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Chp3_ReviewAnswers - can compare them 6 The Net Present...

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Chapter 3 The Valuation Principle: The Foundation of Financial Decision Making Answers to Chapter 3 Review Questions 1. A decision is a good one when the present value of the benefits is greater than the present value of the costs. 2. When markets are competitive, personal preferences are irrelevant in determining the value of an investment. It is the market price that determines the value of a good. 3. Market prices are useful to a manager because it is the market price that determines the value of a good. When market prices are not available, it becomes more difficult to value an investment. 4. The Valuation Principle helps financial managers make decisions by providing a very specific criterion for the decision process: If the present value of the benefits outweigh the present value of the costs, then make the investment. 5. We can directly compare dollar amounts received at different points in time by discounting all future cash flows back to a present value. Once the future amounts are valued at the present, we
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Unformatted text preview: can compare them. 6. The Net Present Value rule is simply taking the present value of the benefits of an investment and subtracting the present value of the costs. It is doing the cost-benefit analysis using present values. 7. The financial manager should take all projects with positive NPVs. If there are multiple projects with positive NPVs that are mutually exclusive, then the financial manager should take the single project with the highest NPV. 8. The Law of One Price states that goods trading simultaneously in different competitive markets will trade for the same price in each market. This is basically saying that there are no arbitrage opportunities for the goods in these markets. Alternatively, one could say that arbitrage trading eliminates any mispricing between the markets, thus resulting in the Law of One Price....
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