This is Part 4 of our CFA Level 1 Corporate Finance MCQ series, covering questions 151–200. These advanced practice questions focus on critical topics such as capital budgeting, dividend policy, corporate governance, cost of capital, and mergers & acquisitions.
Designed with exam-style rigor, each question comes with the correct answer and explanation to help you understand both the concept and its practical application.
If you’ve already completed Parts 1–3, this set will finalize your preparation and give you a solid 200-question practice foundation for the CFA Corporate Finance section.
📘 CFA Level 1 Corporate Finance MCQs (Q151–200) with Answers & Explanations
Q151. Which dividend policy suggests firms should prioritize investment opportunities before paying dividends?
- A) Residual dividend policy
- B) Constant payout ratio
- C) Stable dividend policy
- D) Special dividends
Answer: A) Residual dividend policy
Explanation: The residual dividend policy holds that dividends should only be paid from leftover earnings after all positive NPV projects have been financed. This ensures optimal capital allocation.
Q152. Which of the following best describes the clientele effect in dividend policy?
- A) Investors prefer firms that match their tax preferences
- B) Firms adjust dividends to compete with peers
- C) Dividends are set according to management’s discretion
- D) Dividends reduce signaling risk
Answer: A) Investors prefer firms that match their tax preferences
Explanation: The clientele effect means investors self-select into companies that match their preferences for dividend vs. capital gains, often driven by tax considerations.
Q153. In signaling theory of dividends, an increase in dividends is interpreted as:
- A) Management expecting lower earnings
- B) Positive signal of strong future cash flows
- C) Irrelevant in efficient markets
- D) A tax-driven decision
Answer: B) Positive signal of strong future cash flows
Explanation: Dividend increases often signal management’s confidence in sustained future earnings, thus boosting investor trust.
Q154. Which of the following is most likely an agency cost of equity?
- A) Monitoring management through audits
- B) Corporate income tax
- C) Debt interest expense
- D) Cost of preferred dividends
Answer: A) Monitoring management through audits
Explanation: Agency costs of equity arise when shareholders must spend resources monitoring managers to ensure they act in shareholders’ best interests.
Q155. A company with high financial leverage faces:
- A) Lower fixed obligations
- B) Higher variability in earnings per share
- C) Lower financial risk
- D) Higher dividend stability
Answer: B) Higher variability in earnings per share
Explanation: High leverage amplifies both gains and losses, increasing EPS volatility and overall financial risk.
Q156. If a firm repurchases shares instead of paying cash dividends, this action will:
- A) Reduce EPS
- B) Potentially increase EPS
- C) Increase cash reserves
- D) Reduce financial leverage
Answer: B) Potentially increase EPS
Explanation: Share repurchases reduce the number of outstanding shares, which can increase earnings per share if net income remains constant.
Q157. Pecking order theory suggests firms prefer financing in which order?
- A) Equity → Debt → Retained earnings
- B) Retained earnings → Debt → Equity
- C) Debt → Equity → Retained earnings
- D) Equity → Retained earnings → Debt
Answer: B) Retained earnings → Debt → Equity
Explanation: Pecking order theory states firms prefer internal financing first, then debt, and issue equity only as a last resort due to information asymmetry costs.
Q158. Which is a disadvantage of using too much debt in capital structure?
- A) Tax shield benefits
- B) Increased agency costs of debt
- C) Reduced cost of equity
- D) Enhanced earnings per share
Answer: B) Increased agency costs of debt
Explanation: Excessive debt creates conflicts between shareholders and debtholders, leading to higher agency costs and financial distress risk.
Q159. A stable dividend policy usually results in:
- A) Higher payout during high earnings years
- B) Lower payout during recession years
- C) Consistent dividends regardless of earnings
- D) Dividends always tied to EPS growth
Answer: C) Consistent dividends regardless of earnings
Explanation: A stable dividend policy aims to provide shareholders with predictable income, even if earnings fluctuate.
Q160. Which of the following measures financial leverage?
- A) Return on assets (ROA)
- B) Debt-to-equity ratio
- C) Dividend payout ratio
- D) Current ratio
Answer: B) Debt-to-equity ratio
Explanation: The debt-to-equity ratio measures the relative use of debt financing compared to equity, reflecting financial leverage.
Q161. The weighted average cost of capital (WACC) decreases when:
- A) The cost of equity rises
- B) A firm increases debt within optimal range
- C) Corporate tax rates fall
- D) A firm issues new equity
Answer: B) A firm increases debt within optimal range
Explanation: Debt is cheaper than equity due to tax-deductible interest. Increasing debt up to the optimal capital structure lowers WACC, but beyond that point, financial distress risk increases WACC.
