Q1. Please compare the advantages and disadvantages of the following investment rules: Net Present Value (NPV), Payback Period, Discounted Payback Period, Average Accounting Return, Internal Rate of Return (IRR) and Profitability Index (PI). (You can start by considering the following questions for each investment rule: Does it use cash flows or accounting earnings? Does it consider all cash flows or not? Does it apply a proper discount rate? Whether the acceptance criteria are clear and reasonable? In what situation it can be applied? What kind of weakness does it have?) (4 points)

Firstly, Average accounting return (AAR) is calculated by dividing the average net income by the average book value. A project is accepted if the AAR is greater than a preset rate. However, the discount rate value of money is ignored. Also, it uses accounting earnings which include net income and book value of an investment. In capital budgeting, we use cash flow instead of accounting earning because it is more accurate in calculating budget. Also, the accounting numbers are arbitrary, for example, net income includes depreciation expense which is not an actual payment for every year.

Payback period has a disadvantage that it does not discount the amount in future back to present time. Even Discounted Payback Period uses the discount rate, these two methods only calculate the time period required for to recover the initial investment. After calculating the required time period, the cash flow after that period will be totally ignored. Therefore, it would be a disadvantage for Payback period and Discounted Payback Period because the amounts after payback period do matter in some aspects.

Only Internal Rate of Return (IRR), Profitability Index (PI) and Net Present Value (NPV) use all cash flow and discount value.

...Capital Budgeting
Michele Martin
BUS650: Managerial Finance
Keith Wade
April 01, 2013
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|Earned |Possible |Area |
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|1 |1 |The Written Assignment includes a description of working capital practices, including his methods of capital |
| | |budgeting analysis techniques. |
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|1 |1 |The Written Assignment includes a description of the potential pitfalls in his Capital Budgeting practices that |
| | |George should be aware of. |
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...Internal Rate of Return (IRR) and Net Present Value (NPV) are both powerful tools used in business to determine whether or not to invest in a particular project; both methods have its pros and cons. If given a choice I would choose NPV, because of the potential to anticipate profitability.
As it is assumed that the objective of a firm is to create as much shareholder wealth as possible for its owners through the efficient use of resources, the preferred method in determining whether or not to invest in a project is NPV. The reason for this is that NPV takes into account all the costs and benefits of an investment opportunity, making a logical allowance for the time factor. Generally speaking any appraisal that returns a positive NPV result is a worthwhile investment. This means finding the NPV of a business will have a direct bearing on shareholder wealth. Net present value is a way of comparing the value of money now with the value of money in the future. A dollar today is worth more than a dollar in the future, because inflation erodes the buying power of the future money, while money available today can be invested and grow.
There are two advantages NPV as a capital expenditure appraisal technique it accurately recognizes the time value of money for all expenditures, regardless of the exact time at which they are made or received it enables alternative proposals to be ranked in order of attractiveness it recognizes the time value of money...

...Final Finance Exam Notes
Definitions:
1. Capital Budgeting is the process of evaluating proposed large, long-term investment projects.
Capital budgeting is primarily concerned with evaluating investment alternatives.
The first step in the capital budgeting process is idea development.
A characteristic of capital budgeting is the internal rate of return must be greater than the cost of capital.
One of the simplest capital budgeting decision method is the payback method.
Capital budgeting techniques are usually used only for projects with large cash outlays.
2. Payback period is the number of time periods it will take before the cash inflows of a proposed project equal the amount of the initial project investment (a cash outflow). The payback period is calculated by counting the number of years it will take to recover the cash invested in a project.
3. Net present value is the dollar amount of the change in the value of the firm as a result of undertaking the project.
With non-mutually exclusive projects, the net present value and the internal rate of return methods will accept or reject the same project.
The Net Present Value Method is a more conservative technique for selecting investment projects than the Internal Rate of Return method because the NPV method assumes that cash flows are reinvested at the firm's weighted average cost of capital.
The net present value assumes returns are reinvested at the cost of capital.
If an...

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Study Guide for Final Exam – fin 301 (WC)
calculation of price of bonds
calculation of YTM for bonds
calculation of yield to call for bonds
calculation of current yield/capital gains yield for bonds
calculation of coupon interest rate/PMT for bonds
effect of change in interest rates on price of bonds
Bond sensitivities/Bond theorems
calculation of capital gains yield
calculation of expected total return using expected dividends, stock price and growth rate
calculation of stock price using expected total return, expected dividends/current dividends, and growth rate
calculation of growth rate using stock price, expected total return, expected dividends/current dividends.
calculation of expected stock price using expected total return, expected dividends/current dividends, and growth rate
calculation of expected dividends using stock price expected total return, and growth rate
calculation of preferred stock price, rate of return for preferred stock given other variables (including flotation cost)
calculation of cost of equity from retained earnings using CAPM APPROACH
calculation of weighted average cost of capital (WACC)
calculation of component cost of debt in WACC
calculation of cost of equity from retained earnings using dcf apporach
calculation of cost of equity by selling new common stock using dcf apporach
Calculation of NPV, IRR, MIRR, and Payback period
selection of mutually exclusive/independent...

