HCAD 760 EXAM 2 QUESTIONS AND ANSWERS WIT
COMPLETE SOLUTIONS VERIFIED
What does the "Trade Off" model tell you about how much 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)The extra risk for using debt financing
Business Risk - (ANSWER)The risk of a business being profitable, in general.In other words, the
riskiness of a business' assets, assuming they are all-equity financed
What are the steps of capital investment financial analysis? - (ANSWER)1. Estimate the project's
expected cash flows.
-Capital outlay or cost
- Operating cash flow
-Terminal (ending) cash flow
2. Risk Assessment
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 shows a project's ______ ____ _________
Net Present Value - (ANSWER)NPV stands for _______________ ________________
___________
Internal Rate of Return - (ANSWER)IRR stands for _____________________ ___________
___ ________________
Any value over ZERO - (ANSWER)What NPV shows a good investment?
Any value over the COST OF CAPITAL - (ANSWER)What IRR shows 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
COMPLETE SOLUTIONS VERIFIED
What does the "Trade Off" model tell you about how much 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)The extra risk for using debt financing
Business Risk - (ANSWER)The risk of a business being profitable, in general.In other words, the
riskiness of a business' assets, assuming they are all-equity financed
What are the steps of capital investment financial analysis? - (ANSWER)1. Estimate the project's
expected cash flows.
-Capital outlay or cost
- Operating cash flow
-Terminal (ending) cash flow
2. Risk Assessment
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 shows a project's ______ ____ _________
Net Present Value - (ANSWER)NPV stands for _______________ ________________
___________
Internal Rate of Return - (ANSWER)IRR stands for _____________________ ___________
___ ________________
Any value over ZERO - (ANSWER)What NPV shows a good investment?
Any value over the COST OF CAPITAL - (ANSWER)What IRR shows 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
