TMP 120 Lecture Notes - Lecture 19: Risk Premium, Capital Budgeting, Interest Rate
Document Summary
Capital budgeting: the future of a company lies in the investments it makes today. Investment project proposals are the responsibility of all managers in the organization: capital budgeting is the financial evaluation of project proposals, weigh 30117$ outlay (investment) today vs. expected future benefits. Discount (risk) rate: the discount rate reflects the risk associated with the cash flows. Many investors would rather have their cash now. Investors want to be compensated for the delay. A risk premium is added which reflects extra return investors demand due to their risk. When the discount rate goes up: the present value goes down. When the discount rate goes down: the present value goes up: predicting the future is risky. Higher the project risk, the higher the discount rate should be. Or 8%: future cash flows are discounted at the discount rate: Reflects time value of money, risk or uncertainty of future cash flows.
