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CMA Final Paper 15 study materials
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CMA Final Paper 15 practice questions

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Question 1Strategic Financial Management

A company has a current ratio of 1.6, an inventory turnover of 8 times, and a quick ratio of 0.9. Which conclusion about its liquidity is most defensible?

  1. Inventory represents a small share of current assets
  2. The firm cannot meet its current obligations from current assets
  3. The firm has excess cash relative to its current liabilities
  4. Short-term liquidity depends heavily on converting inventory into cash Correct answer.

Explanation

The gap between the current ratio (1.6) and the quick ratio (0.9) shows a large inventory component in current assets. Since inventory must be sold and collected before it becomes cash, liquidity quality hinges on turnover speed. A quick ratio below 1 also signals reliance on inventory conversion to cover obligations.

Question 2Strategic Financial Management

In a strategic profit model, return on net worth is decomposed as net profit margin multiplied by asset turnover multiplied by which factor?

  1. Dividend payout ratio
  2. Interest coverage ratio
  3. Equity multiplier Correct answer.
  4. Gross margin percentage

Explanation

The strategic profit model links net profit margin, asset turnover, and the equity multiplier (total assets divided by equity) to explain return on net worth. The equity multiplier captures financial leverage, distinct from operating profitability and asset efficiency. Margin and turnover together give return on assets, which leverage then magnifies.

Question 3Strategic Financial Management

A firm's degree of operating leverage is 3.0 and its degree of financial leverage is 1.5. If sales rise by 10%, by approximately what percentage will earnings per share change?

  1. 30%
  2. 45% Correct answer.
  3. 15%
  4. 25%

Explanation

The degree of combined leverage is the product of operating and financial leverage, here 3.0 times 1.5 equals 4.5. Applying this to a 10% sales increase gives a 45% change in earnings per share. The multiplicative effect shows how fixed operating and financing costs amplify earnings volatility.

Question 4Strategic Financial Management

Which capital budgeting method is most likely to conflict with the goal of shareholder wealth maximization when comparing mutually exclusive projects of different sizes?

  1. Discounted payback period
  2. Internal rate of return Correct answer.
  3. Net present value
  4. Profitability index

Explanation

Internal rate of return ignores project scale and can favor a small project with a high percentage return over a larger project that adds more absolute value. Net present value is the theoretically preferred criterion for mutually exclusive projects because it measures the direct change in firm value. Conflicts arise from scale and reinvestment-rate assumptions.

Question 5Strategic Financial Management

A company is considering a project that requires an initial outlay of 500,000 and generates annual after-tax cash inflows of 140,000 for five years. Using a discount rate of 10%, the annuity factor for five years at 10% is 3.791. What is the approximate net present value?

  1. 30,740 Correct answer.
  2. 200,000
  3. 700,000
  4. -30,740

Explanation

The present value of the inflows is 140,000 multiplied by 3.791, which equals 530,740. Subtracting the 500,000 initial outlay gives a positive NPV of approximately 30,740. A positive NPV indicates the project earns more than the 10% required return.

Question 6Strategic Financial Management

Under Modigliani and Miller's propositions with corporate taxes but no bankruptcy costs, what is the effect of increasing debt in the capital structure?

  1. Firm value rises by the present value of the interest tax shield Correct answer.
  2. The cost of equity falls as debt increases
  3. Firm value is unaffected because capital structure is irrelevant
  4. The weighted average cost of capital rises with leverage

Explanation

With corporate taxes and no distress costs, interest is tax-deductible, so leverage creates a tax shield whose present value adds to firm value. The cost of equity rises with leverage because shareholders bear greater financial risk, but the after-tax cost of debt keeps WACC falling. This produces the classic result that value increases with debt up to the point where distress costs appear.

Question 7Strategic Financial Management

A firm's dividend payout ratio is 40%, its return on equity is 15%, and it follows a residual dividend policy based on a constant target. What is its sustainable growth rate?

  1. 4.0%
  2. 15.0%
  3. 9.0% Correct answer.
  4. 6.0%

Explanation

The sustainable growth rate equals the retention ratio multiplied by return on equity. With a 40% payout, the retention ratio is 60%, and 0.60 times 15% equals 9.0%. This is the rate of growth achievable from internally generated funds without altering leverage.

