This Quick Reference is independent exam-prep support for candidates preparing for CPA Canada’s CPA Canada PEP Finance Elective exam, official code CPA Finance. Use it as a compact case-writing and technical review aid, not as a substitute for the CPA Canada materials.
Finance Elective Case Response Framework
Core response pattern
| Step | What to do | Exam-useful phrasing |
|---|
| 1. Identify the decision | State the financial decision and stakeholder objective. | “The issue is whether the company should proceed with the expansion given cash flow, risk, and strategic fit.” |
| 2. Quantify first when possible | Use relevant cash flows, ratios, valuation, or financing capacity. | “Based on incremental after-tax cash flows, the NPV is positive before sensitivity analysis.” |
| 3. Interpret the numbers | Explain what the result means, not only the calculation. | “A positive NPV suggests value creation, but the margin is narrow and sensitive to volume.” |
| 4. Add qualitative factors | Strategic fit, risk, covenants, operational capacity, tax, ethics, governance. | “The proposal increases leverage and may restrict future borrowing capacity.” |
| 5. Recommend clearly | Choose, reject, defer, or request more information. | “Proceed only if the lender confirms covenant relief and management validates demand assumptions.” |
| 6. Provide implementation steps | Financing, controls, monitoring, due diligence, communication. | “Prepare a 12-month cash forecast and negotiate a staged draw facility.” |
Common finance assessment opportunities
| If the case asks about… | Prioritize these tools | Do not forget |
|---|
| Investment or project decision | NPV, sensitivity, payback, strategic fit, risk-adjusted discount rate | Incremental after-tax cash flows; exclude sunk costs |
| Business acquisition | Valuation range, synergies, due diligence, financing, integration risks | Normalize earnings; distinguish enterprise value from equity value |
| Financing proposal | WACC, debt capacity, covenants, dilution, cash flow forecast | Use market values where relevant; assess repayment ability |
| Working capital problem | Cash conversion cycle, AR aging, inventory turnover, supplier terms, short-term financing | Growth can consume cash even when profitable |
| Dividend or share repurchase | Free cash flow, covenants, shareholder preferences, tax considerations | Do not recommend distributions if liquidity is weak |
| Risk exposure | Exposure type, hedge objective, instrument comparison, policy | Hedging manages risk; it is not speculation |
| Valuation dispute | Income, market, asset approaches; sensitivity; control/minority issues | Adjust for non-recurring and non-arm’s-length items |
| Lease-versus-buy | Present value of after-tax cash flows, residual risk, covenants, flexibility | Keep discount rate and cash flows consistent |
Use rates, tax assumptions, lending terms, and constraints provided in the case. Define each variable if the case is ambiguous.
Present value and capital budgeting
\[
NPV=\sum_{t=0}^{n}\frac{CF_t}{(1+r)^t}
\]\[
PV_{\text{annuity}}=PMT \times \frac{1-(1+r)^{-n}}{r}
\]\[
PV_{\text{perpetuity}}=\frac{CF_1}{r-g}
\]\[
EAC=\frac{NPV}{\frac{1-(1+r)^{-n}}{r}}
\]
| Metric | Plain formula | Best use | Trap |
|---|
| NPV | Sum of discounted cash flows | Primary rule for value creation | Do not include financing cash flows if using WACC |
| IRR | Rate that makes NPV = 0 | Quick return indicator | Can mislead for mutually exclusive or non-conventional projects |
| MIRR | Reinvestment-adjusted IRR | When reinvestment assumption matters | Requires reinvestment and finance rates |
| Payback | Years to recover initial investment | Liquidity and risk screen | Ignores cash flows after payback and time value unless discounted |
| Discounted payback | Years to recover on discounted basis | Liquidity with time value | Still ignores later value |
| Profitability index | PV future cash inflows / initial investment | Capital rationing | NPV still drives absolute value |
| Equivalent annual cost | PV cost converted to annual amount | Compare unequal-life assets | Use same discount rate and include residual values |
Cost of capital
\[
\text{WACC}=w_d r_d(1-T)+w_p r_p+w_e r_e
\]\[
r_e=r_f+\beta(r_m-r_f)+\text{specific risk premium}
\]
| Component | Calculation | Notes |
|---|
| After-tax debt cost | Pre-tax debt rate x (1 - tax rate) | Use marginal borrowing rate if new financing is being assessed |
| Preferred share cost | Preferred dividend / net proceeds or market price | Dividends are usually not tax-deductible to issuer |
| Common equity cost | CAPM, dividend growth, or judgment-based build-up | Private companies often require company-specific risk adjustments |
| Weights | Component market value / total capital market value | Book weights are a common trap unless specifically required |
