Preparing for the CFA Level 1 exam requires mastery of Corporate Finance concepts, including capital budgeting, cost of capital, dividend policy, and leverage. In this Part 2 set of CFA Corporate Finance MCQs (Q51–100), we cover exam-style questions with detailed answers and explanations to strengthen your understanding.
These questions are designed to match the real CFA exam format, helping you practice effectively and build exam confidence.
📘 CFA Level 1 Corporate Finance MCQs (Part 2: Q51–100)
Q51. The primary goal of capital budgeting is to:
A) Minimize risk.
B) Maximize shareholder wealth.
C) Increase market share.
D) Minimize debt financing.
Answer: B) Maximize shareholder wealth.
Explanation: Capital budgeting decisions aim to maximize long-term shareholder wealth by selecting projects with positive net present value (NPV).
Q52. Which of the following is NOT a method of evaluating capital budgeting projects?
A) Net Present Value (NPV)
B) Payback Period
C) Internal Rate of Return (IRR)
D) Accounting Profit Margin
Answer: D) Accounting Profit Margin.
Explanation: Accounting profit margin is not a standard capital budgeting tool. NPV, IRR, and Payback are widely used methods.
Q53. A firm’s Weighted Average Cost of Capital (WACC) decreases when:
A) The firm issues more equity at a higher cost.
B) The firm replaces debt with equity.
C) The cost of debt decreases while tax rates remain constant.
D) Market interest rates rise.
Answer: C) The cost of debt decreases while tax rates remain constant.
Explanation: Since interest is tax-deductible, a fall in the cost of debt reduces WACC, making projects more attractive.
Q54. In dividend policy, the residual theory suggests:
A) Dividends should be constant regardless of profits.
B) Dividends should be paid only after funding profitable investments.
C) Firms should maximize dividend payout.
D) Dividends are irrelevant to valuation.
Answer: B) Dividends should be paid only after funding profitable investments.
Explanation: The residual dividend theory implies dividends are a “residual” after all profitable investments have been made.
Q55. Corporate governance primarily aims to:
A) Increase employee benefits.
B) Ensure accountability of management to shareholders.
C) Reduce taxation for corporations.
D) Improve government regulations.
Answer: B) Ensure accountability of management to shareholders.
Explanation: Good corporate governance structures align management actions with shareholder interests.
Q56. Which capital budgeting technique assumes reinvestment at the cost of capital?
A) Payback period
B) IRR
C) Modified IRR (MIRR)
D) NPV
Answer: D) NPV.
Explanation: The NPV method assumes reinvestment at the firm’s cost of capital, which is more realistic than IRR’s reinvestment at the project’s return.
Q57. An increase in the firm’s debt ratio (leverage) generally leads to:
A) Lower financial risk.
B) Higher financial risk.
C) No change in WACC.
D) Lower required return on equity.
Answer: B) Higher financial risk.
Explanation: As leverage increases, equity holders demand a higher return due to higher financial risk.
Q58. According to the pecking order theory of capital structure, firms prefer:
A) Debt over equity.
B) Equity over debt.
C) Internal financing first, then debt, then equity.
D) External financing only.
Answer: C) Internal financing first, then debt, then equity.
Explanation: Pecking order theory suggests firms prefer internal financing to avoid signaling issues and equity dilution.
Q59. Which of the following is an advantage of issuing debt over equity?
A) Lower bankruptcy risk.
B) Tax deductibility of interest payments.
C) Guaranteed fixed dividends.
D) Less restrictive covenants.
Answer: B) Tax deductibility of interest payments.
Explanation: Interest on debt is tax-deductible, reducing the effective cost of debt compared to equity.
Q60. A project has an NPV of -$50,000 and IRR of 8%. If the firm’s cost of capital is 10%, the project should be:
A) Accepted.
B) Rejected.
C) Delayed.
D) Financed with equity.
Answer: B) Rejected.
Explanation: Since IRR < cost of capital and NPV is negative, the project destroys value and must be rejected.
Q61. Which of the following BEST describes the Modigliani-Miller (MM) Proposition I (without taxes)?
A) The value of a firm increases with leverage.
B) Dividend policy affects firm value.
C) Capital structure is irrelevant to firm value.
D) Higher debt always reduces WACC.
Answer: C) Capital structure is irrelevant to firm value.
Explanation: MM Proposition I (no taxes) states that a firm’s value is independent of its capital structure.
Q62. Which of the following is a weakness of the payback period method?