Question 8Strategic Financial Management

Which statement best describes the strategic role of a hedging program using forward contracts for a firm with foreign-currency receivables?

  1. It guarantees a higher cash inflow than an unhedged position
  2. It increases reported earnings volatility relative to no hedge
  3. It eliminates all foreign exchange exposure permanently
  4. It reduces uncertainty in cash flows but forgoes potential gains from favorable rate moves Correct answer.

Explanation

Hedging with forwards locks in an exchange rate, stabilizing expected cash flows but removing upside if the currency later strengthens. The purpose is risk reduction, not return enhancement. Hedging addresses transactional exposure for the covered amount and period only.

Question 9Strategic Financial Management

A company has annual credit sales of 3,650,000 and average accounts receivable of 500,000. Using a 365-day year, what is the average collection period?

  1. 50 days Correct answer.
  2. 73 days
  3. 7.3 days
  4. 5 days

Explanation

Receivables turnover equals credit sales divided by average receivables, or 3,650,000 divided by 500,000, which is 7.3 times. The average collection period is 365 divided by 7.3, approximately 50 days. This measures how long customers take to pay on average.

Question 10Strategic Financial Management

Which working capital financing approach matches the maturity of assets with the maturity of the funds used to finance them?

  1. Aggressive approach
  2. Conservative approach
  3. Spontaneous approach
  4. Matching approach Correct answer.

Explanation

The matching, or maturity-matching, approach finances long-term assets with long-term funds and temporary current assets with short-term funds. This aligns asset life with funding life and limits refinancing risk. The aggressive and conservative approaches deliberately mismatch maturities to trade off risk and return.

Question 11Strategic Financial Management

A firm reports operating profit of 800,000, interest expense of 200,000, and tax expense of 150,000. What is its times interest earned ratio?

  1. 1.75 times
  2. 5.0 times
  3. 3.25 times
  4. 4.0 times Correct answer.

Explanation

Times interest earned equals operating profit (earnings before interest and taxes) divided by interest expense. Here 800,000 divided by 200,000 equals 4.0 times. The ratio shows how many times operating earnings cover the interest obligation.

Question 12Strategic Financial Management

Under the residual dividend model, dividends are paid only after which condition is satisfied?

  1. All positive-NPV investment opportunities funded at the target capital structure are financed Correct answer.
  2. Retained earnings exceed the prior year's dividend amount
  3. The share price has risen above its book value
  4. The firm has met its target dividend payout ratio for the year

Explanation

The residual model treats dividends as what remains after financing all acceptable investment projects with equity at the target capital structure. Dividends therefore fluctuate with investment opportunities and internally generated funds. This prioritizes value-creating investment over dividend stability.

Question 13Strategic Financial Management

A company wants to reduce the length of its cash conversion cycle. Which action achieves this without changing sales volume or the operating cycle components already fixed?

  1. Slowing the collection of receivables
  2. Increasing the level of raw material inventory
  3. Extending credit terms offered to customers
  4. Negotiating longer payment terms with suppliers Correct answer.

Explanation

The cash conversion cycle equals inventory days plus receivable days minus payable days. Lengthening supplier payment terms raises payable days, which shortens the cycle. The other actions extend the cycle by increasing inventory or receivable days.

Question 14Strategic Financial Management

Which of the following best explains why a firm might prefer debt over equity financing when its marginal tax rate is high?

  1. Debt holders share in the firm's residual profits
  2. Dividends paid to shareholders are tax-deductible
  3. Interest is tax-deductible, lowering the after-tax cost of debt relative to equity Correct answer.
  4. Debt covenants are less restrictive than equity issuance

Explanation

Interest payments are deductible from taxable income, creating a tax shield that reduces the effective cost of debt. Equity returns, by contrast, are paid from after-tax earnings. A higher marginal tax rate increases the value of that shield and favors debt.

Question 15Strategic Financial Management

A firm's beta is 1.4, the risk-free rate is 4%, and the expected market return is 10%. Using the capital asset pricing model, what is the cost of equity?

  1. 12.4% Correct answer.
  2. 14.0%
  3. 10.0%
  4. 8.4%

Explanation

The CAPM cost of equity equals the risk-free rate plus beta times the market risk premium. The premium is 10% minus 4%, or 6%, and 1.4 times 6% equals 8.4%. Adding the 4% risk-free rate gives 12.4%.

