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Fluctuating Present Value Of A Cash Flow Finance Essay

Paper Type: Free Essay Subject: Finance
Wordcount: 3219 words Published: 1st Jan 2015

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Answer: – A cash flow stream is a series of cash receipt and payments over the life of an investment. It is the inflow and outflow of cash, which matters in practice. It is the cash, which a firm can invest, or pay to creditors to discharge its obligations, or distribute to shareholders as dividends. The assets are the items which are owned by the business. The level of interest rates arising in the capital market is associated with the cash flows `and the assets , when the rates increases , the availability of the funds decreases. As a result when the interest rates increase in the capital market, the obligation increases which leads to decrease in the availability of funds to invest in the investments. The present value of cash flow is equal to the sum of the present value of individual cash flows. The equation for present value of cash flow stream is as follows-



PV=present value

r= rate of interest

t= the year

n= the last year, where the cash flow occurs

Interest rate is the rate at the interest is paid by the lender to the borrower for use of money by the borrowers from the lenders. So, the rise in the interest rates , the availability of cash flows streams due to higher rate of interest , the present value of cash flow streams will decline.

2. List and explain the points of financial impact on a company if it

raises the credit standards required of its customers who utilized trade

credit offered by the company.

Answer: – Credit standards are the criteria to decide the types of customers to whom goods could be sold on credit. If the firm has more slow-paying customers, its investments in accounts receivable will increase. Trade credit refers to the credit that a customer gets from providers of goods in the normal flow of business. In practice, the buying firms do not have to pay cash immediately for the purchase made .This deferral of payments is a short term financing called trade firms. The credit standard policy has significant impact on the financial condition of a company-The following are the financial impact on a company due to rise in credit standard .

Decrease in credit sales- A rise in credit standards will have a limit on the buyers who will borrow from the company and as a result the sales will decrease as most of the buying firms do not pay cash immediately. This will lower the sales of the company leading to less in revenue generation.

Decrease the demand-The rise in credit standards will lower the demand by the buyers which will lead to decrease in demand and decrease in revenue earning.

Relatively faster average collection period- A rise in credit standards will make the average collection period relatively faster for the new customers leading to better collection process and increase in volume of cash in inflow.

Prompt in collection by existing customers- The rise in standard will pull the collection by the existing customers and make the payments from them prompt and on time.

Better return on investment- The rise in credit standards will lead to better return on investments made and credit allowed will be selected as the customers will be prompt in payments and the selection of the customers will be limited.

3. Define Weighted Average Cost of Capital and explain why a company must

earn at least its Weighted Average Cost of Capital on new investments.

What are the financial implications if it does not?

Answer:- Weighted average cost of capital is organisations the calculation of cost of capital where each category of capital is proportionally weighted .A firm obtains capital from various sources due to the risk differences and contractual agreements between the firms and the investors, the cost of capital of each source of capital differs The cost of capital of each source of capital is component source of capital. The component costs are combined according to the weight of each component capital to obtain average cost of capital. The combined cost of all source of capital is called overall cost which also known as weighted average cost of capital. Thus, it is the overall return that firm must earn on its existing business operation in order to maintain or increase the current value of current stock. A company must earn at least weighted average cost of capital in new investments. By taking weighted average, the interest to be paid by the company for a investment is calculated. Weighted average cost of capital is the expected rate of return, weighted by proportion each to the overall financial structure. The minimum rate of return on the new investments must be earned so as not to reduce the shareholders. A firm should earn at least its average weighted rate on capital investment in its assets the weighted average cost of capital is used a discount rate to calculate the present value of the of a specific investment. If the firm does not earn the least average weighted cost of capital in its new investments, the firm will incur loss in that new investment, and so it should discontinue or should not invest further. The average weighted cost of capital is the minimum expected rate of return from an investment, so it should be calculated first and then the decision for the investment should be made.

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4.As a corporation what are the benefits and ramifications of using

convertible debt to finance a publicly traded company? As an investor what

are the benefits and ramifications of purchasing convertible debt in a

publicly traded company? Are there any conflicts between the goals of the

investor and the goals of the corporation?

Answer:- Convertible debt are the debts like bonds and debentures with an option to convert it into common stock in future date.

The following are the benefits and ramifications of using convertible debt to finance a publicly traded company:-

Attractions for the investors:-convertible debts will attract investors by providing safety of debt along with the option to convert it into common stock in future. The investors will lend money to the company with the view that the company will make regular interest payments and the return of capital. If the company achieves growth in future and the stock value increases, the investors has the option to convert it into common stock.

