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IIA CIA Exam
Certified Internal Auditor Exam (Page 11 )

Updated On: 12-Jan-2026
Page 11 of 342
PDF with 1702 Questions

The appropriate discount rate to use in valuing a business combination is the

  1. Combined entity's cost of debt.
  2. Acquirer's weighted average cost of capital.
  3. Acquirer's cost of equity.
  4. Combined entity's cost of equity.

Answer(s): D

Explanation:

If the not incremental cash flows to the acquirer's shareholders are to be calculated, the discount rate used should be the cost of equity capital. Moreover, this rate should reflect the risk associated with the use of funds rather than their source. The rate therefore should not be the cost of capital of the acquirer but rather the cost of equity of the acquire after the combination. This calculation requires a new estimate of beta to be used in the Capital Asset Pricing Model.



A common mistake in valuing the entity to be acquired in a business combination is

  1. Using market values in the valuation.
  2. Including incremental cash flows in the valuation.
  3. Using the acquirer's discount rate when valuing the incremental cash flows.
  4. Including all related transaction costs associated with an acquisition.

Answer(s): C

Explanation:

If the net incremental cash flows to the acquirer's shareholders are to be valued, the discount rate used should be the cost of equity capital. Moreover, this rate should reflect the risk associated with the use of funds rather than their source. The rate therefore should not be the cost of capital of the acquirer but rather the cost of equity of the combined entity after the combination. This calculation requires a new estimate of beta to be used in the Capital Asset Pricing Model.



Assume that the average collection period is 25 days. After the credit policy is well established. what is the expected average accounts receivable balance for the entity at any moment in time, assuming a 365-day year?

  1. US $684.93
  2. US $1, 808.22
  3. US $27, 123.30
  4. US $45, 205.48

Answer(s): D

Explanation:

The expected average accounts receivable balance equals the average collection period
times the credit sales per day. Thus, the average accounts receivable balance is US $45.205.48 {[(10, 000 units sold on credit x $66 price) - 365 days] x 25 days}. The foregoing calculation assumes that receivables are recorded at their gross amounts.



What is the expected average collection period for the entity?

  1. 10 days
  2. 15 days
  3. 20 days.
  4. 30 days.

Answer(s): C

Explanation:

The average collection period is the average time it takes to receive payment from customers. because one-half of the customers will pay on day 10 and half will pay on day 30, the average collection period is 20 days [.5(10 days) + .5(30 days)]. An entity sells 10, 000 skateboards a year at US $66 each. All sales are on credit, with terms of 3/10, net 30, which means three percent discount if payment is made within 10 days; otherwise full payment is due at the end of 30 days. One half of the customers are expected to take advantage of the discount and pay on day 10. The other half are expected to pay on day
30. Sales are expected to be uniform throughout the year for both types of customers.



The high cost of short-term financing has recently caused an entity to reevaluate the terms of credit it extends to its customers. The current policy is 1/10, net 60. If customers can borrow at the prime rate, at what prime rate must the entity change its terms of credit in order to avoid an undesirable extension in its collection of receivables?

  1. 2%
  2. 5%
  3. 7%
  4. 8%

Answer(s): D

Explanation:

Terms of 1/10, net 60 mean that a buyer can save 1% of the purchase price by paying 50 days early. In essence, not taking the discount results in the buyer's borrowing 99% of the in price for 50 days at a total interest charge of 1% of the invoice price. Because a year has 7.3 50-day per periods 365 50), the credit terms 1/10, net 60 yield an effective
annualized interest charge of approximately 7.371 [(I% 99%) 7.3]. If the prime rate were higher than 7.37%, the buyer would prefer to borrow from the vendor i.e., not pay within the discount period) rather than from a bank. Consequently, an 8% prime rate could cause the vendor's receivables to increase. An entity sells 10, 000 skateboards a year at US $66 each. All sales are on credit, with terms of 3/10. net 30, which means three percent discount if percent it is made within 10 days; otherwise full payment is due at the end of 30 days. One half of the customers are expected to take advantage of the discount and pay on day 10. The other half are expected to pay on day 30. Sales are , , ict id to be uniform throughout the year for both types of customers.



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