FIN-3403 Chapter Notes - Chapter 9: Net Present Value

47 views3 pages

burgundybat929

19 Feb 2018

School

Department

Course

Professor

For unlimited access to Textbook Notes, a Class+ subscription is required.

Document Summary

Ignores the time value of money: requires an arbitrary cutoff point, biased against long-term projects, such as research and. Ignores cash flows beyond the cutoff date development, and new projects. If a project ever pays back on a discounted basis, then it must have a positive. Npv: drawbacks, the cutoff still has to be arbitrary set, and cash flows beyond that point are ignored, a project with a positive npv may be found unacceptable because, advantages the cutoff is too short. Includes time value of money: easy to understand, does not accept negative estimated npv investments, biased toward liquidity, disadvantages, may reject positive npv investments, requires an arbitrary cutoff point, biased against long-term projects, such as research and development, Ignores cash flows beyond the cutoff date and new projects. The internal rate of return: an investment is acceptable if the irr exceeds the required return.

Related Questions

Amongst corporations, sole proprietorships and partnerships, approximately what percentage of revenues are generated by corporations?

50%

42%

33%

82%

Question 2

What should be the financial goal of any firm?

attracting and acquiring capital and investing it

maximization of the ownersâ wealth

offering quality products at fair prices

quality customer service

Question 3
4 pts
Which of the following statement(s) is \ are true regarding the corporate management team?

In a corporation, ownership and direct control are typically separate.

Board of Directors is elected by shareholders and has ultimate decision-making authority

The Chief Executive Officer (CEO) â the Board typically delegates day-to-day decision making to the CEO.

All of the above

Question 4
4 pts
When calculating the present value of either a future single sum or a future annuity, it involves a process called discounting. The applicable interest rate to perform the discounting function is usually called the

yield to maturity

compound interest rate

discount rate

none of the above

Question 5
4 pts
_________________ are used to present additional information about items included in the financial statements and to present additional financial information.

stock certificates

Notes to financial statements

Preferred stocks

Convertible securities
Question 6
4 pts
What should be the financial goal of any firm?

maximization of the ownersâ wealth

attracting and acquiring capital and investing it

offering quality products at fair prices

quality customer service

Question 7
4 pts
A competitive market is one in which a _____ numbers of producers compete with each other to satisfy the wants and needs of a _____ number of consumers.

Large, small

Small, small

Large, large

Small, large

Question 8
4 pts
The Valuation Principle is an analysis between the value of the ______ of a financial alternative and the value of its ______.

revenues, income

benefits, costs

expenses, costs

Question 9
4 pts
The Net Present Value rule implies that we should compare a projectâs net present value (NPV) to___________. (zero \ future value \ the past).

Zero

Future Value

The Past

An Estimate

Question 10
4 pts
The internal rate of return (IRR) rule will _______ agree with the Net Present Value rule on a given investment project.

always

never

sometimes

none of the above

Question 11
5 pts
The law of one price exists due to arbitrage opportunities. If the price of a security, commodity or asset is different in two different markets, then an arbitrageur will ______ the asset in the more expensive market and ________ it where prices are lower.

sell, purchase

purchase, sell

purchase, purchase

sell, sell

Question 12
5 pts
Approaching every problem using a timeline is a(n) ________ idea because timelines identify events in a transaction or investment which might otherwise be easily overlooked.

good

bad

indifferent

unrealistic

Question 13
5 pts
The present value (PV) of a stream of cash flows is the _______ the present values of each individual cash flow

difference between

product of

sum of

same as

Question 14
5 pts
As the number of periods increases, present value (increases\decreases\stays the same).

increases

decreases

stays the same

is unrelated

Question 15
5 pts
When a constant cash flow will occur at regular intervals for a finite number of periods of time, it is called a(n) __________.

annuity

perpetuity

interest payment

principle payment

Question 16
5 pts
When a constant cash flow will occur at regular intervals forever, it is called a(n) ___________.

annuity

perpetuity

interest payment

principle payment

Question 17
5 pts
The NPV measures the ______ change in shareholder wealth that arises from undertaking a project.

consistent

dollar

annual

semi-annual

Question 18
5 pts
When calculating the present value of either a future single sum or a future annuity, the applicable interest rate is usually called the _______ rate

compounding

inverted

market

discount

Question 19
5 pts
To endow a perpetuity is the same as calculating the present value (PV) of a perpetuity. Say you want to endow an annual graduation party at your alma mater. You want the event to be a memorable one, so you budget $30,000 per year forever for the party. If the university earns 8% per year on its investments, and if the first party is in one yearâs time, how much will you need to donate to endow the party?
The formula for PV of a perpetuity = C\r; = $30,000 \ 0.08; =

$3,750

$37,500

$375,000

$3,750,000

Question 20
5 pts
With an Ordinary Annuity, payments are required at the ________ of each period. An example of this is bonds which usually pay coupon payments at the end of every six months until the bond's maturity date.

beginning

middle

end

payments are not required

Question 21
5 pts
Sales of securities that the seller does not own is called a:

stop-loss order

short sale

limit order

maintenance margin

Question 22
5 pts
What is the name of the market where money market securities, bonds, and mortgages are originated and traded?

debt securities market

foreign exchange market

derivative securities market

equity securities market

Question 23
5 pts
If an investor feels the price of a stock will decline in the future, which trade should the investor undertake?

market order

buy on margin

limit order

short sale

Question 24
5 pts
For risk averse investors, how much return is expected for taking on more risk?

lower

equal

zero

higher

Question 25
5 pts
A ___________________ is a highly regulated document which details the issuers operations and finances and must be provided to each buyer of a newly issued security.

