Finance and Financial Management
What this domain tests
Finance and Financial Management tests time value of money, capital budgeting, cost of capital, working capital, risk and return, valuation and dividend policy. You must make and justify investment and financing decisions.
Core rules
- Discount expected cash flows at an appropriate risk-adjusted rate; use after-tax cash flows and incremental cash flows.
- NPV = present value of cash inflows − initial investment. Accept positive-NPV projects.
- IRR is the discount rate that gives NPV = 0; it can mislead when projects differ in scale or timing.
- WACC = weighted average of after-tax cost of debt and cost of equity, using market-value weights.
- Manage working capital by balancing liquidity, credit risk and profitability.
- Higher financial leverage raises financial risk and the required return on equity.
Worked example
A project costs MMK 1,000 million and generates MMK 500 million per year for three years. At a 10% discount rate, the annuity factor is 2.4869. PV of inflows = 500 × 2.4869 = MMK 1,243.45 million. NPV = 1,243.45 − 1,000 = MMK 243.45 million. The project is acceptable. If the cash flows were MMK 400 million, PV = 994.76 million and NPV = −5.24 million, so reject.
Traps
- Using accounting profit instead of incremental after-tax cash flow.
- Ranking mutually exclusive projects by IRR only.
- Including sunk costs or ignoring opportunity costs.
- Using book-value weights when market-value weights are required for WACC.