MGT 201 Financial Management - 2

Short term interest rates are generally lower than long-term rates because they reflect the current market conditions and the overall economic outlook. In the short term, there is often more uncertainty and volatility in the market, which leads to lower interest rates. Long-term rates, on the other hand, take into account expectations for future economic conditions and inflation, which tend to be more stable. Therefore, it is true that short-term interest rates are generally lower than long-term rates.

The correct formula for calculating simple interest is FV = PV + (PV x i x n). This formula takes into account the principal amount (PV), the interest rate (i), and the time period (n) to calculate the future value (FV). It accounts for the initial investment (PV) and adds the interest earned over the given time period.

The correct answer is Option A & B. Default Risk Premium is charged by the investor as compensation for the risk that the company might go bankrupt and the risk of default interest payments. This premium is an additional return demanded by investors to compensate for the higher risk associated with investing in a company that may default on its obligations. By charging this premium, investors are protecting themselves against potential losses in case of default or bankruptcy.

Sovereign Risk refers to the risk of government default on debt because of political or economic
turmoil, war, prolonged budget and trade deficits. This risk is also linked to foreign exchange (F/x),
depreciation, and devaluation. Now-a-days the individuals as well as institutions are investing billions
of rupees globally.

Sunk costs:
Sunk costs need to be excluded while calculating the incremental cash flows. Sunk
costs are the costs that have already incurred in the past. Whether you decide to invest your
money in the new project or not, the sunken costs cannot be recovered. For instance, if a
company has purchased an import/export license and a few years after the company decides to
export a certain commodity, the cost incurred to purchase the license would not be included in
the cash flows. Whether the company decides to undertake the new export project or not, the
license fee cannot be recovered

Opportunity costs relevant to the cash flows of the project
Suppose you are to invest in a new project, a small production unit with 4 weaving looms. You
would also need to have a piece of land where the machinery would be installed. Suppose
further, that you already have that piece of land. While calculating the NPV for the project, you
would have to include the value of the land that you are using. Although you are not buying that
land, but that land has a certain market value. You could have sold that land at the market price
and by not doing so you are incurring an opportunity cost.

formula to calculate the continuous interest Rate
Fv = Pv*e^(n*r)
where e is constant having value of 2.718
Fv = (100)* (2.718)^(.05*5) = 128.40

In case of Simple Interest, the interest incurred in one year is not added to the principal. Instead, the interest is calculated only on the original principal amount. This means that the interest remains constant throughout the duration of the loan or investment. Unlike compound interest, where the interest is added to the principal and then interest is calculated on the new total, simple interest does not take into account any previous interest earned.

When calculating the net incremental after-tax cash flows, it is important to include the incremental effect of externalities, whether they are negative or positive. This means that any additional costs or benefits resulting from external factors that impact the project should be taken into account. By considering both positive and negative externalities, the calculation will provide a more accurate representation of the project's overall financial impact.

Abnormal or downward sloping yield curve:
Sometimes, the reverse is true. This is known as the Abnormal (or Downward Sloping) Yield
Curve. It is the case where the short term raters are higher than long term interest tares. You can also
have a mixed or Humped Back Curve

The Net Present Value (NPV) is a capital budgeting technique that uses the formula mentioned in the question. NPV calculates the present value of expected cash flows by discounting them at a desired rate of return. It considers the time value of money and determines whether an investment will result in a positive or negative value. A positive NPV indicates that the investment is profitable, while a negative NPV suggests that the investment may not be worthwhile. Therefore, NPV is the correct answer in this case.

nominal interest rate or nominal rate of interest refers to the rate of interest before adjustment for inflation (in contrast with the real interest rate); or, for interest rates "as stated" without adjustment for the full effect of compounding (also referred to as the nominal annual rate). An interest rate is called nominal if the frequency of compounding (e.g. a month) is not identical to the basic time unit

Option "C"is incorrect it is related to default risk premium instead of MR

Net present value (NPV) is considered the most important criteria for selecting a project in capital budgeting because it directly relates to shareholders' wealth maximization. NPV takes into account the time value of money by discounting cash flows and compares the present value of cash inflows to the present value of cash outflows. A positive NPV indicates that the project is expected to generate more value than the initial investment, leading to an increase in shareholders' wealth. Therefore, selecting projects with a positive NPV helps in maximizing shareholders' wealth.

In business when we talk
about the interest, we usually refer to nominal rate of interest which is determined with the help of
following factors.
Factors
– i = iRF + g + DR + MR + LP + SR

Cannibalization in marketing and strategy refers to the reduction in sales revenue or market share of one product when a new product is introduced by the same producer. This means that the new product is taking away customers and sales from the existing product, resulting in a decrease in its revenue and market share.

The objective of financial forecasting is to reduce the uncertainty associated with future financial outcomes. By accurately predicting future financial events, businesses can make informed decisions and minimize the risks involved. This allows them to plan for contingencies and emergencies, prepare for future opportunities, and potentially reduce costs associated with responding to unexpected situations. Therefore, reducing uncertainty is not an objective of financial forecasting, as it is actually the main goal.

There are three types of documents that are to be prepared while making a financial plan. These are
1) Cash Budget
2) Pro Forma Balance Sheet
3) Pro Forma Income Statement

The percentage of sales method is a simple forecasting method because it involves using a fixed percentage of past sales to estimate future sales. This method is easy to understand and implement, making it a straightforward approach for forecasting. It does not require complex calculations or extensive historical data analysis, making it suitable for businesses that do not have access to detailed financial information or sophisticated forecasting tools. Additionally, the percentage of sales method can provide a quick estimate of future sales, allowing businesses to make informed decisions and plan accordingly.

The techniques of capital budgeting that do not consider the time value of money are Return on Investment (ROI) and Payback Period. ROI is a simple measure of profitability that calculates the ratio of net profit to the initial investment without taking into account the timing of cash flows. Payback Period also ignores the time value of money by measuring the time required to recover the initial investment without considering the present value of future cash flows. On the other hand, Profitability Index (PI), Net Present Value (NPV), and Internal Rate of Return (IRR) all consider the time value of money by discounting future cash flows to their present value.