Finance Midterm 1

the rate (I/Yr) at which the net present value (NPV) is zero

internal rate of return (IRR)

time until cash flows recover the initial investment of the project

what is a payback period?

reject

what do you do when the IRR is less than the opportunity cost

invest

what do you do when the IRR is more than the opportunity cost

reject

in a payback period (PBP), what happens if you make more money after the cutoff date

true

it is always desirable to have a higher compounding frequency, regardless of the initial investment or the time horizon

make good decisions that maximize shareholder role in an ethical sustainable manner

what is the role of financial managers

capital budgeting and financing decision

what are the two types of financial decisions

refers to a product or service, the “what” in evaluating long-term investments

what is capital budgeting

the “how” in making your investment profitable, using NPV or IRR

what is financing decision

sole proprietorship, partnership, LLC, and corporatio

types of business entities

business profits and losses are taxed once through the owner’s personal tax

what does being passed through mean?

corporation

what is the only company that has double taxation aside from LLC which can do either double or pass through?

corporations and LLC

what forms of company have limited liability?

sole proprietorships and partnerships

what forms of company have unlimited liability?

a concept stating that a dollar received today is worth more than a dollar received in the future

what is time value of money

the difference between an inflow and outflow

what does using a minus sign in excel and calculator indicate?

if the NPV is greater than zero, accept the project. if its equal to or less, don’t accept

what is the decision rule of NPV?

a level stream of evenly spaced cash flows that never ends or finite period of time

perpetuity

a fixed sum of money paid each year

what is annuity

when the nper is indicated as forever, when there is only perpetuity, cash flow, or I/Yr

how to know when to use PV of perpetuity

payments are made at the end of the year

what is an ordinary annuity

effective rate, and equivalent annual rate

what are synonyms of AER?

The question wants you to express an interest rate in a different nominal form (annual percentage with a stated compounding frequency)

When is the problem is asking for Nominal Rate

if you’re comparing two investments with different compounding frequencies (e.g., 6% monthly vs 6% quarterly), you usually need to convert them both into AER first

Even if it doesn’t directly say “AER,” how do you know it’s referring to AER?

present value of cash flows minus initial investments

what is net present value NPV?

expected rate of return given up by investing in a project

what is opportunity cost of capital?

it can ignore the magnitude of a project, you don’t know if you’re lending or borrowing, and certain cash flows can generate NPV=0 at two different discount rates

why can IRR be bad?

the cash flow per period with the same present value as the cost of buying and operating a machine

what is equivalent annual cost?

limit set on the amount of funds available for investment

what is capital rationing?

limits on available funds imposed by management

what is soft rationing?

limits on available funds imposed by the unavailability of funds in the capital market

what is hard rationing?