QAs

FIN320 – Gallaher – Topics for Exam 3

The computational questions on the exam will concern capital budgeting, and the weighted average cost of capital.

The conceptual questions on the test will concern the following topics.

1. How do we handle financing cash flows (interest expense, dividends, etc.) in capital budgeting?

2. What is the Weighted Average Cost of Capital (WACC)?

3. What do we mean by “cost of [debt, preferred stock, common stock]”?

4. What ways can we estimate the cost of debt?

5. How do we estimate the cost of preferred stock?

6. What ways can we estimate the cost of common stock?

7. In the WACC equation, why do we multiply the cost of debt by (1 – tax rate)?

8. What can we use the WACC for?

9. What if the project we are considering is not similar to our existing assets?

10. What do we mean by incremental cash flows?

11. What are sunk costs? Opportunity costs? Cannibalization and synergies? How do we deal with each of these in a capital budgeting analysis?

12. What is free cash flow? How is it different from net income?

13. How are capital expenditures treated by accounting? … by finance?

14. Why do we care about depreciation (which is not a cash flow)?

15. What is working capital (from a finance point of view) and how is it important to capital budgeting?

16. Why is NPV considered to be the best method for capital budgeting?

17. What are the limitations of the payback period?

18. What are the limitations of IRR? When does it have problems? When will it agree with NPV?

19. What are “mutually exclusive” projects?

20. What are “non-normal cash flows”?

21. What is an NPV profile?

22. How can increasing debt make the firm more valuable? How can increasing the debt make the firm less valuable? Explain the Trade-Off Theory of Capital Structure.

23. Explain the Pecking Order Theory of Capital Structure.