Preparing for the CFA Level 1 exam? One of the most important sections is Corporate Finance, where you’ll be tested on topics like capital budgeting, cost of capital, dividend policies, and corporate governance.
In this post, we bring you 50 high-quality CFA Corporate Finance MCQs with detailed answers and explanations. These questions are carefully designed to match the CFA Institute curriculum and exam style, helping you practice effectively.
Whether you are revising concepts, testing your knowledge, or preparing for mock exams, this set will give you clarity and confidence.
CFA Level 1 Corporate Finance MCQs (Part 1: Q1–50)
Q1.
Which of the following best describes Net Present Value (NPV)?
A) The rate at which a project’s NPV becomes zero.
B) The difference between a project’s cash inflows and outflows discounted at the cost of capital.
C) The discount rate that equates present value of inflows with outflows.
D) The time required to recover initial investment.
Answer: B
Explanation: NPV is calculated by discounting future cash inflows at the cost of capital and subtracting the initial outflow. Positive NPV indicates value creation.
Q2.
If a project has a positive NPV, which of the following is TRUE?
A) IRR is lower than cost of capital.
B) Payback period is shorter than average project.
C) The project increases shareholder wealth.
D) The project reduces firm value.
Answer: C
Explanation: Positive NPV means the project generates returns above the cost of capital, increasing shareholder wealth.
Q3.
Which decision rule is most consistent with maximizing shareholder wealth?
A) Payback period.
B) Accounting rate of return.
C) NPV rule.
D) Profitability index.
Answer: C
Explanation: The NPV rule directly measures value added to shareholders. Other methods are useful but less aligned with wealth maximization.
Q4.
The Internal Rate of Return (IRR) is defined as:
A) Discount rate that sets NPV = 0.
B) Average accounting return of a project.
C) Maximum rate acceptable by investors.
D) Discount rate that maximizes payback.
Answer: A
Explanation: IRR is the discount rate at which present value of inflows = outflows, making NPV zero.
Q5.
A project costs $10,000 and generates $3,000 annually for 5 years. Cost of capital = 10%. Should the project be accepted?
A) Yes, because IRR > 10%.
B) No, because IRR < 10%.
C) Accept if payback < 4 years.
D) Reject as NPV < 0.
Answer: A
Explanation: Approximate IRR here is ~15%, which is greater than 10%. Hence, the project is acceptable.
Q6.
The Payback Period Method ignores:
A) Cash flows.
B) Risk of the project.
C) Time value of money.
D) Initial investment.
Answer: C
Explanation: The simple payback method does not discount cash flows, ignoring the time value of money.
Q7.
A project has multiple IRRs when:
A) Cash flows are conventional.
B) Cash flows change sign more than once.
C) NPV is always positive.
D) Cost of capital is negative.
Answer: B
Explanation: Multiple IRRs occur when a project’s cash flows switch from positive to negative more than once.
Q8.
Which of the following measures accounts for both time value of money and risk?
A) NPV.
B) IRR.
C) Payback period.
D) Accounting rate of return.
Answer: A
Explanation: NPV explicitly discounts cash flows at the cost of capital, incorporating time value and risk.
Q9.
If NPV = 0 at a discount rate of 12%, then:
A) IRR = 0%.
B) IRR = 12%.
C) IRR < 12%.
D) IRR > 12%.
Answer: B
Explanation: By definition, IRR is the rate that makes NPV zero. Hence, IRR = 12%.
Q10.
Which statement about the Profitability Index (PI) is correct?
A) PI < 1 indicates project should be accepted.
B) PI is useful for ranking projects with different scales.
C) PI ignores time value of money.
D) PI always equals IRR.
Answer: B
Explanation: PI = Present value of inflows / Initial outflow. It accounts for scale differences and helps rank mutually exclusive projects.
Q11.
Which of the following is a limitation of IRR compared to NPV?
A) IRR considers the time value of money.
B) IRR requires discount rate input.
C) IRR may provide multiple values for non-conventional projects.
D) IRR aligns with shareholder wealth maximization.
Answer: C
Explanation: IRR can give multiple or misleading values when projects have irregular cash flow patterns, unlike NPV.
Q12.
