Capital Management and Financial Decisions 2

Question 1

risk premium is comprised of five components

Answer 1

1) business risk
2) financial risk
3) liquidity risk
4) currency risk
5) country risk

Question 2

rule of 72

Answer 2

time it takes for invested cash to double

72 / interest rate earned

Question 3

Default Bond Risk Rating

Answer 3

AAA = Highest Rating

BBB to AAA = investment grade

Bonds below BBB = high yield or junk bonds

Question 4

The four weighting systems that can be used are

Answer 4

1) book values from the balance sheet
2) market value
3) Optimal or target capital structure weights
4) marginal weights which would assign capital weights in percentages that funds were actually raised

Question 5

Standard capital budgeting techniques (such as NPV, IRR)

Answer 5

are not designed to compare projects with different lives (a 3-year project versus a 4-year project)

Question 6

what calculates present value on an annual basis and allows the analyst to compare projects with different lives

Answer 6

equivalent annual annuity (EAA)

aka

equivalent annual cost or EAC

Question 7

what will lead to a high present value

Answer 7

low discount rate for a cash flow in a quicker period of time

Question 8

Benefit Cost Ratio

Answer 8

Present Value of Cash Flows (Benefits) / Net Investment (Costs)

Index > 1.0 is acceptable

Question 9

Accept the project if

Answer 9

NPV > 0

IRR > Cost of Captial