Finance 320F Unit 4 and 5 Working
Words with Complete Solutions
What is the purpose of "portfolio diversification"?
✔✔ To reduce risk by spreading investments across various assets to minimize the impact of any
single investment’s poor performance.
How is "weighted average cost of capital" (WACC) calculated?
✔✔ By taking the average rate of return required by all of a company's investors, weighted
according to their proportion of the total capital.
What does "systematic risk" refer to in finance?
✔✔ The risk inherent to the entire market or market segment, which cannot be eliminated
through diversification.
How does "capital asset pricing model" (CAPM) determine the expected return on an
investment?
✔✔ By calculating the return based on the risk-free rate plus a risk premium, which is the
product of the investment's beta and the market risk premium.
1
,What is the function of "net present value" (NPV) in investment decisions?
✔✔ To evaluate the profitability of an investment by calculating the difference between the
present value of cash inflows and outflows.
How does "internal rate of return" (IRR) differ from NPV?
✔✔ IRR is the discount rate that makes the net present value of all cash flows from a particular
project equal to zero, while NPV gives a dollar amount.
What is the significance of "beta" in the context of stock investments?
✔✔ Beta measures a stock's volatility relative to the overall market, indicating how much the
stock’s price is expected to move compared to market movements.
How is "price-to-earnings ratio" (P/E ratio) used to evaluate a company's stock?
✔✔ It compares the company’s current share price to its earnings per share, helping investors
assess if the stock is over- or under-valued.
What does "economic value added" (EVA) measure?
✔✔ EVA assesses a company's financial performance based on residual wealth, calculated by
deducting the cost of capital from the company’s net operating profit after taxes.
2
, How is "capital budgeting" used in financial planning?
✔✔ It involves evaluating potential major investments or projects to determine their profitability
and alignment with company goals.
What is the role of "financial leverage" in a company's capital structure?
✔✔ Financial leverage involves using borrowed funds to amplify potential returns on
investment, which also increases financial risk.
What is "return on equity" (ROE) and why is it important?
✔✔ ROE measures the profitability of a company relative to shareholders' equity, indicating how
effectively the company uses equity financing to generate profits.
How is "debt ratio" used in evaluating a company’s financial stability?
✔✔ The debt ratio measures the proportion of a company’s assets that are financed through debt,
helping to assess financial leverage and risk.
What does "liquidity ratio" tell us about a company's financial health?
3
Words with Complete Solutions
What is the purpose of "portfolio diversification"?
✔✔ To reduce risk by spreading investments across various assets to minimize the impact of any
single investment’s poor performance.
How is "weighted average cost of capital" (WACC) calculated?
✔✔ By taking the average rate of return required by all of a company's investors, weighted
according to their proportion of the total capital.
What does "systematic risk" refer to in finance?
✔✔ The risk inherent to the entire market or market segment, which cannot be eliminated
through diversification.
How does "capital asset pricing model" (CAPM) determine the expected return on an
investment?
✔✔ By calculating the return based on the risk-free rate plus a risk premium, which is the
product of the investment's beta and the market risk premium.
1
,What is the function of "net present value" (NPV) in investment decisions?
✔✔ To evaluate the profitability of an investment by calculating the difference between the
present value of cash inflows and outflows.
How does "internal rate of return" (IRR) differ from NPV?
✔✔ IRR is the discount rate that makes the net present value of all cash flows from a particular
project equal to zero, while NPV gives a dollar amount.
What is the significance of "beta" in the context of stock investments?
✔✔ Beta measures a stock's volatility relative to the overall market, indicating how much the
stock’s price is expected to move compared to market movements.
How is "price-to-earnings ratio" (P/E ratio) used to evaluate a company's stock?
✔✔ It compares the company’s current share price to its earnings per share, helping investors
assess if the stock is over- or under-valued.
What does "economic value added" (EVA) measure?
✔✔ EVA assesses a company's financial performance based on residual wealth, calculated by
deducting the cost of capital from the company’s net operating profit after taxes.
2
, How is "capital budgeting" used in financial planning?
✔✔ It involves evaluating potential major investments or projects to determine their profitability
and alignment with company goals.
What is the role of "financial leverage" in a company's capital structure?
✔✔ Financial leverage involves using borrowed funds to amplify potential returns on
investment, which also increases financial risk.
What is "return on equity" (ROE) and why is it important?
✔✔ ROE measures the profitability of a company relative to shareholders' equity, indicating how
effectively the company uses equity financing to generate profits.
How is "debt ratio" used in evaluating a company’s financial stability?
✔✔ The debt ratio measures the proportion of a company’s assets that are financed through debt,
helping to assess financial leverage and risk.
What does "liquidity ratio" tell us about a company's financial health?
3