The Weighted Average Cost of Capital (WACC) is used in capital budgeting because:
A) It reflects the historical cost of financing.
B) It represents the minimum acceptable return to all capital providers.
C) It is equal to the company’s accounting profit.
D) It is lower than the risk-free rate.
Answer: B
Explanation: WACC reflects the overall return required by both debt and equity holders, ensuring projects at least meet this cost.
Q13.
Which project evaluation method gives results that can conflict with NPV when ranking mutually exclusive projects?
A) IRR.
B) PI.
C) Discounted payback.
D) Accounting rate of return.
Answer: A
Explanation: IRR may rank projects differently than NPV, especially when projects differ in scale or cash flow timing.
Q14.
Which capital budgeting technique provides the most direct measure of shareholder wealth creation?
A) NPV.
B) IRR.
C) PI.
D) Payback period.
Answer: A
Explanation: NPV directly shows the amount by which shareholder value increases (in currency terms).
Q15.
In capital budgeting, the sunk cost is:
A) Relevant because it affects future decisions.
B) Irrelevant because it has already been incurred.
C) The opportunity cost of using capital.
D) Always equal to depreciation expense.
Answer: B
Explanation: Sunk costs cannot be recovered and should not influence current investment decisions.
Q16.
Which of the following is considered an incremental cash flow for a project?
A) Interest expense.
B) Opportunity cost of using existing facilities.
C) Allocated overhead.
D) Past R&D expenditure.
Answer: B
Explanation: Opportunity costs are incremental because they represent benefits forgone due to project acceptance.
Q17.
Which risk is best captured by the discount rate in NPV analysis?
A) Firm-specific risk.
B) Market (systematic) risk.
C) Diversifiable risk.
D) Accounting risk.
Answer: B
Explanation: The discount rate incorporates systematic risk (market risk), which cannot be diversified away.
Q18.
If a company increases debt in its capital structure (keeping everything else constant), WACC will:
A) Always increase.
B) Always decrease.
C) Initially decrease then increase due to financial risk.
D) Remain constant.
Answer: C
Explanation: More debt reduces WACC due to tax shield initially, but excessive debt increases financial risk and cost of equity, raising WACC later.
Q19.
The optimal capital structure is achieved when:
A) Cost of equity = Cost of debt.
B) WACC is minimized and firm value is maximized.
C) Debt ratio is 50%.
D) Company achieves highest EPS.
Answer: B
Explanation: The goal is to minimize WACC because it maximizes firm value.
Q20.
Which is a non-financial factor in capital budgeting?
A) Project IRR.
B) Impact on brand reputation.
C) NPV calculation.
D) Cost of equity.
Answer: B
Explanation: Qualitative factors such as environmental impact or brand reputation also influence investment decisions.
Q21.
Which is TRUE about the Modigliani and Miller (M&M) Proposition I without taxes?
A) Firm value increases with leverage.
B) Firm value is unaffected by capital structure.
C) WACC increases with leverage.
D) Equity becomes risk-free with debt.
Answer: B
Explanation: M&M Proposition I (no taxes) states that firm value is independent of capital structure.
Q22.
M&M Proposition II with taxes implies:
A) There is no benefit to debt financing.
B) Firm value increases as leverage rises due to tax shield on interest.
C) WACC rises with debt.
D) Equity risk decreases with leverage.
Answer: B
Explanation: Interest is tax-deductible, creating a tax shield that increases firm value with more debt.
Q23.
Which is the correct sequence in capital budgeting decision-making?
A) Estimate cash flows → Identify alternatives → Apply decision rule.
B) Identify alternatives → Estimate cash flows → Apply decision rule.
C) Apply decision rule → Estimate cash flows → Identify alternatives.
D) Estimate WACC → Apply decision rule → Identify alternatives.
Answer: B
Explanation: First projects are identified, then cash flows are estimated, and finally decision rules are applied.
Q24.
Which of the following is a relevant cash flow in project evaluation?
A) Depreciation.
B) Overhead allocated equally across projects.
C) Opportunity cost of land.
D) Past marketing expenses.
Answer: C
Explanation: Opportunity costs are relevant because they represent the benefit forgone due to the project.
Q25.
Which is the best method to evaluate mutually exclusive projects?
A) IRR.
B) Payback.
