1. Financial Management 1
Barbara Pritchard
Principles of Finance: BUS 401
Financial Management
Thomas Biggers
February 7, 2011

2. Financial Management 2
Introduction
In finance, the goal is to create wealth. This is done by providing customers with the best
product and service possible, and it is the market response that determines whether the company
reaches their goal. There are ten principles that form the foundations of financial management
which are: “(1). The Risk-Return Trade-Off- WeWon’t Take on Additional Risk Unless We
Expect to Be Compensated with Additional Return (2). The Time Value of Money- A Dollar
Received Today Is Worth More Than a Dollar Received in the Future (3). Cash-Not Profits- Is
King (4). Incremental Cash Flows- It’s Only What Changes That Counts (5). The Curse of
Competitive Markets- Why It’s Hard to Find Exceptionally Profitable Projects (6).Efficient
Capital Markets- The Markets Are Quick and the Prices Are Right (7). The Agency Problem-
Managers Won’t Work for the Firm’s Owners Unless It’s in Their Best Interest (8). Taxes Bias
Business Decisions (9). All Risk Is Not Equal-Some Risk Can Be Diversified Away, and Some
Can Not (10). Ethical Behavior Means Doing the Right Thing, but Ethical Dilemmas Are
Everywhere in Finance,” (Keown, Martin, & Petty, 2008). These principles weave together
concepts and techniques that will be entailed into the Mini Case being presented in this paper;
helping us to focus on the logic underlying the practice of financial management.

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Answers
A. The objective of capital budgeting is to ascertain whether a company is able to
maximize its value through investment in the most worthwhile projects. Capital
budgeting analyzes whether cash is being most favorable utilize. Capital budgeting
evaluates the appropriateness of an investment. In analyzing a project, the cash flow
generated is the only consideration. Accounting profits do not necessarily show that a
project will be worthwhile to the company. In assessing a project the incremental
cash flows are considered. The incremental cash flow takes into consideration the
time value of money concept. This concept assumes that cash does not have the same
value over two periods.
B. Depreciation is a non-cash deduction from net income. In the normal course of
operations, companies purchase capital equipments for use within the business. The
company is required to allow for the full costs, of the equipment, in its income
statement. However, for most purchases the amount is usually large and for the
company to record such transactions, on the income statement would reduce the
reported income severely. Depreciation helps the company to spread the costs, of the
equipment, over a number for years through amortization. This practice ensures that
the net income does not very much. Deprecation does not affect free cash flow.
C. Suck costs are costs that are not affected by the decision already made. In other
words, a sunk cost is a cost that has already been incurred and its existence is not
affected by the decision to undertake or reject a project. In most capital budgeting
problems, sunk costs are recouped through the project.

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D. The initial capital outlay is the total amount, paid by the company, for a project. This
amount always takes into consideration all amounts spent in starting the project.
Initial Capital Outlay = $7,900,000 + $100,000 = $8,000,000
E. See attachment: Mini Case
F. Terminal Cash flow = $15,980,000
G. See attachment: Mini Case
H. See attachment: Mini Case
I. See attachment: Mini Case
J. If you observe from the calculations, the project has a positive Net present value of
$15,259,582.72. This positive value means that the project would be beneficial to the
company. Although, the Internal rate of return is at 65%. The internal rate of return
represents the maximum rate, with which the project can be discounted, before it
achieves a negative net present value. The project should be accepted.
K. The three major risks, of capital budgeting are:
1. Stand-alone risk: This is the risk involved when a project is considered as the only
investment vehicle for the company.
2. Corporate or Company risk: The overall risk associated that will be attached to the
firm as a result of its investment in a project.
3. Shareholders risk: The risk, incurred by the shareholders, when the company accepts
a project.
L. The CAPM model is a valuation model that assumes that returns it predicated on the
risk of an investment. In using the CAPM model, for evaluating the required return
for an investment, the company assesses the variability of the project cash flows with

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that of either the company’s other projects or similar projects within the industry. The
most used risk measure is Beta. Beta measures the variability of the projects cash
flows, with regard to either the company’s other projects or of similar projects’ within
the industry. The major problem with CAPM is the fact that most times Beta cannot
be accurately measured. Risk is a subjective measure. It can assume different values
for different individuals. The most appropriate measure of risk will then be viability
of cash flows from the expected values.
M. Simulation is the process whereby different5 scenarios are built into the project. The
objective is to find out what happens as these different scenarios occur. Simulation
measures the effect on project risk and return, as different conditions occur. For
example, the company may revise its terminal cash flow in order to ascertain what the
projects NPV will become. Simulation analysis allows the company evaluates
different possibilities and their outcomes. It allows the company to predict any losses
in the future.
N. Sensitivity analysis is the process of ascertaining the changes, in Net present value,
for different changes in project factors. For example the company may be interested
in knowing what happens on NPV for changing discount rates. Sensitivity analysis
answers the question of “What if”.

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Reference
K e o w n , A . J . , M a r t i n , J . D . , & P e t t y, J . W . ( 2 0 0 8 ) . F o u n d a t i o n s o f
f i n a n c e ( 6 t h . e d . ) . U p p e r S a d d l e R i v e r , N e w J e r s e y: P e a r s o n
Prentice Hall.