Briefly discuss why financial decision makers must focus on incremental cash flows when evaluating new projects.
Answer: Incremental cash flows describe the total cash effect on the company, looking at the difference between total cash flow to the company with the cash flow, and without the cash flow. The company can then value these cash flows and see if the company is worth more with the project or without the project.
Discuss the risk/return tradeoff and how it relates to finance.
Answer: As people are risk averse, they need a higher return as the risk gets higher. This means that investors will need a higher return on bonds that they do not consider to be as safe as other bonds, and they will need a higher return on stock when the company in question's stock seems to be riskier than the stock of other companies.
Why do you think many companies compensate executives with options based on long-term increases in the value of the company's stock?
Answer: Tying executive compensation to long-term increases in the stock price makes sense because they are supposed to be working to maximize shareholder wealth. Stock-based compensation plans imply that decisions made to benefit shareholders will also benefit themselves.
