This is a Finance bLOG, which is affectionately called a FLOG. This FLOG provides a medium for students to post questions about topics that are covered in the Principles of Finance (FIN 3403) course that is offered at the University of South Florida. Various questions and responses are used as input for an FAQ for the course that is updated regularly. The FAQ helps students to better understand the concepts presented in the course, and thus to perform better on assignments and exams.
The Web page for the Principles of Finance course is located at http://www.coba.usf.edu/besley/fin3403/home.html.
February 21st, 2008 at 12:52 pm
Why is it generally better to use the NPV technique to evaluate a capital budgeting project rather than the IRR technique?
February 21st, 2008 at 1:06 pm
The NPV technique provides an indication as to how the value of the firm will be affected if it purchases (invests in) the capital budgeting project that is being evaluated. For example, purchasing a project that has an NPV equal to $450 will increase the value of the firm by $450 in present value terms. The primary goal of the firm should be to maximize value, and the NPV technique provides information as to how well this goal is accomplished when capital budgeting decisions are made.
May 13th, 2008 at 8:34 pm
This is just a general finance question. I am considering buying a house in the next year or two. I have noticed that amount you are allowed to borrow depends on your income and your long-term debt. How exactly is long term debt classified? Are credit cards and student loans classified under long-term debt? And do they affect the amount you are allowed to borrow? Just curious.
May 16th, 2008 at 11:14 am
When banks and other lenders lend money, their primary concern is whether they believe that the borrower will be able to “handle” the debt. As a result, the lender tries to estimate how likely it is that the potential borrower will be able to meet all of the terms of the lending contract—that is, make the payments when due. To make this estimate, the amount of outstanding debt that a person has is considered when the lender determines how much that person can borrow and at what rate he or she can borrow. When borrowing to buy a house, a lender generally examines a person’s long-term debt position more carefully, because a mortgage is a long-term commitment and lenders want to determine whether the potential borrower will be able to handle the additional debt long into the future. The general rule of thumb is that loans with contracts that require payments over long periods (greater than a couple of years) are considered long-term debt. Although credit card debt generally is not classified as long-term debt, lenders examine “card usage tendencies” of borrowers when making decisions about whether to grant mortgage loans (or any other types of loans). Everything else equal, a person who generally has large balances outstanding each month is not considered as good a credit risk as a person who pays his or her credit card purchases in full each month. In most cases, lenders use credit scores of individuals that are calculated and published by various credit agencies to help make lending decisions. It is a good idea to know your credit score, and, if necessary take actions to improve it.
March 4th, 2009 at 7:36 pm
Are there ever circumstances in which a buyer of a big-ticket item like a car or house would be better off borrowing, even if she has the cash available? If the buyer can invest the money at 6% (if they forgo paying cash), and the bank has offered her a 5% loan, wouldn’t it make sense to invest the money and pocket the 1% difference over the payback period of the loan?
Also, what is a reasonable average return on a diversified stock portfolio for the long-term (half a century, or so)?
March 5th, 2009 at 10:02 am
Your logic is correct. If your investment opportunity cost is greater than your borrowing cost, you should borrow. Many people who win lottery jackpots want to immediately pay off their mortgages. Before doing so, however, they should consider what investment opportunities they have relative to the cost of the mortgage. For example, if you win money in a lottery, the interest rate on your home mortgage is 4 percent, and the financial markets are performing well, then it is probably better for you to invest most of the winnings rather than pay off the mortgage.
During the past 50 years, the average return on stocks was between 8 percent and 11 percent, depending on which market index was used for the computation.
March 27th, 2009 at 8:48 pm
I have a question regarding the government bailout. What would happen without a bailout? Bernanke talks a lot about systemic risk and institutions that are “too big to fail,” but do such things present legitimate concerns? What are the tangible effects of systemic risks on Main St? It seems to me like the assignment of a dollar cost to not bailing out these institutions is extremely arbitrary, and it may be worth the risk to not pay out nearly a trillion dollars. Also, what proportion of funds that the government appropriates to stimulate the economy actually make it that far? Does research prove that this Keynesian economic thought has positive long-term effects?