... Lump sum E. Factor 2. Janis just won a scholarship that will pay her $500 a month, starting today, and continuing for the next 48 months. Which one of the following terms best describes these scholarship payments? A. Ordinary annuity B. Annuity due C. Consol D. Ordinary perpetuity E. Perpetuity due 3. The Jones Brothers recently established a trust fund that will provide annual scholarships of $12,000 indefinitely. These annual scholarships can best be described by which one of the following terms? A. Ordinary annuity B. Annuity due C. Amortized payment D. Perpetuity E. Continuation 4. A perpetuity in Canada is frequently referred to as which one of the following? A. Consul B. Infinity C. Forever cash D. Dowry E. Forevermore 5. The stated interest rate is the interest rate expressed: A. as if it were compounded one time per year. B. as the quoted rate compounded by 12 periods per year. C. in terms of the rate charged per day. D. in terms of the interest payment made each period. E. in terms of an effective rate. 6. Anna pays 1.5 percent interest monthly on her credit card account. When the interest rate on that debt is expressed as if it were compounded only annually, the rate would be referred to as the: A. annual percentage rate. B. compounded rate. C. quoted rate. D. stated rate. E. effective annual rate. 7. Lee pays one percent per month interest on his credit card account. When his monthly rate...
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...-1- Equivalence of the different discounted cash flow valuation methods. Different alternatives for determining the discounted value of tax shields and their implications for the valuation∗ Pablo Fernández PricewaterhouseCoopers Professor of Corporate Finance IESE Business School, University of Navarra Camino del Cerro del Aguila 3. 28023 Madrid, Spain. E-mail: fernandezpa@iese.edu Abstract This paper addresses the valuation of firms by cash flow discounting. The first part shows that the four most commonly used discounted cash flow valuation methods (free cash flow discounted at the WACC; cash flow for equityholders discounted at the required return on the equity flows; capital cash flow discounted at the WACC before taxes; and Adjusted Present Value) always give the same value. The disagreements in the various theories on the valuation of the firm arise from the calculation of the discounted value of tax shields (VTS). The paper shows and analyses 7 different theories on the calculation of the VTS: Modigliani and Miller (1963), Myers (1974), Miller (1977), Miles and Ezzell (1980), Harris and Pringle (1985), Ruback (1995), Damodaran (1994), and Practitioners method. The paper also shows the changes that take place in the valuation formulas when the debt's market value does not match its book value. JEL Classification: G12, G31, M21 October 16, 2008 (First version: July 2, 1999) Another version of this paper may be found in chapters 17, 18, 19 and 21 of the author's...
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...Discounted Cash Flow Valuation: Basics Aswath Damodaran Aswath Damodaran 1 Discounted Cashflow Valuation: Basis for Approach t = n CF t Value = ∑ t t = 1( 1 +r) where CFt is the cash flow in period t, r is the discount rate appropriate given the riskiness of the cash flow and t is the life of the asset. Proposition 1: For an asset to have value, the expected cash flows have to be positive some time over the life of the asset. Proposition 2: Assets that generate cash flows early in their life will be worth more than assets that generate cash flows later; the latter may however have greater growth and higher cash flows to compensate. Aswath Damodaran 2 Equity Valuation versus Firm Valuation n n Value just the equity stake in the business Value the entire business, which includes, besides equity, the other claimholders in the firm Aswath Damodaran 3 I.Equity Valuation n The value of equity is obtained by discounting expected cashflows to equity, i.e., the residual cashflows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity, i.e., the rate of return required by equity investors in the firm. t=n Value of Equity = CF to Equity t ∑ (1+ k )t t=1 e where, CF to Equityt = Expected Cashflow to Equity in period t ke = Cost of Equity n The dividend discount model is a specialized case of equity valuation, and the value of a stock is the present value of expected future dividends...