A) Considers all cash flows.
B) Considers the time value of money.
C) Ignores cash flows after the cutoff period.
D) Is difficult to calculate.
Answer: C) Ignores cash flows after the cutoff period.
Explanation: Payback period only considers cash flows until the initial investment is recovered, ignoring later inflows.
Q63. The optimal capital structure is the one that:
A) Maximizes cost of capital.
B) Minimizes WACC and maximizes firm value.
C) Has the highest debt-equity ratio possible.
D) Maximizes dividend payout.
Answer: B) Minimizes WACC and maximizes firm value.
Explanation: The optimal capital structure is achieved at the point where WACC is lowest, and firm value is highest.
Q64. Which of the following is a flotation cost?
A) Underpricing of equity issue
B) Tax on dividends
C) Interest on debt
D) Shareholder opportunity cost
Answer: A) Underpricing of equity issue.
Explanation: Flotation costs include expenses like underwriting fees and underpricing when raising new equity.
Q65. A firm is evaluating two mutually exclusive projects. Project A has higher NPV, while Project B has higher IRR. Which should the firm choose?
A) Project A
B) Project B
C) Either project
D) The one with shortest payback
Answer: A) Project A.
Explanation: When NPV and IRR conflict, the project with the higher NPV should be chosen, as it maximizes value.
Q66. Dividend payout is more likely to be higher in firms that:
A) Have fewer growth opportunities.
B) Have higher expected return on equity.
C) Face high business risk.
D) Are early-stage start-ups.
Answer: A) Have fewer growth opportunities.
Explanation: Mature firms with fewer investment opportunities distribute more earnings as dividends.
Q67. Which of the following describes the clientele effect in dividend policy?
A) Shareholders prefer stock splits.
B) Different investors prefer different dividend payout levels.
C) Managers adjust dividends to maintain EPS.
D) Investors ignore dividends in valuation.
Answer: B) Different investors prefer different dividend payout levels.
Explanation: Some investors prefer current income (high dividends), while others prefer capital gains (low dividends).
Q68. Which of the following is an example of a stock dividend?
A) Firm issues bonds instead of dividends.
B) Firm issues additional shares to existing shareholders.
C) Firm repurchases its own stock.
D) Firm pays cash dividend quarterly.
Answer: B) Firm issues additional shares to existing shareholders.
Explanation: A stock dividend gives shareholders additional shares rather than cash.
Q69. Which measure is MOST affected by changes in dividend policy?
A) Return on equity (ROE)
B) Earnings per share (EPS)
C) Retained earnings growth rate
D) Price-to-book ratio
Answer: C) Retained earnings growth rate.
Explanation: Dividend policy directly impacts how much of net income is retained for reinvestment.
Q70. The sustainable growth rate (SGR) of a firm is:
A) ROE × Dividend payout ratio
B) ROE × (1 – Dividend payout ratio)
C) Net income ÷ Total assets
D) ROA × Dividend payout ratio
Answer: B) ROE × (1 – Dividend payout ratio).
Explanation: The sustainable growth rate is the maximum growth a firm can achieve without increasing leverage.
Q71. Which of the following is TRUE about share repurchases?
A) They always reduce EPS.
B) They can signal undervaluation to the market.
C) They are tax-deductible.
D) They increase outstanding shares.
Answer: B) They can signal undervaluation to the market.
Explanation: Share repurchases reduce outstanding shares and often signal management’s belief that stock is undervalued.
Q72. Which is an advantage of NPV over IRR?
A) NPV assumes reinvestment at the IRR.
B) NPV can handle multiple IRRs.
C) NPV provides a direct measure of value creation.
D) NPV ignores time value of money.
Answer: C) NPV provides a direct measure of value creation.
Explanation: NPV shows the dollar value added by the project, making it superior in decision-making.
Q73. Which of the following increases a firm’s WACC?
A) Increase in risk-free rate
B) Decrease in tax rates
C) Increase in equity beta
D) All of the above
Answer: D) All of the above.
Explanation: Any factor that increases required returns for debt or equity increases WACC.
Q74. Which factor would most likely encourage a firm to issue more equity?
A) Low interest rates
B) High share price
C) Lower stock market liquidity
D) Lower cost of debt
Answer: B) High share price.
Explanation: Firms are more likely to issue equity when share prices are high to minimize dilution.
Q75. Which dividend model values stock as the PV of future dividends?
A) Dividend Discount Model (DDM)
B) Free Cash Flow Model
C) Residual Income Model
D) CAPM
Answer: A) Dividend Discount Model (DDM).