| Project discount rate | Base WACC adjusted for project risk | Do not use company WACC for a project with materially different risk |
Free cash flow and valuation
\[
\text{FCFF}=\text{EBIT}(1-T)+\text{D\&A}-\text{Capex}-\Delta \text{NWC}
\]\[
\text{Enterprise Value}=\frac{\text{FCFF}_{1}}{\text{WACC}-g}
\]\[
\text{Equity Value}=\text{Enterprise Value}+\text{Non-operating Assets}-\text{Interest-bearing Debt}
\]
| Valuation item | Formula or approach | Exam reminder |
|---|
| FCFF | Cash flow available to all capital providers | Discount using WACC |
| FCFE | Cash flow available to common shareholders after debt cash flows | Discount using cost of equity |
| Terminal value | Next-period cash flow / (discount rate - growth) | Growth must be sustainable and below discount rate |
| EBITDA multiple | Normalized EBITDA x market multiple | Adjust for debt, excess cash, and non-operating assets |
| P/E multiple | Normalized earnings x P/E | Better when capital structures are comparable |
| Asset approach | Fair value assets - liabilities | Useful for asset-heavy, holding, or liquidation situations |
| Liquidation value | Net proceeds after disposal costs and obligations | Usually a floor, not a going-concern value |
| Area | Ratio | Plain formula | Interpretation focus |
|---|
| Profitability | Gross margin | Gross profit / sales | Pricing, input cost, product mix |
| Profitability | EBITDA margin | EBITDA / sales | Operating cash proxy before capex and working capital |
| Profitability | ROA | Net income / average assets | Asset efficiency and returns |
| Profitability | ROE | Net income / average equity | Return to shareholders; affected by leverage |
| Liquidity | Current ratio | Current assets / current liabilities | Short-term cushion |
| Liquidity | Quick ratio | Cash + short-term investments + AR / current liabilities | Excludes less-liquid inventory |
| Working capital | DSO | Average AR / credit sales x days | Collection speed |
| Working capital | DIO | Average inventory / COGS x days | Inventory holding period |
| Working capital | DPO | Average AP / COGS or purchases x days | Supplier payment period |
| Working capital | Cash conversion cycle | DSO + DIO - DPO | Days cash is tied up in operations |
| Leverage | Debt-to-equity | Interest-bearing debt / equity | Capital structure risk |
| Leverage | Debt-to-EBITDA | Interest-bearing debt / EBITDA | Debt load relative to operating earnings |
| Coverage | Interest coverage | EBIT or EBITDA / interest | Ability to service interest |
| Coverage | DSCR | Cash available for debt service / required debt service | Define numerator based on case or lender terms |
| Market | EPS | Earnings available to common shareholders / weighted average shares | Dilution and profitability per share |
| Market | P/E | Share price / EPS | Relative valuation and expectations |
Capital Budgeting Reference
Relevant cash flow rules
| Include | Exclude | Usually analyze separately |
|---|
| Incremental revenue | Sunk costs already incurred | Financing structure if NPV uses WACC |
| Incremental variable and fixed costs | Allocated overhead unless incremental | Accounting income impact |
| Opportunity costs | Book value write-offs without cash/tax impact | Strategic benefits that cannot be quantified |
| Working capital investment and release | Historical research costs | Scenario and sensitivity analysis |
| Tax effects, including tax shields if applicable | Depreciation as a cash cost | Capacity constraints |
| Disposal proceeds and tax effects | Interest expense in project cash flows when using WACC | Covenant implications |
Capital budgeting traps
| Trap | Correct treatment |
|---|
| Mixing nominal cash flows with real discount rate | Match nominal with nominal, real with real |
| Treating depreciation as a cash outflow | Exclude depreciation; include tax shield if relevant |
| Ignoring working capital | Include initial investment and later recovery if appropriate |
| Including sunk costs | Exclude unless there is a future cash consequence |
| Double-counting financing | If discounting at WACC, exclude loan principal and interest from project cash flows |
| Using average accounting profit | Use incremental cash flows |
| Using IRR to rank mutually exclusive projects | Prefer NPV and strategic fit |
| Ignoring replacement cycles | Use EAC or repeat-cycle logic for unequal-life assets |
| Using one discount rate for all projects | Adjust for risk differences |
| Forgetting sensitivity | Test key drivers: volume, price, cost, discount rate, terminal value |
CCA and tax shield case approach
When a case provides Canadian tax assumptions, CCA rates, and tax rates, use the facts given. If unsure, a year-by-year schedule is safer than relying on a shortcut formula.