C) NPV.
D) Accounting return.
Answer: C
Explanation: For mutually exclusive projects, the one with the highest NPV should be chosen.
Q26.
Which risk arises due to uncertainty in cash flows of a specific project?
A) Systematic risk.
B) Unsystematic risk.
C) Market risk.
D) Portfolio risk.
Answer: B
Explanation: Project-specific or firm-specific risk is unsystematic and can be diversified away.
Q27.
In sensitivity analysis, we:
A) Change multiple variables at the same time.
B) Change one variable at a time to assess its impact.
C) Test the probability of default.
D) Estimate project WACC.
Answer: B
Explanation: Sensitivity analysis examines the impact of changes in a single variable on project outcomes.
Q28.
Which technique evaluates the effect of multiple uncertainties simultaneously?
A) Sensitivity analysis.
B) Scenario analysis.
C) Break-even analysis.
D) Payback analysis.
Answer: B
Explanation: Scenario analysis tests different sets of assumptions (e.g., best case, worst case) to evaluate project risk.
Q29.
The break-even point is where:
A) NPV = 0.
B) Total revenue = Total cost.
C) IRR = WACC.
D) Depreciation = Cash inflows.
Answer: B
Explanation: Break-even occurs when revenue just covers costs, resulting in zero profit.
Q30.
Which risk adjustment method is commonly used in capital budgeting?
A) Adjusting cash flows upward.
B) Changing accounting standards.
C) Increasing the discount rate for riskier projects.
D) Ignoring risk in analysis.
Answer: C
Explanation: Higher risk projects are evaluated at higher discount rates.
Q31.
Which of the following capital budgeting techniques ignores the time value of money?
A) NPV.
B) IRR.
C) Payback period.
D) PI.
Answer: C
Explanation: The payback period only measures the time required to recover initial investment and ignores time value of money.
Q32.
The Profitability Index (PI) is useful because:
A) It is independent of project size.
B) It always gives the same ranking as NPV.
C) It ignores risk.
D) It ignores opportunity costs.
Answer: A
Explanation: PI is a relative measure (ratio) and helps compare projects of different sizes, though it may conflict with NPV in ranking.
Q33.
Which factor is considered in the adjusted present value (APV) method but not in NPV?
A) Tax shield from debt.
B) Time value of money.
C) Project cash flows.
D) Required return.
Answer: A
Explanation: APV separates the value of the project if all-equity financed and adds the effect of financing (e.g., tax shields).
Q34.
Which statement about real options in capital budgeting is correct?
A) They reduce project flexibility.
B) They have no effect on project value.
C) They increase project value by providing managerial flexibility.
D) They are included in traditional NPV automatically.
Answer: C
Explanation: Real options (e.g., abandonment, expansion) allow managers to respond to uncertainties, adding value beyond static NPV.
Q35.
A company is evaluating two projects. Project A has higher NPV but lower IRR than Project B. Which should be accepted?
A) Project A, if projects are mutually exclusive.
B) Project B, if payback is shorter.
C) Both, since IRR is always superior.
D) Project B, since higher IRR indicates higher value.
Answer: A
Explanation: For mutually exclusive projects, NPV is the best decision rule as it measures shareholder wealth directly.
Q36.
The hurdle rate in capital budgeting refers to:
A) The historical average return of the firm.
B) The minimum required return on a project.
C) The dividend payout ratio.
D) The highest IRR achieved in the past.
Answer: B
Explanation: The hurdle rate is the minimum acceptable rate of return, often based on WACC.
Q37.
Which cost of capital approach uses the CAPM?
A) Cost of equity.
B) Cost of debt.
C) Cost of preferred stock.
D) Weighted cost of retained earnings.
Answer: A
Explanation: CAPM is used to estimate cost of equity:
ke=Rf+β(Rm−Rf)k_e = R_f + β (R_m – R_f)ke=Rf+β(Rm−Rf)
Q38.
If the firm’s beta increases, holding everything else constant, WACC will:
A) Decrease.
B) Increase.
C) Stay the same.
D) First decrease, then increase.
Answer: B
Explanation: Higher beta increases the cost of equity, raising WACC.
Q39.
Which is an advantage of using debt financing?
A) Reduces financial risk.