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...Financial Analysis & Management Discounted cash flow techniques Discounted cash flow is a method used to evaluate a company based on the concept of time value of money, cash flows of the future are estimated then discounted to their present value, There are four discounted cash flow techniques which are; Net present value technique(N.P.V), Internal rate of return technique(I.R.R), Discounted payback technique and The profitability index technique (P.I) and every one of those techniques has its own purpose(Alfred, et al, 1971) DCF Advantages|DCF Disadvantages| · Theoretically, it’s the most rational method of valuation.· It depends on future estimations rather than historical results.· It focuses on cash flow generation and less affected by accounting practices.· It allows for the different business components to be valued separately or to value the whole business.· Ease of use· Convenient for both equity shareholders and debt holders.|· Accuracy of valuation highly depends on the quality of the assumption; any wrong inputs will result in wrong outputs, "Garbage in, Garbage out".· Any slight changes in inputs can cause large changes in the outputs.· Depends on the ability of user to predict future cash flows accurately or not.| (www.macabacus.com, valuation, 5/4/2013) The Discounted cash flow method is better than compounding cash flow because discounting cash flows gives us the Present value of the money, and the present value of money is more useful in finance...
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...uncertain at best and this was key for Arcadian getting its products into the market. Importance of Terminal Value The final steps in Chu’s analysis were to estimate a terminal value for Arcadian. In order to evaluate the market price of a firm, one of the methods involves discounting future dividends at the cost of equity (dividend discount model). After discounting projected 5 year dividends for 19 randomly picked firms it was established that resulting prices were considerably lower than actual market prices for that time. The average percentage of market price not attributable to dividends of these 19 firms equated to 93%. This discrepancy is largely due to the terminal value, which is the lump-sum of cash flow at the end of a stream of forecasted cash flows. Thus, terminal value proves to be a huge value driver. The unexplained part of the share price could also be...
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...Principles of finance Gyimah Kyei Prof. James M. Triplett 12/17/2014 YEAR 0 1 2 3 4 | CASH FLOW -1,000,000 450,000 350,000 300,000 250,000 | COST OF FORMULAR = N=0NCFn1+in CAPITAL – 8% (1,000,0001+0.08) + (450,0001+0.08) + (350,000(1+0.08)) + (300,000(1+0.08)) + (250,000(1+0.08)) = 138,642.39 >0 INTERNAL RULE OF RETURN FORMUA – 0= n=0NCFn1+IRRn IRR= 14.79% SIMPLE PAYBACK YEAR 0 1 2 3 4 | CASH FLOW-1,000,000 450,000 350,000 300,000 250,000 | CUMULATIVE CASH FLOW-1,000,000 -550,000 -200,000 100,000 | PB= 2+200,000300,000 =2.67 YEARS Net present value is a technique that generates a decision rule and associated metric for choosing projects based on the total discounted value of their cash flow. Because the net preset value of 138,642.39 is greater than zero the proposal to replace the company’s central office stores with outside vendors should be accepted. Shareholders should recognize that the projects are going to help maximize shareholders value and there...
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...INTERNATIONAL Table of Contents Executive Summary 1 1. Introduction 1 2. Basis of Investment Decision 1 3. Figures produced by financial accountants 2 4. Rate of Return on investment 5 5. Net Present Value of the project 6 6. Conclusion and Recommendation 8 References 9 Executive Summary The purpose of this report is to discuss the investment decision regarding the project for the manufacture of new product. I will start by critically analyzing the basis on which current investment decisions are made by the company followed by a review on the figures produced by the financial accountants. I will then present my views on the minimum return that is required on this project and then explain the computation that I have made using the Discounted Cash Flow (DCF) techniques. Finally, I will recommend to you whether to go ahead with the project or not. 1. Introduction Our company, Greinam International is considering investing ₤ 840,000 in new machinery to be used in the manufacturing of one of the company’s products. The information available for this project is not to the satisfaction of our management group and therefore needs a review from the management accountant. The Payback method may not be the correct way of valuing such major investment project and therefore we will use DCF method which is commonly used to appraise investment project. There are a number of elements which have cropped up during my meetings with my colleague managers and same have been duly considered in...
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...has been a very typical issue in the sustenance of a company. Several companies have lost their identity or liquidated due to wrong capital budgeting decision they made at one particular time or the other. Based on these prevalent problems in industries and the effect of globalisation on industries, it is important to use effective method to analyse investment before decision is made. Capital budgeting is extremely important because the decision made involve the direction and opportunity for future growth of the organisation. One of the traditional methods commonly used for capital investment appraisal by some organizations is the payback method, although this method has been criticized by academicians that it does not include the future cash flow and do not measure profitability. The wide acceptance of this method by practicing managers, has called for...
