8. Long Term Decision Making Flashcards
What are the 7 typical stages of project appraisal?
- Identify range of potential projects
- Initial screening tests
- Detailed project analysis
- Go/No Go Decision
- Project Implementation
- Project Controls
- Post Completion Audit
What is soft capital rationing?
When capital budgets are limited for internal reasons
What is hard capital rationing?
When capital budgets are limited for external reasons - no stakeholder is prepared to invest more
What are the 5 general phases of a project in which controls are defined?
- The defining phase
- The planning phase
- The implementing phase
- The controlling phase
- The completing phase
What is a post completion audit?
An objective independent assessment of the success of a capital project in relation to plan, giving feedback that is useful for future projects
What are the 3 key benefits of post completion audits?
- May be time to implement changes for this project
- Holds managers accountable and encourages careful decisions in the first place
- Highlights weaknesses and high calibre personnel
What are the 3 difficulties with post completion audits?
- May stifle creativity by making management cautious
- Can be expensive
- Difficult to assess intangible costs and benefits
What are 6 costs of high quality data?
- Direct data capture
- Processing costs
- Database costs
- Cost of personnel and systems
- Data and system security costs
- Subscriptions to external sources of data
What are 4 key benefits to high quality data?
- Confidence in data for decision making
- Better understanding in external environment
- Less time spent reconciling costs
- Improved customer satisfaction
What are 4 common problems with data quality?
- Difficult to collate and analyse huge volumes
- Variety of data sources hard to make connections
- Data might be duplicate or out of date
- Data security and compliance becomes important
What are Business Intelligence Systems? (BIS)
The technology, methods and applications used for the integration and presentation of business information
How do you create BIS? (3)
- Define roles in the organisation
- Discuss and define what information is needed
- Design and build the system to create the reports
What 4 things make successful BIS?
- High quality data
- Regularly evaluating and adjusting targets
- Senior management involvement in culture
- Discussion of negative and position performance
What are the 4 main ways that BIS can help identify new business opportunities and reduce costs?
- Providing the right information at the right time to the right people to make better business decisions
- Enabling employees to use information to focus on process improvement
- Helps closer tracking of competitors
- Creates insights from complex data
What is a data lake?
A repository that stores data from all sources, with no processing or organisation, to be used for ad hoc analysis
What is a data warehouse?
A repository that orders and archives only specific data in defined ways, designed specifically for reporting
What is more secure - a data lake or data warehouse?
A data warehouse
What are the 3 categories of relevant project cash costs?
- Infrastructure
- Marketing
- Human resource development
What are the 3 categories of relevant project cash benefits?
- Direct cash flow benefits (e.g. incr sales)
- Incremental effects on other activities
- Residual values
What are 3 possible non financial benefits from projects?
- Better customer satisfaction
- Better staff morale (better assets)
- Better decision making (better systems)
What is the payback period?
The time required for the cash inflows from a capital investment project to equal the cash outflows (not accounting for the time value of money)
What are the 4 main benefits of using payback period for project appraisal?
- Simple to calculate
- Easy to understand
- Good initial screening tool
- Allows for risk in the timing of cash flows
What are the 4 main drawbacks of using payback period for project appraisal?
- It ignores time value of money
- Only considers cash flows up to the payback date
- Has no clear decision rule
- May lead to short termist decision making
What is the accounting rate of return?
Average Annual Profit / Average Investment x 100%
WHERE
Average annual profit = Total cash inflows - Total depreciation / project length
Average investment = Initial investment + Scrap value / 2
What are the 4 main benefits of using accounting rate of return for project appraisal?
- It is simple to calculate
- Easy percentage measure
- Looks at the entire project
- Reflects the way external investors judge
What are the 3 main drawbacks of using accounting rate of return for project appraisal?
- Ignores time value of money
- Based on profits and not cash flows - open to accounting decisions
- Doesnt consider the length of projects
What is the Net Present Value?
The sum of all cash inflows and outflows of a project, discounted to their present value today
What are the 5 main benefits of using NPV for project appraisal?
- Allows for time value of money
- Shows change in shareholder wealth
- Allows for risk
- Looks at entire project
- Clear decision rule
What are the 3 main drawbacks of using NPV for project appraisal?
- Requires cost of capital to be estimated
- Calculation can be time consuming
- Not easily understood
What is the discounted payback period?
The time required for the cash inflows from a capital investment project to equal the cash outflows - discounted to todays present value and so accounting for the time value of money
What is the Internal Rate of Return? (IRR)
The discount factor which would give a zero NPV - the actual % return that the project generates
How do we approximate the IRR?
L + ( NPV(L) / (NPV(L) - NPV(H)) ) + (H - L)
What are the 4 main benefits of using NPV for project appraisal?
- Allows for time value of money
- Does not require exact cost of capital to be known
- Familiar % measure
- Looks at the entire project
What are the 2 main drawbacks of using NPV for project appraisal?
- Ignores the size - a %
2. Not ideal in situations with mutually exclusive projects or non conventional cash flows
What are 2 limitations of the traditional IRR calculation?
- Multiple IRRS arise when cash flows change direction on more than one occasion
- It is assumed that surplus cash flows are reinvested at the projects IRR
What are the 3 steps in the Modified IRR calculation?
- Calculate the net cash flows in each year
- Compound the cash flows to give the terminal values at the end of the project
- Calculate the compound rate that would be needed to equate the outflow at time zero to the sum of the terminal values
What is the relationship between real and nominal interest rates?
(1 + nominal rate) = (1 + real rate) x (1 + inflation rate)
If you are given UNINFLATED cash flows, at TODAY’S prices, in REAL terms, what cost of capital should be used to discount them?
The REAL cost of capital
If you are given INFLATED cash flows, in NOMINAL terms, as their actual MONEY cash cash flows, what cost of capital should be used to discount them?
The NOMINAL (money) cost of capital
Which method of discounting is recommended where there are a number of different costs at different inflation rates?
The inflated cash flow/nominal cost of capital rate
What are capital allowances?
Tax allowable depreciation - the amount authorities allow as tax deductible amounts each year in relation to capital purchased
What is the tax saved cash flow on capital allowances?
Capital allowance x Tax %
What is the tax saved cash flow in the year of disposal?
Carrying value - scrap value x Tax %
What year do the tax saved cash flows occur?
In the year after the allowance in given
How is an increase in working capital investment relating to a capital project reflected in an NPV calculation?
As a cash outflow
What adjustment to working capital is made at the end of a project?
All released back as a cash inflow
What is the term used when two or more projects cannot be done together?
Mutually exclusive
What is the best equation to use to compare the benefits of two projects that have unequal lives?
Equivalent Annual Cost = NPV / Annuity factor for the project life
In the EAC calculation, how is the annuity factor found?
Discount Factor Yr 1 + Discount Factor Yr 2 + ….
What is the equation for the profitability index?
NPV of the project / Initial Investment
When do we use the PI?
When funds are limited and we need to rank projects that are not divisible
What are the 3 main types of real options?
- Option to make an investment (CALL)
- Option to wait (delay)
- Option to abandon (PUT)
