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Fundamentals of Corporate Finance

WEEK 4 ASSIGNMENT 1 1 Week 4 Assignment 1 Edwin Lopez-Petrilli Professor William Hall Fundamentals of Corporate Finance Tuesday July 26, 2011 WEEK 4 ASSIGNMENT 1 2 Explain why market prices are useful to a financial manager. Financial managers are tasked with making investment decisions, financing, and managing cash flows from operating activities therefore when prices from competitive markets determine the cash value of goods and the price determines the value of the goods.

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Financial managers must be able to evaluate costs and benefits in order to make the right decisions that benefit the organization. When market prices are used to evaluate the costs and benefits, in terms of cash on hand now, the determination is the best decision for the organization. This makes the organization and its investors profits, because the value of its benefits exceeds the value of its cost. Discuss how the Valuation Principle helps a financial manager make decisions. . The task of every financial manager is to make educated decisions on behalf of the investors and shareholders.

Managers in these positions are faced with questions regarding investments, production, etc. ; each and every day. It is too often that within an organization, a propose idea that sounds good at the time but may not be of benefit. It is the job of the financial managers to break the idea down into detail to analyze the cost and benefits, and then make a decision based on concrete numbers. The process is the Valuation Principle, an analysis between the value of the cots and the value of its benefits. It provides a basis for making decisions within a company.

In a competitive market in which the good(s) can be bought and sold at the same price, the value of a good(s) is set by its price, and any personal opinion or preference is irrelevant when determining value. WEEK 4 ASSIGNMENT 1 3 Describe how the Net Present Value is related to cost-benefit analysis. . Cost-benefit analysis (CBA), sometimes called benefit-cost analysis (BCA), is an economic decision-making approach, used particularly in government and business. CBA is used in the assessment of whether a proposed project, program or policy is worth doing, or to choose between several alternatives.

It involves comparing the total expected costs of each option against the total expected benefits, to see whether the benefits outweigh the costs, and by how much. In CBA, benefits and costs are expressed in money terms, and are adjusted for the time value of money, so that all flows of benefits and flows of project costs over time (which tend to occur at different points in time) are expressed on a common basis in terms of their “net -present value. ” CBA usually tries to put all relevant costs and benefits on a common temporal footing using time value of money formulas.

This is often done by converting the future expected streams of costs and benefits into a present value amount using a suitable discount rate. Explain how an interest rate is just a price. Money like any other good can be bought and sold with a supply and a demand, interest rate is the equivalent of the price of that good over a period of time. When money is borrowed, interest is typically paid to the lender as a percentage of the principal, the amount owed. The percentage of the principal that is paid as a fee over a certain period of time is called the interest rate (price).

Therefore interest is the price paid over a period of time for the acquired good(s) now. In economics, interest is considered the price of credit. WEEK 4 ASSIGNMENT 1 4 Describe how a bond is like a loan. A bond is like a loan: the issuer is the borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds provide the borrower with external funds to finance longterm investments, or, in the case of government bonds, to finance current expenditure. Bonds must be repaid at fixed intervals over a period of time.

A bond is a debt security, in which the authorized issuer owes the holders a debt depending on the terms of the bond, is indebted to pay interest (the coupon) and/or to repay the principal at a later date, termed maturity. A bond is a formal contract to repay borrowed money with interest at fixed intervals. Just like borrowing money for any purpose there’s a term and an interest that is paid for the use of that good. WEEK 4 ASSIGNMENT 1 5 References Berk, J. , DeMarzo, P. , & Harford, J. (2009). FIN100:Fundamentals of corporate finance: 2010 custom edition. New York, NY: Prentice Hall.

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