Question

1) What is incremental cash flow?

2) Accounting income is used to evaluate the projects. True or False? Please explain.

3) Sunk cost must be considered when evaluating projects. True or False? Please explain.

4) What is an opportunity cost? How do we use opportunity cost in project evaluation?

5) What are the problems with estimating the beta?

6) What are the disadvantages of using dividend discount model?

Answer 1

1)The additional increase or decrease operating cash flow in a company's cash flow due to the acceptance of a new project or investment in a new project or investment in a new asset.

2) True, Accounting income is used to evaluate the projects.

Accounting income is a key point in calculating the cash flow of a Project. From there the changes in cash flow due to various fuctions and operations are computed to find the net change in cash in any given period.

3) False,Sunk cost must not be considered while evaluating projects.

These are cost that have already inccured and cannot be recovered in any way and should not be considered in evaluating a project.

4)The possible benefits an individual, investor, or business likely to miss out while selecting one alternative/option over another option of projects is reffered to as Opportunity Cost.

Use of Opportunity cost while evaluating a company should look into the expected return of the investment when compared to the opportunity cost and these also provide the expected returns of an alternative investment of the same risk.

5)

According to the CAPM "beta" is always positive.So,If beta is zero, then according to the model, the required rate of return should be equal to risk free rate which is not rationally always possible.

6) Disadvantages of DDM are:

- whatever may be the captial gains, DDM cannot  be used to evaluate stocks that don't pay dividends.

- DDM requires a lot of assumptions such as growth rate,the required rate of return,tax rate etc.

- DDM always misses or ignores the effects of stock buybacks,which can make a large differences between the stock value that is being returned back to share-holders.