Question 16Strategic Financial Management

In a discounted cash flow valuation, which adjustment is required when computing free cash flow to the firm from net income?

  1. Subtract interest expense and add dividends paid
  2. Add depreciation and subtract taxes only
  3. Add net borrowing and subtract dividend payments
  4. Add back after-tax interest and non-cash charges, then subtract capital expenditures and working capital investment Correct answer.

Explanation

Free cash flow to the firm is the cash available to all capital providers, so it starts from operating earnings and adds back after-tax interest and non-cash charges such as depreciation. Capital expenditures and increases in net working capital are then deducted as reinvestment. Discounting this flow at WACC yields enterprise value.

Question 17Strategic Financial Management

A company has a debt-to-equity ratio of 1.0 and a tax rate of 25%. If its unlevered beta is 1.2, what is its levered beta using the Hamada equation?

  1. 1.8
  2. 1.2
  3. 2.1 Correct answer.
  4. 1.5

Explanation

The Hamada equation gives levered beta as unlevered beta times one plus the after-tax debt-to-equity ratio. The after-tax ratio is 1.0 times 0.75, or 0.75, so the multiplier is 1.75. Multiplying 1.2 by 1.75 yields 2.1.

Question 18Strategic Financial Management

Which statement about economic value added as a performance measure is most accurate?

  1. It is positive only when operating profit after tax exceeds the dollar cost of capital employed Correct answer.
  2. It ignores the cost of equity because equity is not a contractual obligation
  3. It equals net income minus dividends paid to shareholders
  4. It rises automatically whenever a firm increases its invested capital

Explanation

Economic value added is after-tax operating profit minus the dollar cost of capital, calculated as invested capital times the weighted average cost of capital. A positive result means the firm earned more than the opportunity cost of the funds employed. Growth in capital only adds value when returns exceed that cost.

Question 19Strategic Financial Management

A firm faces a decision to invest in a project now or defer it for one year. Which concept best justifies deferral when the project has high uncertainty and the investment is largely irreversible?

  1. The payback period criterion
  2. The accounting rate of return
  3. The value of the option to wait Correct answer.
  4. The dividend irrelevance theorem

Explanation

When investment is irreversible and uncertainty is high, deferral preserves the ability to avoid a poor outcome while keeping the opportunity to invest if conditions improve. This real option to wait has value that conventional discounted cash flow analysis omits. The value rises with uncertainty and with the length of the deferral window.

Question 20Strategic Financial Management

A company's bonds currently yield 7% before tax, its marginal tax rate is 30%, and its target capital structure is 40% debt and 60% equity. If the cost of equity is 12%, what is the weighted average cost of capital?

  1. 8.40%
  2. 9.16% Correct answer.
  3. 10.80%
  4. 9.50%

Explanation

The after-tax cost of debt is 7% times 0.70, or 4.9%. Weighting by the target structure gives 0.40 times 4.9% plus 0.60 times 12%, which equals 1.96% plus 7.20%, or 9.16%. WACC uses after-tax debt cost because interest is deductible.

Question 21Strategic Financial Management

Which of the following is the primary reason a firm sets a target capital structure rather than constantly rebalancing to a precise ratio?

  1. Regulators prohibit firms from changing capital structure frequently
  2. Debt ratios have no effect on the cost of capital
  3. Shareholders require a fixed debt-to-equity ratio each year
  4. Flotation costs and market timing make continuous rebalancing costly and impractical Correct answer.

Explanation

Issuing and retiring securities involves flotation costs, and market conditions vary, so firms allow leverage to drift within a range around the target. The target guides financing decisions over time rather than dictating continuous adjustment. This balances the benefits of an optimal structure against transaction costs.

Question 22Strategic Financial Management

A firm with a high proportion of fixed costs relative to variable costs will typically exhibit which characteristic?

  1. A lower break-even point than a labor-intensive firm
  2. A high degree of operating leverage and greater sensitivity of operating profit to sales changes Correct answer.
  3. Insensitivity of operating profit to changes in sales volume
  4. A low degree of operating leverage and stable operating profit

Explanation

High fixed costs mean that once the break-even point is passed, each additional sales dollar contributes heavily to operating profit, raising operating leverage. The same structure amplifies losses when sales fall. A capital-intensive firm therefore shows more volatile operating income than a labor-intensive one.