| Item | Practical treatment |
|---|
| Capital cost | Start with eligible asset cost provided in the case |
| CCA | Apply the case-provided rate and convention |
| Tax shield | CCA x tax rate |
| Asset disposal | Consider proceeds, UCC effect, possible recapture or terminal loss if facts support it |
| Salvage value | Include after-tax disposal proceeds |
| Timing | Match tax shields to the year they are realized |
| Recommendation | State assumptions clearly if tax details are incomplete |
Financing and Capital Structure
Financing source selection
| Source | When to choose | Advantages | Risks / exam concerns |
|---|
| Operating line of credit | Seasonal working capital or short cash cycle needs | Flexible, interest only on use | Demand risk, borrowing base, covenants |
| Term loan | Long-term asset purchase or expansion | Matches financing term to asset life | Fixed payments; covenant pressure |
| Equipment loan | Specific equipment purchase | Asset-secured, easier monitoring | Less flexibility; collateral restrictions |
| Lease | Need use of asset without ownership emphasis | Lower upfront cash, flexibility | Higher total cost possible; accounting and covenant impacts |
| Trade credit | Short-term supplier financing | Simple and operationally linked | Lost discounts; supplier relationship risk |
| Factoring AR | Urgent liquidity or weak collections | Converts receivables to cash | Costly; customer perception; recourse risk |
| Equity issuance | High leverage or growth without fixed payments | Strengthens balance sheet | Dilution and governance changes |
| Preferred shares | Need capital with fixed return but less debt pressure | No mandatory principal repayment | Dividend expectations; investor rights |
| Convertible debt | Growth company with valuation uncertainty | Lower coupon potential | Dilution and complex terms |
| Sale-leaseback | Unlock cash from owned assets | Liquidity improvement | Loss of control; long-term lease obligation |
Debt capacity checklist
| Question | Evidence to calculate or discuss |
|---|
| Can the company service debt? | Forecast EBITDA, interest, principal, DSCR |
| Will covenants be met? | Debt-to-EBITDA, current ratio, tangible net worth, interest coverage |
| Is cash flow stable? | Customer concentration, recurring revenue, seasonality, backlog |
| Is collateral sufficient? | AR quality, inventory turnover, equipment resale value, real estate |
| Is financing matched to asset life? | Short-term debt for working capital; long-term debt for long-term assets |
| Is there room for downside? | Sensitivity under lower sales, higher rates, delayed collections |
| Are owners willing to dilute? | Shareholder objectives, control, succession plans |
WACC decision rules
| Situation | Use |
|---|
| Project has same risk and capital structure as existing business | Company WACC may be reasonable |
| Project is riskier than existing business | Increase discount rate or model downside scenarios |
| Project is less risky | Lower discount rate may be justified |
| Acquisition has different business risk | Use target or industry risk, not blindly acquirer WACC |
| Highly leveraged transaction | Consider APV, lender constraints, and equity returns separately |
| Private company with no beta | Use comparable companies, build-up approach, or case-provided rate |
Business Valuation and Acquisition Analysis
Valuation method selection
| Method | Best for | Strengths | Weaknesses |
|---|
| Discounted cash flow | Going concern with forecastable cash flows | Captures company-specific expectations | Sensitive to assumptions and terminal value |
| Capitalized cash flow | Stable mature business | Simple and direct | Poor fit for volatile or high-growth businesses |
| EBITDA multiple | Operating businesses with comparable transactions | Market-based and intuitive | Multiples may not match risk, growth, or accounting policies |
| P/E multiple | Profitable companies with comparable capital structures | Easy equity value reference | Distorted by leverage, one-time items, tax differences |
| Net asset value | Asset-heavy or holding companies | Anchored in asset values | May miss goodwill and earning power |
