[4] Investment Criteria Flashcards
1
Q
Net Present Value (NPV)
A
NPV = sum[k=0, N, CF_k/(1+r)^k]
- NPV > 0: accept the project, recover investment + surplus
- NPV < 0: reject the project
2
Q
Total Cash-flow (Total CF)
A
Total CF = Investment CF + Operating CF
- Investment CF: -capital investment + residual value [RV-(RV-BV)t]
- Operating CF: +EBIT(1-t)+Amortizations
- BV is the sum of amortizations yet to pay; MV is the price of sale in the year n
- Change in working capital: in year 0 (-i-r+p), in year n the inverse
3
Q
Discount Rate/Cost of Capital
A
It is the return that the investor requires to implement an investment project, and will serve to update the cash flows generated by the project
4
Q
Weighted Average Cost of Capital (WACC) and Capital Assets Pricing Model (CAPM)
A
WACC = E/V re + D/V rd (1-t)
- firm’s cost of capital
- V = E+D
- rd = Financial Expenses/Total Liabilities
ra = rf + beta*(rm-rf)
- relationship between expected return and market risk
- re: expected return on the asset
- rf: return on a risk-free investment (TB)
- beta: risk (relationship between investment and the market)
- rm: expected return on the market
- (rm-rf): risk premium; compensation investors require to support market risk
5
Q
Unlevered Beta
A
beta_u = beta_l/(1+D/E*(1-t))
- Unlevered beta is only operational (without the influence of its financial leverage)
- Compare the inherent risk of different assets without the distortion introduced by debt
6
Q
Internal Rate of Return (IRR)
A
IRR <=> NPV = 0
- To the left: NPV > 0
- To the right: NPV < 0
- The project is economically viable when IRR >= Discount Rate
- Problems: (1) multiple IRR’s; (2) zero IRR’s
7
Q
Discounted Payback Period (DPBP)
A
sum[k=0, PB, CF_k/(1+r)^k] = 0
8
Q
Profitability Index (PI)
A
PI = (NPV+Inv)/Inv
- How much we earn for each profitability unit (regain PI euro for each 1 euro invested)
- Accept if PI > 1
- If PI=NPV/Inv, then accept if PI > 0
