Unit 4 - Intro to Finance Management and Investment Rules

Question 1

Successful companies need this to survive in the long run

Answer 1

Take good care of customers

Question 2

2 types of decisions made by Upper Level Management in Corporations

Answer 2

Investment Decisions, Financing Decisions

Question 3

Capital Structure Risk Management concerned with

Answer 3

Debt/Equity

Question 4

Good Investment Decisions…

Answer 4

increase good Cash Flows

Question 5

Good Financing Decisions… (2)

Answer 5

Reduce cost of Capital, to create shareholder value

Question 6

Ultimate goal of Upper Level Management Decisions

Answer 6

Create shareholder value

Question 7

Shareholders are… (1)

Answer 7

the owners of the corporation

Question 8

The primary financial goal of any public corporation is…

Answer 8

to create economic value for its shareholders

Question 9

Shareholders are… (2)

Answer 9

residual claimants

Question 10

Shareholders receive money only after:

Answer 10

1) Suppliers have been paid
2) Wages to workers have been paid
3) Interest to bondholders have been paid
4) Taxes have been paid.

Question 11

Shareholders receive money only after:

Answer 11

1) Suppliers have been paid
2) Wages to workers have been paid
3) Interest to bondholders have been paid
4) Taxes have been paid

Question 12

If shareholders are happy…

Answer 12

so are the other stakeholders

Question 13

Capital Budgeting

Answer 13

Process of determining which assets to invest in and how much to invest

• Capital Budgeting decision
• Capital expenditure decision
• Capital Investment decision

Question 14

Capital Budgeting Decision Making Process Steps

Answer 14

Identification
Evaluation
Selection
Implementation

Question 15

Identification Step

Answer 15

• Finding out opportunities

- Generating investment proposals

Question 16

Evaluation Step

Answer 16

Estimating the project’s:

• Relevant cash flows
• Appropriate discount rate

Question 17

Selection Step

Answer 17

Choosing a decision making rule (accept/reject criterion)

Question 18

Implementation

Answer 18

Establishing an audit and a follow-up procedure

Question 19

4 Identification Types

Answer 19

Required Investment
Replacement Investment
Expansion Investment
Diversification Investment

Question 20

2 Evaluation Types

Answer 20

Expected Cash-flow stream

Discount rate

Question 21

4 Selection Types

Answer 21

Net Present value
Profitability index
Internal Rate of return
Payback period

Question 22

Implementation Steps

Answer 22

• Monitor the magnitude and timing of cash flows
• Check if the project still meets the selection criterion
• Decide on a continuation or abandonment
• Review previous steps if failure rate is high

Question 23

Opportunity Cost

Answer 23

Rate of return you sacrifice on the next best alternative

Question 24

Future Values

Answer 24

• The first method for deciding which option is best

- Calculates the future value of investing the payment at your opportunity cost of capital for years

Question 25

Future Value Formula

Answer 25

FV = PV x (1+r)^t

Question 26

Present Values

Answer 26

• More common method

- Amount of money you would need to invest today in order to duplicate some future dollar amount.

Question 27

Present Value Formula

Answer 27

PV = FV/(1+r)^t

Question 28

Rate Function Excel

Answer 28

=RATE(time in years, PV, FV)

Question 29

Number of Periods Function Excel

Answer 29

=NPER(Rate, PV, FV)

Question 30

Payment Function Excel

Answer 30

=PMT(Rate, Time, PV)

Question 31

Net Present Value

Answer 31

Forecasting the benefits and costs of the project for period “t”.

Question 32

Net Present Value Formula

Answer 32

NPV = C0 + (C1/1+r) + (C2/1+r^2)…

Question 33

If NPV > 0

Answer 33

Accept Project

Question 34

If NPV < 0

Answer 34

Reject Project

Question 35

Independent

Answer 35

Acceptance or rejection is independent of the acceptance or rejection of other projects

Question 36

Mutually Exclusive

Answer 36

Can accept A or B, or reject both, but cannot accept not both.

Question 37

Payback period

Answer 37

Number of periods required for the sum of the project’s expected cash flows to equal its initial cash outlay. (time to recover investment)

Question 38

Internal Rate of Return

Answer 38

The Discount rate that makes the net present value of the project equal to 0.

Question 39

Accept the project if IRR is…

Answer 39

the cost of capital

Question 40

Profitability Index

Answer 40

The present value of an investment’s future cash flows / initial cost.

Question 41

Profitability Index Formula

Answer 41

(CF0 + NPV)/CFO

Question 42

Profitability Index > 0

Answer 42

Accept

Question 43

Problems with IRR

Answer 43

Multiple IRRs Can Exist
The Scale Problem
The Timing Problem

Question 44

Multiple IRRs

Answer 44

There can be 2 or more

Question 45

The Scale Problem

Answer 45

Depends on initial investment amount, can skew IRR

Question 46

The Timing Problem

Answer 46

When 2 projects IRR flip over time

Question 47

Crossover Rate

Answer 47

When project’s NPV are equal to each other

Question 48

NPV versus IRR

Answer 48

Usually give the same decision

Question 49

NPV verses IRR Exceptions

Answer 49

1) Non-Conventional cash flows- cash flow sign change more than once
2) Mutually exclusive projects
- Initial Investments substantially differ
- Timing of cash flows substantially differ