CA Inter P6 · Chapter 1
Scope and Objectives of Financial Management MCQs with Answers
7 multiple-choice questions on Scope and Objectives of Financial Management for CA Inter P6 Financial Management and Strategic Management. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Wealth maximisation is generally regarded as a superior objective of financial management compared with profit maximisation mainly because wealth maximisation:
- A) Can be measured directly from the statement of profit and loss
- B) Ignores the interests of lenders and creditors
- C) Focuses on maximising accounting profit in each year
- D) Considers both the timing and the risk of expected benefits
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Answer: D) Considers both the timing and the risk of expected benefits
Wealth maximisation measures value as the present value of expected future cash flows discounted at a rate that reflects risk, so it captures both the time value of money and risk. Profit maximisation looks at accounting profit, which ignores timing and risk and is open to different definitions. Wealth is reflected in the market value of shares, not in the statement of profit and loss.
Question 2
The board of Saraswati Polymers Ltd is deciding what proportion of a new ₹ 40 crore project should be funded by debentures and what proportion by issuing equity shares. This is an example of a:
- A) Investment decision
- B) Dividend decision
- C) Financing decision
- D) Working capital decision
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Answer: C) Financing decision
Deciding the mix of debt and equity used to raise funds is a financing decision, which shapes the capital structure. Whether to take up the project at all would be the investment decision. A dividend decision concerns how much of the profit to distribute and how much to retain.
Question 3
Which of the following is a recognised limitation of profit maximisation as the objective of a company?
- A) It takes into account the time value of money too heavily
- B) The term 'profit' is vague, since it could mean profit before tax, after tax, total profit or earnings per share
- C) It always leads to excessive payment of dividends
- D) It is concerned only with the interests of creditors
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Answer: B) The term 'profit' is vague, since it could mean profit before tax, after tax, total profit or earnings per share
A key criticism of profit maximisation is that 'profit' is ambiguous: short-term or long-term, before or after tax, total or per share. It also ignores the timing of returns and the risk attached to them, so it does not take the time value of money into account at all. It has no built-in effect on dividends or on creditors.
Question 4
The conflict of interest that can arise when managers, acting as agents, pursue perks and job security rather than maximising the wealth of shareholders is known as the:
- A) Agency problem
- B) Information asymmetry premium
- C) Clientele effect
- D) Pecking order problem
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Answer: A) Agency problem
When ownership and management are separate, managers (agents) may act in their own interest rather than in the interest of shareholders (principals). This is the agency problem. The costs of monitoring, bonding and the residual loss that follow are called agency costs. Pecking order and clientele effect relate to financing and dividend theory.
Question 5
Which of the following is an example of an agency cost borne by shareholders?
- A) Depreciation charged on factory machinery
- B) Discount allowed to customers for early payment
- C) Interest paid on debentures issued to finance a new plant
- D) Fees paid to an independent firm to audit the financial statements prepared by management
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Answer: D) Fees paid to an independent firm to audit the financial statements prepared by management
Agency costs include monitoring costs incurred so that managers act in the interest of shareholders. An external audit is a classic monitoring mechanism. Interest, depreciation and cash discounts are normal business costs, not costs of resolving the principal-agent conflict.
Question 6
In a large company, the function usually split between the Treasurer and the Controller is best described as:
- A) Both perform identical duties, and the titles differ only by company size
- B) The Treasurer handles raising funds, banking relationships and cash management, while the Controller handles financial accounting, cost accounting, budgeting and internal control
- C) The Treasurer handles financial accounting and audit, while the Controller handles raising funds and banking relationships
- D) The Treasurer is responsible for production planning, while the Controller is responsible for marketing
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Answer: B) The Treasurer handles raising funds, banking relationships and cash management, while the Controller handles financial accounting, cost accounting, budgeting and internal control
In the traditional division of the finance function, the Treasurer looks after obtaining and managing funds: capital raising, banking, cash and credit management. The Controller looks after accounting, reporting, budgeting and control. The two roles are complementary, not identical.
Question 7
Under the modern approach to financial management, the finance manager's role is best described as:
- A) Taking part in decisions on how funds are allocated and used, how they are raised and how returns are distributed, with the aim of maximising the value of the firm
- B) Keeping books of account and preparing statutory financial statements
- C) Raising funds only on occasional events such as incorporation, mergers or reorganisation
- D) Maximising sales revenue in each accounting period regardless of cost
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Answer: A) Taking part in decisions on how funds are allocated and used, how they are raised and how returns are distributed, with the aim of maximising the value of the firm
The traditional approach saw finance as procuring funds for episodic events such as incorporation or mergers. The modern approach is wider: it covers investment, financing and dividend decisions as an integrated whole, aimed at maximising shareholder wealth. Bookkeeping belongs to accounting, and maximising sales is not a financial management objective.