Fina 5133 Exam 2 Review Notes Essay

By computing the highest discount rate at which a project will have a positive NPV, the IRR method is supposed to assure that the actual rate of return on an accepted project is higher than the required rate of return.

c) Optimization of the capital structure is also consistent with the growth of the company. The optimal capital structure

20. A firm's capital structure is the mix of financial securities used to finance its activities and can include all of the following except

A project may have more than one IRR, especially when returns of an investment yield negative cash flows following positive cash flows.

3) What is the weighted average cost of capital and why is it important to estimate it? Is the

This analysis is done assuming the benefits accrued in the year 2050. The costs are evaluated from the year 2011 – the proposed time of starting the project, while the benefits are calculated from the year 2020 – the expected time of launching the project. The estimated streams of benefits and costs occurring each year between 2011 and 2050 were discounted to their present value and summarized to calculate the benefit cost ratio.

1. Please define Weighted Average Cost of Capital (WACC). Write down the WACC formula, and discuss its components.

The rate of return (IRR) is projected to be 23.6%, which is significantly higher than the discount rate.

Importantly, IRR is a method for determining value that does not depend on the determination of a discount rate. This method requires the calculation of a discount rate such that the discounted value of future cost-benefit flows exactly equals the initial investment. Dean (1951 in Smith, 1986:8) recommends that the company make investment decisions by "looking to the capital markets for the firm 's cost of capital, accepting each project with an internal rate of return and exceeds this market-determined cost of capital". As such, to apply the IRR reference must be made to the discount rate in order to arrive at a decision.

According to Ben-Horin and Kroll (2017, p. 6), “NPV ranks investment projects by their amount of value creation.” In addition, NPV is considered the predominant measure to be used when considering the acceptance or rejection of potential projects as it is a “direct measure of the value of the project to shareholders” (Ehrhardt and Brigham,

There are several factors that are normally considered when deciding on a capital budget decision . Some of the most common ways to evaluate if

Internal Rate of Return is the discount rate that NPV become zero. It will accept the project that has a greater discount rate compare to IRR. It is usually used because it is easy for manager to find out the rate of return. But it is no accurate when the project have some non-normal cash flow or when evaluating mutually exclusive projects.

The modified internal rate of return is also the discount rate at which the net present value of an investment equal zero, but it is an improved version of the internal rate of return as it does not require the assumption that project cash flows are reinvested as the internal rate of return but it determines a reinvestment rate. If the modified internal rate of return is greater than the project’s hurdle rate, which is the rate of return specified as the lowest acceptable return on investment, then the project should be accepted. If choosing between several projects, the one with the highest rate would be the best option. The advantage of the modified internal rate of return is that it solves some of the problems associated with the regular internal rate of return. The modified rate of return considers that funds reinvested are going

IRR is one of the techniques (Lock, 2004). IRR is the rate at which the present value of the future cash flow will be equal to the initial cash flow and the NPV of the project will be zero. A project will be accepted if the cost of capital is lower than the IRR. Otherwise the project will be rejected. IRR provides many benefits. It helps to compare the cost of capital with the rate of return that will be earned on the project. It discounts the future cash flow and give correct decision in most of the cases (Daft, 1997).

NPV compares the value of a dollar today to the value of that same dollar in the future, taking inflation and returns into account. If the NPV of a prospective project is positive, it should be accepted. However, if NPV is negative, the project should probably be rejected because cash flows will also