Investment Appraisal and Risk

These flashcards cover key concepts related to investment appraisal and risk management based on the lecture notes.

What is the Net Present Value (NPV) rule?

Invest in all projects for which NPV > 0.

How is NPV calculated?

NPV = PV - investment.

What does a discount rate reflect in investment appraisal?

The discount rate reflects the risks of cash flows and the opportunity cost of funds.

What does CAPM stand for?

Capital Asset Pricing Model.

What are the assumptions of CAPM?

Investors are risk-averse, capital markets are perfect, investors share the same opportunities, and expectations are homogeneous.

What does Beta measure in finance?

Beta measures an asset's market risk.

What is the formula for calculating the company's cost of capital?

COC = rassets = WACC = (rdebt * (D/V)) + (requity * (E/V)).

What is WACC?

Weighted Average Cost of Capital, reflecting the average risk and return of capital structure.

What method corrects optimistic forecasts in project risk analysis?

Applying a risk-adjusted discount rate.

What is a Certainty Equivalent?

A minimum cash flow that can be guaranteed, reflecting no risk.

How do you calculate required return on stock using CAPM?

E(rx) = rf + β(E(rmarket) - rf).

What is the average beta of J&J's assets?

0.81.

What type of assets are considered speculative ventures in discount rates?

30%.

What is the cost improvement discount rate for known technology?

10%.

What is the formula used for Certainty Equivalent Cash Flows?

CEQ = Cash Flow * [1 + r / (1 + y)]^n.

How can project risk be analyzed with respect to bad outcomes?

Adjusting forecasts to account for uncertainties in cash flows.