations using current assets and liabilities.
Working capital measures economic performance by totaling receivables, inventories, payables, net fixed assets, and net debt.
Return on capital employed (ROCE) measures the firm's economic return on operating assets.
Capital budgeting is the process of evaluating and selecting long-term investments that increase shareholder value.
Net present value (NPV) measures the difference between the present value of cash inflows and cash outflows from an investment.
Internal rate of return (IRR) is the discount rate at which the net present value of an investment is zero.

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Description

Test your knowledge on Free Cash Flow (FCF) and capital costs with this comprehensive quiz. Explore key concepts, calculations, and differences between accounting statements. Gain insights into how changes in accounts payable and receivables affect cash flow.