Lesser fixed-rate borrowing cost-Convertible debt will allow the issuers to issue the debts at lower cost.

Increase in total debt gearing -The convertible debt will increase the total amount of debt level in the company .It will provide additional funding to the company which will be beneficial to the issuers.

Financing option- The convertible debts are good financing option for start up companies as equity shares pose a challenge for them. As the convertible debts carry low interest payments by the company, while remaining competitive.

Fixed limited income- The convertible debt holders obtains fixed limited income until its conversion and it will benefit the company because more of operating income is available for the common stock holders.

Voting solution is deferred- With the convertible debts, the voting rights of existing shareholders happens only on eventual conversion of debts.

Ramifications of convertible debts to company-

There are some complications for issuers as well .First one , is that financing with convertible debts draws the risk of debasing not only the EPS of its common stock, but also the control of the organisation. If a heavy part of the issue is purchased by one buyer, like investment banking company or insurance company, conversion will change over or take over the voting control from original owners of the company and toward the converters. This issue may not be a significant matter for bigger companies with millions of stock holders, but for the small company, it will be a real and important consideration.

Due prominent use of debt will adversely affect a company’s capability to finance operations in clips of economic downturn. If the company faces any downfall, it will experience great trouble in raising capital further.

The following are the advantages and ramifications to the investors.-

Safer investment -The convertible debts are the safer investment compared to buying common stock with returns They are less explosive than stocks and their value can only come down to a price where the yield would be equal to a non-convertible bond of the same terms.

Strong protection- The convertible debts provide strong protection to the investors in the times of market fluctuations and at the same time providing periodic returns.

Interest payments-The convertible debt holders have a right on the receiving of interest and periodic returns in spite of any downturn in the market.

Larger claim on company’s assets – Convertible bond holders have a larger claim on the assets of the company as compared to the shareholders in case of collapse.

More protection from economic downtrend- The convertible debt holder will have a gain during the economic downtrend due the option of conversion into equity shares. As a result, the market stock of share stocks will increase with market prices dissimilar for the debts where the interest rates are fixed. This means that bond holders will gain as during inflation because his money looses value more.

Ramification to the investors-

Convertible debts could have complication in the view that the debt holder will be obtaining considerably lower yield to maturity in comparison to the non-convertibles. But it is only a worry when the issuer’s equity does not gain the upward price predictions that would make taking the lower grant speculation worthy.

Finally, the ability for predictions are reduced to a great extend when a call provision is bonded to the convertible bond. This will limits the upside and will let the debt holder to declare their debt at a discount to market.

The goals of an investors towards the convertible debts is to invest in debts at lower cost and gain fixed returns whereas the goal of a issuing company is to achieve higher operating income with lower borrowing cost.

5) Which two of the six methods used to evaluate projects, and to decide

whether or not they should be accepted, do you prefer as a financial

manager?  Explain why you decided on these two and not the other four.

List the perceived deficiencies of the four not selected.

The six methods which are used to evaluate projects, and to decide whether or not they should be accepted are as follows:-

Investment decisions for a project evaluation postulate special aide due to the following reasons

The projects influence the long term growth of the firm.

The decision for a project will affect the risk factor of the firm

Evaluation of the project is an important tool as it involves commitment of large amount of finances or stocks

They are one of the most difficult conclusions to arrive at.

The six methods are as follows:-

Accounting rate of return (ARR)

Internal rate of return (IRR)

Net Present Value (NPV)

Payback Period

Profitability index

Modified Internal rate of return

Accounting rate of return

ARR is also referred as Return on investment (ROI), as it uses the information of accounting revealed by the financial statements, to measure the gainfulness of an investment. The calculation of ARR involves the ratio of the average tax after profit divided by the average investment done


– it can be calculated in a lot of ways

– profit is not a good alternate option for cash flow

– adjustment is not considered to calculate the time value of money

– Impulsive break-off date

– Contrary decisions can be made.

Net Present Value

NPV is the method of measuring the investment proposals. It is the discounted cash flow technique that explicitly acknowledges the time value for money. It rightly takes that cash flow coming up from various time periods differ in values and are comparable only when their corresponding present values are taken out.


Says if the finances invested will increase the firm’s value

Takes into account all the cash flows

Takes into account the time value of money

Takes the risk of future cash flows.

Profitability Index

The profitability Index is the ratio of present value of cash influxes to the initial of cash outlay of investment at a required rate of return


Says if the finances invested can increase the firm’s value

Takes into account all cash flows of the project

Takes the time value of money

Takes the risk of future cash flows

Provide ranking and selection of projects when capital is rationed out.

