CB1 Business Finance
HOW FUTURES ARE DIFFERENT FROM FORWARDS?
A forward is an agreement between two parties to trade a specified asset at a set date in the future at a set price whereas futures are standardised and exchange-tradeable.
WHAT ARE DERIVATIVES?
A derivative is a financial instrument that derives its value from the value of some other asset. Some types of derivatives are swaps, options, futures and forwards.
STATE THE RELATION BETWEEN EPS AND DPS?
Dividend per share is the actual EPS that is paid out to the shareholders in the form of dividends.
HOW CROWDFUNDING TAKES PLACE?
Crowdfunding is the way through which a large number of participants, individuals or businesses, support a business, project, campaign or an individual by often building a crowdfunding website which will typically charge a fee, eg a percentage of the money raised.
WHAT DO YOU UNDERSTAND BY DOUBLE TAXATION RELIEF? WHEN DOES IT OCCUR?
Double taxation relief (DTR) means that the local tax authority allows companies with overseas income or capital gains to offset tax paid overseas against their liability to domestic tax on that income or capital gains.
WHAT IS NIL PAID RIGHTS?
In case of rights issue, when the shareholders acquire these shares without paying immediately, such issue is known as nil-paid rights.
WHAT IS THE USE OF DELPHI TECHNIQUE?
The Delphi technique involves gathering the thoughts of a number of experts in a particular area where the organiser sends questions to experts and maintains the anonymity of the answers to finally reach a common conclusion.
WHAT IS MEANT BY GEARED BETA?
The beta of a company’s shares is affected by the company’s existing gearing. If the gearing were to change, then the volatility of returns would change, and hence the beta would change.
WHAT ARE THE MAIN DECISIONS TAKEN BY A FINANCIAL MANAGER?
A company’s financial managers are responsible for the major investment and financing decisions.
WHY CAPITAL BUDGETING IS IMPORTANT?
The capital budgeting decision considers the choice of projects, and hence real assets, in which the firms should invest. Thus, it helps in deciding the profitable project amongst the alternatives.
STATE SOME CONFLICTING OBJECTIVES OF DIFFERENT STAKEHOLDERS.
The scope for conflict between owners and managers may arise when some managers might wish to pursue projects of interest over more profitable projects but shareholders’ objective will normally be to receive a high return on their investment in the company. Also there may be differences between the lenders’ short-term desire for security and the shareholders’ long-term interest in the development of the company.
WHAT IS AGENCY PROBLEM?
The managers of a company may have aims which are not in the best interests of the shareholders, this is known as the ‘agency problem’. For example, some managers might wish to pursue projects of interest over more profitable projects but shareholders’ objective will normally be to receive a high return on their investment in the company.
WHAT DO YOU UNDERSTAND BY OPPORTUNITY COST OF CAPITAL?
It is the cost of the next best alternative foregone. Since firms have limited cash, they may wish to invest in one project by sacrificing to invest in some other project. The cash flows arising from the foregone project is then the opportunity cost of capital for the existing project.
WHAT IS CAPITAL GAINS TAX?
Capital gains tax is the difference between the sale price and purchase price of a real asset when the former is greater.\
WHAT IS OFFER FOR SALE?
In an offer for sale at a fixed price, a predetermined number of shares is offered to the general public at a specified price.
WHAT IS THE MAIN DIFFERENCE BETWEEN HIRE PURCHASE AND LEASE?
A hire purchase agreement is an agreement to pay regular rental payments for the goods you hire and then to buy them at the end of the agreed period. Legal ownership passes to the buyer only when the final payment is made. A lease is an agreement where the owner of an asset gives the lessee the right to use the asset over a period of time, in return for a regular series of payments. Legal ownership does not change hands.
WHEN ARE DERIVATIVES MOST USEFUL?
The uses of derivatives vary widely: risk management, e.g. of interest rates, exchange rates, stock market indices or prices along with borrowing cost reduction.
