Class 8

Question 1

what is business risk

Answer 1

risk inherent to operations

Question 2

what is financial risk

Answer 2

risk that is purely financial

Question 3

when do you use a firms own cost of capital for a project?

Answer 3

same business risk (same line of business)
same financial risk (same debt/equity mix)

Question 4

how to find cost of equity when a company maintains an 80% D/V ratio but will finance their project with a 50%

Answer 4

unlever betas
relever to a 50% D/V
Plug into capm

Question 5

what is a pure play

Answer 5

company that focuses exclusively in one area

Question 6

what is a hurdle rate

Answer 6

minimum rate of return required before project can be approved

Question 7

what are some disadvantages of hurdle rates

Answer 7

• projects often have different levels of risk
• some firms set the hurdle rate above the cost of capital, so positive npv projects are rejected
• firms may not revisit and update hurdle rates enough

Question 8

what are some advantages of hurdle rates

Answer 8

• no need to use different cost of capital for every project
• clear rule applied to every project