Question 23Strategic Financial Management

In an interest rate swap used to convert floating-rate debt to fixed-rate exposure, what is the primary financial effect for the payer of the fixed rate?

  1. It locks in a fixed net interest cost while retaining the underlying loan obligation Correct answer.
  2. It converts fixed-rate debt into floating-rate debt
  3. It eliminates the firm's obligation to repay the principal
  4. It removes all credit risk from the lender

Explanation

In a plain vanilla swap, the fixed-rate payer exchanges fixed payments for floating payments, which offsets the floating interest on its loan and creates a synthetic fixed cost. The underlying debt remains on the balance sheet and principal repayment is unaffected. Credit risk between counterparties still exists.

Question 24Strategic Financial Management

A company reports a return on assets of 12%, a net profit margin of 4%, and a debt-to-equity ratio of 1.5. What is its return on equity?

  1. 30% Correct answer.
  2. 12%
  3. 18%
  4. 8%

Explanation

Return on equity equals return on assets multiplied by the equity multiplier, where the multiplier is one plus debt-to-equity, or 2.5. Multiplying 12% by 2.5 gives 30%. This shows how leverage magnifies returns to shareholders when asset returns exceed the cost of debt.

Question 25Strategic Financial Management

Which factor most directly increases a firm's exposure to transaction risk from foreign exchange movements?

  1. Issuing long-term bonds in the domestic currency
  2. Paying domestic suppliers in the domestic currency
  3. Receiving export payments denominated in a foreign currency with delayed settlement Correct answer.
  4. Holding a diversified portfolio of domestic equities

Explanation

Transaction exposure arises when contractual cash flows are denominated in a foreign currency and settle at a future date, so exchange rate changes alter the domestic-currency value received. Domestic-currency transactions carry no such exposure. Timing and currency denomination are the defining elements.

Question 26Strategic Financial Management

A company has an inventory turnover of 6 times per year and an accounts receivable collection period of 45 days. Using a 365-day year, what is the approximate operating cycle?

  1. 91 days
  2. 151 days
  3. 61 days
  4. 106 days Correct answer.

Explanation

The operating cycle equals the inventory conversion period plus the receivables collection period. Inventory conversion period is 365 divided by 6, approximately 61 days, and adding 45 days of receivables gives about 106 days. The payables deferral period is not part of the operating cycle, only of the cash conversion cycle.

Question 27Strategic Financial Management

Which statement best captures the strategic rationale for a firm to centralize its treasury function across subsidiaries?

  1. It eliminates all foreign exchange exposure because transactions are recorded in one currency
  2. It allows netting of intercompany exposures and pooling of cash, reducing external borrowing and transaction costs Correct answer.
  3. It guarantees that each subsidiary will report identical profit margins
  4. It transfers the responsibility for hedging decisions to local operating managers

Explanation

Centralized treasury enables multilateral netting of group exposures and cash pooling, which lowers gross external funding needs and transaction costs. It is a coordination and efficiency argument, not an elimination of risk. Local knowledge may still inform hedging, but decision authority is consolidated rather than devolved.

Question 28Strategic Financial Management

A firm has a return on equity of 18% and a dividend payout ratio of 30%. Using the sustainable growth rate formula, what is its sustainable growth rate?

  1. 25.7%
  2. 12.6% Correct answer.
  3. 18.0%
  4. 5.4%

Explanation

The sustainable growth rate equals retention ratio multiplied by return on equity. Retention is 70%, so 0.70 times 18% equals 12.6%. This represents growth financeable from internally generated equity at a constant capital structure.

Question 29Strategic Financial Management

Which statement best describes how a company can use a money market hedge to cover a future foreign currency payable?

  1. It buys the foreign currency forward at a locked rate for future delivery
  2. It borrows the foreign currency now, converts it at spot, and repays from the future payable funds Correct answer.
  3. It purchases a call option on the foreign currency to cap the cost
  4. It invests surplus domestic cash until the payment date without currency conversion

Explanation

A money market hedge replicates a forward by borrowing in the currency of the payable today, converting at spot, and using the eventual payment funds to settle the loan. This locks in the domestic currency cost through interest rate differentials. It differs from a forward because it involves actual borrowing and conversion now.

