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SDSU BA323 BRINCKS FINAL EXAM 2025 | ALL
QUESTIONS AND CORRECT ANSWERS |
GRADED A+ | NEWEST VERSION | VERIFIED
ANSWERS
What is the difference between business risk and financial risk? --------- CORRECT ANSWER-----------------Business risk is risk from underlying business, while financial risk is risk from the use of financial instruments What is the Hamada Equation? ---------CORRECT ANSWER----------------- The Hamada equation quantifies the increase cost of equity due to financial leverage. What does the Hamada equation try to quantify the trade off between? ------ ---CORRECT ANSWER-----------------The Hamada equation quantifies the increase cost of equity due to financial leverage. Or, how adding more debt increases the cost of equity. What are the two ways to find a firm's optimal capital structure. --------- CORRECT ANSWER-----------------Minimize WACC or maximize the stock price. What is the Modigliani-Miller Irrelevance Theory? ---------CORRECT ANSWER-----------------Trade off between tax benefits of debt and bankruptcy cost
What are signaling effects in capital structure? ---------CORRECT ANSWER-----------------Managers have better information about a firm's long-run value than outside investors. What will management do if they believe the stock is overvalued or undervalued? ---------CORRECT ANSWER-----------------If overvalued, stock will be issued. If undervalued, buyback shares or issue debt Why do investors view stock offerings as negative for the firm's future prospects? ---------CORRECT ANSWER-----------------Investors view strong offering as a negative sign because they think that the company may not be optimistic about the future. What are various risk factors for multinational corporations? --------- CORRECT ANSWER-----------------Different currency exchange rate, political risk, economic and legal ramifications, role of governments, and language and culture differences. How do companies hedge currency risk? ---------CORRECT ANSWER------- ----------Use exchange rate futures/forwards to hedge currency risk What is exchange rate risk? ---------CORRECT ANSWER-----------------The risk that the value of cash flows will change due to changes in the value of exchange rates. Why do companies care about exchange rate risk? ---------CORRECT ANSWER-----------------Impact costs and profitability
What is interest rate parity? ---------CORRECT ANSWER-----------------All investors should expect to earn the same return in all countries after adjusting risk. What is purchasing power parity? ---------CORRECT ANSWER----------------- Implies that the level of exchange rates adjust so that identical goods cost the same amount in different countries Does PPP hold in real life? ---------CORRECT ANSWER----------------- Partially, depends on the good or service (i.e. Big Mac Index) What impact does relative inflation have on interest rates and exchange rates? ---------CORRECT ANSWER-----------------Lower inflation leads to lower interest rates. Currency in low-inflation coutnries tend to appreciate against those in high-inflation rate countries- so negates the difference in interest rates. What are Eurobonds? ---------CORRECT ANSWER-----------------Bonds that are sold internationally What are Eurocredits? ---------CORRECT ANSWER-----------------Fixed term, floating-rate bank loans with no early repayment What are ADRs? ---------CORRECT ANSWER-----------------American Depositary Receipts; dollar denominated receipts for the stock of foreign firms held in vaults of home-Country banks
Why do companies issue ADRs? ---------CORRECT ANSWER----------------- To sell to an international market. Why do we care about the weighted average cost of capital (WACC)? ------- --CORRECT ANSWER-----------------WACC is necessary for making corporate investment decisions, such as building a new factory. WACC gauges the risk of a project (Higher WACC means more risk associated.) Two sides of an investment decision:
- How much money will this project make?
- How much does it cost for the firm to get the funds for this investment? What are the 3 main sources of capital for the firm? ---------CORRECT ANSWER-----------------Debt, preferred stock, and common equity are 3 main sources of capital What are the 2 components of common equity? ---------CORRECT ANSWER-----------------Retained earnings and new common stock are 2 components of common equity. What are 2 components of debt? ---------CORRECT ANSWER----------------- Short term notes payable and long-term debt are 2 components of debt. Do we care about after-tax or pre-tax analysis? Why? ---------CORRECT ANSWER-----------------After-tax capital cost since interest is tax deductible
Transaction costs associated with issuing new securities. Issuing new common stocks may send a negative signal to the capital markets, which may depress the stock price. How do changes in stock or debt change capital structure? --------- CORRECT ANSWER-----------------Stock is expensive and debt is cheap. Since stock is more risky than debt, it cost more to issue stock than debt. If you increase the percentage of stock, __________. If you decrease the percentage of debt, ___________. ---------CORRECT ANSWER--------------- --WACC goes up If you decrease the percentage of stock, _____________. If you increase the percentage of debt, ___________. ---------CORRECT ANSWER---------- -------WACC goes down. Which method used to calculate WACC would yield the highest value? ------ ---CORRECT ANSWER-----------------Market value since it has the highest equity. Which method used to calculate WACC would yield the lowest value?? ----- ----CORRECT ANSWER-----------------Book value What is capital budgeting? ---------CORRECT ANSWER----------------- Analysis of potential additions to fixed assets. Long-term decisions; involve large expenditures. Very important to firm's future.
