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