Finance
Core concepts
Finance questions test the time value of money, capital budgeting, cost of capital, and working capital management. You must be able to compute present and future values, net present value (NPV), internal rate of return (IRR), payback, and the weighted average cost of capital (WACC). Understand the distinction between systematic and unsystematic risk, the Capital Asset Pricing Model (CAPM), and the role of gearing in the cost of equity. Know the sources of business finance - equity, debt, retained earnings - and their relative costs and risks.
Common traps
A classic trap is discounting the wrong cash flow: use after-tax incremental cash flows and ignore sunk costs and financing costs (which are captured in the discount rate). Another is confusing IRR with NPV - IRR can give multiple answers with non-conventional cash flows. Watch for questions that mix nominal and real rates; match the discount rate to the cash flow. Also be alert to the difference between the cost of debt before and after tax.
Worked example / rule of thumb
A project costs 1,000,000 and yields 400,000 per year for 3 years. At 10%, discount factors are 0.909, 0.826, and 0.751. PV = 400,000 × (0.909 + 0.826 + 0.751) = 400,000 × 2.486 = 994,400. NPV = 994,400 − 1,000,000 = −5,600, so reject. Rule of thumb: accept if NPV > 0; IRR must exceed the cost of capital.
Exam technique
Lay out cash flows year by year; label discount factors clearly.