Prospectus

An underwriting agreement

A best efforts agreement

none of the above

Question 26
5 pts
Which of the following statements about liquidity ratios is true?

The lower the quick ratio relative to the current ratio, the safer a firm is in terms of liquidity.

The higher the current ratio, the more likely a firm is able to pay its short-term obligations.

The quick ratio is always between 0 and 1.

All the above statements are true.

Question 27
5 pts
The ability of a firm to meet its short-term debt obligations as they come due is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 28
5 pts
Which one of the following financial statements reports a firmâs assets and the claims on assets?

balance sheet

income statement

statement of changes in financial position

cash flow statement

Question 29
5 pts
The extent to which assets are used to support sales is indicated by which of the following ratios:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 30
5 pts
The extent to which assets are financed by borrowed funds and other liabilities is indicated by:

liquidity ratios

asset utilization ratios

financial leverage ratios

profitability ratios

Question 31
5 pts
The basic price that equates the demand for and supply of loanable funds in the financial markets is the __________:

interest rate

yield curve

term structure

cash price

none of the above

Question 32
5 pts
Federal obligations usually issued for maturities of two to ten years are called:

Treasury bonds

Treasury notes

Treasury bills

Agency issues

Question 33
5 pts
An increase in the demand for loan-able funds, holding supply constant, will cause interest rates to:

increase

decrease

stay the same

none of the above

Question 34
5 pts
As interest rates rise, the prices of existing bonds will:

rise

stay the same

fall

either a or b

Question 35
5 pts
In an inflationary period, interest rates have a tendency to:

rise

fall

stay the same

act erratically

salmonhound248

[1] The explicit costs, such as the legal expenses, associated with corporate default are classified as _____ costs.
[A] beta conversion
[B] direct bankruptcy
[C] indirect bankruptcy

[2] An indirect cost of bankruptcy is the loss of key employees.
[A] True
[B] False

[3] A legal attempt to financially restructure a failing firm so that it can continue operating as a going concern is called a reorganization.
[A] True
[B] False

[4] The optimal capital structure has been achieved when the:
[A] weight of equity is equal to the weight of debt.
[B] debt-to-equity ratio selected results in the lowest possible weighted average cost of capital.
[C] cost of equity is maximized.

[5] The optimal capital structure will tend to include more debt for firms with:
[A] less taxable income.
[B] lower probability of financial distress.
[C] substantial tax shields from other sources.

[6] The optimal capital structure of a firm:
[A] will remain constant over time unless the firm makes an acquisition.
[B] will be the same for all firms in the same industry.
[C] will vary over time as taxes and market conditions change.

[7] In a world with corporate taxes, MM theory implies that that all firms should choose an all-debt capital structure.
[A] True
[B] False

[8] A firm is technically insolvent when:
[A] the value of its stock declines by more than 50 percent in any given 12-month period.
[B] the value of the firm's assets is less than the value of the firm's liabilities.
[C] it is unable to meet its financial obligations.

[9] Which one of the following statements is correct concerning a Chapter 7 bankruptcy?
[A] A firm reorganizes its operations in an effort to return to being a viable concern.
[B] A trustee will assume control of the firm's assets until those assets can be liquidated.

[10] If the net present value of a project is positive (non-zero), then the project's internal rate of return will exceed its required rate of return.
[A] True
[B] False

[11] Which one of these methods uses accounting values rather than financial values?
[A] AAR
[B] IRR
[C] NPV

[12] An investment should be accepted if the NPV is positive and rejected if it is negative.
[A] True
[B] False

[13] The length of time required for an investment to generate cash flows sufficient to recover the initial cost of the investment is called the:
[A] net present value.
[B] payback period.
[C] internal rate of return.

[14] An investment is acceptable if its average accounting return (AAR):
[A] exceeds the target AAR.
[B] is less than the target AAR.

[15] The discount rate that makes the net present value of an investment exactly equal to zero is called the internal rate of return.
[A] True
[B] False

[16] The most valuable investment given up if an alternative investment is chosen is referred to as a(n):
[A] sunk cost.
[B] opportunity cost.
[C] erosion cost.