Q162. The Modigliani and Miller (M&M) Proposition I (without taxes) suggests:
- A) Capital structure is irrelevant
- B) Higher debt reduces firm value
- C) Equity is always cheaper than debt
- D) WACC decreases with leverage
Answer: A) Capital structure is irrelevant
Explanation: M&M Proposition I states that in a perfect market without taxes, bankruptcy costs, or asymmetric information, the value of a firm is independent of its capital structure.
Q163. In the presence of corporate taxes, debt financing is beneficial because:
- A) Debt reduces liquidity risk
- B) Dividends are tax deductible
- C) Interest expense provides a tax shield
- D) Debt reduces agency conflicts
Answer: C) Interest expense provides a tax shield
Explanation: Interest payments are deductible from taxable income, reducing tax liability and increasing firm value.
Q164. Which theory explains that managers use dividends to signal private information about future earnings?
- A) Bird-in-hand theory
- B) Dividend signaling theory
- C) Agency theory
- D) Residual dividend model
Answer: B) Dividend signaling theory
Explanation: Managers may use dividend changes to convey expectations about future profitability. An increase signals strong earnings, while a cut signals weakness.
Q165. Which method of project evaluation assumes reinvestment at the internal rate of return (IRR)?
- A) Payback period
- B) NPV
- C) IRR
- D) Discounted payback
Answer: C) IRR
Explanation: The IRR method assumes cash flows are reinvested at the IRR, which may not always be realistic compared to NPV (which assumes reinvestment at the cost of capital).
Q166. A firm with high operating leverage is more sensitive to:
- A) Tax rates
- B) Interest rate changes
- C) Sales fluctuations
- D) Dividend payout
Answer: C) Sales fluctuations
Explanation: Firms with high operating leverage have high fixed costs. Small changes in sales significantly impact operating income (EBIT).
Q167. Which of the following is a disadvantage of the payback period method?
- A) Easy to calculate
- B) Ignores cash flows after the payback point
- C) Focuses on liquidity
- D) Useful for high-risk projects
Answer: B) Ignores cash flows after the payback point
Explanation: While simple, payback period fails to consider profitability beyond recovery and ignores the time value of money.
Q168. If a firm’s EBIT is highly volatile, it is better to:
- A) Use more debt financing
- B) Use less debt financing
- C) Pay higher dividends
- D) Increase financial leverage
Answer: B) Use less debt financing
Explanation: Volatile EBIT means uncertain income, so using less debt reduces financial distress risk and obligations.
Q169. A dividend reinvestment plan (DRIP) allows investors to:
- A) Sell shares without tax
- B) Receive dividends in the form of additional shares
- C) Avoid stock splits
- D) Convert debt into equity
Answer: B) Receive dividends in the form of additional shares
Explanation: DRIPs let shareholders reinvest dividends automatically into company stock, often at a discount.
Q170. Which project evaluation technique directly measures the increase in firm value?
- A) IRR
- B) Payback period
- C) NPV
- D) Profitability index
Answer: C) NPV
Explanation: Net Present Value (NPV) represents the dollar value added to the firm from undertaking a project, making it the best measure of shareholder wealth creation.
Q171. Which type of risk arises from conflicts between bondholders and shareholders?
- A) Systematic risk
- B) Agency cost of debt
- C) Liquidity risk
- D) Diversifiable risk
Answer: B) Agency cost of debt
Explanation: Bondholders may fear shareholders will take excessive risk because shareholders enjoy upside while bondholders bear downside losses.
Q172. If a project has an NPV of zero, it means:
- A) The project destroys shareholder value
- B) The project just meets the required return
- C) The project is risk-free
- D) The IRR is negative
Answer: B) The project just meets the required return
Explanation: An NPV of zero means the project generates exactly the required rate of return (cost of capital). It neither adds nor subtracts value.
Q173. Which is most likely an example of financial synergy in mergers?
- A) Increased economies of scale
- B) Tax benefits from loss carry-forwards
- C) Improved operational efficiency
- D) Access to new markets
Answer: B) Tax benefits from loss carry-forwards
Explanation: Financial synergies arise from tax savings, improved debt capacity, or lower capital costs, while operational synergies involve efficiency gains.
Q174. Which capital budgeting method is least affected by cash flow timing?
- A) IRR
- B) Payback period
- C) NPV
- D) Profitability index
Answer: B) Payback period
Explanation: Payback only considers the time to recover initial investment and ignores the exact timing of future cash flows and time value of money.
