D076 Unit 6 Finance Skills for Managers - QUESTION AND AMSWER PASSED

A bond becomes "premium" or "discount" once it - begins trading on the secondary market. A company called Bobby's Books is considering purchasing a new bookbinding machine. The company calculates the hurdle rate of the project to be 9% and the IRR to be 11%. Should the company purchase the bookbinding machine? - Yes, because the IRR exceeds the cost of capital. A company is considering five projects that are not mutually exclusive. However, the company does not have enough money to do all of them. In order to prioritize projects that fit within the company's budget, which capital budgeting method should be used? - Profitability index (PI) Correct! The PI should be used first to compare the projects and then to rank them to maximize the value of the firm. A PI of 1 is the break-even point.The decision rule is as follows: - you should accept a project with a PI greater than 1, and you should reject a project with a PI less than 1. If the profitability index is exactly equal to 1, then you would be indifferent about whether you did the project or not. A potential project to expand the size of an apartment complex will cost $100,000. Its calculated net present value is $5,000. Given this information, which statement is correct? - The project should be accepted because it has a positive NPV. A share repurchase - where the firm buys back its own shares Affirmative covenants - describe things the company pledges itself to do. Examples include paying taxes on time, maintaining a certain level of working capital, and maintaining a certain debt ratio. aggressive assets - Companies or securities with high betas (beta > 1) Alphabet Co. has $50,000 to spend on capital investment projects for the next year. It will do as many projects as it has cash for. Alphabet Co. calculates the potential incremental cash flows and costs of the projects as well as the NPV, IRR, and PI for each project. How should the company decide which projects to invest in if it wants to maximize the total amount of value created? - It should choose the projects with the highest PIs until all capital has been used. Correct! By choosing the projects with the highest PI, Alphabet Co. will be able to use its limited capital effectively to create the most overall value for the firm. An ideal evaluation method for capital investment includes three key attributes: - It includes all cash flows that occur during the life of the project. It considers the time value of money. It incorporates the cost of capital—or in other words, the required rate of return on the project. An investor just purchased a bond for $973 that has a par value of $1,000. What type of bond is this? - A discount bond Another advantage of the NPV method is that it tells you how much value is.... - added to the firm with the investment project. The NPV is a dollar amount, so if you calculate the NPV of $15,000, you are adding $15,000 to the firm's value by doing the project at today's value. Beta - describes how the price of a security varies with the market. By definition, the market has a beta of 1. A riskless asset has a beta of 0. If the market goes up by 10%, the value of the riskless asset does not change. bond cash flows comprise two distinct parts: - A stream of semi-annual interest payments (an annuity) A final principal repayment (a lump sum) bond indenture - governs the relationship between the firm and the bondholders.