BEC 3 Financial modeling Flashcards
Sunk costs
Sunk costs are those costs that have already been incurred, are unavoidable in the future, and will not vary with the course of action taken
After tax cash flow
(1- tax rate) x Pretax cash flows
A depreciation tax shield
Tax rate x depreciation deduction
Stages in which capital investment cash flows are categorized
Cash flow at the inception of the project
Operating cash flows
Cash flows from the disposal of the project
Rate of return for a project
- use a weighted average cost of capital (WACC) method
- assign a target rate for new projects
- recommended that the discount rate be related to the risk of the project
Net present value NPV
NPV is the difference between the present value of the cash inflows and outflows from a project
Profitability index
The ratio of the present value of net future cash inflows to the present value of the net initial investment.
The higher the profitability index, the more desirable the project.
Internal rate of return IRR
The IRR is the discount rate at which the present value of the cash inflows equals the present value of the cash outflows form an investment or project.
Investment decisions made using IRR
An investment should be made when the IRR exceeds the hurdle rate
Payback method
Net initial investment / Increase in annual net after tax cash flow
Operating leverage
Operating leverage is defined as the degree to which a firm uses fixed operating costs, as opposed to variable operating costs
Degree of operating leverage formula
% change in Earnings before interest and taxes / % Change in sales
