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FINN Exam 2 Study Guide Questions With All Correct Answers.
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FINN Exam 2 Study Guide Questions With All Correct Answers.
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Name: Score:27 Multiple choice questions
,Term 1 of 27
How Does the Time Value of Money Relate to Opportunity Cost?
-IF YOUR COMPANY HAS NO PUBLIC DEBT, Look up the rating for the firm and estimate
the default spread based upon the rating. Then:
RD = Rf + Default Spread determined by company's debt rating
-Step 3: If your company has no debt rating, create company's synthetic debt rating! (You
can predict company's debt rating (i.e. what the rating would be if the company had
publicly traded rated debt (ratings spreadsheet can be found e.g. on damodaran.com)
-If everything fails, analysts sometimes use coupon rates for recent loans to estimate cost
of debt
The time value of money (TVM) is the concept that a sum of money is worth more now than
the same sum will be at a future date due to its earnings potential in the interim.
A sum of money in the hand has greater value than the same sum to be paid in the future.
also referred to as present discounted value.
Opportunity cost is key to the concept of the time value of money. Money can grow only if
it is invested over time and earns a positive return.
Money that is not invested loses value over time. Therefore, a sum of money that is
expected to be paid in the future, no matter how confidently it is expected, is losing value
in the meantime.
Market Risk Premium
-the difference between the expected return on a market portfolio and the risk-free rate
•Such a portfolio will likely mimic the behavior of some broad market index (such as
S&P500), and thus such a premium is called Market Risk Premium (MRP).
•MRP is equal to the expected difference between return on market (RM) and the risk free
rate (Rf), MRP=E[RM - Rf]
•In the United States, typical analyst estimates of MRP are between 4% and 7%. In our class,
MRP estimate will be 5.0% for projects with finite lives.
, Definition 2 of 27
- Discounted cash flow (DCF) helps determine the value of an investment based on its future cash
flows.
- The present value of expected future cash flows is arrived at by using a discount rate to
calculate the DCF.
- If the DCF is above the current cost of the investment, the opportunity could result in positive
returns.
- Companies typically use the weighted average cost of capital (WACC) for the discount rate,
because it takes into consideration the rate of return expected by shareholders.
- The DCF has limitations, primarily in that it relies on estimations of future cash flows, which could
prove inaccurate.
What returns do bondholders get?
What Is the Time Value of Money (TVM)?
What Is Discounted Cash Flow (DCF)?
What Is the Cost of Equity?
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