CFA Corporate Finance Syllabus

Corporate Finance syllabus — full chapter and topic list

Expand any chapter to see its topics and sub-topics. This is the whole examinable outline for Corporate Finance in CFA, not a summary of it.

1. 1

   Capital Budgeting

   3 topics

   • Net Present Value and Internal Rate of Return
   • Project Cash Flows
   • Risk Analysis in Capital Budgeting
2. 2

   Cost of Capital

   2 topics

   • Cost of Debt and Equity
   • Weighted Average Cost of Capital (WACC)
3. 3

   Corporate Governance

   2 topics

   • Principles of Corporate Governance
   • Stakeholder Management

Corporate Finance flashcards for CFA

19 of 50 cards from the Corporate Finance deck — real questions with worked answers.

1. What is Net Present Value (NPV) and how is it calculated?

   NPV is the sum of the present values of all a project's expected cash flows, discounted at the required rate of return. $$NPV = \sum_{t=0}^{N} \frac{CF_t}{(1+r)^{t}}$$ where $CF_t$ is the cash flow in period $t$, $r$ is the discount rate, and $CF_0$ is usually the initial outlay (negative).

2. What is the NPV decision rule for independent projects?

   Accept the project if $NPV > 0$ (it adds value); reject if $NPV < 0$. If $NPV = 0$, the project exactly earns the required return, leaving value unchanged.

3. Define the Internal Rate of Return (IRR).

   The IRR is the discount rate that sets a project's NPV equal to zero: $$\sum_{t=0}^{N} \frac{CF_t}{(1+IRR)^{t}} = 0$$ It is the project's expected compound annual rate of return.

4. State the IRR decision rule for a single independent project.

   Accept the project if $IRR > r$ (the required rate of return / cost of capital); reject if $IRR < r$.

5. Why can NPV and IRR give conflicting rankings for mutually exclusive projects?

   Conflicts arise from differences in project scale (size) and in the timing/pattern of cash flows, combined with differing reinvestment rate assumptions. NPV assumes reinvestment at the required rate $r$, while IRR assumes reinvestment at the IRR.

6. When NPV and IRR conflict for mutually exclusive projects, which should be used and why?

   Use NPV. It measures the absolute increase in shareholder wealth and uses the more realistic reinvestment assumption (the required rate of return), whereas IRR can mislead due to scale and reinvestment-rate distortions.

7. What is the 'multiple IRR' problem?

   When a project's cash flows change sign more than once (nonconventional cash flows), the NPV = 0 equation can have more than one real root, producing multiple IRRs. By Descartes' rule, the number of possible IRRs equals the number of sign changes in the cash flow stream.

8. How is a project's NPV profile constructed and what does the x-intercept represent?

   An NPV profile plots a project's NPV (y-axis) against the discount rate (x-axis). The curve slopes downward; the point where it crosses the x-axis (NPV = 0) is the project's IRR.

9. What is the crossover rate in an NPV profile?

   The crossover rate is the discount rate at which two projects have equal NPVs (their NPV profiles intersect). Below the crossover rate, rankings by NPV may reverse relative to above it, which is the source of NPV–IRR conflicts.

10. Define initial outlay (initial investment) in project cash flow analysis.

    The initial outlay is the up-front cash flow at time 0: $$Outlay = FCInv + NWCInv$$ where $FCInv$ is investment in fixed capital (including installation/shipping) and $NWCInv$ is the increase in net working capital.

11. What is the formula for annual after-tax operating cash flow in capital budgeting?

    $$CF = (S - C - D)(1 - T) + D$$ equivalently $$CF = (S - C)(1 - T) + T\,D$$ where $S$ = sales, $C$ = cash operating costs, $D$ = depreciation, and $T$ = tax rate. The term $T\,D$ is the depreciation tax shield.

12. What is the depreciation tax shield and its value?

    The depreciation tax shield is the tax savings created because depreciation is a tax-deductible non-cash expense. Its value each period is $T \times D$ (tax rate times depreciation), which reduces taxes owed and adds to cash flow.

13. What is the terminal (non-operating) cash flow at the end of a project's life?

    $$TNOCF = Sal_T + NWCInv - T(Sal_T - B_T)$$ where $Sal_T$ = salvage (sale) value at time $T$, $NWCInv$ = recovery of net working capital, $B_T$ = book value at time $T$, and $T$ = tax rate. $T(Sal_T - B_T)$ is the tax on the gain over book value.

14. Why are sunk costs excluded from project cash flow analysis?

    A sunk cost is a cost already incurred that cannot be recovered and does not change with the accept/reject decision. Only incremental cash flows matter, so sunk costs must be ignored.

15. How should opportunity costs and externalities be treated in project cash flows?

    Opportunity costs (the value of a resource in its best alternative use) must be included as a cost. Externalities—effects on the firm's other cash flows—must also be included; e.g., cannibalization (lost sales of existing products) is a negative externality.

16. What is a replacement project and how does it differ from an expansion project?

    A replacement project swaps an existing asset for a new one, so cash flows are computed on an incremental basis (new minus old), including the sale of the old asset and differences in depreciation and operating cash flows. An expansion project is a new stand-alone investment analyzed on its own cash flows.

17. What is sensitivity analysis in capital budgeting?

    Sensitivity analysis changes one input variable at a time (holding others constant) to see how much the project's NPV or IRR responds. It identifies which variables the outcome is most sensitive to.

18. What is scenario analysis and how does it differ from sensitivity analysis?

    Scenario analysis evaluates NPV under a small number of discrete scenarios (e.g., best case, base case, worst case), changing several variables together. Unlike sensitivity analysis, it varies multiple inputs simultaneously in internally consistent combinations.

19. What is Monte Carlo simulation in risk analysis of capital budgeting?

    Monte Carlo simulation assigns probability distributions to uncertain inputs, then randomly samples them over thousands of iterations to generate a probability distribution of NPV (or IRR), giving expected value, dispersion, and the probability of a negative NPV.

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