Financial Management Test

Free cash flows of the project for next five years can be calculated by adding depreciation values and subtracting changes in working capital from net income. In 2010, there will be a cash outflow of $2.2 million as capital expenditure. In 2011, there will be an additional one time cash outflow of $300,000 as an advertising expense. Using net free cash flow values for next five years and discount rate for discounting, NPV for the project comes out to be $2907, 100. The rate of return at which net present value becomes zero i.e.

b) The decision to invest in projects increases the shareholders value of the company. This is consistent with the growth and from the NPV criteria, positive NPV of projects increases the shareholder's value.

a) In the first set of calculations, the staff used a discount rate of 20%, a five-year time horizon, and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives?

The difference between the present value of an investment?s future cash flows and its initial cost is the:

e. modified internal rate of return (MIRR) discount rate which causes the PV of a project’s terminal value (TV) to equal PV of costs.

"e. What is each project's MIRR at a cost of capital of 12%? At r = 18%? (Hint: Consider Period 7 as the end of

21.Generally, investors expect that projects with high expected net present values also will be projects with

| The stock's price one year from now is expected to be 5% above the current price.

Discounting a project at a reasonable rate, takes charge of the possible depreciation of the project value in the future. Estimated returns on a project can dwindle for so many reasons such as market fluctuations, price changes, technological innovations, depreciation in the value of money. Even the fixed assets of production are subject to the law of diminishing returns. A pipeline value can be fixed but that value depreciates over time due to ageing, wear

Using a 10 percent discount rate, the net present value of all benefits is $1,645,201.46; the net present value of all costs is $1,576,173.19; the overall net present value is $69,028.27, and the project breaks even in approximately 4.04 years.

The present value of the net incremental cash flows, totaling $5,740K, is added to the present value of the Capital Cost Allowance (CCA) tax shield, provided by the Plant and Equipment of $599K, to arrive at the project’s NPV of $6,339K. (Please refer to Exhibit 4 and 5 for assumptions and detailed NPV calculations.) This high positive NPV means that the project will add a significant amount of value to FMI. In addition, using the incremental cash flows (excluding CCA) generated by the NPV calculation, we calculated the project’s IRR to be 28%. This means that the project will generate a higher rate of return than the company’s cost of capital of 10.05%. This is also a positive indication that the company should undertake the project.

Payback period can be defined as the anticipated number of years needed to recuperate an original investment. Payback indicates number of years an invesment takess to return the actual cash outflows or investment.

3. The time-pattern of the cash flows attributes of a financial asset refers to the

Project A would be rejected if WACC was used as discount rate, because the internal rate of return (IRR) of the project is less than the WACC. This investment decision is not correct, however, since the project A would be accepted if a CAPM - the discount rate derived for specific projects is used because the project IRR is above the SML. The project offers a larger than necessary to compensate for the level of systematic risk, and accept that it will increase shareholder wealth

The following paper analyzes a project from financial perspectives using the capital budgeting techniques like Net Present Value (NPV) and Internal Rate of Return (IRR).