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...Question 1: ASC410-20-35-8 states that “changes resulting from revisions to the timing or the amount of the original estimate of undiscounted cash flows shall be recognized as an increase or a decrease in the carrying amount of the liability for an asset retirement obligation and the related asset retirement cost capitalized as part of the carrying amount of the related long-lived asset. Upward revisions in the amount of undiscounted estimated cash flows shall be discounted using the current credit-adjusted risk-free rate. Downward revisions in the amount of undiscounted estimated cash flows shall be discounted using the credit-adjusted risk-free rate that existed when the original liability was recognized. If an entity cannot identify the prior period to which the downward revision relates, it may use a weighted-average credit-adjusted risk-free rate to discount the downward revision to estimated future cash flows. When asset retirement costs change as a result of a revision to estimated cash flows, an entity shall adjust the amount of asset retirement cost allocated to expense in the period of change if the change affects that period only or in the period of change and future periods if the change affects more than one period as required by paragraphs 250-10-45-17 through 45-20 for a change in estimate.” DR Oil platform 1,000,000 CR Cash or debt 1,000,000 DR Asset Retirement Obligation 100,000 CR Oil platform 100,000 DR Asset Retirement Cost 175,000 CR Asset Retirement...
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...Take the Book Value of net worth -assets not acquired +liabilities not assumed +fair market value of assets acquired +any net worth adjustments =Adjusted Book Value ____________________________________________________________ II. Capitalized Adjusted Earnings First Step: Adjust Historical Earnings Seller’s Discretionary Cash Flow Net Profit +Officer’s salary +Discretionary expenses -New Owner salary Adjusted Profit Last Year 50.0 +70.0 +30.0 -60.0 90.0 Second Step: Get the adjusted profits for 5 years then do a Weighted Average of the Adjusting Earnings Year 95 96 97 98 99 Totals Average Earnings $ 50 $ 30 $ 70 $ 60 $ 90 Weight 1 2 3 4 5 15 $ Adjusted $ 50 $ 60 $ 210 $ 240 $ 450 $1,010 /15 67 (rounded) Third Step: Calculate a Discount Rate Determine T-Bill Rate Determine Offset Risk Rate √ √ Establish rate of return based on risk factors Establish rate of return based on general economy 5.0% 12.0% Determine Offset Illiquidity Rate Total the Rates 3.0% 20.0% Fourth Step: Take the weighted average of the adjusted earnings and divide by the discount rate. Example: $67/.20 = $335 ___________________________________________________________________ III. Discounted Future Earnings First Step: Adjust Historical Earnings Last Year 50.0 +70.0 +30.0 -60.0 90.0 Net Profit +Officer’s salary +Discretionary expenses -New Owner salary Adjusted Profit Second Step: Get the adjusted profits for 5 years then do a Weighted Average of the Adjusting Earnings Year 95 96 97 98 99 Totals Average...
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...Problems and Solutions 1. Payback Period – Given the cash flows of the four projects, A, B, C, and D, and using the Payback Period decision model, which projects do you accept and which projects do you reject with a three year cut-off period for recapturing the initial cash outflow? Assume that the cash flows are equally distributed over the year for Payback Period calculations. |Projects |A |B |C |D | |Cost |$10,000 |$25,000 |$45,000 |$100,000 | |Cash Flow Year One |$4,000 |$2,000 |$10,000 |$40,000 | |Cash Flow Year Two |$4,000 |$8,000 |$15,000 |$30,000 | |Cash Flow Year Three |$4,000 |$14,000 |$20,000 |$20,000 | |Cash Flow Year Four |$4,000 |$20,000 |$20,000 |$10,000 | |Cash Flow year Five |$4,000 |$26,000 |$15,000 |$0 | |Cash Flow Year Six |$4,000 |$32,000 |$10,000 |$0 | Solution ...
