In this discussion, please reflect on the previous weeks’ topics. Choose a topic you found to be difficult or hard to understand. Research this topic and present your findings. Include a summary of the topic, why you found the topic to be difficult, and what you learned after conducting the research. 

The Capital Budgeting Process.

LENIN CASTILLO

Week 4 Chapter 10 to me was one that was a little hard to understand, and not because the explanation was not good enough, but because it is still a subject I don’t understand clearly. I owe stocks in different companies and in a way, I understand the process of their value going up and down at all times, but at the same time, it is hard for me to understand it. Why and how my stocks go from $3.00 per share to .59 per share? I know it is a process and things change on by the minute, especially with the stock market.

Chapter 10. Valuation and Rates of Return explains this in a way I was able to understand it better. It explains in detail some of the reasons for all these changes. ” The valuation of a financial asset is based on determining the present value of future cash flows. Thus, we need to know the value of future cash flows and the discount rate to be applied to the future cash flows to determine the current value.

The market-determined required rate of return, which is the discount rate, depends on the market’s perceived level of risk associated with the individual security. Also important is the idea that required rates of return are competitively determined among the many companies seeking financial capital. For example, Microsoft, due to its low financial risk, relatively high return, and strong market position, is likely to raise debt capital at a significantly lower cost than can United Airlines, a firm with high financial risk. This implies that investors are willing to accept low return for low risk, and vice versa. The market allocates capital to companies based on risk, efficiency, and expected returns—which are based to a large degree on past performance. The reward to the financial manager for efficient use of capital in the past is a lower required return for investors than that of competing companies that did not manage their financial resources as well”. VitalSource Bookshelf: Foundations of Financial Management

This to me was the most important part where it explains the process and it helps understand how the stock market works.

 

Schaefer

Mayson Schaefer 

Hello Class and Professor,

I hope all is well this week. This is the end of the course and a door open to endless opportunities with the knowledge acquired. Within the last 8 weeks we’ve covered an array of topics within Financial Management. The topic that I found to be the most difficult was calculating the Net Present Value. “The net present value is the sum of the present values of all outflows and inflows related to a project” (Danielsen, 2018). Since the net present value is the sum of the present values of all outflows and inflows we can conclude that the NPV = Cash Inflows – Cash Outflows.

Understanding the NPV will allow for the understanding of the total cash inflows of the company with the addition of the cost of capital acquired over a given period of time.

The example that helped me understand NPV the best was the homework assignment on week 7 work covering chapters 18,19, and 20. The example provided was:

“Worldwide Scientific Equipment is considering a cash acquisition of Medical Labs for $3.6 million. Medical Labs will provide the following pattern of cash inflows and synergistic benefits for the next 25 years. There is no tax loss carryforward. Use Appendix D as an approximate answer, but calculate your final answer using the formula and financial calculator methods.”

Years

1–5 6–15 16–25

Cash inflow (aftertax) $ 350,000 $ 370,000 $ 410,000

Synergistic benefits (aftertax) 40,000 50,000 70,000

The cost of capital for the acquiring firm is 10 percent.

First we must add the totals for years 1-5, 6-15, and 16-25

Years 1-5 = $350,000 + 40,000 = 390,000

Years 6-15 = $370,000 + 50,000 = 420,000

Years 16-25 = $410,000 + 70,000 = 480,000

We know that the cost of capital for acquiring the firm is 10%. Instead of using the present value of annuity formula of $1, we can use the provided chart. This will allow us to calculate the present value for the given periods with the data already provided of rates.

For Years 1-5 @ 10% = 3.791

For Years 6-15 @ 10% = 7.606 – 3.791 = 3.815

For Years 16-25 @ 10% = 9.077 – 7.606 = 1.471

For years 6-15 and 16-25 we had to get technical and take the rate from years 1-5 and subtract it from the rates provided at 1-15 and 1-25. If we didn’t do this we would be using rates for years 1-15 and 1-25, instead of 6-15 and 16-25.

Now that we have the present value of the given years, we can calculate the total present value with our data provided.

Years 1-5 = 390,000 * 3.791 = $1,478,490

Years 6-15 = 420,000 * 3.815 = $1,602,300

Years 16-25 = 480,000 * 1.471 = $706,080

+

___________________________________________________

Total cash inflow after 25 years = $3,786,870

Now we can finally calculate the NET PRESENT VALUE

NPV = Cash Inflows – Cash Outflow

NPV = $3,786,870 – $3,600,000 = $186,870

These questions take some time to calculate, but after understanding the process of calculating the Net Present Value I am capable of solving equations similar in a timely manner.

I hope this helped other understand the Net Present Value a little bit more.

Thank you,

Mayson