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FIN 571 WEEK 5 DQs__2 SETS OF ANSWERS

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The idea that we can know the return on a security for each possible outcome is overly simplistic. However, even though we cannot possibly predict all possible outcomes, this fact has little bearing on the risk-free return. Explain why.

 

  • Under what circumstances might the IRR and NPV approaches have conflicting results?

 

  • MusicHeaven, Inc., is a producer of MP3 players, which currently have either 20 gigabytes or 30 gigabytes of storage. Now the company is considering launching a new production line making mini MP3 players with 5 gigabytes of storage. Analysts forecast that MusicHeaven will be able to sell 1 million such mini MP3 players if the investment is taken. In making the investment decision, discuss what the company should consider other than the sales of the mini MP3 players.

 

  • Explain how EBITDA differs from incremental after-tax free cash flows (FCF) and discuss the types of businesses for which this difference would be especially small or large.

 

  • Your friend has recently told you that the federal government effectively subsidizes the use of debt financing (vs. equity financing) for corporations. Do you agree with that statement? Explain.

 

  • Like all other models, the binomial pricing model is a simplification of reality. In this model, how do we represent high volatility or low volatility of the value of the underlying asset?