10 - Capital Budgeting Flashcards
why do we take TVM into account for investing decisions?
as the initial inv may only recovered after a long time
do we include interest expenses in NPV calc?
no, already included in WACC
what do we do with the assessed loss if the project is making a profit?
deduct it directly from project’s taxable income
what do we do with the assessed loss if the loss canNOT be utilized elsewhere in the company?
carry it over to the next year
what do we do with the assessed loss if the loss CAN be utilized elsewhere in the company?
don’t carry over, will just have + tax for that year
what is the IRR?
internal rate of return – takes into account TVM
how do we manually calculate IRR?
discounted earnings from project / inv amount
what do we do with IRR?
compare to WACC
must be bigger than WACC to accept
how do we calculate ARR?
average annual acc profit / inv amount
what do we do with ARR?
compare to WACC
must be bigger than WACC to accept
how do we calculate payback period?
- take initial inv and reduce by profit in each year
decimals and months etc - can discount or not
how to calculate profitability index?
PV / investment
why do we base our decision on profitability index and not just NPV?
NPV bases our decision only on cash flows, whereas using profitability index allows us to see how profitable the project is in relation to its cost
when do we use capital rationing?
when we have limited funds to spend on investments and we are deciding between multiple projects
how do we perform capital rationing?
calculate all the PVs and profitability indexes and then rank them to decide which. Add up the projects which add up to the budget from the cost column
which columns do we include in a capital rationing table?
projects, investment, PV, NPV, profitability index, rank 1, rank 2
what is the outcome of capital rationing?
we get our most profitable mix of projects
how can we compare repeating projects with unequal lives (and no budget limit)?
1) rank them based on NPV using lowest common multiple of years
2) equivalent annual amount
how do we calculate the equivalent annual amount?
find the PMT through the calculator
PV = NPV
I/Y = WACC
FV = 0
N = number of years of project
what is the impact of inflation on our capital budgeting?
- cash flows will increase each year by the interest rate
- incorporated into the discount rate
when do we use a project-specific WACC for evaluating?
when we a project which is much riskier, as d/e holders and investors will require a higher return to compensate for the higher risk and we use this for the NPV calculation
