Certified Internal Auditor (CIA) Financial Management and Economics (Part 3) Flashcards

24 sample cards from the Financial Management and Economics (Part 3) deck

Sampled from the end of the deck, so these are different cards from the ones shown on the syllabus page.

1. How is the payback period calculated and what is its main weakness?

   Payback = time required for cumulative cash inflows to recover the initial investment; its main weakness is ignoring the time value of money and cash flows after payback.

2. What is the profitability index (PI) and the decision rule?

   PI = Present Value of Future Cash Flows / Initial Investment; accept the project if PI > 1.0.

3. When NPV and IRR give conflicting rankings for mutually exclusive projects, which should be preferred and why?

   NPV should be preferred because it measures the actual dollar value added and assumes reinvestment at the cost of capital, whereas IRR assumes reinvestment at the IRR.

4. What is the discounted payback period?

   The time required to recover the initial investment using discounted (present value) cash flows rather than nominal cash flows.

5. What is the weighted average cost of capital (WACC)?

   The blended required return on a firm's capital: WACC = (E/V)(cost of equity) + (D/V)(after-tax cost of debt), weighted by each source's proportion of total capital.

6. Why is the after-tax cost of debt used in WACC?

   Because interest expense is tax-deductible, the effective cost of debt is reduced: after-tax cost of debt = pre-tax rate x (1 - tax rate).

7. According to the trade-off theory of capital structure, what limits the use of debt despite its tax shield?

   The rising costs of financial distress and bankruptcy, which eventually offset the tax benefits of additional debt.

8. What is operating leverage?

   The degree to which a firm uses fixed operating costs; higher operating leverage magnifies the effect of sales changes on operating income (EBIT).

9. What is the net working capital formula?

   Net Working Capital = Current Assets - Current Liabilities.

10. What is the cash conversion cycle (CCC)?

    CCC = Days Inventory Outstanding + Days Sales Outstanding - Days Payables Outstanding; it measures the time between paying for inputs and collecting cash from sales.

11. What does the economic order quantity (EOQ) model minimize?

    The total of inventory ordering costs and carrying (holding) costs to determine the optimal order size.

12. Compare an aggressive versus a conservative working capital financing policy.

    An aggressive policy finances more current (and even permanent) assets with short-term debt (higher return, higher risk); a conservative policy uses more long-term financing (lower risk, lower return).

13. What does GDP measure, and what are its four expenditure components?

    Gross Domestic Product measures the total market value of final goods and services produced within a country in a period; components are Consumption + Investment + Government spending + Net Exports (C + I + G + NX).

14. What is the difference between fiscal policy and monetary policy?

    Fiscal policy uses government spending and taxation (controlled by the government); monetary policy controls the money supply and interest rates (controlled by the central bank).

15. Define demand-pull inflation versus cost-push inflation.

    Demand-pull inflation results from aggregate demand exceeding supply ('too much money chasing too few goods'); cost-push inflation results from rising production costs (e.g., wages, raw materials).

16. What are the four phases of the business cycle?

    Expansion, peak, contraction (recession), and trough.

17. What is the law of demand?

    All else equal, as the price of a good rises, the quantity demanded falls, and as price falls, quantity demanded rises (inverse relationship).

18. What does price elasticity of demand measure, and what makes demand elastic?

    It measures the responsiveness of quantity demanded to a price change (% change in quantity / % change in price); demand is elastic when the absolute value exceeds 1 (quantity is highly responsive).

19. Distinguish perfect competition from a monopoly.

    Perfect competition has many firms selling identical products as price takers with free entry; a monopoly is a single seller of a unique product with high barriers to entry that is a price maker.

20. What is the law of diminishing marginal returns?

    As successive units of a variable input are added to fixed inputs, beyond some point the additional output (marginal product) from each extra unit declines.

21. What is comparative advantage and why does it drive trade?

    A country has comparative advantage when it can produce a good at a lower opportunity cost than another; specializing accordingly and trading increases total output and benefits both parties.

22. What is the difference between a tariff and a quota?

    A tariff is a tax on imported goods (raising their price and generating government revenue); a quota is a quantitative limit on the amount of a good that can be imported.

23. What does a spot exchange rate versus a forward exchange rate represent?

    A spot rate is the price for immediate (current) currency exchange; a forward rate is an agreed price today for exchanging currency at a specified future date.

24. If a company expects to receive foreign currency in 90 days and wants to eliminate exchange-rate risk, what hedging instrument can it use?

    A forward contract (or currency futures/options) to lock in the exchange rate at which the foreign currency will be converted.

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Financial Management and Economics (Part 3) flashcards FAQ