Exam 3 Short Answer

Annuity

Series of consecutive payments over a specific length of time

Required Rate of Return

Yield investors demand from an investment depending on amount of risk involved

Perpetuity

An investment without a maturity date

Dividend Evaluation Model

A model used to determine the value of a share of stock by taking the present value of an expected stream of future dividents

Price Earnings Ratio

Multiplier added to earnings per share to determine current value

Weighted Average Cost of Capital (WACC)

Average rate a firm has to pay to use other peoples money

Capital Asset Pricing Model (CAPM)

A model that relates the risk return tradeoffs of individual assets to market returns

What are 2 reasons Debt is the cheapest source of capital for a company?

Provides a tax benefit and investors require a lower rate of return- since it appears less risker

What are the advantages of using the NPV method to analyze capital investments?

Its objective, not influenced by external opinions or judgements and directly measures wealth

Why do business manages prefer to use accelerated depreciation methods?

Reduces taxable income of an asset early on in order to pay less tax in the short term

When using IRR as a decision rule, what is the decision rule to determine if a project is acceptable?

A project is acceptable when its IRR is greater than the WACC (Weighted Avg. Cost of Capital)

Why do financial managers prefer a lower cost of capital?

Directly increases the value of a firm and lowers financial costs