W1: Fundamental Principles & Time Value of Money

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Select one question to analyze. Referring to the three fundamental principles and three precepts of finance below, integrate a principle, a precept, or both in your response. In addition, integrate 1-2 external credible references to support your thoughts.

W1: Fundamental Principles & Time Value of Money

Contains unread posts

Select one question to analyze. Referring to the three fundamental principles and three precepts of finance below, integrate a principle, a precept, or both in your response. In addition, integrate 1-2 external credible references to support your thoughts.

• FP1: The value of any asset is equal to the present value of the cash flows the asset is expected to produce over its economic life.
• FP2: There is a direct relationship between risk and return; as perceived risk increases, required return will also increase (and vice versa), holding other things constant.
• FP3: There is an inverse relationship between price and yield; if an asset’s price increases, its return will decrease (and vice versa), holding other things constant.

• PR1: The present value of a cash flow (or an asset) is inversely related to its discount rate; increasing the discount rate decreases the present value (and vice versa), holding other things constant.
• PR2: The timing of the cash flows of an asset is important; sooner is better (later cash flows are more heavily discounted, reducing their present value).
• PR3: The present value of a cash flow (or an asset) is inversely related to its perceived risk; the higher the risk, the higher the discount rate, and therefore the lower the present value.

1. The marketing manager at your firm shows you an analysis he performed of a new production process that he believes will reduce production costs and show a slight profit after taking into account the cost of operating the new technology. While the marketing manager believes the project is of average risk, you believe the new technology is riskier than the projects the firm normally invests in. How will this affect your evaluation of the new technology?

2. You win a lottery that pays $5,000 per month for 20 years, starting today. You have the option of taking a lump sum today instead of the monthly payments. The lottery people tell you that, if you take the monthly payments, the money you won is expected to earn 7.25% APR, compounded monthly, for the entire 20 years it will be invested. Given these data, what is the lump sum you would expect to receive today? Discuss the pros and cons of receiving a lump sum or monthly payments?