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?
o Higher risk businesses should borrow less money to avoid financial distress.
o Businesses with tangible assets should borrow more money. (Becau...
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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?
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
The extra risk for using debt financing
Business Risk
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?
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
NPV shows a projects _________ ______________.
Rate of Return
IRR shows a project's ______ ____ _________
Net Present Value
NPV stands for _______________ ________________ ___________
Internal Rate of Return
IRR stands for _____________________ ___________ ___ ________________
Any value over ZERO
What NPV shows a good investment?
Any value over the COST OF CAPITAL
What IRR shows a good investment?
NPV
• 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
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