Discounted Cash Flow Formula
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CPA Auditing and Attestation (AUD) › Discounted Cash Flow Formula
Future payments must be discounted in a bond valuation in order to take into account the:
Expected interest rate on the coupon payments
Fact that the bond was sold at a premium
Time value of money
Difference between the market rate of interest and the coupon rate
Explanation
The process of accounting for time value of money is discounting.
The discount rate is determined in advance for which of the following capital budgeting techniques?
Net present value
Payback
Accounting rate of return
Internal rate of return
Explanation
In order to work with net present value, a discount rate must be calculated.
Using the discounted cash flow method, estimate the cost of retained earnings for a firm with a stock price of \$30, an estimated dividend at the end of the first year of \$3 per share, and an expected growth rate of 10%.
20%
11%
21.10%
12.20%
Explanation
$3/$30 + 10% = 20% Cost of retained earnings.
The length of time required to recover the initial cash outlay of a capital project is determined by using the:
Payback method
Net present value method
Discounted cash flow method
Accounting rate of return
Explanation
The payback method measures the time required to recover the initial investment.
Which of the following statements is true regarding the payback method?
It is the time required to recover the investment and earn a profit.
The salvage value of old equipment is ignored in the event of equipment replacement.
It is a measure of how profitable one investment project is compared to another.
It does not consider the time value of money.
Explanation
The payback method determines the number of years that it will take for a company to recoup or be paid back for its investment. The payback method does not consider the time value of money.
Which of the following phrases could be used to describe the Discounted Cash Flow formula?
Cost of debt
Cost of retained earnings
Cost of cash flow
None of the answer choices are correct
Explanation
The Discounted Cash Flow formulas involving dividends, price, and growth is also known as the cost of retained earnings.