Corporate finance, decision analysis, and risk management concepts tested on CMA Part 2.
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- What does the Net Present Value (NPV) method measure in capital budgeting?
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The difference between the present value of future cash inflows and the initial investment outlay.- Define the Internal Rate of Return (IRR) for a capital project.
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The discount rate at which the project's net present value equals zero.- What is the payback period rule in capital budgeting?
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The time required for a project's cumulative cash flows to recover the initial investment.- What is the Weighted Average Cost of Capital (WACC)?
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The average rate a company must pay to finance its assets, weighted by the proportion of debt and equity.- Explain the capital asset pricing model (CAPM) relationship.
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Expected return equals the risk-free rate plus beta times the market risk premium.- What does beta measure in the context of investment risk?
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The systematic risk of a security relative to the overall market.- Define the profitability index in capital budgeting decisions.
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The ratio of the present value of future cash inflows to the initial investment.- What is the difference between independent and mutually exclusive projects?
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Independent projects do not compete; mutually exclusive projects mean selecting one eliminates others.- Explain the concept of operating leverage in financial analysis.
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The degree to which a company uses fixed costs, creating higher variability in operating income with sales changes.- Define the Degree of Operating Leverage (DOL).
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The percentage change in operating income divided by the percentage change in sales.- What is the Modigliani-Miller proposition on capital structure (ignoring taxes)?
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The value of a firm is independent of its capital structure; debt-to-equity ratio does not affect firm value.- How does corporate income tax affect the optimal capital structure?
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The tax deductibility of interest makes debt financing cheaper, favoring a higher proportion of debt.- What is the cash conversion cycle?
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The number of days between paying for inventory and collecting cash from customer sales.- Explain the concept of efficient frontier in portfolio theory.
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The set of optimal portfolios offering the highest expected return for a given level of risk.- What is the dividend discount model (DDM) and what does it calculate?
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A valuation method that estimates stock price based on the present value of future dividend payments.
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