Application of DCF Technique Flashcards
What is capital rationing?
A situation in which there is not enough finance (capital) available to undertake all available positive NPV projects.
What is hard capital rationing?
The capital markets impose limits on the amount of finance available
What is soft capital rationing?
The company sets internal limits on finance availability
What is single-period capital rationing?
Capital is in short supply in only one period
What is multi-period capital rationing?
Capital is rationed in two or more periods
Reasons why capital markets may restrict funds available?
High business and financial risk
Lack of reliable independent information
Reason why company directors might restrict available funds?
Preference for slower organic growth and avoid using further equity finance
Create an internal market for investment funds
What is a divisble project?
If the company can make any partial or proportionate investment in it
What is a non-divisible project?
Must be done 100% or not at all
What is meant by mutually exclusive divisble projects?
Means that two or more particular projects cannot be undertaken at the same time
What is the equivalent annual cost?
The annual cost of owning, operating and maintaining an asset over its entire life
Limitations of replacement analysis?
Changing technology may also require earlier replacement
Non-financial factors
Like-with-like replacement is rarely possible
How may use of an asset be obtained in a lease?
An outright purchase (e.g. by borrowing to buy)
A lease agreement
What is the decision whether to lease or buy an asset?
It is a financing decision relevant to overall investment decision
What is assumed in the financing decision?
The lower PV of cost and that the purchased asset is financed with a bank loan
How are cash flows discounted ina financing decision?
At an after-tax cost of borrowing
Investment decision calculation?
Discount the cash flows from using the asset (sales, materials, labour, overheads, tax on net cash flows, etc) at the company’s WACC
Financing decision calculation?
Discount the cash flows specific to each financing option at the after-tax cost of debt
What is the preferred financing option?
The lowest NPV of cost
Typical relevant cash flows for buying an asset?
Purchase cost
Tax benefit of TAD
Scrap proceeds.
Typical relevant cash flows for leasing an asset?
Lease payments (assume all to be tax-allowable deductions)
Tax benefit of lease payments.
Are interest payments included for financing an asset?
No