Internal Rate of Return (IRR)

IRR is the way of DCF(Discounted Cash Flow), which takes into consideration the intensity and timing of cash inflows and outflows. The concept of IRR is quite simple to understand in the case of a one-period project.


It needs to have a projection of the COC (Cost of Capital) to make a decision

The given value-maximizing decision when used to compare mutually exclusive projects may not give the proper decision

The given value-maximizing decision when used to choose any projects when there is capital rationing may not give the proper decisions

It’s not useful in the situations in which sign of cash flows for a project changes more than once during the life of the project.


Payback is the number of years needed to retrieve the original cash expenditure invested in a project. If the project yields constant annual cash influxes, the computation of payback period is carried out by dividing cash outlays by the annual cash influxes.


1) the decision criteria is not that concrete to show if an investment increases the firm’s value

2) Refuses the cash flows beyond the payback period

3) Refuses the time value of money

4) Refuses the risk of future cash flows

I will take into consideration the Net present value and the profitability index for the consideration of two of the techniques for the project which will be undertaken due to the advantages which has been described above. I dint find much disadvantages in those methods and so I have given the advantages of those two methods which will be taken under consideration by me, the other methods I dint find of much worth in respect to evaluation for the concerned project as they have less advantages and more disadvantages and so I have written the same above for them.

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6.What are the benefits and costs of placing a financially troubled

company into a Chapter 11 Bankruptcy proceeding? Is this a legitimate and

ethical vehicle for management to use for the benefit of the company’s


A)  Bankruptcy is a legal process for financial debtors who seek to eliminate their debts. Bankruptcy’s governs the federal statutory law which is there in the Title 11 of the U.S. Code. It provides for federal procedures of statutes and courts which objects the debtors to put their financial matters under the hold of the bankruptcy court.

Chapter 11 Bankruptcy

Chapter 11 bankruptcy says to restructure a business under some kind of supervision, rather getting liquidated because the business will still be functioning, but in case of a whole new different circumstances, the benefits of the retirement may or may not be ceased.

Protection Benefits

Federal law entitles a person to get pensions with some protection. When an employee announces himself to be bankrupt, finances for pensions are not to be utilized for the repayment to creditors. Also, all the retirement benefits you have earned being an employee will not be enforced to him.

Federal Insurance

The federal government assures standard and effective retirement plans. Any employer who cannot fund Federal government will fund temporarily. This type of insurance is not eligible for 401(k) plans.

Chapter 11 Bankruptcy is the most costly anatomy of Bankruptcy in respect to average cost front. It is the most expensive form of bankruptcy and the small businesses should also take this into consideration before filling the bankruptcy. It is expensive as it involves two separate elements which are debt repayment plan and reorganization plan a. The reorganization plan means the person has to convince the court and the debtors that you can put in profit very soon which should be detailed and supported by proper research wherein you have to show a budget through which you need to assess how you are going to pay your creditors in the next several years. It’s a process wherein you have to negotiate the same with the creditors and the court. A minimum of $15,000 have to be paid if there is no disputes and expensive attorneys over your reorganization plan but for Chapter 11 bankruptcy it will exceed to $ 100,000 and also this amount can vary depending upon the attorneys and disputes filed by the creditors.

I understand that its not an ethical and legitimate step for the stakeholders but when there is no words to express the matter in concern and already the things have gone wrong and worse there can be few things which, if kept in mind can at least fetch some benefits for the stakeholders

Filling in Court

This is the first way when you can file in the court for a recovery notice wherein you owe the creditors and attorneys that you will come up with the company in a stipulated years of time and also by paying a fees for the time being just to show a courtesy to the creditors and the attorneys.

Cost Minimization

In this approach, an effort to minimize the cost of Chapter 11 Bankruptcy can be exercised while it may not work in most cases. The matters can be sorted out with the help of an attorney a fee agreement which would imply that most of the paper work preparation planning and filling must be carried out by the concerned person and he would simply pay his attorney to act as a legal coach in case of any need or questions. Most of the attorneys may not accept this type of payment agreement due to the complexity of plan of Chapter 11.


The rate of success in Chapter 11 bankruptcies is exceedingly low, which means that a very small percentage of reorganization plans will actually obtain approval from the court. As without the approval the plan will be worthless. There will be higher chance of spending lot of money and putting together a plan along with creditors negotiation and attending to win approval from the court, but this could be a failure too.


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