Buying a lottery ticket. Buying fire insurance for your home Backing up your com
ID: 2799977 • Letter: B
Question
Buying a lottery ticket. Buying fire insurance for your home Backing up your computer a. b. c. pr 10. What causes the slope of the security market line to become steeper? Capital Budgeting What are the 2 main criticisms of Payback as a capital budgeting technique? 2. 1. In the case of independent projects, would NPV and IRR ever lead to different decisions? 3. For mutually exclusive projects, if NPV prefers project A and IRR prefers project B, which should you accept? Why? 4. Which capital budgeting technique is subject to the "magnitude" issue? What is the "magnitude" ssue? 5. What is the main advantage of the Modified Internal Rate of Return (MIRR) over the IRR? 6. What are the accept rules for NPV and IRR? 7. Why is it a problem to have more than 1 sign change in our cash flows? Cost of Capital What are the 2 main methods for determining the Cost of equity? 2. 1. How can one find the before tax cost of debt? Which cost used in the Weighted Average Cost of Capital needs to be multiplied by (1-T)2 4. 3. When calculating WACC, which capital is excluded and why? Stocks 1. What is the preemptive right associated with a stock? What is the role of the stockholders, board ofdirectors, and the management team .Explanation / Answer
CAPITAL BUDGETING
1) Criticism of Payback period includes that
a) It ignores TVM(Time Value of Money)
b) It ignores the cash flows after the payback period.
2) Independent projects are also referred as mutually exclusive projects. In case of mutually exclusive projects, NPV and IRR can lead to different decisions due to a different distribution of cash flows or size of the project . Since NPV is an absolute measure(it gives value/Number) whereas IRR is a relative measure(in percentage).
3) In mutually exclusive projects, if NPV prefers A over B then we should go with NPV and we should accept A rather than B project because, in case of IRR, it is assumed that reinvestment will be done at the rate of IRR(which is unrealistic as it cant be achieved every time) whereas NPV assumes that reinvestment will be done at the cost of capital.
4) Magnitude issue is the different magnitudes of cash flows available from a proposal. So, capital budgeting technique is not good to deal with different magnitudes of cash flows.
5) The advantage of MIRR is that in reinvestment assumption the rate to be considered is not IRR, it considers the cost of capital.
6) Accept rules of NPV
If the value of NPV is positive , accept the project and if its negative reject the proposal.
Accept rules of IRR
If the IRR is more than the pre-specified rate of return then the proposal should be accepted otherwise it should be rejected.
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