Finance Week 8

Question 1

Why use cashflows to find NPV? And why use these and not income statements?

Answer 1

Incremental after-tax cash flows are used to calculate the NPV of a project. Use this and not net income as IS only show how firm performed that year and not cash flows firm receives and when.

Question 2

What are incremental cash flows and After tax cash flows?

Answer 2

Cash flows that a firm receives with the project minus cash flows receives without . After tax cash flows are the cash flows a firm receives after taxes are paid.

Question 3

What cashflows do you include/ not include when finding NPV of a new project?

Answer 3

Include all indirect effects, investments in working capital, terminal cash flows, opportunity costs. Don’t include sunk costs (old) or interest expenses.

Question 4

What 3 sources do incremental cash flows come in?

Answer 4

Cash flows capital investments, operations and changes in net working capital

Question 5

What are cash flows from capital investments?

Answer 5

Required initial investment (PPE), after-tax flows from selling machine later

Question 6

What are cash flows from operations?

Answer 6

Projects incremental revenues minus incremental costs, taxes, depreciation and tax shield (reduction in taxes due to depreciation charge)

Question 7

What are cash flows form changes in net working capital?

Answer 7

Changes in working capital (from buying inventory, allowing AR, or selling inventory, AR paid)

Question 8

How do you calculation CF from capital investments?

Answer 8

Initial investment is added to year 0, the calculate after-tax cash flows from selling machine by finding the book value of the machine at the specific year: (Buying price - (years * depreciation)) and deduction this from selling price to find the gain, tax this gain at 21% and deduct from selling again.

Question 9

How do you calculate CF from operations?

Answer 9

Find the sales and operating expenses per year, depreciation is the same as it is the cost of machine/useful life. Taxes are calculated: Revenues - operating expenses - depreciation *21%. After finding taxes, total CF from operations is: After tax profits + depreciation: (revenues - operating expenses - depreciation - taxes) + depreciation. Don’t count depreciation as it is a non-cash expense.

Question 10

How do you calculate CF from NWC?

Answer 10

done in year 0 due to using raw material to get machine and allow AR, this is given back when machine is sold as collected NWC.

Question 11

How do you find total cash flows?

Answer 11

Find from year 0 to year 5 by adding up cashflows of years.

Question 12

How do you find the NPV of machine once you have found all the cash flows?

Answer 12

Find PV of cashflows of each year and if they are the same this is annuity, if NPV positive then invest.

Question 13

What is the efficient market hypothesis?

Answer 13

Hypothesis about how well prices of assets reflect their intrinsic values. Says that an efficient capital market is a market in which prices reflect all available info. If markets efficient, the price is right. If new info, price immediately adjusts.

Question 14

What if markets are not efficient?

Answer 14

When new info available, price does not fully and immediately adjust and so does not reflect all info. Can get superior return and compensation for waiting (TMV) and risk.

Question 15

Why should markets be efficient?

Answer 15

Because competition among investors drives price to intrinsic value and makes markets efficient. Investors constantly valuing assets and trying to buy at a bargain to profit, if find undervalued stock, buy and drive price up. Arbitrage trading- constantly valuing and buying stocks below intrinsic value.

Question 16

Why should markets be inefficient?

Answer 16

Prices may deviate from intrinsic values as investors people who are not always rational. May overweight recent past and forget distance past, prone to overall market sentient, and dislike losses too much.

Question 17

What are views about inefficient vs efficient?

Answer 17

Proponents of hypothesis state even with behavioral biases, arb-traders still trading away the mis-prices that occur from behaviors. Opponents state that they are not able to trade all mis-pricing away as trading is costly.

Question 18

What does the weak form of market efficiency suggest?

Answer 18

Prices reflect past price changes. Implies it is impossible to have good returns based off only past price changes.

Question 19

What does the semi-strong form of market efficiency suggest?

Answer 19

Says that prices reflect all publicly available info and that it is impossible to have good returns using only public info.

Question 20

What does the strong form of market efficiency suggest?

Answer 20

Prices reflect all info available including insider info, says impossible to have good returns even with insider info.

Question 21

What does evidence suggest about weak form?

Answer 21

Evidence suggests that markets are weak form efficient and can’t use past price info alone to get good returns.

Question 22

What does evidence suggest about semi strong?

Answer 22

Suggests that markets are semi-strong to large degree and it is difficult to use public info to get good returns as prices immediately adjust to new info on announcement (earnings)

Question 23

What does evidence suggest about strong form?

Answer 23

Evidence suggests markets are strong form INefficient and can use insider info to get superior returns however this is illegal.

Question 24

Are markets efficient? What do Eugene Fama and Robert Shiller argue?

Answer 24

Research shows that markets are semi strong form efficient to large degree- can’t use public info to get good returns. Eugene argues markets are efficient while Robert says they are not.

Question 25

What mistake should you avoid when finding CF from Capital?

Answer 25

When find capital gain * this by tax rate not 1 - tax rate. because that is the tax you pay, then deduct from selling.

Question 26

What should you remember to do if you are finding the NPV of a new machine and using cash flows?

Answer 26

You should make sure that when you use annuity you do it only for the years where CF is the same and not the last year.