Question 3 In your own words describe the concept of Opportu

Question 3: In your own words, describe the concept of \"Opportunity Cost\". How does Opportunity Cost factor in to your choice of discount rate? Please provide a real-world, non-financial example of Opportunity Cost that you encounter in your day-to-day life. Question 4: What will the yield be on the 5-year U.S. Treasury Note 5 years from now? What generalization can you make about the shape of the U.S. Treasury Yield Curve and the direction of interest rates?

Solution

1) Opporutinity cost refers to the benefit lost from next best alternative. It basically refers to the fact that in order to consume one thing, what is the next best thing i have to sacrifice. Opportunity cost should be considered as a good measure of discount rate because, it gives us the detail that it is the minimum rate of return that is required. One example of opportunity costis the investment in Bonds over Equity shares.

2) Interest rates are supposed togoup from now,considering the rise in inflation & decrease in unemployment. It will be an upward sloping curve.

3) While calculating FREE cash Flow, interest payments are not included because Free Cash Flow basically refers to Cash Flow for the firm, & Interest payments should not be subtracted because bond holders or Debenture holders or Lenders are also part of the company. Depreciation is a tax deductible expense , so it is deducted for tax purpose but to calculate the returns in csh,it needs to be added back. NWC represents assets & if it increases, it means more money is blocked in stock, debors which means that cash is still stuck & the profit figure isnt correct.

4) In case of mutually exclusive projects, the CEO needs to check the NPV of the projects & determine which project he needs to select. In case there are sufficient funds to do all 3 projects then all 3 projects should be done. IRR is also an important measure to select the projects, & it serves he same purpose as served by NPV.