Q175. Which dividend policy gives priority to maintaining consistent dividend levels regardless of fluctuations in earnings?
- A) Stable dividend policy
- B) Residual dividend policy
- C) Target payout ratio
- D) Special dividend
Answer: A) Stable dividend policy
Explanation: Firms following a stable dividend policy aim to provide shareholders predictable income, avoiding frequent changes.
Q176. Which statement is TRUE under the trade-off theory of capital structure?
- A) More debt always increases firm value
- B) Firms balance tax shields with bankruptcy costs
- C) Equity is always preferred to debt
- D) Dividend policy does not matter
Answer: B) Firms balance tax shields with bankruptcy costs
Explanation: Trade-off theory states that firms choose an optimal capital structure by weighing benefits of tax shields against costs of financial distress.
Q177. Which measure captures both profitability and investment efficiency?
- A) Net profit margin
- B) Return on assets (ROA)
- C) Return on equity (ROE)
- D) Economic Value Added (EVA)
Answer: D) Economic Value Added (EVA)
Explanation: EVA measures value created after deducting the cost of capital from net operating profit after tax (NOPAT).
Q178. Which is NOT a method of dividend distribution?
- A) Cash dividends
- B) Stock dividends
- C) Share repurchases
- D) Bond issuance
Answer: D) Bond issuance
Explanation: Dividends can be distributed as cash, additional stock, or buybacks. Issuing bonds is financing, not dividend distribution.
Q179. Which theory states firms should match the maturity of assets and liabilities?
- A) Pecking order theory
- B) Maturity matching principle
- C) Signaling theory
- D) Agency theory
Answer: B) Maturity matching principle
Explanation: Firms should finance long-term assets with long-term financing (equity, long-term debt) and short-term assets with short-term financing to avoid liquidity risk.
Q180. Which factor generally increases the cost of equity in CAPM?
- A) Higher risk-free rate
- B) Lower beta
- C) Lower market risk premium
- D) Higher dividend payout
Answer: A) Higher risk-free rate
Explanation: In the CAPM model: Cost of equity = Risk-free rate + Beta × (Market risk premium). An increase in the risk-free rate directly increases the cost of equity.
Q181. Which corporate governance mechanism is considered internal?
- A) Board of directors
- B) Shareholder lawsuits
- C) Government regulations
- D) External audits
Answer: A) Board of directors
Explanation: Internal governance mechanisms include board oversight, management structure, and company policies. External mechanisms include audits, regulations, and market discipline.
Q182. Which is a primary objective of corporate governance?
- A) Maximizing firm’s market share
- B) Protecting shareholder interests
- C) Reducing tax liability
- D) Increasing dividend payouts
Answer: B) Protecting shareholder interests
Explanation: Good corporate governance ensures accountability, transparency, and long-term shareholder value.
Q183. A hostile takeover attempt is most effectively resisted by:
- A) Dividend reinvestment plan
- B) Poison pill strategy
- C) Stock dividend issuance
- D) Stock repurchase
Answer: B) Poison pill strategy
Explanation: A poison pill allows existing shareholders (except acquirer) to buy more shares at a discount, making a takeover expensive.
Q184. Which type of merger is between two firms at different stages of the supply chain?
- A) Horizontal merger
- B) Vertical merger
- C) Conglomerate merger
- D) Leveraged buyout
Answer: B) Vertical merger
Explanation: Vertical mergers occur when firms in different production stages (supplier and buyer) combine to improve efficiency and control.
Q185. Which is a disadvantage of using debt financing?
- A) Tax shield
- B) Lower cost than equity
- C) Increased financial risk
- D) No ownership dilution
Answer: C) Increased financial risk
Explanation: Debt increases fixed obligations, raising the probability of financial distress if earnings decline.
Q186. Which dividend policy aligns dividends with investment opportunities?
- A) Stable dividend policy
- B) Constant payout ratio
- C) Residual dividend policy
- D) Irregular dividend policy
Answer: C) Residual dividend policy
Explanation: Firms following residual policy pay dividends only after funding profitable investment projects, leading to fluctuating payouts.
Q187. Which ratio best measures a firm’s ability to meet short-term obligations?
- A) Debt-to-equity ratio
- B) Quick ratio
- C) Return on equity
- D) Interest coverage ratio
Answer: B) Quick ratio
Explanation: Quick ratio (acid-test) = (Current assets – inventory) ÷ Current liabilities. It evaluates short-term liquidity without relying on inventory sales.
Q188. Which is TRUE about the profitability index (PI)?