What is capital? ---------CORRECT ANSWER-----------------Long-term assets used in production. What is a company's strategic business plan? ---------CORRECT ANSWER- ----------------A long-run plan that outlines in broad terms the firm's basic strategy for the next 5-10 years. What are the 5 criteria used to accept or reject a project? ---------CORRECT ANSWER-----------------1. Net present value (NPV)
- Internal rate of return (IRR)
- Modified internal rate of return (MIRR)
- Regular payback
- Discounted payback What is the difference between independent and mutually exclusive projects? Which type of project is harder to calculate? ---------CORRECT ANSWER-----------------With independent projects, the cash flows of one project are unaffected by the acceptance of the other. In mutually exclusive projects, the cash flows of one can be adversely impacted by the acceptance of other projects (harder to calculate) Explain the difference between normal and nonnormal cash flow streams. - --------CORRECT ANSWER-----------------Normal cash flow streams initially have a negative cash flow followed by a series of positive cash inflows. Non-normal cash flow streams are irregular. Which cash flow is most common and why. ---------CORRECT ANSWER---- -------------Normal cash flow is more common.
Why do companies often use the payback period despite its problems? ----- ----CORRECT ANSWER-----------------Payback period serves as a quick indication of project's risk. What are the pros and cons of using the payback period? --------- CORRECT ANSWER-----------------Pros: easy to calculate and understand Cons: No relation with investor wealth maximization. What is scenario analysis and why is it used? ---------CORRECT ANSWER- ----------------Projecting cash flows under different possible investment outcomes What is the baseline scenario? ---------CORRECT ANSWER----------------- Baseline scenario is projected cash flows under the most likely scenario Why do managers care about worst-case scenarios more than other scenarios? ---------CORRECT ANSWER-----------------Worst case scenario is analyzed to try to avoid bankruptcy and prevent managers from being fired. How can using comparables improve accuracy? ---------CORRECT ANSWER-----------------Comparables use existing projects to predict cash flows, often improves forecast accuracy. If 2 projects have the same expected NPV, select the project with the less risky cash flow
How can Monte Carlo simulations improves forecast accuracy? --------- CORRECT ANSWER-----------------Monte Carlo simulation allow you to estimate a large number of scenarios for investment analysis What are 3 types of project risk? ---------CORRECT ANSWER----------------- Stand-alone risk Corporate risk Market risk Stand-alone risk ---------CORRECT ANSWER-----------------A project's total risk, if it were operated indepedently. Corporate risk ---------CORRECT ANSWER-----------------Project's risk when considering the firm's other projects Market risk ---------CORRECT ANSWER-----------------Project's risk to a well- diversified investor Which risk is most relevant for corporations and why? ---------CORRECT ANSWER-----------------Market risk is the most relevant risk because management's primary goal is shareholder wealth maximization. Care most about systematic risk What is real option analysis and why does this matter for deciding which projects to accept? ---------CORRECT ANSWER-----------------The analysis
Uncertainty about demands (sales) Uncertainty about output prices Uncertainty about costs Product obsolescence Foreign risk exposure Regulatory risk Operating leverage What is operating leverage? ---------CORRECT ANSWER----------------- Operating leverage is the use of fixed costs instead of variable costs If a company mainly has high fixed costs, does it have high or low operating leverage? ---------CORRECT ANSWER-----------------High fixed costs: high operating leverage. Does operating leverage create more or less business risk? --------- CORRECT ANSWER-----------------Creates more business risk What is the pro and con of using operating leverage to increase risk? --------
- CORRECT ANSWER-----------------Higher returns, more risk
What is financial leverage? ---------CORRECT ANSWER----------------- Financial leverage is the use of debt and preferred stock to increase returns Does financial leverage create more or less risk? ---------CORRECT ANSWER-----------------Financial leverage increases risk What does a firm's optimal capital structure mean? ---------CORRECT ANSWER-----------------The mix of debt, preferred, and common equity that maximizes shareholder value Describe the sequence of events in a recapitalization ---------CORRECT ANSWER-----------------1. Firm announces the recapitalization
New debt is issued
Proceeds are used to repurchase stock What effect does more debt have on a firm's cost of equity? --------- CORRECT ANSWER-----------------Increase the firms cost of equity
