Finance: 5 questions

Answer the following questions in a small essay format. 1.There has been a trend across corporate America of promoting financial officers to CEO. What are some advantages and disadvantages of this practice? 2.What is your personal discount rate or rate of preferences? I.e. how much would you pay for a promise of $1000 to be received one year from now? Would you discount it by 10%, 5%, etc? 3.Now that you have read about the CAPM, would you ever use it to make personal investment decisions? Consider the following:WHAT IS THE MAIN MESSAGE OF THE CAPM? IT EVOLVES FROM THE NOTION THAT INVESTORS IN GENERAL AREN'T STUPID: THEY DIVERSIFY THEIR INVESTMENT FUNDS INTO A WELL DIVERSIFIED PORTFOLIO. THEREFORE IF ALL ARE WISE ENOUGH, IT FOLLOWS THAT THE 'MARKET' WON'T COMPENSATE PEOPLE FOR NOT BEING SMART ENOUGH TO DIVERSIFY. MORE SPECIFICALLY - THE MAIN MESSAGE OF THE CAPM IS THAT THE RATE OF RETURN ONE SHOULD EXPECT TO EARN ON A PARTICULAR INVESTMENT IS ONLY RELATED TO THE SYSTEMATIC RISK OF THE SECURITY, NOT TO ITS TOTAL RISK. WHEN YOU PURCHASE A STOCK (BECAUSE YOU LIKE IT OR BECAUSE YOU GOT A 'TIP'), YOU'LL BE EXPOSED TO THE TOTAL RISK OF THIS STOCK, BUT THE MARKET THEORY IMPLIES THAT YOU'LL ONLY BE COMPENSATED FOR A SMALL PROPORTION OF THAT RISK. HENCE, IF YOU DO LIKE RISK YOU SHOULD INVEST IN A WELL DIVERSIFIES RISKY PORTFOLIO WITH MANY SECURITIES HAVING A HIGH BETA, RATHER IN AN INDIVIDUAL STOCK. NOW GO BACK TO THE INITIAL QUESTION AND PRESENT YOUR THOUGHTS... 4.How accurate do you think a company's estimates of the net present value of a proposed project are? Refer to both the initial investment and to the components of the cash flow: revenues, operating expenses, depreciation, taxes, and the cost of capital to use for the computation of the present value. Keep in mind that NPV is the value in today's dollars of cash flows to be received some time in the future (just like the gold mine example back in Module 2) minus what we have to pay today to get those cash flows. Which of the following do you think would give you the most accurate NPV calculation: (a) a brand new retail startup (b) a pharmaceutical company introducing a new drug (c) a company with a successful product in Chile trying to introduce it to the USA. 5. Many of the small "dot-com" companies got financing in the form of an instrument called convertible debt. This is like ordinary debt, in that it pays a regular interest amount. But debtholders have the right to convert it to equity. Why do you think these companies chose this instrument? Do you think it was a good idea? Remember: there's no 'free lunch'. If a company offer creditors an option to convert the bond into stocks it must be giving them something of value. It should get something in return... (You may of course browse for 'convertible debentures' on the web)...