- A) It ignores time value of money
- B) PI > 1 indicates positive NPV
- C) It always gives the same ranking as payback
- D) PI < 1 is better than PI > 1
Answer: B) PI > 1 indicates positive NPV
Explanation: PI = PV of future cash flows ÷ Initial investment. PI > 1 means the project creates value.
Q189. Which merger is primarily aimed at diversification?
- A) Horizontal merger
- B) Vertical merger
- C) Conglomerate merger
- D) Reverse merger
Answer: C) Conglomerate merger
Explanation: Conglomerate mergers combine firms in unrelated industries, reducing risk through diversification.
Q190. Which factor directly increases a firm’s sustainable growth rate?
- A) Higher dividend payout
- B) Higher retention ratio
- C) Lower profit margin
- D) Higher debt financing
Answer: B) Higher retention ratio
Explanation: Sustainable growth rate = ROE × Retention ratio. Retaining more earnings increases reinvestment capacity.
Q191. In a leveraged buyout (LBO), most of the financing comes from:
- A) Equity issuance
- B) Retained earnings
- C) Debt financing
- D) Preferred shares
Answer: C) Debt financing
Explanation: LBOs are acquisitions financed primarily with borrowed funds, using target company’s assets as collateral.
Q192. Which project ranking conflict occurs between NPV and IRR?
- A) When projects have equal scale
- B) When projects are mutually exclusive with different sizes
- C) When all projects have positive NPVs
- D) When projects have normal cash flows
Answer: B) When projects are mutually exclusive with different sizes
Explanation: NPV and IRR may give different rankings if project scale and timing of cash flows differ. NPV is preferred.
Q193. Which is NOT a feature of good corporate governance?
- A) Transparency in reporting
- B) Alignment of management and shareholder interests
- C) Concentration of power in one executive
- D) Accountability of the board
Answer: C) Concentration of power in one executive
Explanation: Concentration of power weakens governance. Good governance requires checks and balances.
Q194. The cost of preferred stock is calculated as:
- A) Dividend ÷ Market price
- B) Dividend ÷ Earnings per share
- C) Earnings ÷ Dividend
- D) Dividend ÷ Par value
Answer: A) Dividend ÷ Market price
Explanation: Cost of preferred = Preferred dividend ÷ Market price of preferred stock.
Q195. Which type of risk can be eliminated through diversification?
- A) Systematic risk
- B) Market risk
- C) Unsystematic risk
- D) Beta risk
Answer: C) Unsystematic risk
Explanation: Unsystematic (firm-specific) risk can be diversified away, while systematic (market) risk cannot.
Q196. Which project evaluation measure is most useful when capital is rationed?
- A) Payback period
- B) Profitability index (PI)
- C) NPV
- D) IRR
Answer: B) Profitability index (PI)
Explanation: PI helps prioritize projects by return per unit of investment, useful when funds are limited.
Q197. Which financing source has the lowest explicit cost?
- A) Equity
- B) Retained earnings
- C) Debt
- D) Preferred stock
Answer: C) Debt
Explanation: Debt has the lowest cost due to tax-deductibility of interest, but excessive debt increases financial risk.
Q198. Which of the following is an advantage of share repurchases over cash dividends?
- A) Guaranteed income for investors
- B) Flexibility and potential tax efficiency
- C) Increase in outstanding shares
- D) Permanent reduction in equity
Answer: B) Flexibility and potential tax efficiency
Explanation: Repurchases are flexible, can signal undervaluation, and may be more tax-efficient than dividends.
Q199. Which type of takeover defense involves selling the most valuable part of the company to discourage acquirers?
- A) Poison pill
- B) Crown jewel defense
- C) Golden parachute
- D) White knight defense
Answer: B) Crown jewel defense
Explanation: The target sells its most valuable assets to make itself less attractive to the hostile acquirer.
Q200. The primary goal of financial management is to:
- A) Maximize profits
- B) Maximize shareholder wealth
- C) Minimize costs
- D) Increase market share
Answer: B) Maximize shareholder wealth
Explanation: The central objective of corporate finance is maximizing shareholder wealth (firm value), not just accounting profits.
You’ve now completed the CFA Level 1 Corporate Finance Part 4 (Q151–200). This concludes our 200-question Corporate Finance practice bank, covering every key concept tested in the CFA exam.
👉 Continue your CFA preparation with:
- CFA Level 1 Ethics
- CFA Level 1 Quantitative Methods
- CFA Level 1 Financial Reporting & Analysis
- CFA Level 1 Economics MCQs
💡 Pro Tip: Review all four parts (1–200) to maximize your retention and accuracy before attempting the Corporate Finance master set.