Question 30Strategic Financial Management

A firm's earnings per share is expected to fall if it proceeds with an acquisition financed by issuing new shares. Which concept best explains why the deal may still create value?

  1. Bootstrapping of earnings growth through combining low price-earnings targets
  2. Synergy value exceeding the premium paid, even if short-term EPS falls Correct answer.
  3. Reduction in the number of shares outstanding after the transaction
  4. Dilution of the acquirer's weighted average cost of capital

Explanation

Share-financed deals can dilute EPS while still being value-creating if the present value of synergies exceeds the premium paid. EPS dilution is an accounting outcome, not a valuation test. Bootstrapping raises EPS artificially without creating economic value, so it is not the justification.

Question 31Strategic Financial Management

Which of the following is a primary advantage of using a currency option rather than a forward contract to hedge a foreign currency receivable?

  1. The option eliminates counterparty credit risk entirely
  2. The option locks in a fixed exchange rate for certain
  3. The option preserves upside if the foreign currency strengthens while limiting downside Correct answer.
  4. The option requires no upfront premium

Explanation

An option gives the holder the right but not the obligation to exchange currency, so favorable movements can be captured while adverse movements are limited. This asymmetry is valuable when the direction of the currency is uncertain. The trade-off is the premium paid upfront.

Question 32Strategic Financial Management

A company has a gross profit margin of 40%, operating expenses equal to 15% of sales, and sales of 2,000,000. What is its operating profit?

  1. 500,000 Correct answer.
  2. 300,000
  3. 800,000
  4. 200,000

Explanation

Gross profit is 40% of 2,000,000, or 800,000. Subtracting operating expenses of 15% of sales, or 300,000, leaves operating profit of 500,000. Operating profit excludes interest and tax, so no further deduction is made.

Question 33Strategic Financial Management

Which statement best explains the economic rationale for a share buyback when a company's shares trade below intrinsic value?

  1. It reduces the firm's debt burden by retiring liabilities
  2. It increases earnings per share without any change in underlying cash flows or value
  3. It allows remaining shareholders to capture value as fewer shares share the same firm value Correct answer.
  4. It transfers wealth from remaining shareholders to selling shareholders

Explanation

When shares trade below intrinsic value, repurchasing them concentrates ownership of the firm's true value among remaining shareholders. The value transferred comes from selling shareholders who exit at a discount. EPS accretion alone is not evidence of value creation.

Question 34Strategic Financial Management

A firm's weighted average cost of capital is 10%, its return on invested capital is 13%, and its invested capital is 50,000,000. What is its economic value added?

  1. 6,500,000
  2. 500,000
  3. 3,500,000
  4. 1,500,000 Correct answer.

Explanation

EVA equals invested capital multiplied by the spread between return on invested capital and the cost of capital. The spread is 13% minus 10%, or 3%, and 3% of 50,000,000 is 1,500,000. EVA measures profit above the required return on capital employed.

Question 35Strategic Financial Management

Which statement best explains why a firm with substantial debt may reject a positive net present value project that equity holders would otherwise favor?

  1. Positive NPV projects always reduce the firm's debt capacity
  2. Debt overhang causes value created by the project to accrue mainly to existing creditors Correct answer.
  3. Equity holders prefer projects with negative NPV when leverage is high
  4. The project's systematic risk is necessarily higher than the firm's average risk

Explanation

When existing debt is risky, much of the gain from a new investment flows to creditors who become safer, so shareholders may forgo positive NPV projects. This is the debt overhang or underinvestment problem. It arises from the conflict between shareholders and creditors, not from project risk per se.

Question 36Strategic Financial Management

A company's current ratio is 1.8 and its quick ratio is 1.1. Which conclusion is most consistent with these figures?

  1. The firm is technically insolvent
  2. The firm has no accounts receivable
  3. Inventory constitutes a material portion of current assets Correct answer.
  4. Inventory represents a small portion of current assets

Explanation

The gap between the current ratio and the quick ratio reflects the inventory component, since the quick ratio excludes inventory. A gap of 0.7 indicates inventory is a meaningful share of current assets. Solvency cannot be inferred from liquidity ratios alone, and receivables are included in both ratios.

Question 37Strategic Financial Management

Which of the following best describes the role of a target cash balance in a firm's cash management policy?