B) Interest payments are tax-deductible.
C) Always reduces bankruptcy risk.
D) Increases WACC.
Answer: B
Explanation: Debt provides a tax shield since interest is deductible, lowering effective cost of capital.
Q40.
Which is the primary disadvantage of debt financing?
A) Tax benefits.
B) Lower agency costs.
C) Fixed interest obligations increase financial risk.
D) Dilution of control.
Answer: C
Explanation: Debt increases financial risk since interest must be paid regardless of earnings.
Q41.
The residual dividend policy means:
A) Dividends are paid before capital expenditures.
B) Dividends are distributed from leftover earnings after financing profitable projects.
C) Dividend payout is fixed.
D) Dividends are irrelevant to shareholders.
Answer: B
Explanation: Under residual dividend policy, firms invest in all positive NPV projects first and then pay dividends from residual earnings.
Q42.
Which factor would most likely increase a firm’s dividend payout ratio?
A) Higher growth opportunities.
B) Higher debt obligations.
C) Stable earnings with low reinvestment needs.
D) Increased risk of bankruptcy.
Answer: C
Explanation: Firms with stable earnings and fewer reinvestment opportunities tend to distribute more dividends.
Q43.
According to the clientele effect, firms should:
A) Choose dividend policies based on investors’ preferences.
B) Never change dividends.
C) Always reinvest profits instead of paying dividends.
D) Target maximum debt-equity ratio.
Answer: A
Explanation: Different investors prefer different dividend policies; firms may attract certain clientele with their policies.
Q44.
Which dividend policy aims to keep the payout ratio stable over time?
A) Residual policy.
B) Constant dividend per share policy.
C) Constant payout ratio policy.
D) Special dividend policy.
Answer: B
Explanation: Under this policy, firms maintain a stable dividend per share, regardless of earnings fluctuations.
Q45.
Which factor most influences the firm’s target capital structure?
A) Historical cost of debt.
B) Management’s risk tolerance and market conditions.
C) Past dividend policies.
D) Current stock price.
Answer: B
Explanation: Optimal capital structure depends on balancing risk and return in light of management strategy and market conditions.
Q46.
Which is NOT a motive for share repurchases?
A) To signal undervaluation of shares.
B) To provide an alternative to dividends.
C) To permanently reduce equity base.
D) To increase agency costs.
Answer: D
Explanation: Repurchases often reduce agency costs by aligning managers’ and shareholders’ interests.
Q47.
Which statement about stock splits is correct?
A) They reduce a firm’s value.
B) They increase the number of shares while reducing price per share.
C) They dilute ownership permanently.
D) They increase book value per share.
Answer: B
Explanation: Stock splits increase the number of shares but do not change the total value of the firm.
Q48.
The bird-in-the-hand theory of dividends suggests:
A) Investors are indifferent to dividends or capital gains.
B) Dividends are riskier than capital gains.
C) Investors prefer certain dividends to uncertain future capital gains.
D) Dividend irrelevance theory holds true.
Answer: C
Explanation: The theory argues that investors value dividends more highly because they are certain, unlike uncertain future gains.
Q49.
Which of the following is an implication of the pecking order theory?
A) Firms prefer debt over retained earnings.
B) Firms prefer equity over debt.
C) Firms prefer internal financing, then debt, and issue equity last.
D) Firms are indifferent between financing choices.
Answer: C
Explanation: Pecking order theory states firms prioritize retained earnings, then debt, and equity as a last resort.
Q50.
Which is the main focus of corporate governance?
A) Maximizing government regulation.
B) Reducing competition.
C) Protecting shareholders’ interests through monitoring and control mechanisms.
D) Increasing stock splits.
Answer: C
Explanation: Corporate governance ensures accountability, transparency, and protection of shareholders’ rights.
concepts such as capital budgeting, cost of capital, dividend policies, and corporate governance.
👉 Next, continue your preparation with:
- CFA Level 1 Corporate Finance Part 2 (Q51–100)
- CFA Level 1 Ethics
- CFA Level 1 Quantitative Methods
- CFA Level 1 Financial Reporting & Analysis
- CFA Level 1 Economics MCQs
Keep practicing consistently, and you’ll strengthen your conceptual base for the CFA exam. 🚀