Running Head: FINANCE QUESTIONS 1
Finance Questions
Institutional Affiliation
Date
FINANCE QUESTIONS 2
Question 1
Changes in credit rates affect borrowing cost of organizations (interest rates to loans) by either
creating an upgraded or downgraded credit rate (Garicano, & Steinwender, 2016). In this case,
there is a downgrade from the highest grade, AAA to A and thus this means that there will be an
increase in interest rates charged on the capital which further translates to a fact that there will be
a high cost incurred in the operations of the project. This will be because of the added cost that
will be by the additional rates of servicing the capital.
Stock price impact
Bond and stock pricing is affected by the downgrade or upgrade of the credit rating or if there are
rumors of either a downgrade or an upgrade because investors will sell the stock whose quality is
going down. In this case, there will be no noticeable change in the stock prices because the
downgrade doesn’t move below the investment grade indicated by A. its below the rate A where
there are red flags from which pricing goes down to a noticeable margin.
Question 2
IRR Rule
When the IRR is less than the Cost of capital, it translates to an NPV that is less than zero.
Therefore, the decisions to make concerning the project are simply a rejection of the investment
perspective and consider other factors that could seem important.
Question 5
FINANCE QUESTIONS 3
Cost of capital is defined as the minimum return rates that ought to be earned by the firm for it to
satisfy investor expectations and is affected by factors in the categories of; ‘economic’
‘fundamental’ and other factors’ (Caballero, Farhi, & Gourinchas, 2017).
The economic factors include;
i. Federal trade policies on trade activities
ii. Risks in exchange rates
iii. Country risk
Fundamental factors include;
i. Market opportunities
ii. Risks
iii. Inflation
Other factors include;
i. Firms policy on capital structure
ii. Dividend policy
iii. Investment policy
Question 6
Apply the available resources in an optimum manner to get maximum outputs usually in terms of
profits.
Question 7
FINANCE QUESTIONS 4
This is a false statement. Using 100% debt financing doesn’t allow capital ownership of the
capital employed by a firm and also leads to repayment obligations and it's therefore highly
recommendable to apply equity financing or a mixture of both debt and equity financing.
Question 8
Retained earnings can be defined as the profits of a company that it has got, taking away any
payment made to investors or any dividends. Retained earnings can be used when there is access
to accounting records which expense account or impact revenue. A financially strong
organization can be determined by huge retained earnings (Ball, Gerakos, Linnainmaa, &
Nikolaev, 2017).
Keeping Retained Earnings
i. Retained earnings are used to establish what a firm has used its profits for. This is the
amount the firm has reinvested since the beginning. The firm can either buy assets or
liability reduction as a way of reinvesting.
ii. Retained earnings fairly replicate the dividend policy of a firm. The decision of the firm
to pay stakeholders or reinvest the profits is revealed by the retained earnings. The firms
analyze the retained earnings aiming at evaluating procedures which created or can create
highest shareholders return.
iii. Growing firms keep retained earnings to necessitate an investment of more assets in order
to function. Retained earnings are symbolized by all profits less the dividends of a firm
since it started.
Question 9
FINANCE QUESTIONS 5
A high cost of capital shows that there are high costs of financing the capital too. The reasons
that make it hard for a firms growth is due to the many payments that include the debt
obligations and required rate of return (equity financing costs) all which will be listed as
expenditures rather than profits due to huge capital costs (Hanlon, Maydew, & Thornock, 2015).
Question 10
By the application of the IRR rule where to invest in a project that has a positive NPV, this
project is viable and it to be considered. Mathematically;
NPV = (cash flows expected in today value) – (Today’s invested cash value)
This, therefore, translates to;
$34.35 = (cash flows expected in today value) – $800 million
This gives expected cash flow in today’s values to be $34.35 + $800 million
Therefore, this project is viable and has to be invested.
FINANCE QUESTIONS 6
REFERENCES
Garicano, L., & Steinwender, C. (2016). Survive another day: Using changes in the composition
of investments to measure the cost of credit constraints. Review of Economics and
Statistics, 98(5), 913-924.
Caballero, R. J., Farhi, E., & Gourinchas, P. O. (2017). Rents, technical change, and risk premia
accounting for secular trends in interest rates, returns on capital, earning yields, and
factor shares. American Economic Review, 107(5), 614-20.
Ball, R., Gerakos, J. J., Linnainmaa, J. T., & Nikolaev, V. V. (2017). Earnings, retained earnings,
and book-to-market in the cross section of expected returns.
Hanlon, M., Maydew, E. L., & Thornock, J. R. (2015). Taking the long way home: US tax
evasion and offshore investments in US equity and debt markets. The Journal of
Finance, 70(1), 257-287.
