1: Investment Decisions Flashcards
What are the 4 aspects of environmental costing?
Environmental protection costs
Environmental appraisal costs
Environmental internal failure costs
Environmental external failure costs
Two types of capital rationing
Hard - externally imposed limits on funds available
Soft - internal constraints eg budgets
7 key drivers of value in shareholder value analysis (SLOWCAT)
S - Sales growth rate
L - Life of projected cash flows
O - Operating profit margin
W - investment in Working capital
C - cost of Capital
A - investment in non-current Assets
T - corporation Tax rate
After regearing a beta to consider a new decision, what does a higher WACC indicate?
The systematic risk of the (diversification of whatever in Q) is greater than the existing business because the WACC is higher (or vice versa)
What is the reasoning for regearing a beta
The discount rate should reflect the systematic risk of the project
and the financial risk of the company.
Define pecking order
Due to issue costs, firms try to access equity finance in a particular oder:
RE
Rights issues
New issues
Define M&M theory
Dividend policy is irrelevant and dividends do not increase shareholder wealth long term, firms should seek positive NPVs
Define dividend signalling
Pattern of dividends is a key consideration for investors, eg, growing dividends signals greater confidence
Define clientele effect
Investors may be attracted to firms for their dividend policy eg high dividend policy attracts those who prefer high current income vs low for tax cover
Define cash part of M&M theory
If cash is unavailable to pay a dividend, find cash from other projects or borrow to pay, in order to avoid adverse signalling
Define traditional theory
As a firm introduces debt, the WACC falls because cheaper finance will outweigh any increase in the cost of equity.
However, as gearing becomes greater, the cost of debt will start to rise and WACC will rise too as the value of the company will fall.
Advantages and disadvantages of using NPV
Adv:
NPV of a project will be reflected in company’s share price
Easy to understand
Disadv, only works if:
Financing used does not create a significant change in gearing
Project is small relative to the size of the company
The project risk is the same as the company’s average operating risk
Relies on restrictive assumptions which are made in the CAPM and in theories of capital structure
Figures used in CAPM can be difficult to determine
Business risks are assumed to be constant
Does not consider real options
Advantages and disadvantages of using APV
Adv
Can incorporate changing gearing by using ungeared cost of equity
Disadv
Estimation of various financing side effects and discount rates used to appraise them
May assume risk free debt
Relies on restrictive assumptions which are made in the CAPM and in theories of capital structure
Figures used in CAPM can be difficult to determine
Business risks are assumed to be constant
Does not consider real options
Risks other than currency risk to be considered if trading abroad
Government stability
Political and business ethics
Economic stability
Import restrictions
Remittance restrictions
Special taxes, regulations for foreign companies
Trading risks - physical risk, credit risk, liquidity risk etc
Weaknesses of dividend yield and price/earnings valuation methods?
Comparator statistics
Unrepresentative annual figures
Is the discount for non-marketability reasonable
Purchasers may perfer a valuation based non present value of forecast future cash flows
