Exam 1
FINA 3620 Example of Short Answer Questions for Exam 1
Chapter 11
1. Define cost of capital and investors’ required return respectively. Explain the relationship between these two.
Cost of Capital is the required rate of return on the various types of financing. The overall cost of capital is a weighted average of the individual required rates of return (costs). It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company.
2. Identify two different approaches to estimate component cost of equity. Explain which type of data will be necessary to be able to use each approach.
CAPM- risk free rate, Beta, and expected market return
Constant growth model- expected div per share one year from now, required rate of return, and growth rate of dividends
3. Assume your firm has three new projects under consideration. When using firm level weighted cost of capital to evaluate all these new projects would be justified? When using division level cost of capital to evaluate these new projects would be justified? Explain why.
Chapter 12
1. Define opportunity costs, sunk costs, substitutionary and complementary effects respectively.
What would be a good example of each type of cash flow above? Explain whether each type of cash flow above should be included in the cash flow estimation for projects or not. Why?
2. In class, we discussed three distinct cash flows (i.e. at time zero, each year over the life of the project and at the very end of project) to be estimated to come up with total cash flows. What are those? Explain how each cash flow can be estimated.
3. When two projects have different project lives, is it o.k. to use NPVs of projects to choose the better one? Why or why not? If it is not o.k., please explain how you can choose the better project.
Chapter 13
1. Define NPV and IRR. Explain how decision can be made on projects, once you calculate NPV and IRR of
Chapter 11
1. Define cost of capital and investors’ required return respectively. Explain the relationship between these two.
Cost of Capital is the required rate of return on the various types of financing. The overall cost of capital is a weighted average of the individual required rates of return (costs). It is used to evaluate new projects of a company as it is the minimum return that investors expect for providing capital to the company.
2. Identify two different approaches to estimate component cost of equity. Explain which type of data will be necessary to be able to use each approach.
CAPM- risk free rate, Beta, and expected market return
Constant growth model- expected div per share one year from now, required rate of return, and growth rate of dividends
3. Assume your firm has three new projects under consideration. When using firm level weighted cost of capital to evaluate all these new projects would be justified? When using division level cost of capital to evaluate these new projects would be justified? Explain why.
Chapter 12
1. Define opportunity costs, sunk costs, substitutionary and complementary effects respectively.
What would be a good example of each type of cash flow above? Explain whether each type of cash flow above should be included in the cash flow estimation for projects or not. Why?
2. In class, we discussed three distinct cash flows (i.e. at time zero, each year over the life of the project and at the very end of project) to be estimated to come up with total cash flows. What are those? Explain how each cash flow can be estimated.
3. When two projects have different project lives, is it o.k. to use NPVs of projects to choose the better one? Why or why not? If it is not o.k., please explain how you can choose the better project.
Chapter 13
1. Define NPV and IRR. Explain how decision can be made on projects, once you calculate NPV and IRR of