| Liquidation value | Distress or wind-up scenario | Downside floor | Not a going-concern value |
Normalization adjustments
| Adjustment | Why it matters |
|---|
| Owner-manager salary above or below market | Normalizes maintainable earnings |
| Related-party rent or fees | Removes non-arm’s-length pricing |
| Non-recurring legal, restructuring, or disaster costs | Avoids undervaluing sustainable earnings |
| One-time gains on asset sales | Avoids overvaluing operations |
| Personal expenses in company | Adds back expenses not needed for operations |
| Redundant assets or excess cash | Value separately from operating business |
| Unusual bad debt or inventory write-downs | Assess whether recurring or one-time |
| Discontinued product line | Remove if not part of future operations |
| Customer concentration | May require risk adjustment or lower multiple |
| Working capital deficiency | May reduce purchase price or require closing adjustment |
Enterprise value versus equity value
| Concept | Meaning | Common error |
|---|
| Enterprise value | Value of operations to all capital providers | Treating EV as the amount payable for shares without debt adjustment |
| Equity value | Value attributable to common shareholders | Forgetting to subtract interest-bearing debt |
| Net debt | Debt minus excess cash | Including operating cash as excess cash without support |
| Purchase price | Consideration paid under deal terms | Ignoring working capital adjustment, earnout, or assumed liabilities |
| Synergy value | Incremental value to buyer | Giving all synergy value to seller without negotiation rationale |
Acquisition due diligence prompts
| Area | Questions |
|---|
| Financial | Are earnings quality, margins, working capital, and debt complete and reliable? |
| Tax | Are there unpaid taxes, tax loss restrictions, recapture, or transaction structure issues? |
| Legal | Are contracts assignable? Any litigation, liens, or regulatory constraints? |
| Operations | Are systems, staff, capacity, and suppliers scalable? |
| Customers | Is revenue concentrated? Are contracts recurring or cancellable? |
| HR | Are key employees retained? Any pension, bonus, or severance obligations? |
| IT | Are systems compatible? Any cybersecurity or data issues? |
| Integration | Can synergies be achieved realistically and on time? |
| Financing | Will acquisition debt create covenant pressure? |
| Governance | Are approvals, conflicts, and related-party interests addressed? |
Working Capital and Cash Management
Cash conversion cycle diagnosis
| Symptom | Likely cause | Finance recommendation |
|---|
| Rising DSO | Slow collections, loose credit, billing errors | Tighten credit policy, aging review, early payment discounts, collection targets |
| Rising DIO | Obsolete inventory, poor forecasting, overbuying | SKU analysis, reorder points, supplier flexibility, liquidation plan |
| Falling DPO | Paying suppliers too quickly | Use terms strategically, negotiate terms, preserve discounts if economical |
| Negative cash despite profit | Growth consuming AR/inventory | Forecast working capital, arrange operating line |
| Frequent overdrafts | Weak cash planning | Rolling 13-week cash forecast, payment approval controls |
| Excess idle cash | No deployment plan | Debt repayment, investment policy, strategic reserve, dividends if prudent |
| Tool | Suitable when | Watch for |
|---|
| 13-week cash forecast | Near-term cash stress or seasonal business | Daily receipts, payroll, tax remittances, debt payments |
| Borrowing base certificate | Asset-based lending | Eligible AR, inventory margins, aging exclusions |
| AR aging analysis | Collection issues | Concentration, disputes, bad debt allowance |
| Inventory aging | Obsolescence risk | Write-downs, carrying costs, storage limits |
| Supplier term analysis | Payment timing opportunity | Lost discounts versus financing cost |
| Sensitivity analysis | Uncertain demand, price, FX, interest rates | Identify break-even points and downside funding needs |
Risk Management and Hedging
Exposure identification
| Exposure | Example | Best response |
|---|