Explanation: The DDM assumes intrinsic value equals the present value of all expected future dividends.
Q76. According to signaling theory, an increase in dividends generally signals:
A) The firm is in financial distress.
B) Management expects stable or higher future earnings.
C) The firm has no investment opportunities.
D) Market inefficiency.
Answer: B) Management expects stable or higher future earnings.
Explanation: Dividend increases are usually interpreted as a signal of strong future performance.
Q77. Which project evaluation technique measures the discount rate at which NPV = 0?
A) IRR
B) Payback period
C) Profitability index
D) MIRR
Answer: A) IRR.
Explanation: The Internal Rate of Return is the rate at which project inflows equal outflows (NPV = 0).
Q78. Which of the following is TRUE under MM Proposition II (no taxes)?
A) Cost of equity rises as leverage increases.
B) Cost of equity falls as leverage increases.
C) WACC decreases with higher leverage.
D) Dividend policy determines capital structure.
Answer: A) Cost of equity rises as leverage increases.
Explanation: MM Proposition II shows that as debt increases, equity becomes riskier, and investors demand a higher return.
Q79. Which measure considers the PV of future cash flows relative to investment?
A) IRR
B) Profitability Index (PI)
C) NPV
D) ROE
Answer: B) Profitability Index (PI).
Explanation: PI = PV of future cash inflows ÷ Initial Investment. It helps in ranking projects.
Q80. Which is the MOST conservative measure for project evaluation?
A) NPV
B) IRR
C) Payback period
D) Discounted payback period
Answer: D) Discounted payback period.
Explanation: The discounted payback period accounts for time value of money and measures how long it takes to recover investment.
Q81. Which of the following is a limitation of IRR?
A) Ignores time value of money.
B) Cannot be compared across projects.
C) Can give multiple values when cash flows change signs.
D) Always produces a negative return.
Answer: C) Can give multiple values when cash flows change signs.
Explanation: Projects with unconventional cash flows may yield multiple IRRs, making interpretation difficult.
Q82. Which type of project decision is MOST difficult when using the payback method?
A) Independent projects
B) Mutually exclusive projects
C) Short-term projects
D) Replacement projects
Answer: B) Mutually exclusive projects.
Explanation: Payback ignores profitability beyond recovery, making it unsuitable for ranking mutually exclusive projects.
Q83. A firm’s dividend policy is considered irrelevant under which theory?
A) Bird-in-hand theory
B) Clientele effect
C) Modigliani-Miller Dividend Irrelevance
D) Signaling theory
Answer: C) Modigliani-Miller Dividend Irrelevance.
Explanation: MM theory states dividend policy does not affect firm value in a perfect market.
Q84. Which of the following BEST describes residual dividend policy?
A) Dividends are paid before investments.
B) Dividends are based on residual earnings after financing all positive NPV projects.
C) Dividends are set equal to retained earnings.
D) Dividends are fixed regardless of profits.
Answer: B) Dividends are based on residual earnings after financing all positive NPV projects.
Explanation: Under residual policy, investment decisions are prioritized over dividends.
Q85. Which factor is MOST important in determining a firm’s cost of equity?
A) Dividend payout ratio
B) Risk-free rate and beta
C) Level of debt
D) Dividend history
Answer: B) Risk-free rate and beta.
Explanation: CAPM estimates cost of equity using the risk-free rate, equity beta, and market risk premium.
Q86. Which capital budgeting method can handle differences in project scale?
A) IRR
B) Payback period
C) NPV
D) Accounting rate of return
Answer: C) NPV.
Explanation: NPV directly measures absolute value creation, making it suitable for comparing projects of different sizes.
Q87. A company with a high debt ratio is MOST exposed to:
A) Business risk
B) Financial risk
C) Liquidity risk
D) Operational risk
Answer: B) Financial risk.
Explanation: High leverage increases the fixed obligation of interest payments, raising financial risk.
Q88. Which of the following BEST explains the pecking order theory?
A) Firms prefer debt over equity.
B) Firms prefer equity over debt.
C) Firms prefer internal financing, then debt, then equity.
D) Firms maintain a target debt ratio.
Answer: C) Firms prefer internal financing, then debt, then equity.
Explanation: Pecking order theory suggests managers prefer using retained earnings first, then debt, and equity last.
Q89. Which payout method directly increases EPS and ROE if all else remains constant?
