Investment Decision Making Principles

The primary consideration is how much not to consume today to increase future consumption possibilities.

An optimal investment decision maximizes expected utility of consumption over a lifetime.

Managers can either pay out earnings as dividends or invest earnings in productive opportunities.

<p>It is assumed that capital markets are perfect and complete, and the market interest rate is known with certainty.</p> Signup and view all the answers

<p>Shareholders can delegate investment decisions to managers since these decisions are independent of their time preferences for consumption.</p> Signup and view all the answers

<p>Narrowing down on expected utility helps determine whether future investments outweigh the utility of current consumption.</p> Signup and view all the answers

<p>The expected utility of future consumption provided by an additional dollar investment.</p> Signup and view all the answers

<p>Certainty allows for all payoffs from investment decisions to be known, making decision-making straightforward.</p> Signup and view all the answers

<p>The primary criterion is to undertake projects that earn more than the market rate of return.</p> Signup and view all the answers

<p>MRT indicates the trade-off between different investment choices and is critical for achieving optimal investment decisions.</p> Signup and view all the answers

<p>It represents the present value of wealth, combining initial investments and future projected cash flows.</p> Signup and view all the answers

<p>Shareholders' wealth is determined by dividends paid and capital gains from stock sales.</p> Signup and view all the answers

<p>It is determined by the market and is viewed as a constant opportunity cost over time.</p> Signup and view all the answers

<p>It is assumed that all future cash flows are known with certainty.</p> Signup and view all the answers

<p>Capital budgeting techniques help in the selection of profitable projects for investment.</p> Signup and view all the answers

<p>Individuals borrow or lend funds to optimize their consumption over time.</p> Signup and view all the answers

<p>Dividends paid to shareholders and capital gains from stock sales.</p> Signup and view all the answers

<p>By maximizing the price per share, which involves maximizing the present value of cash flows from investment projects.</p> Signup and view all the answers

<p>Payback method, Net Present Value (NPV), and Internal Rate of Return (IRR).</p> Signup and view all the answers

<p>Cash flows are known with certainty, and it is assumed there are perfect and complete capital markets.</p> Signup and view all the answers

<p>The opportunity cost of capital, which is equal to the risk-free rate (T-bill rate).</p> Signup and view all the answers

<p>It is often considered less effective than the other methods for maximizing shareholder wealth.</p> Signup and view all the answers

<p>They represent the cash flows that are available for consumption in a specific time period.</p> Signup and view all the answers

<p>To choose projects that add value to the firm while working with limited resources.</p> Signup and view all the answers

<p>The criteria are: 1) Consideration of all cash flows, 2) Account for the time-value of money, 3) Usability for selecting between mutually exclusive projects, and 4) Allowance for independent project consideration.</p> Signup and view all the answers

<p>The NPV decision rule is the only technique consistent with the maximization of shareholders' wealth as it considers all cash flows and the time-value of money.</p> Signup and view all the answers

<p>The payback period is the number of years it takes to recover the initial investment.</p> Signup and view all the answers

<p>Invest if the payback period is less than an arbitrary cutoff period.</p> Signup and view all the answers

<p>A major disadvantage is that it does not consider cash flows beyond the payback period.</p> Signup and view all the answers

<p>The exact payback period is calculated as: period A + (cum.FCF in period A / FCF in the period after period A).</p> Signup and view all the answers

<p>Cumulative cash flow indicates the total cash flows accumulated up to a certain period, helping to identify when the initial investment is recovered.</p> Signup and view all the answers

<p>The payback method does not account for the time-value of money, ignoring the present value of future cash flows.</p> Signup and view all the answers

<p>IRR represents the discount rate that makes the Net Present Value (NPV) of a project equal to zero.</p> Signup and view all the answers

<p>A project should be accepted if its IRR is greater than the weighted average cost of capital (k).</p> Signup and view all the answers

<p>The IRR method assumes that cash flows will be reinvested at the same rate as the IRR, which may not be realistic.</p> Signup and view all the answers

<p>The IRR method and the NPV method generally lead to similar project accept/reject decisions.</p> Signup and view all the answers

<p>The equation is $NPV = 0 = \sum_{t=1}^{N} \frac{FCF_t}{(1 + IRR)^t} - I_0$.</p> Signup and view all the answers

<p>The cash flow values represent the initial investment and subsequent returns expected at specific time intervals.</p> Signup and view all the answers

<p>The value-additivity principle implies that the combined value of two projects should be more than the sum of individual projects when selected wisely.</p> Signup and view all the answers

<p>Selecting based solely on IRR may lead to choosing a project with a high IRR but potentially lower NPV, failing to maximize shareholder wealth.</p> Signup and view all the answers

<p>It implies that the Value-Additivity Principle is not maintained, affecting the validity of the investment decisions.</p> Signup and view all the answers

<p>Multiple IRRs can occur when cash flows shift signs more than once, leading to different IRR calculations.</p> Signup and view all the answers

<p>Because the project with the highest IRR may not have the highest NPV, leading to potentially incorrect investment choices.</p> Signup and view all the answers

<p>It indicates that the combined value of independent projects should equal the value of their separate evaluations, which may not always hold true.</p> Signup and view all the answers

<p>NPV is less susceptible to the pitfalls of multiple IRRs and considers the time value of money directly.</p> Signup and view all the answers

<p>The key challenge is that cash flow sign changes can yield more than one IRR, complicating the decision-making process.</p> Signup and view all the answers

<p>Combining projects can result in a higher combined IRR that may not represent the best individual project choices.</p> Signup and view all the answers

<p>The IRR assumes reinvestment at the calculated IRR rate, which may not align with the firm's actual cost of capital or market rates.</p> Signup and view all the answers