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FIN 300 Lecture Notes - Lecture 10: Net Present Value, Decision Rule, Cash Flow

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azurelocust49
24 Mar 2017
School
Ryerson University
Department
Finance
Course
FIN 300
Professor
Patricia Mc Graw

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Document Summary

We need to ask ourselves the following questions when evaluating decisions. The difference between the market value of a project and its cost. The first step is to estimate the expected future cash flows. The second step is to estimate the required return for projects of this risk level. The third step is to find the present value of the cash flows and subtract the initial investment. If the npv(net present value) is positive, accept the project. A positive npv means that the project is expected to add value to the firm and will therefore increase the wealth of owners. Since our goal is to increase owner wealth npv is a direct measure of how well this project will meet our goal. Formula : cf1/(1+r)+ cf2/(1+r)^2+ cf3/(1+r)^3+ cf4/(1+r)^4+ , npv= 63120/(1. 12)+ 70800/(1. 12)^2+ 91080/(1. 12)3 165000=12627. 42, accept the project because its positive.

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Related Questions

1. The ________ considers the project'srisk relative to the firm overall risk.

A. The Objective Approach

B. The Pure Pay Approach

C. The Subjective Approach

D. The Bottom-Up Approach

2. ________ are not tax deductible, so there is no taximpact on the cost of equity.

A. Interest expenses

B. Director's remuneration

C. Dividends

D. All of the above

3. ________ itself is a non-cash expense and it is onlyrelevant because it affects taxes.

A. Depreciation expense

B. Interest expense

C. Capital gain

D. Both A and C

4. Which of the following is correct about AverageAccounting Return

A. Reject the project if the ARR is less than a preset rate

B. Accept the project if the ARR is large than IRR

C. Accept the project if the ARR is greater than a presetrate

D. ARR must be equal to a preset rate for the acceptance of aproject

5. What is the disadvantage of Paybackmethod?

A. Difficult to understand

B. No adjustment for uncertainty of later cash flows

C. Ignores the time value of money

D. Biased again short-term project

6. Which of the following statement is true about NetPresent Value decision rule?

A. If the NPV is negative, reject the project

B. A negative NPV mean the project will increase the wealth ofthe owners

C. If value of the NPV means the amount of value created for thefirm

D NPV rule does not account for the time value of money

Heywood Diagnostic Enterprises is evaluating a project with the following net cash flows and
probabilities:

Year Prob=0.2 Prob=0.6 Prob=0.2
0 -$100,000 -$100,000 -$100,000
1 $20,000 $30,000 $40,000
2 $20,000 $30,000 $40,000
3 $20,000 $30,000 $40,000
4 $20,000 $30,000 $40,000
5 $30,000 $40,000 $50,000

The Year 5 values include salvage value. Heywood's corporate cost of capital is 10 percent.
a. What is the project's expected (i.e., base case) NPV assuming average risk? (Hint: The base case net cash flows are the expected cash flows in each year.)
b. What are the project's most likely, worst, and best case NPVs?
c. What is the project's expected NPV on the basis of the scenario analysis?
d. What is the project's standard deviation of NPV?
e. Assume that Heywood's managers judge the project to have higher-than-average risk. Furthermore, the company's policy is to adjust the corporate cost of capital up or down by 3 percentage points to account for differential risk. Is the project financially attractive?

General Co. is considering investing $3,000,000 in a project that is expected to generate the following net cash flows:

Year 1 = $275,000

Year 2 = 400,000

Year 3 = 475,000

Year 4 = 475,000

General Co. uses WACC of 10% when evaluating proposed capital budgeting projects. Based on these cash flows, what is the project's profitability index (PI)?

General Co. decision to accept or reject the project is indepedent of its decision on other projects. Based on the project's PI, should the firm accept or reject?

By comparison, what is the NPV of this project? On the basis of evaluation criterion, should General Co. invest/not invest because the project will/will not increase the firm's value?

A project with a negative NPV will have PI that is equal to 1/greater than 1/less than 1 ; when it has a PI of 1.0, it will have a NPV greater than $0/less than $0/equal to $0 ?

Thank you!