| Transaction FX risk | Foreign currency receivable or payable | Forward, option, money-market hedge, natural hedge |
| Economic FX risk | Long-term competitiveness affected by exchange rates | Natural hedge, pricing strategy, sourcing strategy |
| Translation FX risk | Consolidating foreign subsidiary | Often accounting-focused; hedge only if policy supports |
| Interest rate risk | Variable-rate debt or refinancing exposure | Fixed-rate debt, interest rate swap, cap, floor |
| Commodity price risk | Input cost uncertainty | Supplier contracts, futures, options, price escalation clauses |
| Credit risk | Customer non-payment | Credit checks, limits, deposits, insurance, factoring |
| Liquidity risk | Inability to meet obligations | Cash reserves, committed facilities, forecasts |
| Refinancing risk | Debt maturing during weak conditions | Stagger maturities, negotiate early, diversify lenders |
Hedge instrument comparison
| Instrument | What it does | Choose when | Trade-off |
|---|
| Forward contract | Locks in exchange rate or price | Certain amount and timing | No upside participation |
| Futures contract | Standardized exchange-traded hedge | Standard size/date fits exposure | Basis risk and margin requirements |
| Option | Right but not obligation | Need downside protection and upside potential | Premium cost |
| Swap | Exchanges variable/fixed or currencies | Long-term recurring exposure | Counterparty and valuation complexity |
| Money-market hedge | Uses borrowing/lending to lock rate | Forward unavailable or comparison needed | Requires credit capacity |
| Natural hedge | Matches inflows and outflows in same currency | Operationally feasible | May not fully offset exposure |
Hedging case traps
| Trap | Better answer |
|---|
| Recommending a hedge without defining exposure | Identify amount, currency, timing, and probability |
| Treating hedging as profit-seeking | State objective: reduce volatility and protect margins |
| Ignoring policy | Recommend hedge limits, approvals, counterparties, and reporting |
| Hedging forecast sales with a forward | Consider options or partial hedge if volume is uncertain |
| Ignoring accounting impact | Note potential financial reporting effects if material |
| Forgetting operational alternatives | Pricing clauses, supplier matching, local financing, diversification |
Dividend, Repurchase, and Shareholder Decisions
| Decision | Analyze | Favourable when | Unfavourable when |
|---|
| Cash dividend | Free cash flow, covenants, growth needs, shareholder expectations | Stable excess cash and low reinvestment needs | Cash constraints or covenant risk |
| Special dividend | One-time excess cash | Non-recurring surplus after maintaining reserves | Future investment pipeline is strong |
| Share repurchase | Valuation, liquidity, control, tax preferences | Shares undervalued and cash available | Weak liquidity or unfair treatment of shareholders |
| Retain earnings | ROIC versus shareholder alternatives | Positive NPV opportunities exist | Management is hoarding cash without plan |
| New equity | Dilution, control, valuation, investor rights | Leverage is high or growth requires patient capital | Existing owners reject dilution |
| Management buyout | Financing, fairness, conflicts, valuation | Succession and alignment benefits | Conflict of interest or excessive leverage |
Lease-versus-Buy Reference
| Factor | Lease | Buy |
|---|
| Upfront cash | Usually lower | Usually higher |
| Ownership | No ownership unless bargain or purchase option | Full ownership |
| Residual risk | Often less for lessee | Owner bears resale/obsolescence risk |
| Flexibility | Easier replacement if short term | More control over asset use |
| Covenants | Lease obligations may affect ratios | Debt financing may affect leverage |
| Tax and accounting | Depends on facts and standards applied | Depreciation/CCA and interest impacts may apply |
| Best analysis | PV of lease payments and tax effects | PV of purchase, financing, tax effects, maintenance, residual |
Exam recommendation: compare after-tax present values, then discuss flexibility, technology risk, capacity needs, and covenant effects.
