As of today, there are diverse investment rules to evaluate a project like NPV and IRR.I will evaluate the advantages and disadvantages of each investment rule one by one as follows. Net Present Value (NPV) is calculated by the total present value of future cash flows minus initial investment. The first advantage is that NPV takes into consideration all cash flows, times value of money and future cash flows through the cost of capital. Undoubtedly, it will make the decision more reliable. The second benefit is that the criteria for acceptance is quite precise and reasonable – accept when project is positive NPV and reject when project is negative NPV.
For each one the WACC has different importance. Such as: 1) Capital Budgeting Decision: It is important to estimate a firm’s cost of capital to decide Capital Budgeting Decision. Cost of capital is used to decide to accept the investment or not. A wrong estimation of WACC would lead to select a wrong investment or reject a good investment. However, the firm should accept a project if the return from it is greater than the return of the capital required to fund it.
Assuming that their NPVs based on the firm's cost of capital are equal, the NPV of a project whose cash flows accrue relatively rapidly will be more sensitive to changes in the discount rate than the NPV of a project whose cash flows come in later in its life. a. True b. False (11-2) NPV and IRR F I Answer: b EASY [iv]. A basic rule in capital budgeting is that If a project's NPV exceeds its IRR, then the project should be accepted.
This is important for intrinsic value is value of firm’s business, not its stocks. Buffett admits that value invest is important and subjective. Warren Buffett’s idea is to estimate the cash flow. This is like NPV, a firm business cash flow. This is only a estimate that today’s value to obtain an intrinsic value.
The Hertz Corporation – Leveraged Buy Out Key Inferences and Conclusions: 1. Hertz was attractive as a leverage buyout candidate, having: • Relatively low existing debt loads with assets available to further leverage; • A multi-year history of stable and recurring cash flows; • Hard assets (Rental Fleet and Equipment) that may be used as collateral for lower cost secured debt; • The potential for new management to make operational or other improvements to the firm to boost cash flows; • Market conditions (9/11) that depress the valuation or stock price. 2. CD&R had the following advantages if this deal went through • The use of debt increases (leverages) the financial return to the private equity sponsor. The total return of an asset to its owners, all else being equal and within strict restrictive assumptions, is unaffected by the structure of its financing.
Also, incremental cash flows take other costs into account, if available. In this particular case, the information needed to figure out the incremental cash flow of the product was limited. However, if the information was available, it would be useful to figure out if the sale of this product took away from the sale of another Caledonia product. Incremental cash flows consider this and other circumstances such as opportunity cost. Year | Net Profit(units sold x price per unit) – ((units sold x
In demand based pricing, the more people want a product, the more that product will cost. However, product price is sensitive to you customers budget. If your customers can’t afford it, they will not buy it. In demand based pricing, it is possible that you may lose money because you don’t cover all your cost. Also if demand is low, you will have a small profit margin.
Liquidity ratios measure short-term ability of a company to pay obligations ant to meet unexpected needs for cash. Profitability Ratios Measure the income or operating success of a company for a given period of time. Solvency ratios measure the ability of the company to survive over a long period of time. Ratios provide clues to underlying conditions that may not be apparent from individual financial statement. All of the ratios would be helpful to internal users because this would provide the company with the knowledge of if they would be approved for a loan that is needed or how much the company lost or gained as well as if the company looks as though it will be able to survive over a long period of time.
It helps us to understand the relationship between the usage of money and the value of returns it provides from a particular venture or avenue based on the time it would take for providing the return and the future value of the return. Opportunity cost is economic decisions based on a limited resources i.e time or money. Opportunity cost is defined as the next best choice available for a person. Opportunity costs are not restricted to monetary costs only. Trade-off is the form of either buying less or a lesser quality item in order to purchase more or a greater quality item.