WHAT ARE THE THREE SECTIONS OF CASH FLOW STATEMENT?
Cash flow from operating activities, cash flows from investing activities and cash flow from financing activities.
WHAT IS WORKING CAPITAL? HOW IS IT CALCULATED?
Working capital is the amount that the business has in cash or near-cash having deducted the claims on that cash in the form of current liabilities. It is calculated as the difference between current assets and current liabilities.
DIFFERENCE BETWEEN A FORECAST AND A BUDGET?
Forecasts are predictions of future events in a passive manner. In contrast, budgets are active. They are plans, expressed in monetary terms, for the future.
HOW IS DIVIDEND POLICY OF A COMPANY DECIDED?
Key factors in the dividend decision are stock market reaction eg adverse reaction to dividend cuts, competitors’ policies cash reserves, tax – investors prefer dividends if they are taxed at a higher rate on capital gains, growth opportunities – if these exist it may be better to retain profits stability and consistency with previous dividend policy and investor preferences- eg need for cash, better opportunities to invest elsewhere.
HOW PRECISION AND ACCURACY ARE DIFFERENT?
Accuracy measures how close the result is to the actual value required whereas precision measures how close results are to one another. While accuracy can be used in one instance, precision will be measured over time.
WHAT ARE THE THREE MAIN FINANCIAL STATEMENTS?
The Statement of Financial Position (Balance Sheet), the Statement of Profit or Loss (Income Statement), and the Statement of Cash Flows. They provide a snapshot of assets/liabilities, performance over time, and liquidity, respectively.
EXPLAIN THE ACCOUNTING EQUATION.
The fundamental basis of the balance sheet is:
Assets = Liabilities + Equity
This ensures the statement always balances, reflecting that assets are financed by either debt or owners’ funds.
WHAT IS THE ACCRUAL PRINCIPLE?
It states that transactions should be recorded when they occur, not necessarily when cash changes hands. For example, revenue is recognized when a service is provided, even if the invoice hasn’t been paid yet.
DEFINE DEPRECIATION AND AMORTIZATION.
Depreciation: Allocating the cost of a tangible asset (like a computer) over its useful life.
Amortization: The same concept applied to intangible assets (like a patent or goodwill).
WHAT IS “GOODWILL” IN AN ACQUISITION?
Goodwill is an intangible asset that arises when one company purchases another for more than the fair market value of its net identifiable assets. It represents brand reputation, customer loyalty, or intellectual property.
WHAT IS THE DIFFERENCE BETWEEN GROSS PROFIT AND NET PROFIT?
Gross Profit: Revenue minus Cost of Goods Sold (COGS). It measures production efficiency.
Net Profit: The “bottom line”—Gross Profit minus all operating expenses, interest, and taxes.
WHY IS CASH FLOW DIFFERENT FROM PROFIT?
Profit includes non-cash items (like depreciation) and accruals. A company can be profitable on paper but go bankrupt because it lacks the actual cash to pay its immediate bills.
EXPLAIN THE “CONSISTENCY” CONCEPT IN ACCOUNTING.
Firms should use the same accounting policies and methods from one period to the next so that financial statements are comparable over time.
WHAT IS WORKING CAPITAL?
Working Capital is a measure of a company’s operational liquidity, calculated as:
Working Capital = Current Assets – Current Liabilities
HOW DO YOU CALCULATE THE CURRENT RATIO AND THE QUICK RATIO?
Current Ratio: Current Assets / Current Liabilities.
Quick Ratio (Acid Test): (Current Assets – Inventory) / Current Liabilities. It is a more conservative measure of liquidity.
WHAT DOES THE “INVENTORY TURNOVER” RATIO TELL YOU?
It measures how many times a company has sold and replaced its inventory during a period. A high ratio suggests strong sales or effective inventory management.
DEFINE RETURN ON EQUITY (ROE).