  1. It balances the opportunity cost of holding cash against the cost of running short and having to liquidate investments Correct answer.
  2. It fixes the interest rate the firm pays on its revolving credit facility
  3. It determines the firm's dividend payout ratio for the year
  4. It sets the maximum level of short-term borrowing the firm may undertake

Explanation

The target cash balance reflects a trade-off between the return forgone on idle cash and the transaction and disruption costs of running short. Firms hold a buffer to avoid forced borrowing or asset sales. It is a liquidity buffer decision, not a borrowing cap or dividend determinant.

Question 38Strategic Financial Management

A firm has sales of 5,000,000, a net profit margin of 6%, total assets of 2,500,000, and a debt-to-equity ratio of 1.0. Using the DuPont framework, what is its return on equity?

  1. 18%
  2. 24% Correct answer.
  3. 6%
  4. 12%

Explanation

DuPont decomposes ROE into margin, asset turnover, and equity multiplier. Margin is 6%, turnover is 5,000,000/2,500,000 or 2.0, and with debt-to-equity of 1.0 the equity multiplier is 2.0, giving 6% times 2.0 times 2.0, or 24%.

Question 39Strategic Financial Management

Which statement best explains the effect of financial distress costs on a firm's capital structure choice?

  1. They are irrelevant when the firm has a high credit rating
  2. They increase the tax benefit of debt and push leverage toward 100%
  3. They offset part of the tax shield from debt, producing an interior optimal leverage ratio Correct answer.
  4. They apply only to firms with no taxable income

Explanation

In the trade-off theory, expected distress costs rise with leverage and offset the interest tax shield, so value is maximized at an interior debt level. This reconciles observed moderate leverage with the tax advantage of debt. Distress costs are relevant to all leveraged firms, though they vary with business risk.

Question 40Strategic Financial Management

A company is evaluating a project with an initial outlay of 400,000 and expected annual cash inflows of 120,000 for five years. At a discount rate of 10%, the annuity factor for five years is 3.791. What is the project's net present value?

  1. 200,000
  2. -54,920
  3. 145,080
  4. 54,920 Correct answer.

Explanation

The present value of inflows is 120,000 times 3.791, or 454,920. Subtracting the 400,000 initial outlay gives a net present value of 54,920. A positive NPV means the project earns more than the 10% required return.

Question 41Strategic Cost Management and Performance Evaluation

In a traditional absorption costing system, a favourable fixed production overhead volume variance arises when actual production activity exceeds the level used to set the fixed overhead absorption rate. Which statement best explains the underlying cause of this variance?

  1. Fixed overheads were over-absorbed because more units were produced than budgeted, so spread fixed cost over more units. Correct answer.
  2. Actual fixed overhead expenditure was lower than the budgeted fixed overhead figure for the period.
  3. The standard hours allowed for actual output were below the budgeted hours used in the absorption rate.
  4. Variable overhead efficiency deteriorated, which released capacity that was absorbed as fixed overhead.

Explanation

The volume variance isolates the effect of producing at a different activity level from the one used to derive the absorption rate. When output exceeds the budgeted activity, the same fixed cost is spread over more units, so overhead is over-absorbed and the variance is favourable. It is driven by activity, not by the amount of expenditure incurred.

Question 42Strategic Cost Management and Performance Evaluation

A company uses a standard marginal costing system. Which variance would NOT appear in its operating statement?

  1. Fixed overhead capacity variance Correct answer.
  2. Sales volume contribution variance
  3. Material price variance
  4. Fixed overhead expenditure variance

Explanation

Marginal costing reports contribution, so fixed overheads are charged in total and only an expenditure variance is computed. Capacity and efficiency volume variances exist only in absorption costing, where fixed overhead is absorbed into product cost. Hence the capacity variance is absent from a marginal costing statement.

Question 43Strategic Cost Management and Performance Evaluation

A firm's learning curve index is 80%. The first unit took 100 hours. Using the cumulative average time model, what is the total time for the first four units?

  1. 400 hours
  2. 320 hours Correct answer.
  3. 409.6 hours
  4. 256 hours

Explanation

Under the cumulative average time model the average time per unit falls to 80% of its prior value each time cumulative output doubles. After four units the average is 100 × 0.8 × 0.8 = 64 hours, so total time is 64 × 4 = 256 hours... check: 64 × 4 = 256.

