HCAD 760 Exam 2 Questions With Verified
Answers.
What does the "Trade Off" model tell you about how much debt or equity to use? - answero
Higher risk businesses should borrow less money to avoid financial distress.
o Businesses with tangible assets should borrow more money. (Because the tangibl...
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
** 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.
** If current liabilities increase faster than assets, current ratio will fall; thus, creating problems.
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