Review Questions for Second Exam in Advanced Topics 1. Identify the three basic types of cash flows developed in the capital budgeting process. 2. What is an externality? 3. How are sunk costs treated in the capital budgeting process? 4. Why is the MACRs rate for the first year smaller than for the second year, regardless of the class life? 5. When working with replacement decisions, why do you need to know the book value of the old asset that is being replaced? 6. If you were responsible for the capital budgeting function in your firm, what do you feel would be your biggest challenge? Why? 7. Distinguish between business and financial risk. 8. What is leverage? 9. Identify some factors that influence the level of business risk. 10. How do taxes affect capital structure decisions? 11. What role do bankruptcy costs play in capital structure development? 12. How does asymmetric information affect capital structure? 13. Why do firms commonly maintain a reserve borrowing capacity? 14. How does a firm know when it has identified its optimal capital structure? 15. Why does the optimal capital structure not necessarily occur where EPS is greatest? 16. Are capital structure decisions or operating decisions more likely to have a greater effect on stock prices? Explain. 17. How is the price to be paid in a stock repurchase determined? Be prepared to draw and/or interpret Figure 16-2 and Figure 16-4. Problems: You should be prepared to solve problems similar to those assigned and those for which your background in finance should have prepared you. Topics likely to be addressed include, capital budgeting (cash flow development and decision for expansion or replacement, unequal lives, abandonment), operating breakeven, DOL and DFL, capital structure aspects including determination of stock price in a recapitalization.
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