Unit 7

Question 1

From a financial point of view, the goal of a company is to _____________.

Answer 1

maximize the stockholders’ wealth

Question 2

return or profitability of an investment is ______________.

Answer 2

the average increase in wealth produced by an investment per invested monetary and time unit

Question 3

Return =

Answer 3

(total amount at the end of the term - original investment) / original investment

Question 4

Cost of capital of a project is defined as _____________.

Answer 4

the minimum return necessary to make the project worthwhile

Question 5

The profitability of a project is _______________.

Answer 5

the return the project actually yields

Question 6

The difference between the profitability of a project and the cost of capital is ______________–.

Answer 6

The profitability of a project is the return the project actually yields and the cost of capital is the return the project should yield to be worthwhile

Question 7

The return on an investment will be used to remunerate

Answer 7

both the providers of equity capital and the providers of debt capital

Question 8

The cost of capital will depend on how ________________ due to ________________.

Answer 8

the investment is funded

The return on the investment being used to remunerate both the providers of equity capital and the providers of debt capital

Question 9

The cost of capital of a project will depend on the following two costs of capital:

Answer 9

1. Cost of debt capital

2. Cost of equity capital

Question 10

Cost of debt capital is ______________ and is explicitly determined by _____________.

Answer 10

the return required by the debt holders of the company.

the conditions of the debt contracts

Question 11

Cost of equity capital is _______________.

Answer 11

the minimum return required by the stockholders of a

company.

Question 12

The cost of debt capital is different from the cost of equity in that ______________.

Answer 12

The cost of debt capital is not explicitly
determined but can be estimated as the rate of return of a similar investment
(that is , an investment with a similar risk level).

Question 13

A similar investment is ___________.

Answer 13

an investment with a similar risk level

Question 14

The cost of capital of a company at a given moment can be estimated as ________________.

Answer 14

the weighted average of the cost of equity capital and the cost of debt capital.

Question 15

The increase in the value of the assets of the company is calculated as ____________.

Answer 15

∆A = R * A

where R = rate of return & A = assets

Question 16

That variation in assets must be used to ______________, which is calculated as _______________.

Answer 16

pay the remuneration of the debt

I = D * KD

where D = debt & KD = cost of debt

Question 17

After paying the remuneration of debt, the remaining assets would be the actual variation in the value of equity and calculated as ______________.

Answer 17

∆E actual = ∆A - I

where ∆A = increase in value of assets & I = variation in assets

Question 18

Stockholders require a minimum increase in the value of their investments of ∆E required = ______________.

Answer 18

∆E required = E * Ke

where E = equity & Ke = cost of equity

Question 19

For the stockholders’ wealth to remain unchanged, the actual variation in the value of equity should equal _______________ and can be represented by the formula ________________.

Answer 19

the required variation in the value of equity

∆E actual = ∆E required <=> RA - DKD = EKe <=> R = (EKe + D*KD) / A

where E = equity, Ke = cost of equity, D = debt, KD = cost of debt, & A = assets

Question 20

For the stockholders’ wealth to remain unchanged, R =

Answer 20

(EKe + DKD) / A

where E = equity, Ke = cost of equity, D = debt, KD = cost of debt, & A = assets

Question 21

The formula of the weighted average cost of capital (WACC) is ______________.

Answer 21

R = (EKe + DKD) / A

Question 22

Let’s suppose that we lack our own capital and that we request a loan of 100 monetary units with a financial cost of 5% per year.

If we invest the 100 monetary units in the acquisition of an investment, what minimum profitability should we achieve in order not to reduce our wealth if the return on investment is 4%?

Answer 22

In this case, the value of our investment would
have increased to 104 monetary units, but the value of the liability we used to acquire it would
have increased to 105 monetary units. The result will be that our wealth has been reduced to a
value of -1.

We need a profitability of 5%

Question 23

Let’s suppose that we lack our own capital and that we request a loan of 100 monetary units with a financial cost of 5% per year.

If we invest the 100 monetary units in the acquisition of an investment, what personal profitability would we achieve if the profitability of the investment is 7%?

Answer 23

The value of the investment would have amounted to 107 monetary units, so that by returning the 105 of the liabilities, our wealth would have amounted to 2 monetary units.

The profitability is 2%

Question 24

Let’s suppose that we lack our own capital and that we request a loan of 100 monetary units with a financial cost of 5% per year.

If we invest the 100 monetary units in the acquisition of an investment and the return on investment is 5%, what minimum profitability should we achieve in order not to reduce our wealth?

Answer 24

The final value of the investment (105 monetary units)
will be equal to that of the liabilities (105 monetary units), so that our wealth will remain unchanged.

We need a profitability of 5%

Question 25

The WACC (weighted average cost of capital) indicates ___________________.

Answer 25

the cost of capital at a given moment of time

Question 26

In capital budgeting, the proportions of debt and equity in the financing of an investment usually _________-. Consequently, we will estimate the cost of capital using an alternative method, which is ________________.

Answer 26

vary over time

the calculation of the rate of interests of the financial
structure of the company

Question 27

the rate of interests of the financial structure of a company is _________________.

Answer 27

the rate that where the cash-inflows from the financial operations equal to the cash-outflows from the financial operations

Question 28

The mínimum profitability that should be obtained with the investment project is the ______________.

Answer 28

cost of capital of the project

Question 29

The cost of capital of a project is minimum profitability that should be obtained with the investment project so that ________________.

Answer 29

if the profitability of the project does not
exceed the cost of capital, the project will reduce the wealth of the shareholders and, consequently, not be a desirable project.

Question 30

Cash-inflows are assigned _________ values.

Answer 30

positive

Question 31

Cash out-flows are assigned ________ values.

Answer 31

negative

Question 32

When we have different sources of financing for a project, we add all the cash-flows in a global cash-flow that will be the ____________, and we use this __________ to calculate the cost of capital (K) of the financing project.

Answer 32

global cash-flow of the financial structure

global cash-flow of the financial structure