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Free Business Finance MCQs with Answers

975 Business Finance MCQs from Management Sciences, each with the correct answer and a written explanation of why it is correct. Free and unlimited, with no account needed.

Business finance explains how organisations plan, obtain and use money while balancing risk, return and liquidity. Topics include financial statements, time value of money, budgeting, working capital, capital structure, sources of finance, investment appraisal and cost of capital. Capital budgeting evaluates long-term projects, whereas working capital manages day-to-day operations.

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975 questions · page 2 of 49

21. A company reports sales of Rs. 2,000,000 and cost of goods sold of Rs. 1,200,000. What is its gross profit margin?

  • A. 30%
  • B. 40%
  • C. 50%
  • D. 60%

Explanation: Gross profit is Rs. 800,000, calculated as sales minus cost of goods sold. Dividing Rs. 800,000 by Rs.

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Correct answer: 40%

22. Which financial statement primarily explains the movement of cash and cash equivalents during an accounting period?

  • A. Income statement
  • B. Cash flow statement
  • C. Statement of changes in equity
  • D. Statement of financial position

Explanation: The cash flow statement classifies cash movements into operating, investing and financing activities.

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Correct answer: Cash flow statement

23. A depreciation expense is added back to accounting profit when preparing cash flow from operations under the indirect method because depreciation:

  • A. Increases sales revenue
  • B. Is a non-cash expense
  • C. Creates a financing inflow
  • D. Reduces current liabilities

Explanation: Depreciation reduces reported profit but does not involve a current cash payment.

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Correct answer: Is a non-cash expense

24. A project has an internal rate of return of 14%, while the company's required rate of return is 11%. Based only on the IRR rule, the project should be:

  • A. Rejected because IRR exceeds the required return
  • B. Accepted because IRR exceeds the required return
  • C. Rejected because IRR is a percentage measure
  • D. Accepted only if its payback period is shortest

Explanation: Under the IRR decision rule, a project is normally accepted when its IRR is greater than the required rate of return.

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Correct answer: Accepted because IRR exceeds the required return

25. If a business increases its use of fixed-interest debt while operating income remains unchanged, which measure is most directly affected?

  • A. Financial leverage
  • B. Inventory turnover
  • C. Gross profit margin
  • D. Receivables collection period

Explanation: Fixed-interest debt creates compulsory finance costs and therefore increases financial leverage.

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Correct answer: Financial leverage

26. Which arrangement allows a business to obtain immediate cash by selling its credit invoices to a finance company?

  • A. Factoring
  • B. Leasing
  • C. Underwriting
  • D. Securitisation of equity

Explanation: Factoring involves transferring receivables to a factor, often at a discount, in exchange for earlier cash.

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Correct answer: Factoring

27. A company has profit after tax of Rs. 300,000 and ordinary shareholders' equity of Rs. 2,000,000. What is its return on equity?

  • A. 10%
  • B. 12%
  • C. 15%
  • D. 20%

Explanation: Return on equity is calculated as profit after tax divided by ordinary shareholders' equity. Rs. 300,000 divided by Rs.

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Correct answer: 15%

28. In capital budgeting, the profitability index is generally calculated as:

  • A. Initial investment divided by present value of inflows
  • B. Present value of inflows divided by initial investment
  • C. Accounting profit divided by total assets
  • D. Cash inflows divided by project life

Explanation: The profitability index compares the present value of future cash inflows with the initial investment.

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Correct answer: Present value of inflows divided by initial investment

29. Under the capital asset pricing model, if the risk-free rate is 6%, beta is 1.2 and the expected market return is 11%, what is the required return?

  • A. 10%
  • B. 11%
  • C. 12%
  • D. 13.2%

Explanation: CAPM gives required return as risk-free rate plus beta multiplied by the market risk premium. Thus, 6% plus 1.2 multiplied by 5% equals 12%.

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Correct answer: 12%

30. A firm maintains a high level of cash and inventory to reduce the risk of interruptions in production and payments. Compared with an aggressive policy, this approach is generally:

  • A. More conservative and less liquid
  • B. More conservative and more liquid
  • C. More aggressive and less liquid
  • D. More aggressive and more profitable by definition

Explanation: A conservative working capital policy holds relatively more current assets, improving liquidity and reducing operating risk.

