Finance test 3
What does the net present value NPV assume about reinvestment
The projects cost of capitol
Modified rate of return
The rate that forces the present value of the cash out flows (PVCOF) to equal the future value of cash inflows (FVCIF).
What is the value of a firm
The sum of all the expected future cash flows discounted at the cost of capital
Project independent
We can take project A, we can take project B. We can take A and B we can take both or we can take none. Do what works best for the firm
What does WACC mean?
Weighted average cost of Capitol
mutually exclusive projects
When a manager is evaluating multiple projects that have inter related cash flows if the cash flows of one can be adversely impacted by the acceptance of the other
When should a net present value (npv) be accepted? Why?
When it is positive because it shows that the benefits out weigh the cost of the project
Unequal Lives
When projects have different time periods of cash flows.
the value of equity can be found as the price of a
call option
incremental cash flows
cash flows that will occur if a project is accepted
Define weighted average cost of capital (WACC)
how much it costs firms to raise new capitol
The present value of all cash flows associated with a project. a direct measure of expected value creation
net present value
NPV and IRR will generally give us...
same decisions on a particular project
Internal Rate of return IRR
the discount rate that makes the NPV of an investment zero
book value
the undepreciated portion of the assets original price
What is the goal of reinstating cash flows after NPV has been calaucted?
to find out how low the net cash flow would have to be to find an NPV of zero
True or false: The value of the MIRR will always be in between the costs of funds and the IRR. for both good and bad investments
true
When does The disagreement between the IRR and NPV matter?
when a project is mutually exclusive
List some characteristics of capital budgeting
• Extreme importantly • they are the hearts of investing decisions • can be expensive • assets must be carefully considered and planned before they are reallocated. • requires a lot of input from functional areas through out the firm
What does firm value depend on?
. The firms a ability to generate cash flows . How much the assets used to generate cash flows cost - the cost of attracting financing needed to support the assets
Option Pricing Theory
An alternative approach to firm valuation which gives the firm's owners the rights to force the sale of an exercise price that is equal to the retirement value of dest
Replacement chain
Assumes that once the short project is over it can be repeated exactly as before
How can money be raised in the finical markets
Borrower must convince the lender that they can earn a fair risk adjusted rate of return
how can a firm increase its firm values?
By getting new productive assets or improve the way that they are using existing resources IN regards to capital budgeting
What is an important component in using the capital budgeting techniques?
Calculating the cost of funds for the firm
The decisions about requiring or updating long term fixed assets
Capital budgetting
What is typically used as the hurdle rate?
Capital cost
What could drive NPV to zero? What could firms put in place to STOP this from happening?
Competition. Firms would need some sort of advantage such as a patent or monopolistic industry power to easily overcome competitors
Find an annuity that has the same NPV as the original projects. Then assume the annuity can be extended forever into the future as a perpetuity.
Equivalent Annual Annuity (EAA)
What is NPV a direct measure of?
Expected value creation
If IRR is ____ than the hurdle rate _____ the project -
Greater than >, accept
Modified Internal Rate of Return (MIRR) reconciles problems associated with _____
IRR
Yield to maturity is the ______ of a bond
IRR
What may be the most important part of capital budgetting
Identifying which cash flows are actually relevant to the decision
What could destroy a project when using the capital budgeting technique?
If a project cannot cover the cost of financing
What happens when the benefits out weigh the cost of a project?
NPV will be positive, and the project should be accepted
Should managers make a decision based on one single estimated#?
No
How do you find the modified rate of return?
Take all of the net cash in flows and move them to time period t, the last project years using the firms cost of funds. Find the value of all out flows as of period period zero
What does mutually exclusive mean?
Taking one project means that we cannot take the other.
What is modified accelerated cost recovery (MACRS) used for?
Tax purpose to realize tax advantages earlier
Weighted Average Cost of Capital (WACC)
The cost of the firm raising an additional dollar of a new finical capital while maintaining the optimal or best capital structure
floation costs
The cost paid to investment banks
In net present value, what is often used to be the firms cost of funds?
The discount rate
