Question

1. In capital budgeting, a company might use which of the following as its discount rate?
2. 1. Return on total assets
   2. After-tax cost of debt
   3. Times interest earned
   4. Weighted average cost of capital

1. Which causes a company to become leveraged?
2. 1. Issuing high amounts of common stock
   2. Making an initial public offer (IPO)
   3. Having high fixed costs
   4. Having high variable costs

1. Which of the following correctly describes how a firm's required return is determined?
2. 1. Using the going market rate for risk-free securities
   2. As the present value of the firm's debt and equity
   3. As the opportunity cost that its investors forego
   4. Using the average rate paid for debt and the company's share price

1. All of the following are true of the free cash flow (FCF) analysis EXCEPT
2. 1. it can also be calculated using the operating cash flow figure from the statement of cash flows less capital expenditures.
   2. it includes adjustments for the difference between the change in total current assets and total current liabilities.
   3. it must be a positive amount for it to be interpreted positively by investors.
   4. it is considered a better representation of the value of the firm to shareholders than operating cash flow.

Answer 1

1. In capital budgeting the company will use weighted average cost of capital as it includes both equity as well as debt portion and provides overall cost to the company. Also it justifies that company is atleast recovering it's actual cost of capital.

2. High fix cost will make a company leveraged as it is to be paid whether or not you are doing production or earning profits. Common stock and IPO are related to shares so no leverage involved and variable cost will vary according to output so no leverage involved.

3. Opportunity cost that investors forego because required rate of return is from the view point of investors i.e. how much return is required to keep investors with you. Other options are based on the market or cost to company.

4. Free cash flow and operating cash flow are equally preferable and that's why it can't be said that free cash flow are better representation than operating.