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Correct answer: More conservative and more liquid

31. A company has long-term debt of Rs. 900,000 and shareholders' equity of Rs. 1,500,000. What is its debt-to-equity ratio?

  • A. 0.4:1
  • B. 0.6:1
  • C. 1.7:1
  • D. 2.4:1

Explanation: The debt-to-equity ratio is calculated as long-term debt divided by shareholders' equity. Thus, Rs. 900,000 divided by Rs.

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Correct answer: 0.6:1

32. A firm's inventory conversion period is 45 days, its receivables collection period is 30 days, and its payables payment period is 20 days. What is its cash conversion cycle?

  • A. 35 days
  • B. 55 days
  • C. 75 days
  • D. 95 days

Explanation: The cash conversion cycle equals inventory days plus receivable days minus payable days. Therefore, 45 plus 30 minus 20 equals 55 days.

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Correct answer: 55 days

33. Which statement best describes a finance lease from the lessee's perspective?

  • A. It transfers most ownership risks and rewards
  • B. It requires payment only after the asset is sold
  • C. It provides funds only for seasonal inventory
  • D. It allows cancellation without significant penalty

Explanation: A finance lease substantially transfers the risks and rewards associated with ownership to the lessee, even though legal title may remain…

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Correct answer: It transfers most ownership risks and rewards

34. A company earns profit after tax of Rs. 800,000 and pays ordinary dividends of Rs. 200,000. What is its dividend payout ratio?

  • A. 20%
  • B. 25%
  • C. 40%
  • D. 75%

Explanation: The dividend payout ratio is ordinary dividends divided by profit after tax, multiplied by 100. Rs. 200,000 divided by Rs.

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Correct answer: 25%

35. Which feature distinguishes the accounting rate of return method from discounted cash flow methods in investment appraisal?

  • A. It uses accounting profit rather than cash flow
  • B. It always includes the time value of money
  • C. It discounts all cash flows at the cost of debt
  • D. It measures only the project's payback period

Explanation: The accounting rate of return uses accounting profit and an accounting measure of investment.

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Correct answer: It uses accounting profit rather than cash flow

36. Under the Modigliani and Miller proposition for capital structure in a perfect market without taxes or bankruptcy costs, the value of a firm is primarily determined by its:

  • A. Dividend payment schedule
  • B. Operating investment decisions
  • C. Debt-to-equity ratio
  • D. Short-term borrowing policy

Explanation: In the basic Modigliani and Miller model, financing mix does not determine firm value under the stated ideal conditions.

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Correct answer: Operating investment decisions

37. What is the main purpose of a flexible budget?

  • A. To adjust budgeted costs for the actual activity level
  • B. To replace the firm's annual financial statements
  • C. To estimate only the required cash balance
  • D. To record transactions after they occur

Explanation: A flexible budget changes expected revenues and costs according to the actual level of activity.

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Correct answer: To adjust budgeted costs for the actual activity level

38. A preference share pays an annual dividend of Rs. 12 and currently sells for Rs. 100. Ignoring issue costs, what is the cost of preference shares?

  • A. 8%
  • B. 10%
  • C. 12%
  • D. 20%

Explanation: The cost of irredeemable preference shares is calculated as the annual preference dividend divided by the current market price. Rs.

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Correct answer: 12%

39. When two mutually exclusive projects have conflicting rankings under NPV and IRR, which criterion is generally preferred for maximising shareholder wealth?

  • A. Accounting rate of return
  • B. Payback period
  • C. Net present value
  • D. Average inventory period

Explanation: Net present value measures the amount by which a project is expected to increase wealth in present-value terms.

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Correct answer: Net present value

40. What is the usual effect of a rights issue on existing shareholders who do not exercise or sell their rights?

  • A. Their voting and ownership percentage may be diluted
  • B. Their dividend becomes legally guaranteed
  • C. Their shares automatically become preference shares
  • D. Their original share price is fixed permanently

Explanation: A rights issue offers new shares to existing shareholders, usually in proportion to their current holdings.

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Correct answer: Their voting and ownership percentage may be diluted
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