1. Describe the role a company's cost of capital plays in capital budgeting for both net present value (NPV) and internal rate of return (IRR) calculations. What are the rules for capital budgeting decisions that are made based on NPV and IRR. Explain how the dollar value of a project's NPV relates to the overall value of the firm. The NPV profile graphs NPV values on the y-axis and discount rates on the x-axis. If Project X's profile crosses the x-axis at the 20% value, what does this tell us about the project?
2 What happens to the financial risk of a firm as it increases the amount of debt in its capital structure? What happens to the cost of debt and to the cost of equity as the firm increases the amount of debt in its capital structure? How would managers of a firm go about trying to find the optimal capital structure for the firm?
3. Assume each of the following functions is linear: fixed costs, variable costs, total costs, and total revenue. If you were to graph each of these against the number of units produced and sold (assume these two are equal) as depicted in your book and in class, describe the slopes of each of these four lines. What would we learn about a company's upside and downside potential by studying these four lines on the graph described in this question? Explain.
4. Define the cost of equity capital. Is it an accounting cost? If not, what is it? Is it a low cost source of capital or a high cost source compared to other possible sources of capital? Explain. What would happen to a firm if it failed to deliver to its common stockholders the cost of equity capital? This question refers only to common equity.