Risk Management and Capital Budgeting 2 Flashcards
net present value technique
determines the present value of future cash flows discounted at a predetermined rate.
best method in terms of considering profitability of the project
takes into account the compounding of returns (the time value of money).
Interest rates have declined over the last five years
If interest rates have declined, the loans obtained five years ago would have a higher interest rate than loans obtained today.
what would encourage a company to use short-term loans to retire its ten-year bonds that have five years until maturity
additional investment in working capital
must be considered a part of the initial investment, and its recovery at the end of year 5 must be discounted back to its present value.
Difference between NPV and IRR
NPV assumes that cash inflows from the investment project can be reinvested at the cost of capital
IRR assumes that cash flows from each project can be reinvested at the IRR for that particular project
This underlying assumption is considered to be a weakness of the IRR technique
An option
ALLOWS, but does NOT require the holder to purchase the subject of the option
Limitations when evaluating mutually exclusive investments.
is a disadvantage of the internal rate of return as a method of evaluating investments is
Purchase a short position in the Treasury bill futures market
Enter into an interest rate swap
Enter into a forward contract to sell Treasury bonds in the future
are some effective hedging strategies when concerned about the volatility of short-term interest rates
weighted-average cost of capital
Is most commonly compared to the IRR
Initial investment divided by annual cash flows
Payback method calculation
The expected market rate of interest
has no effect on the variance of the portfolio return