[17] The cost of test marketing a product prior to deciding whether or not to produce the product is a sunk cost.
[A] True
[B] False

[18] An asset will be depreciated faster using MACRS rather than the straight-line method.
[A] True
[B] False

[19] The financial break-even point determines which one of these values?
[A] Fixed costs
[B] Variable cost per unit
[C] Sales quantity

[20] The return earned in an average year over a multi-year period is called the _____ average return.
[A] arithmetic
[B] standard
[C] geometric

[21] The capital gains yield plus the dividend yield on a security is called the:
[A] geometric return.
[B] total return.
[C] variance of returns.

[22] Which one of the following is an example of a nondiversifiable risk?
[A] A poorly managed firm suddenly goes out of business due to lack of sales
[B] A key employee of a firm suddenly resigns and accepts employment with a key competitor
[C] A well respected chairman of the Federal Reserve suddenly resigns

[23] Beta values are highly dependent on the covariance of a security with the market.
[A] True
[B] False

[24] Insider trading does not offer any advantages if the financial markets are:
[A] inefficient.
[B] semiweak form efficient.
[C] strong form efficient.

[25] MM Propositions ignore bankruptcy costs.
[A] True
[B] False

blushspider431

You have just completed your undergraduate degree, and one of your favorite courses was "Today's Entrepreneurs." In fact, you enjoyed it so much you have decided you want to "be your own boss." While you were in the program, your grandfather died and left you $300,000 to do with as you please. You are not an inventor, and you do not have a trade skill that you can market; however, you have decided that you would like to purchase at least one established franchise in the fast foods area, maybe two (if profitable). The problem is that you have never been one to stay with any project for too long, so you figure that your time frame is three years. After three years you will sell off your investment and go on to something else. You have narrowed your selection down to two choices; (1) Franchise L: Lisa's Soups, Salads, & Stuff and (2) Franchise S: Sam's Fabulous Fried Chicken. The net cash flows shown below include the price you would receive for selling the franchise in Year 3 and the forecast of how each franchise will do over the three-year period.

Franchise L's cash flows will start off slowly but will increase rather quickly as people become more health conscious, while Franchise S's cash flows will start off high but will trail off as other chicken competitors enter the marketplace and as people become more health conscious and avoid fried foods. Franchise L serves breakfast and lunch, while Franchise S serves only dinner, so it is possible for you to invest in both franchises. You see these franchises as perfect complements to one another: you could attract both the lunch and dinner crowds and the health conscious and not so health conscious crowds without the franchises' directly competing against one another. Here are the net cash flows (in thousands of dollars):

	Expected
	net cash flows
Year	Franchise S	Franchise L
0	($100)	($100)
1	70	10
2	50	60
3	20	80

Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.

You also have made subjective risk assessments of each franchise, and concluded that both franchises have risk characteristics that require a return of 10 percent. You must now determine whether one or both of the projects should be accepted.

In order to do so please answer the following questions fully. Make sure to show a time line, the formula to be used, the steps taken to solve the problem (calculator or excel) and the final numerical answer when appropriate.

Questions:

Define the term net present value (NPV).

What is each franchise's NPV? Make sure to show the formula, steps and final answer.

Based on your answer which franchise would you select? Why?

Would your answer be different if the projects are independent or mutually exclusive? Why or why not?

Would the NPVs change, and therefore your answer, if the cost of capital changed? Why or why not?

Internal Rate of Return (IRR) â you may use a financial calculator or excel. (Worth 8 points)

What is the logic/idea behind the IRR method?

Calculate the IRR for each project. Make sure to show the formula, calculator or excel steps and final answer.

According to IRR, which franchise should be accepted if they are independent? Mutually exclusive? Why?

Would the franchises' IRRs change if the cost of capital changed? Why or why not?

Define the term modified IRR (MIRR).

Find the MIRRs for Franchise L and S. Make sure to show the formula, steps and final answer.

What are the MIRR's advantages and disadvantages vis-a-vis the regular IRR? What are the MIRR's advantages and disadvantages vis-a-vis the NPV?

What is the rationale for the payback method?

Calculate the payback period for each franchise. Make sure to show the formula, steps and final answer.

Calculate the discounted payback period for each franchise. Make sure to show the formula, steps and final answer.

According to the payback criterion, which franchise or franchises should be accepted if the firm's maximum acceptable payback is 2 years, and if Franchise L and S are independent? If they are mutually exclusive? Why?

What is the difference between the regular and discounted payback periods? Make sure to mention the advantage and disadvantage of each.

Based on the results obtained and everything that you have described above, which franchise would you ultimately choose if the projects are mutually exclusive? Explain in detail your decision and why you chose the model you did to make your final decision.

FIN-3403 Chapter Notes - Chapter 9: Net Present Value

Document Summary

Get access

Related Documents

Management and Organizational Studies 2310A/B Chapter Notes - Chapter 9: Net Present Value, Cash Flow, Decision Rule

Management and Organizational Studies 2310A/B Chapter Notes - Chapter 9: Decision Rule, Cash Flow, Net Present Value

MGT 181 Chapter Notes - Chapter 9: Payback Period, Cash Flow, Net Present Value

Related Questions