{[ promptMessage ]}

Bookmark it

{[ promptMessage ]}

FM11 31 - present value basis This $18.79 excess PV belongs...

Info icon This preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
Mini Case: 11 - 31 c. 2. What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted if they are independent? Mutually exclusive? Answer: The rationale behind the NPV method is straightforward: if a project has NPV = $0, then the project generates exactly enough cash flows (1) to recover the cost of the investment and (2) to enable investors to earn their required rates of return (the opportunity cost of capital). If NPV = $0, then in a financial (but not an accounting) sense, the project breaks even. If the NPV is positive, then more than enough cash flow is generated, and conversely if NPV is negative. Consider franchise L's cash inflows, which total $150. They are sufficient (1) to return the $100 initial investment, (2) to provide investors with their 10 percent aggregate opportunity cost of capital, and (3) to still have $18.79 left over on a
Image of page 1
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: present value basis. This $18.79 excess PV belongs to the shareholders--the debtholders' claims are fixed, so the shareholders' wealth will be increased by $18.79 if franchise L is accepted. Similarly, Axis's shareholders gain $19.98 in value if franchise S is accepted. If franchises L and S are independent , then both should be accepted, because they both add to shareholders' wealth, hence to the stock price. If the franchises are mutually exclusive , then franchise S should be chosen over L, because s adds more to the value of the firm. c. 3. Would the NPVs change if the cost of capital changed? Answer: The NPV of a project is dependent on the cost of capital used. Thus, if the cost of capital changed, the NPV of each project would change. NPV declines as r increases, and NPV rises as r falls....
View Full Document

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern