Finance and Managerial Accounting
This section covers Finance and Managerial Accounting. The exam tests capital allocation, cost behaviour and performance measurement, including whether you can separate relevant from irrelevant numbers.
Core rules and concepts
- NPV discounts incremental after-tax cash flows at the project's opportunity cost of capital; accept positive NPV. IRR can mislead when projects differ in scale or timing. WACC is the blended required return of debt and equity, adjusted for tax.
- Managerial accounting focuses on decision-relevant costs: contribution margin, avoidable fixed costs and opportunity cost. Sunk costs are irrelevant. Variances separate price and quantity effects.
- Accounting profit differs from cash flow and economic profit. Working capital and capital expenditure can make a profitable project cash-negative.
Worked example
A project costs $500,000 and yields $120,000 after-tax cash flow for five years. At a 10% WACC, the annuity factor is 3.7908, so PV = $454,896 and NPV = −$45,104. Reject on financial grounds unless strategic options not captured in the cash flows are material and explicitly valued. Reason: the IRR might still look acceptable, but NPV measures value added in dollars.
Traps
Including sunk R&D in a go/no-go decision; deducting financing interest after already discounting at WACC; comparing IRR across different scales; treating allocated fixed overhead as avoidable; confusing gross margin with contribution margin.