...International Risk Paper
Organizations encounter financial risks in business everyday, especially when looking at capital budgeting. An organization can use capital budgeting techniques like; cost of capital, Net Present Value, and Internal rate of Return to value the amount of risk the organization is willing to take. When an organization decides to venture into the international arena different risks need to be analyzed. Some of the main International investment concerns are Exchange Rate Risk, Political Risk, and Cultural Risk. We will look at how these concerns can effect international investing and what tools are out there to help mitigate the risk.
Exchange Rate Risk
Exchange Rate Risk reflects the danger an unexpected change in the exchange rate between the dollar and the currency in which a project’s cash flows are denominated will reduce the market value of that project’s cash flow. The dollar value of future cash inflows can be dramatically altered if the local currency depreciates against the dollar. (Gitman) A tool to manage this exchange rate risk is an option. An option gives the buyer the right, but not the obligation, to sell a specified amount of foreign currency to an option seller at a fixed dollar price, up to an agreed upon expiration date. Another tool to manage exchange rate risk is a forward. A forward is similar to an option, but the firm will be obligated to make the transaction at a specific rate in a time period of one...

...economic risk+operational risk = business risk + financial risk = total firm’s risk
EVA = EBIT – TAX = the aftertax operating profit (sometimes referred to as net operating profit after taxes or NOPAT)
* Less the dollar cost of the capital employed to finance these assets = COST OF CAPITAL
Invested Capital =
Cash +
Net fixed assets +
WCR (investment the firm must make to support its operating cycle is the sum of its inventories and accounts receivable minus its accounts payable)
WCR = (Accounts receivable + Inventories + Prepaid expenses) – (Accounts payable + Accrued expenses).
Cash-to-cash period = cash collected from customers – cash paid to suppliers
Matching strategy = match the lifetime of an asset with its financing source
WCR is mainly a lt investment as it remains on the BS indefinitely- permanent part to be financed with LT finance, and seasonal part with ST finance
Liquidity issues arising from matching issues – the higher the proportion of WCR financed with LTF, the higher the liquidity
Net long-term financing (NLF) = Long-term debt + Owners’ equity – Net fixed assets
Net short-term financing (NSF) = Short-term debt – Cash
Net long-term financing working capital requirement
Percentage of working capital financed long term
* Liquidity position will improve if:
* Long-term financing increases, and/or
* Net fixed assets decrease, and/or...

...(a) Investment appraisal involves the assessment and selection of projects that add value to an organisation. Discuss what capital appraisal methodologies are most commonly used and explain the different techniques that can be applied to account for business risk when assessing the viability of investments.
Introduction
Capital investment is a long term investment on non-current assets that will bring wealth to a business and because finance is costly and scarce, risks need to accessed before any decision is made. Certain methodologies are used to analyse whether investments are worthwhile and will add value. In the following paper I will discuss these methods and explain the different techniques that a business can use to access the risk involved. To conclude I will look at the more superior method and explain how accurate it is.
One of the most important decisions’ that management have to make is capital investment decisions. A business has to invest to grow and in turn create wealth for its shareholders. Modern managers have a choice of different methods to help them choose the right investment. They are.
Payback method
Net present Value (NPV)
Internal Rate of Return (IRR)
Payback Method
The Payback method is the simplest method appraisal available to a manager of an investment centre. This method entails measuring the length of time it takes an investment to be repaid. Projects that...

...COURSE OBJECTIVE
The course is aimed at to develop in-depth understanding of Finance function of a corporation and build capacity to apply theory in real world situations. The course will present the ‘Big Picture’ of Corporate Finance so that students understand how things fit together. After successfully completing the course, students should be able to take optimal decisions in a corporate setting, when working as professionals in the field.
COURSE OUTLINE
Introduction to Corporate Finance:
Financial Management; Corporate Finance; Corporate Finance vs. Financial Management; Differences between ‘Finance’ and ‘Accounting’; Investment, Financing, and Dividend decisions
Role of Financial Management:
Goals of a Firm; Profit Maximization Approach vs. Shareholders' Wealth Maximization Approach; Time Value of Money and Uncertainty; Agency Problem; Social Responsibility
Business Environment, Taxes, and Financial Environment:
Forms of Business Organizations; Financial Instruments; Money Market and Capital Market Instruments; Financial Intermediaries; Financial Risk and Return
Concepts in Valuation / Time Value of Money:
Present Value vs. Future Value; Simple Interest vs. Compound Interest; Annuities vs. Simple Compounding and Discounting; Future Value of an Ordinary Annuity and Annuity Due
Concepts in Valuation: (Continued)
Present value of an...