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...planning expenditures on assets whose cash flows are expected to extend beyond one year. By convention, the process is referred to as financial asset valuation when it deals with financial, or derivative assets, and as Capital Budgeting when it deals with real assets. Comparing processes: Real Assets Financial assets Determine the cost of the investment project Determine the price that must be paid for the asset Estimate expected cash flows including salvage value Determine future interest or dividend payments and expected sales price Determine the riskiness of the cash flows Determine the riskiness of the cash flows Determine cost including risk premium Determine cost including risk premium Estimate the NPV of cash flows Estimate the NPV of future interest or dividend payments Compare NPV of inflows and outflows Compare NPV of inflows and outflows Capital budgeting decision rules: The corporation’s long-run targets concerning its competitive edge, survival and growth are spelled out in its Strategic Business Plan = source of a number of potentially profitable investment opportunities that can be translated into a set of capital expenditure proposals. The Capital Budgeting Decision Rules are all based on analyzing the free cash flow associated with each capital expenditure proposal. Typically, these analyses include three fundamental elements: 1. Initial investment outlay 2. Operating cash flows over the project’s life (after-tax...
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...Mercury Athletic Footwear: Valuing Opportunity Case Summary: John Liedtke, head of business development for Active Gear Inc. (AGI), is evaluating the acquisition of Mercury Athletic (Luehrman & Hielprin, 2009). Both companies compete in the footwear industry which is a highly competitive industry characterized by low growth and stable profit margins (Luehrman & Hielprin, p. 1). Liedtke’s initial assumptions was that the acquisition of Mercury Athletic would double AGI’s revenue, increase its leverage with manufacturers and expand its distribution. In order to evaluate these assumptions and determine if the acquisition would be a good decision, Liedtke generated pro forma income from Mercury’s four main segments and key balance sheet account for the years spanning 2007 through 2011. In preparing these, he made the following assumptions: • Mercury’s women’s casual footwear would be merged with AGIs within the first year. • Overhead to revenue ratio would conform to historical averages • Capital structure would follow AGI post acquisition • Discount rate was calculated using AGI’s leverage and tax rate Additionally, he was counting on synergies between the two companies with respect to inventory management and the women’s casual footwear line. Using this information, he calculated projected EBIT margin of 9% and revenue growth of 3%. Case Questions: a. Is Mercury an appropriate target for AGI? Why or why not? According to Liedtke, Mercury is...
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...Guillermo Furniture Store Concepts * Guillermo Furniture Store (GFS) in the late 1990s faced a financial crisis because of changes in the furniture industry. By going from a leader in the field down to a company that can hardly survive amongst its current competition, different financial concepts for GFS need to be evaluated and incremental financial decisions need to be made in order for GFS to survive (Guillermo Furniture Store Scenario, 2011). This paper will contain a discussion of the weighted average cost of capital (WACC), background on the use of multiple valuation techniques in reducing risks, a discussion on the net present value (NPV) of future cash flows for different alternative methods, and a sensitivity analysis. Guillermo Alternatives The financial downturn of Guillermo Furniture resulting from developments in the industry has caused a need for alternatives to be evaluated in order for Guillermo to remain in business. Alternative one is the option of keeping everything the same until business fails while option two offers the possibility of becoming a broker and distributor for a different furniture store that is currently dominating the market. Option three, is to allow Guillermo to keep the store he has in business but invest capital in a manner that allows the store to move into high-tech manufacturing processes to allow for a competitive edge to exist against the other industry leader. By Guillermo opting to move forward with technological advances...
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...Company Name: MW Petroleum Amoco Corporation was the fifth largest oil company in United States with 28 billion in operating revenues and 1.9 billion in net income. The low oil prices in the 1980s depressed the profitability of many oil companies and most of which responded with downsizing and other cost cutting measures aimed at overhead expenses. Amoco had already sold more than 750 million worth of small properties, which it felt could be more economically operated by companies with low overhead costs. Amoco conducted an extensive study on capital structure and profitability in 1988 and found that 85% of its margin in United States was provided by 11% of its producing fields and rest had disproportionately high overhead costs and repair costs. Based on this a strategy was formed to divest up to 1.2 billion worth of additional properties. As the spinoff could take almost two years it was decided to assemble the properties in a new free standing E&P company called MW Petroleum. In the 1990s MW was up for sale and Apache expressed interest in the deal. Apache, a Denver based operator of small- medium sized properties was an efficient and cost effective company and the business strategy was to “rationalize and reconfigure”. The strategy involved acquiring and controlling producing properties, and quickly turn around the efficiency. Apache was specifically interested in MW as it was a large company that would more than double Apache’s reserves and was comprised of properties...
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