ROE measures profitability from the perspective of the shareholders:
ROE = Net Income/ Shareholder’s Equity
WHAT IS FINANCIAL GEARING (LEVERAGE)?
Gearing measures the extent to which a company’s operations are funded by debt versus equity. High gearing increases financial risk but can also magnify returns for shareholders.
WHAT IS THE WEIGHTED AVERAGE COST OF CAPITAL (WACC)?
WACC is the average rate a company is expected to pay to all its security holders to finance its assets. It is often used as the “hurdle rate” for new projects.
EXPLAIN NET PRESENT VALUE (NPV).
NPV is the sum of the present values of all future cash flows of a project, discounted at the cost of capital, minus the initial investment.
NPV > 0: Accept the project.
NPV < 0: Reject the project.
WHAT IS THE INTERNAL RATE OF RETURN (IRR)?
IRR is the discount rate that makes the NPV of a project equal to zero. If the IRR exceeds the company’s required return, the project is generally considered viable.
COMPARE NPV AND IRR.
While both are used for investment appraisal, NPV is generally considered superior because it assumes reinvestment at the cost of capital and handles mutually exclusive projects more reliably.
WHAT IS THE “PAYBACK PERIOD”?
The time it takes for an investment to generate enough cash flow to recover its initial cost. It ignores the time value of money unless “discounted payback” is used.
DEFINE THE “CAPITAL ASSET PRICING MODEL” (CAPM).
CAPM calculates the required return on equity based on the risk-free rate, the asset’s beta (systematic risk), and the equity risk premium:
E(R_i) = R_f + beta_i*[E(R_m) – R_f]
WHAT DOES “BETA” SIGNIFY?
Beta measures the volatility (systematic risk) of a security or portfolio in comparison to the market as a whole. A beta of 1.2 means the stock is 20% more volatile than the market.
WHAT ARE THE ADVANTAGES OF DEBT FINANCING OVER EQUITY?
Debt is often cheaper because interest payments are tax-deductible (the “tax shield”), and it doesn’t dilute ownership for existing shareholders.
WHAT IS A “RIGHTS ISSUE”?
An offer to existing shareholders to purchase additional new shares in the company at a discount to the current market price, usually in proportion to their existing holdings.
EXPLAIN “MODIGLIANI-MILLER THEOREM” (WITHOUT TAXES).
In its simplest form, it suggests that in a perfect market, the value of a firm is independent of its capital structure (how it is financed).
WHAT IS A “DIVIDEND COVER”?
A ratio showing how many times a company can pay its dividends out of its current net income.
Dividend Cover = Earnings Per Share (EPS) / Dividend Per Share (DPS)
WHAT ARE AGENCY COSTS?
Expenses that arise from the conflict of interest between “principals” (shareholders) and “agents” (management), such as the cost of auditing or performance-based bonuses.
DEFINE “OVERTRADING.”
This occurs when a business expands its operations too rapidly without having sufficient long-term funds, leading to a cash flow crisis despite potentially high sales.
WHAT IS THE DIFFERENCE BETWEEN AN OPERATING LEASE AND A FINANCE LEASE?
Operating Lease: Like a rental; the asset stays off the balance sheet (though rules like IFRS 16 have changed this for many).
Finance Lease: Effectively a loan to buy the asset; the risks and rewards of ownership are transferred to the lessee.
WHAT IS “SENSITIVITY ANALYSIS” IN PROJECT APPRAISAL?
It involves changing one variable (like sales volume or cost of capital) to see how sensitive the project’s NPV is to that specific change.
WHAT IS A VENTURE CAPITALIST?
An investor who provides capital to startups or small companies that wish to expand but do not have access to public equities markets.
HOW DOES CB1 RELATE TO ACTUARIAL WORK?
Actuaries use CB1 concepts to interpret the financial health of the insurance companies they work for, manage corporate assets/liabilities, and evaluate the capital requirements needed to stay solvent.
