Essay on Fina 5133 Exam 2 Review Notes

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Chapter 9 Cost of Capital 1. What is the WACC? a. Weighted Average Cost of Capital- most firms employ different types of capital, and because of their differences in risk, the difference securities have different required rates of return. Typically=debt, preferred stock and common equity. 2. What precautions must we take when measuring the WACC to use for capital budgeting decisions (future investment)? b. The company’s current and recent past book and market value structures. As well as rates of returns. 3. What do we mean by "target capital structure"? (this is in the Web appendix to Ch. 11) 4. What is the "marginal cost of capital"? 5. Know how to calculate the cost of debt, before and after taxes, …show more content…
3. Explain why the NPV and IRR methods can give conflicting results for some project analyses. k. Timing differences: if most of the cash flows from one project come in early while most of those from the other project come in later, the NPV profiles may cross. l. Project size differences: if the amount invested in one project is larger than the other this can also lead to profiles crossing. No conflict for independent projects but only for mutually exclusive projects. If this occurs, the NPV method should generally be relied upon. 4. Explain the reinvestment assumptions of NPV, IRR, and MIRR. m. The NPV calculation is based on the assumption that cash inflows can be reinvested at the projects risk-adjusted WACC whereas the IRR calculation is based on the assumption that the cash flows can be reinvested at the IRR itself. For most firms, reinvesting at WACC is better. MIRR modifies the IRR to make it a better measure of the profitability but assumes that cash flows are reinvested at the WACC. 5. Explain several reasons why NPV is superior to IRR for making capital budgeting decisions. n. Hard to draw the line on where it’s realistic and not. o. It tells us how much each project will add to the firm’s value 6. Explain what is wrong with the payback and discounted payback methods. p. Payback period has three flaws: iii. Ignores cash flows beyond
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