Question 44Strategic Cost Management and Performance Evaluation

A company has a throughput accounting ratio (TPAR) of 0.85 for a product that uses a bottleneck resource. What is the most appropriate interpretation and response?

  1. The ratio measures machine utilisation and a value below one signals idle capacity to be filled.
  2. The product is highly profitable per bottleneck minute and should be prioritised over all other products.
  3. The ratio confirms that the product covers its material cost and should always be produced first.
  4. The product generates less return per bottleneck minute than the factory operating cost, so it should be re-priced or de-emphasised. Correct answer.

Explanation

The TPAR compares throughput per unit of bottleneck time with the total factory cost per unit of bottleneck time. A ratio below one means the product does not fully cover conversion costs per bottleneck minute, so it should be re-priced, redesigned or dropped. Products are ranked by throughput per bottleneck minute, not by TPAR itself.

Question 45Strategic Cost Management and Performance Evaluation

In target costing, the allowable cost is determined by which relationship?

  1. Target selling price minus target profit margin Correct answer.
  2. Target cost plus value engineering savings
  3. Current standard cost minus planned cost reduction
  4. Competitor price plus a standard markup

Explanation

Target costing works backwards from a market-driven selling price, deducting the required profit to derive the allowable cost. The gap between the allowable cost and the current cost drives value engineering and cost-reduction activity. It is a market-in, not cost-plus, approach.

Question 46Strategic Cost Management and Performance Evaluation

Which characteristic distinguishes a cost driver in activity-based costing from an arbitrary allocation base?

  1. It has a causal relationship with the consumption of the activity's resources. Correct answer.
  2. It is always expressed in monetary units.
  3. It is selected because it is readily available in the accounting system.
  4. It allocates total overhead equally across all products.

Explanation

An activity cost driver is chosen because changes in the driver cause changes in the activity's resource consumption, giving a causal link. Arbitrary bases are chosen for convenience and may bear no causal relationship to overhead consumption. Availability or monetary units do not establish causality.

Question 47Strategic Cost Management and Performance Evaluation

A division reports residual income of a positive amount under a cost of capital of 12%. If the cost of capital is raised to 15% with all else unchanged, what happens to residual income?

  1. It doubles because the rate increase is proportionally large.
  2. It rises because the capital charge increases.
  3. It falls, and may become negative. Correct answer.
  4. It is unchanged because operating profit is unaffected.

Explanation

Residual income equals divisional operating profit less a capital charge calculated as the cost of capital multiplied by invested capital. Raising the rate increases the capital charge, so residual income falls and could turn negative. Operating profit is unaffected, but residual income is not.

Question 48Strategic Cost Management and Performance Evaluation

A company produces two joint products from a common process. Which method of allocating joint costs is most defensible when the products have significantly different sales values at the split-off point?

  1. Physical units method
  2. Sales value at split-off method Correct answer.
  3. Net realisable value after further processing only
  4. Equal gross margin method

Explanation

When products have materially different sales values, allocating on relative sales value at split-off reflects the economic benefit each product derives from the common process. The physical units method ignores value differences and can distort product profitability. NRV is used where split-off value is unavailable or further processing is required.

Question 49Strategic Cost Management and Performance Evaluation

Under the high-low method, a cost of £40,000 at 10,000 units and £60,000 at 20,000 units implies a variable cost per unit and fixed cost of:

  1. £2.00 per unit and £20,000 fixed Correct answer.
  2. £2.00 per unit and £40,000 fixed
  3. £3.00 per unit and £10,000 fixed
  4. £4.00 per unit and £0 fixed

Explanation

The variable rate is the change in cost divided by the change in activity: (£60,000 − £40,000) ÷ (20,000 − 10,000) = £2 per unit. Substituting into the high point gives fixed cost of £60,000 − (20,000 × £2) = £20,000.

Question 50Strategic Cost Management and Performance Evaluation

A company faces a single limiting factor and produces three products. Which ranking rule maximises total contribution?

  1. Rank by contribution per unit of the scarce resource Correct answer.
  2. Rank by contribution per unit of product
  3. Rank by selling price per unit
  4. Rank by gross profit percentage

Explanation

When one resource constrains output, contribution per unit of the limiting factor determines how much value each scarce unit generates. Ranking by this ratio maximises total contribution for the available resource. Absolute contribution or price per unit ignores resource consumption.