HCAD 760 EXAM 2 QUESTIONS & ANSWERS
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.
• Know formula to calculate the fixed asset turner ratio and interpret/explain results of
calculation. - Answer -** Also called Fixed Asset Utilization Ratio
** Measures utilization of equipment and property
** In other words, how well the company is using their fixed assets to generate sales
** The higher the ratio, the better. Shows company is effectively using its fixed assets.
Know formula to calculate the debt-to-equity ratio and interpret/explain results of
calculation. - Answer -** The higher the ratio, the riskier creditors position
** The higher the ratio, the company may not be able to generate cash to satisfy the
debt obligations
** Measures company leverage
** Indicates how much debt is being used to finance its assets
What do liquidity ratios measure? - Answer -Amount of cash available
Know steps in the financial planning process. - Answer -• 1. Create sets of forecasted
financial statements to analyze the effects of alternative operating assumptions on the
firm's financial conditions. These statements can also be used to monitor the operations
after the plan has been put into action.
2. Determine the financial needs to support each set of alternative operating
assumptions. These financial requirements must include funds for the new
facilities/renovations/inventory/receivables/research/education/marketing
3. Forecast the financing sources to be used over the next five years to support each alt
set of operating assumptions. Primary retention-Involves estimating funds that will be
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.
• Know formula to calculate the fixed asset turner ratio and interpret/explain results of
calculation. - Answer -** Also called Fixed Asset Utilization Ratio
** Measures utilization of equipment and property
** In other words, how well the company is using their fixed assets to generate sales
** The higher the ratio, the better. Shows company is effectively using its fixed assets.
Know formula to calculate the debt-to-equity ratio and interpret/explain results of
calculation. - Answer -** The higher the ratio, the riskier creditors position
** The higher the ratio, the company may not be able to generate cash to satisfy the
debt obligations
** Measures company leverage
** Indicates how much debt is being used to finance its assets
What do liquidity ratios measure? - Answer -Amount of cash available
Know steps in the financial planning process. - Answer -• 1. Create sets of forecasted
financial statements to analyze the effects of alternative operating assumptions on the
firm's financial conditions. These statements can also be used to monitor the operations
after the plan has been put into action.
2. Determine the financial needs to support each set of alternative operating
assumptions. These financial requirements must include funds for the new
facilities/renovations/inventory/receivables/research/education/marketing
3. Forecast the financing sources to be used over the next five years to support each alt
set of operating assumptions. Primary retention-Involves estimating funds that will be