Integrated Finance Judgment Points
Quantitative-to-qualitative bridge
| Quant result | Do not stop there; add |
|---|
| Positive NPV | Sensitivity, funding capacity, strategic fit, execution risk |
| Negative NPV | Non-financial rationale, regulatory or strategic necessity, alternative designs |
| High IRR | Scale of investment, reinvestment assumption, NPV ranking |
| Strong EBITDA | Working capital, capex, debt service, earnings quality |
| High valuation | Normalization, market comparability, buyer-specific synergies |
| Covenant compliance | Downside sensitivity and lender relationship |
| Liquidity surplus | Opportunity cost, reserves, debt repayment, shareholder distributions |
Professional judgment and ethics prompts
| Trigger | Response angle |
|---|
| Management bias in forecasts | Challenge assumptions, use sensitivity, request support |
| Related-party transaction | Fair value, disclosure, conflict management, independent approval |
| Aggressive valuation | Explain risk of overpayment or unfairness |
| Financing pressure | Avoid misleading lenders; provide balanced forecasts |
| Insider information | Consider confidentiality and governance |
| Weak controls over treasury | Segregation of duties, approval limits, reconciliations |
| Major acquisition | Recommend due diligence and board approval process |
Common CPA Finance Calculation Traps
| Area | Common mistake | Correct approach |
|---|
| NPV | Using accounting profit | Use incremental cash flow |
| NPV | Forgetting tax effects | Include income tax, tax shields, and disposal tax effects when provided |
| NPV | Including interest expense | Exclude if discounting at WACC |
| NPV | Ignoring terminal working capital recovery | Recover only if realistic and supported |
| WACC | Using book-value weights | Use market-value weights unless case directs otherwise |
| WACC | Applying after-tax cost to equity | Only debt gets tax shield in standard WACC |
| Valuation | Discounting FCFF at cost of equity | Discount FCFF at WACC |
| Valuation | Treating EBITDA multiple as equity value automatically | Determine whether multiple gives enterprise or equity value |
| Ratios | Using ending balances when averages are more appropriate | Use averages if available and meaningful |
| Ratios | Comparing companies with different accounting policies | Normalize or explain limitations |
| Hedging | Hedging uncertain exposure with rigid forward | Consider options or partial hedge |
| Working capital | Seeing higher sales as automatically positive | Higher sales may require financing AR and inventory |
| Financing | Choosing cheapest rate only | Consider covenants, flexibility, collateral, and refinancing risk |
| Recommendations | Listing pros and cons without a decision | Make a supported recommendation |
Compact Case-Writing Templates
Investment recommendation template
Based on the incremental after-tax cash flows, the project has an NPV of [amount] using a discount rate of [rate]. This suggests [value creation/value destruction]. However, the result is most sensitive to [driver], and the company must also consider [financing/capacity/strategy/risk]. I recommend [proceed/reject/defer] because [main reason]. Before implementation, management should [specific next steps].
Financing recommendation template
The company requires [amount] for [purpose]. [Financing option] is preferable because it matches the asset life, maintains liquidity, and [supports objective]. The main risks are [covenants/cash flow/collateral/dilution]. Management should negotiate [terms], prepare a cash forecast, and monitor [ratios] monthly.
Valuation recommendation template
A reasonable valuation range is [low] to [high] based on [methods]. The most reliable method appears to be [method] because [reason]. Key assumptions include [growth/margin/discount rate/multiple/normalization]. Before agreeing to a price, management should complete due diligence on [areas] and negotiate adjustments for [working capital/debt/earnout/indemnities].
Last-Week Review Checklist
| Task | Done |
|---|
| Memorize core formulas for NPV, WACC, CAPM, FCFF, terminal value, and working capital ratios. | |
| Practise identifying whether a valuation output is enterprise value or equity value. | |
| Review when to use NPV versus IRR, payback, EAC, and profitability index. | |
| Practise writing recommendations that combine quantification, risk, and implementation. | |
| Rework one acquisition case focusing only on normalization and due diligence. | |
| Rework one financing case focusing on debt capacity, covenants, and cash forecasts. | |
| Rework one working capital case focusing on CCC and short-term financing. | |
| Rework one hedging case focusing on exposure type and hedge selection. | |
| Build speed: set up clean tables, label assumptions, and conclude decisively. | |
Practical Next Step
Use this Quick Reference while completing timed CPA Canada PEP Finance Elective practice cases. After each case, debrief by asking: Did I quantify the right issue, interpret the result, address risk, and make a clear finance recommendation?