FIN 304 FINAL EXAM STUDY GUIDE
opportunity cost of capital - Answers - Expected rate of return given up by investing in a
project.
Net Present Value (NPV) - Answers - Present value of cash flows minus investment.
payback period - Answers - Time until cash flows recover the initial investment in the
project.
internal rate of return (IRR) - Answers - Discount rate at which project NPV = 0.
profitability index - Answers - Ratio of net present value to initial investment.
capital rationing - Answers - Limit set on the amount of funds available for investment.
capital structure - Answers - The mix of long-term debt and equity financing.
weighted-average cost of capital (WACC) - Answers - Expected rate of return on a
portfolio of all the firm's securities, adjusted for tax savings due to interest payments.
free cash flow - Answers - Cash flow that is not required for investment in fixed assets
or working capital and is therefore available to investors.
restructuring - Answers - Process of changing the firm's capital structure without
changing its real assets.
operating risk (business risk) - Answers - Risk in firm's operating income.
financial leverage - Answers - Debt financing to amplify the effects of changes in
operating income on the returns to stockholders.
financial risk - Answers - Risk to shareholders resulting from the use of debt.
MM's proposition I (debt-irrelevance proposition) - Answers - The value of a firm is
unaffected by its capital structure.
MM's proposition II - Answers - The required rate of return on equity increase as the
firm's debt-equity ratio increases.
interest tax shield - Answers - Tax savings resulting from deductibility of interest
payments.
opportunity cost of capital - Answers - Expected rate of return given up by investing in a
project.
Net Present Value (NPV) - Answers - Present value of cash flows minus investment.
payback period - Answers - Time until cash flows recover the initial investment in the
project.
internal rate of return (IRR) - Answers - Discount rate at which project NPV = 0.
profitability index - Answers - Ratio of net present value to initial investment.
capital rationing - Answers - Limit set on the amount of funds available for investment.
capital structure - Answers - The mix of long-term debt and equity financing.
weighted-average cost of capital (WACC) - Answers - Expected rate of return on a
portfolio of all the firm's securities, adjusted for tax savings due to interest payments.
free cash flow - Answers - Cash flow that is not required for investment in fixed assets
or working capital and is therefore available to investors.
restructuring - Answers - Process of changing the firm's capital structure without
changing its real assets.
operating risk (business risk) - Answers - Risk in firm's operating income.
financial leverage - Answers - Debt financing to amplify the effects of changes in
operating income on the returns to stockholders.
financial risk - Answers - Risk to shareholders resulting from the use of debt.
MM's proposition I (debt-irrelevance proposition) - Answers - The value of a firm is
unaffected by its capital structure.
MM's proposition II - Answers - The required rate of return on equity increase as the
firm's debt-equity ratio increases.
interest tax shield - Answers - Tax savings resulting from deductibility of interest
payments.
