1. Explain why the present value of a cash flow stream, and the asset associated
ID: 2683384 • Letter: 1
Question
1. Explain why the present value of a cash flow stream, and the asset associated therewith; fluctuate in value with the level of interest rates in the capital markets.2. List and explain the points of financial impact on a company if it raises the credit standards required of its customers who utilized trade credit offered by the company.
3. Define Weighted Average Cost of Capital and explain why a company must earn at least its Weighted Average Cost of Capital on new investments. What are the financial implications if it does not?
4. As a corporation what are the benefits and ramifications of using convertible debt to finance a publicly traded company? As an investor what are the benefits and ramifications of purchasing convertible debt in a publicly traded company? Are there any conflicts between the goals of the investor and the goals of the corporation?
5. Which two of the methods used to evaluate project, and used to decide whether or not they should be accepted, do you prefer as a financial manager? Explain why you decided on these two and not the others. List the perceived deficiencies of those not selected.
6. What are the benefits and costs of planning a financially troubled company into a Chapter 11 Bankruptcy proceeding? Is this a legitimate and ethical vehicle for management to use for the benefit of the company
Explanation / Answer
1. The current worth of future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations. Discounted cash flow method: This method estimates the value of an asset based on its expected future cash flows, which are disounted to the present value. This concept of discounting monies is commonly known as Time value of money. The size of discount rate is based on opportunity cost of capital and it is expressed as a percentage. Some people call this percentage as discount rate. In finance theory, the amount of opportunity cost is based on a relation between risk and return of some sort of investment. The incentive in finance comes in the form of higher expected return after buying a risky asset. In other words, the more risky the investment, the more returns the investor expects from the investment. For a valuation using the discounted cash flow method, one first estimates the future cash flows from the investment and then estimates a reasonable discount rate after considering the riskiness of those cash flows and interest rates in the capital markets. Next, one makes calculations to compute the present value of future cash flows. ........................ 2. The guidelines issued by a comany that are used to determine if a potential borrower is creditworthy. Credit standards are often created after careful analysis of past borrowers and market conditions, and are designed to limit the risk of a borrower not making credit paymants of defulting on loaned money. At any point of time the company would be interested in examining the effect of change in credit standards. This is done by comparing the profitability generated by raising the credit standards and the added cost of accounts receivable. If we raises credit standards it will show high impact on working capital Impact of Credit Standards raises: 1. Increase in average collection period 2. Increase in Sales 3. Increase in account receivable investment 4. Increase in bad debt losses 5. Increase in servicing cost of account receivable 6. Increase in new customers. ............................... 3. The weighted average cost of capital (WACC) measures the capital discount of a company
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