Concepts: BEP and TIE, Annuity vs. Annuity due, Loan Amortization, Present and Future Value
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b. Briefly discuss the concept of relevant cash flows when evaluating a new project.
1- Explain the relationship between (i) discount rate and present value, and (ii) compound
rate and future value.
2- Why is the future value for an annuity due always higher than that of an ordinary
annuity?
3- Although the payment made on an amortized loan is constant, it can be decomposed
into two components. What are the TWO (2) components? Describe the patterns of each
component over time.
4- Your company has recently announced that its net income was lower than last year.
However, analysts found that the company's net cash flow increased. What factors could
explain this discrepancy?
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Solution Summary
This solution provides conceptual explanations on basic earning power, times interest earned ratio, present value, future value, annuity, annuity due, loan amortization, and net cash flow.
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588427 Cash Flow
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b. Briefly discuss the concept of relevant cash flows when evaluating a new project.
The project cash flows are the incremental cash flows of a proposed new project. The relevant cash flows include the initial investment and required other investments at the beginning or during the project, the annual cash inflows and outflows, depreciation if applicable, and the cash flows at the end of the project. All cash flows are discounted to the present, using the appropriate discount rate, to find the net present value (NPV).
Basic Earnings Power Ratio (BEP) is calculated by dividing earnings before interest and taxes (EBIT) by total assets. This ratio shows the earnings power of the firm's assets before the influence of taxes and interest expense.
Times interest earned ratio (TIE) is determined by dividing earnings before interest and taxes (EBIT) by the interest expenses. This ratio measures the extent to which operating income can decline before ...
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