HCAD 760 Exam 2 Questions And Correct
Answers A+ Graded
What does the "Trade Off" model tell you about the amount of debt or equity to use? -
ANSWER o Higher risk businesses should borrow less money to avoid financial distress.
o Businesses with tangible assets should borrow more money. (Because the tangible
assets are less likely to lose value during financial distress) o Businesses at high tax
rates should borrow more money (to take advantage of tax reductions of interest)
Financial Risk - ANSWER Additional risk due to debt financing
Business Risk - ANSWER General risk of a business earning a profit.
In other words, the risk inherent in the business' asset base, assuming they were all
equity-financed
What are the steps of capital investment financial analysis? - ANSWER 1. Estimate the
expected project cash flows
-Capital outlay or cost
-Operating cash flow
-Terminal (ending) cash flow
2. Risk Analysis
3. Estimate the project's cost of capital
-Its operating costs or discount rate
-This represents the aggregate risk of an asset (risk inherent in average project)
-If it doesn't have an average risk, the CCC has to be adjusted
*NPV & IRR both used to calculate cost of a project or how much profit the project will
generate.
Dollar Return - ANSWER NPV shows a projects _________ ______________.
, Rate of Return - ANSWER IRR reflects a project's ___ ___ ___
Net Present Value - ANSWER NPV stands for _____________ _____________ _______
Internal Rate of Return - ANSWER IRR stands for _____________________ _________ ___
_____________
Any value over ZERO - ANSWER What does NPV reflect a good investment?
Any value over the COST OF CAPITAL - ANSWER What does IRR reflect a good
investment?
NPV - ANSWER • Sum of all cash flows of a project
discounted at the cost of capital rate
• Represented in dollars, easier to
understand, more commonly used,
used in excel
IRR - ANSWER •.shown in percentage, rate of return
the investment will make, used in excel
•. evaluate capital budgeting
• Know formula to calculate return on assets and interpret/explain results of calculation
- ANSWER ** Shows how a business is using their assets.
** Measures ability to both control expenses and use its assets to generate revenue.
** Higher ROA= greater net income on each dollar invested in assets
• Know formula to calculate the current ratio and interpret/explain results of calculation.
- ANSWER ** The current ratio is an indication of a firm's liquidity.
** Measures the company being able to pay back short term obligations
** The higher current ratio is better than a low current ratio, because a high current
ratio shows a company is more likely to pay the creditor back.
Answers A+ Graded
What does the "Trade Off" model tell you about the amount of debt or equity to use? -
ANSWER o Higher risk businesses should borrow less money to avoid financial distress.
o Businesses with tangible assets should borrow more money. (Because the tangible
assets are less likely to lose value during financial distress) o Businesses at high tax
rates should borrow more money (to take advantage of tax reductions of interest)
Financial Risk - ANSWER Additional risk due to debt financing
Business Risk - ANSWER General risk of a business earning a profit.
In other words, the risk inherent in the business' asset base, assuming they were all
equity-financed
What are the steps of capital investment financial analysis? - ANSWER 1. Estimate the
expected project cash flows
-Capital outlay or cost
-Operating cash flow
-Terminal (ending) cash flow
2. Risk Analysis
3. Estimate the project's cost of capital
-Its operating costs or discount rate
-This represents the aggregate risk of an asset (risk inherent in average project)
-If it doesn't have an average risk, the CCC has to be adjusted
*NPV & IRR both used to calculate cost of a project or how much profit the project will
generate.
Dollar Return - ANSWER NPV shows a projects _________ ______________.
, Rate of Return - ANSWER IRR reflects a project's ___ ___ ___
Net Present Value - ANSWER NPV stands for _____________ _____________ _______
Internal Rate of Return - ANSWER IRR stands for _____________________ _________ ___
_____________
Any value over ZERO - ANSWER What does NPV reflect a good investment?
Any value over the COST OF CAPITAL - ANSWER What does IRR reflect a good
investment?
NPV - ANSWER • Sum of all cash flows of a project
discounted at the cost of capital rate
• Represented in dollars, easier to
understand, more commonly used,
used in excel
IRR - ANSWER •.shown in percentage, rate of return
the investment will make, used in excel
•. evaluate capital budgeting
• Know formula to calculate return on assets and interpret/explain results of calculation
- ANSWER ** Shows how a business is using their assets.
** Measures ability to both control expenses and use its assets to generate revenue.
** Higher ROA= greater net income on each dollar invested in assets
• Know formula to calculate the current ratio and interpret/explain results of calculation.
- ANSWER ** The current ratio is an indication of a firm's liquidity.
** Measures the company being able to pay back short term obligations
** The higher current ratio is better than a low current ratio, because a high current
ratio shows a company is more likely to pay the creditor back.