A) Stock dividend
B) Share repurchase
C) Cash dividend
D) Stock split
Answer: B) Share repurchase.
Explanation: Repurchases reduce outstanding shares, increasing EPS and potentially ROE.
Q90. Which of the following is an assumption of MM Proposition I (with no taxes)?
A) Markets are perfect with no transaction costs.
B) Cost of debt increases with leverage.
C) Dividend policy impacts firm value.
D) Firms face bankruptcy costs.
Answer: A) Markets are perfect with no transaction costs.
Explanation: MM assumes perfect capital markets without taxes, costs, or bankruptcy risk.
Q91. Which measure BEST captures the risk-adjusted return of a project?
A) IRR
B) Sharpe ratio
C) NPV
D) Profitability Index
Answer: C) NPV.
Explanation: NPV discounts future cash flows at a risk-adjusted rate, reflecting risk-return tradeoff.
Q92. According to the bird-in-hand theory, investors prefer:
A) Capital gains over dividends
B) Dividends over uncertain future capital gains
C) No dividends at all
D) Residual dividend policy
Answer: B) Dividends over uncertain future capital gains.
Explanation: This theory argues dividends are valued more since they are certain.
Q93. Which factor reduces the weighted average cost of capital (WACC)?
A) Lower tax rate
B) Higher beta
C) Higher debt proportion (up to optimal point)
D) Increase in market risk premium
Answer: C) Higher debt proportion (up to optimal point).
Explanation: Debt is cheaper due to tax shields, reducing WACC until financial risk becomes excessive.
Q94. If a project has a PI (Profitability Index) < 1, the project:
A) Has NPV > 0
B) Should be accepted
C) Should be rejected
D) Has IRR > cost of capital
Answer: C) Should be rejected.
Explanation: PI < 1 means present value of inflows is less than outflows, making it unprofitable.
Q95. Which of the following is TRUE about stock splits?
A) They increase shareholder wealth.
B) They reduce the number of outstanding shares.
C) They reduce the share price while increasing outstanding shares.
D) They increase dividends proportionally.
Answer: C) They reduce the share price while increasing outstanding shares.
Explanation: Stock splits make shares more affordable but do not change overall shareholder wealth.
Q96. Which type of project risk is considered MOST important in capital budgeting?
A) Firm-specific risk
B) Systematic risk
C) Liquidity risk
D) Inflation risk
Answer: B) Systematic risk.
Explanation: Systematic (market) risk cannot be diversified away and directly impacts required returns.
Q97. Which method adjusts IRR to assume reinvestment at cost of capital?
A) NPV
B) MIRR (Modified Internal Rate of Return)
C) Payback period
D) Profitability Index
Answer: B) MIRR (Modified Internal Rate of Return).
Explanation: MIRR assumes reinvestment at cost of capital, addressing IRR limitations.
Q98. According to the signaling hypothesis, a dividend cut indicates:
A) Strong growth expectations
B) Financial weakness or poor future earnings
C) Lower payout ratio due to expansion
D) No change in valuation
Answer: B) Financial weakness or poor future earnings.
Explanation: Dividend cuts usually signal management’s expectation of lower future performance.
Q99. Which factor would increase a firm’s sustainable growth rate (SGR)?
A) Higher dividend payout ratio
B) Higher return on equity (ROE)
C) Lower retention ratio
D) Lower profit margin
Answer: B) Higher return on equity (ROE).
Explanation: SGR = ROE × Retention ratio. Higher ROE raises growth potential.
Q100. Which statement BEST describes the effect of leverage on EPS?
A) EPS always increases with leverage.
B) EPS is unaffected by leverage.
C) Leverage magnifies both gains and losses in EPS.
D) EPS falls as debt increases.
Answer: C) Leverage magnifies both gains and losses in EPS.
Explanation: Higher debt increases potential returns to equity but also raises financial risk.
This concludes Part 2 (Q51–100) of CFA Level 1 Corporate Finance MCQs. By practicing these questions, you’ve reinforced your knowledge of capital budgeting methods, dividend theories, WACC, and leverage.
👉 Continue your preparation with other parts of this series:
- CFA Level 1 Corporate Finance MCQs Part 1 (Q1–50)
- CFA Level 1 Corporate Finance MCQs Part 3 (Q101–150)
- CFA Level 1 Corporate Finance MCQs Part 4 (Q151–200)
- CFA Level 1 Corporate Finance Master Practice Test (200+ Questions)
Keep practicing consistently, and you’ll be better prepared for exam day.