Question

1. What determines the value of an economic asset?

2. If we know the projected cash flows from loan notes and their current market value, what approach would we take to deducing the cost of the loan notes?

3. Why does it seem likely that businesses have a target gearing ratio?

4. What is wrong with using the cost of the specific capital used to finance a project as the discount rate in relation to that project?

5. When calculating the weighted average cost of capital (WACC) should we use market values or balance sheet values as the weights of debt and equity? Explain

Answer 1

1) A value of an economic assets is the fair value or recoverable value or investment value of that that..Asset value depend on the type of user of that asset, Life, obsolences etc

2) We should enter into pay Libor received fix swap at the same loan fixed rate .

In that case we can have the positive value or the equal answer same as before .so altogether we would be in a no lesser position

3)gearing ratio suggest that how much proportion of capital and other fixed instrument for the company balance sheet.

Every business suffer from operation risk as well as financial risk.

So if business risk is more than nobody want to take financial risk so would keep gearing ratio will be high. So depending on business nature , each business decide their capital debt target.

4)Discount rate use to discount the cash flow should be that rate which the business wanted to earn or the rate at which the firm take out the funds.

If it will considered then we will hv a positive as well negative answer

5) we should use the market weights while using WACC. because funds are borrowed from the market so comparison should made in term of market valued not the book value weights.