Ch.2 - Introduction & PV Calculations Flashcards
Payments occurring in different periods are not comparable before we take account of?
Time value of money: a dollar is worth more today than a dollar tomorrow
Risk: a safe dollar is worth more than a risky dollar
If a company sells its investment in government bonds to finance a real investment, the opportunity cost of capital is the lost income from holding the government bond.
True/ False
False: the appropriate opportunity cost of capital is the return one could have earned by investing in an alternative investment with EQUIVALENT risk level.
Therefore, the answer is no since (default-free) government bond risk is lower than risk of real investment.
“r” used to discount real investment cash flows denotes the expected rate of return offered by an equivalent investment alternative in the financial (capital) market.
True/ False
True: The valuation of real assets happen in the product market, where we compute the discount rate on the basis of an alternative investment with similar risk profile in the financial market.
A stream of fixed cash flows taking place every year until infinity, with the first payment taking place immediately (t=0) is defined as:
A) Perpetuity
B) Annuity
C) Annuity due
D) Perpetuity due
D) Perpetuity due
What is the difference between a perpetuity and a perpetuity due?
Both a perpetuity and a perpetuity due define a fixed amount of cashflows occurring until infinity.
- A perpetuity due: first cashflow takes place in year 0 (immediately)
- A perpetuity: first cashflow takes place in year 1 (one year from today)
What is a growing perpetuity?
A growing perpetuity is defined as a stream of cash flows that grows at a constant rate (g) to infinity
What is an annuity?
An n-year ordinary annuity is defined as a fixed sum of cash flows occurring at the end of every year for n years until and including year n.
What is an annuity due?
An annuity due is defined as a fixed sum of cash flows occurring at the BEGINNING of the year for n years
What is a growing annuity?
A growing annuity: a stream of cash flows occurring for n-years and growing at a rate of g% per year
Following is NOT true about the effective annual interest rate:
A) it is denoted by ei
B) it when the quoted annual interest rate is compounded m times a year
C) when it is continuously compounded, it is calculated as e^r
D when it is compounded m times a year, it is calculated as 1+ei=(1+(r/m)^m)
All of the above are correct
Which is the better offer?
A. A savings account offering a rate per annum of 9.75 percent compounded two times a year.
B. A savings account offering a rate per annum of 9.55 percent compounded twelve times a year.
C. A savings account offering a rate per annum of 9.50 percent continuously compounded.
Answer: we can determine the most attractive option by calculating the effective annual interest rate for each alternative:
The answer is A - check page 21 to see formula
What is the objective of any capital budgeting decision?
To find real assets worth more than their cost - positive NPV investments
